Importance of Accounting in Sole Proprietorship

Importance of Accounting in Sole Proprietorship

Accounting is a procedure of recording financial statements.

Information that helps managers, investors, tax authorities and others to understand the organizations ups and downs carefully.

This information is very useful for the externals parties i.e. people who invest into a business but are not involved in day-to-day transactions of the organization, such external users are:

• General public,
• Investors,
• Share/stock holders,
• Government agencies,
• Customers,
• Suppliers etc

While internal users are:

• Employees,
• Managers,
• Labor unions, and Owner.

Accounting System

It consists of personnel, procedures, devices, and records used by the organizations. These are discussed as follows:

• To develop the knowledge of accounting information and
• To communicate this information to the decision makers.

The design and capabilities of these systems vary greatly from organization to the next. In a small business accounting system may consists of little more than one register but when we talk about large firms, an accounting system includes computers, highly trained personnel and accounting reports that effect the daily operations of every department.

Many factors affect the structure of an accounting system within an organization. Factors can be as follows:

• Company need’s for accounting information and
• The resources available for operation of the system.

Accounting Cycle

Accounting cycle consists of analyzing, recording, classifying, summarizing, and reporting the transactions for a business. These steps are very important for businesses especially for the sole proprietor.

If we have a look at the diagram below, we will notice that all the steps of accounting cycle are related to one another. A sole proprietor should have a command over the transactions he makes and he should also record them in an organized form. As he is the only person responsible for his business, so he should take into account all the factors that influence his business- no matter if the business is small or large. The inflow and out flow of money should be recorded on daily basis.

When the inflow and outflow of money is recorded on daily basis, this procedure is known as bookkeeping or journalizing. An owner should maintain this book to avoid errors in future.

Then the posting of same transactions leads further, the posting of amounts into ledgers show how many debtors and creditors a business have. As in starting a new business a sole proprietor must have invested some capital, capital includes some of the owner’s money and some liabilities, the ledgers shows how much of the liability is to be paid in the near future.

Coming up to the summary of all the transactions, which took place earlier, these are headed by financial reports that organizations have to make annually. These include trading, profit and loss account, and balance sheet and cash flow statements. These are of great value for the internal and external parties who are connected from the business.

By keeping in view the above concepts of accounting, the owner of a business i.e. the sole proprietor can easily understand the nature of the business he’s dealing with. At the year end he can compare the current outcome from the previous year’s outcome and get to know about the losses and the profits. It will help him to set some do’s and don’ts for his business. For instance see the graph below

The graph represents the comparison of the sales between the years 2005 and 2006. The sales significantly rose from 2005 to 2006. This can be one of the ways, by which the owner can checkout the business’s turn over.

The accountings concepts can also help him acquiring the desired goals. The matching principle can also help him identifying his expenses and revenues.

Sole Proprietorship

An unincorporated business that is owned by a person is called a sole proprietorship. The owner himself is a manager here. The sole proprietorship is commonly used for small businesses for example a small grocery shop near a street. Or a small medical shop etc.

Dealing with sole proprietorship the owner is the only risk taker who will enjoy all what he gets and who will also suffer alone the losses. The easiest and cheapest way to run a business is through sole proprietorships. In short, the owner himself is the whole and soul responsible for the business.

From the accounting point of view, a sole proprietorship is regarded as a business entity i.e. separate from owner’s personal affairs. The owner should not involve his family or belongings into his business. There are some advantages and drawbacks for such businesses.

• Owner’s liability: as the owner is the only caretaker of the business, he will have to suffer the losses alone. He might sell his house or his car just to pay back his debtor. The owner will always mention his debts on the balance sheet.
• Product Liability: For instance, the owner is selling some edible items, which are dangerous for the society then sole proprietorship type of business is not good for him.

In addition, business taxes are part of owner’s taxes so the owner cannot enjoy the tax laws set by the government.

Conclusively, we have tried our best to explain, discuss, and understand the Importance of Accountancy in terms of Sole Proprietorship. We wrap up that accounting is a very significant part of a firm and an owner, whether it is a corporation, or a proprietorship, the need of accounting will always be felt by the firm owners in the coming generation.