The purpose of accounting

The core aim of any business is to survive. After this, if it is in the private sector it will want to make a profit. If it is in the public sector it may want to improve or expand the services it provides. Either way, it will need to control its finances. By collecting all the available financial information and recording it in various accounts a business can assess how well it is performing. This is important both for a business internally as well as externally.

Internally, managers want to know how much they are selling, the level of their costs and the amount of profit they are making. From this information they can set budgets and performance targets to plan for the next trading year. An accountant can show managers where financial problems might be occurring within their company.

Externally, all businesses are legally required to keep records of their finances. A firm has to make its accounts available to HMRC [HMRC: Formed during 2005 following the merger of Inland Revenue and HM Customs and Excise Departments. ] (Her Majesty's Revenue & Customs). The larger the business, the stricter the rules on what accounts it has to prepare. Most business have to prepare a:

• Trading and Profit and loss account
• Balance sheet
• Directors' report (describing the previous year's activities)

Limited companies also have to publish an annual report and final accounts because they have a separate legal identity.

These accounts have to be checked by an independent person - an auditor [Auditor: An independent person who checks the accounts. ] - to ensure that they give a 'true and fair view' of what has happened to the business during the previous year. Potential investors or shareholders, for example, will want to know if a business is worth investing in. Potential creditors will also want to know whether the company will be able to repay any loans or credit they give them.

These assessments are based on two key accounting concepts: liquidity [Liquidity: A firm's ability to meet short-term debts. Assets of a firm which are cash or can be turned into cash very quickly are the most liquid. ] and profitability [profitability: A firm's income relative to expenditure. ].