Accounting: The Language of Business (Part 1)

• Accounting is the language of business.
• 
  
• Warren Buffett
• 
  

Introduction to Accounting and Business

(Part A)

by

Charles Lamson

Is accounting important to you? Yes, accounting is important in your personal life as well as your career, even though you may not be---or have any intention to become---an accountant. For example, assume that you are the owner/manager of a small Mexican restaurant and are considering opening another restaurant in a neighboring town. Accounting information about the restaurant will be a major factor in your deciding whether to open the new restaurant and the bank's deciding whether to finance the expansion.

The primary objective in this analysis is to illustrate basic accounting concepts that will help you to make good personal and business decisions. We begin by discussing what a business is, how it operates, and the role that accounting plays.

Nature of a Business

You can probably list some examples of companies with which you have recently done business. Your examples might be large large companies, such as Coca-Cola, Dell Computer, or Amazon. They might be local companies, such as gas stations or grocery stores, or perhaps employers. They might be restaurants, law firms, or medical offices. What do all of these examples have in common that identify them as businesses?

In general, a business is an organization in which basic resources (inputs), such as materials and labor, are assembled and processed to provide goods or services (outputs) to customers. Businesses come in all sizes, from a local coffeehouse to an international automobile manufacturer. A business's customers are individuals or other businesses who purchase goods or services in exchange for money or other items of value. In contrast, a church is not a business because those who receive its services are not obliged to pay for them.

The objective of most businesses is to maximize profits. Profit is the difference between the amounts received from customers for goods or services provided and the amounts paid for the inputs used to provide the goods or services. Some businesses operate with an objective other than to maximize profits. The objective of such nonprofit businesses is to provide some benefit to society, such as medical research or conservation of natural resources. In other cases, governmental units such as cities operate waterworks or sewage treatment plants on a nonprofit basis. We will focus in this analysis on businesses operating to earn a profit. Keep in mind, though, that many of the same concepts and principles apply to nonprofit businesses as well.

Types of Businesses

There are three different types of businesses that are operated for profit: manufacturing, merchandising, and service businesses. Each type of business has unique characteristics.

• Manufacturing businesses change basic inputs into products that are sold to individual customers.
• Merchandising businesses also sell products to customers. However, rather than making the product, they purchase them from other businesses (such as manufacturers). In this sense, merchandisers bring products and customers together.
• Service businesses provide services rather than products to customers.

Types of Business Organizations

The common forms of business organization are proprietorship, partnership, corporation, or limited liability corporation. The following paragraphs, briefly describe each form and discuss its advantages and disadvantages.

A proprietorship is owned by an individual. More than 73 percent of the businesses in the United States are organized as proprietorships (taxfoundation.org). The popularity of this form is due to the ease and the low cost of organizing. The primary disadvantage of proprietorships is that the financial resources available to the businesses are limited to the individual owner's resources. Small local businesses such as hardware stores, repair shops, laundries, restaurants, and maid services are often organized as proprietorships.

As the business grows and more financial and managerial resources are needed, it may become a partnership. A partnership is owned by two or more individuals. Like proprietorships, small local businesses such as automotive repair shops, music stores, beauty salons, and clothing stores may be organized as partnerships. Currently, about 8 percent of the businesses in the United States are organized as partnerships (taxfoundation.org).

A corporation is organized under state or federal statutes as a separate legal taxable entity. The ownership of a corporation is divided into shares of stock. A corporation issues stock to individuals or other businesses, who then become owners or stockholders of the corporation.

A primary advantage of the corporate form is the ability to obtain large amounts of resources by issuing stock. For this reason, most companies that require large investments in equipment and facilities are organized as corporations.

About 5 percent of businesses in the United States are organized as corporations (taxfoundation.org). Given that most large companies are organized as corporations, over 60 percent all of revenues are received by corporations. Thus, corporations have a major influence on the economy.

A limited liability corporation combines attributes of a partnership and a corporation in that it is organized as a corporation, but it can elect to be taxed as a partnership. Thus, its owners' (or members') liability is limited to their investment in the business, and its income is taxed when the owners report it on their individual tax returns.

The three types of businesses we discussed earlier---manufacturing, merchandising, and service---may be either proprietorships, partnerships, corporations, or limited liability corporations. However, because of the large amount of resources required to operate a manufacturing business, most manufacturing businesses are corporations. Likewise, most large retailers such as Wal-Mart, are corporations. 

*WARREN, REEVE, AND FESS, 2005, ACCOUNTING, 21ST ED., PP. 2-4*

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