Financial accounting is a powerful tool that can help you manage your business. It allows you to track all of your company’s financial transactions and measure how well they’re performing. However, there are a few limitations of financial accounting. In this blog post, we will explore these limitations and share some tips on how to overcome them.
1) Financial accounting does not take into account the time value of money
2) Many companies make use of different depreciation methods
3) The current system may be difficult for smaller companies to use
4) There is a limit on how many transactions can be inputted into the system
5) The information provided by the system may be confusing or misleading
The Time Value of Money
Financial accounting deals with systems that don’t take the time value of money into account. In other words, it doesn’t show how much money is worth in the future.
Let’s say you have $1,000 now, but in 10 years that will be worth more. Financial accounting systems won’t factor that in when they’re calculating the impact of how much money your company is making.
However, when you are looking at specific transactions or periods of time, the time value of money might be useful to consider. For example, if your company makes a purchase with cash now vs credit in 10 years, the cash becomes more valuable because you could invest that money at a higher return than the cost of debt.
Depreciation Methods
Depreciation methods are different ways to account for the time value of money. Nature of financial accounting is that it only recognizes the original purchase price of an asset, which can lead to incorrect calculations.
The two most common depreciation methods are straight-line and accelerated, though there are many variations of both. With straight-line depreciation, the company would divide the cost by the number of years the asset will be used. This means that over time, the company will see the same depreciation expense each year. With accelerated depreciation, the company would see higher depreciation in the beginning and will reduce the depreciation expense every subsequent year.
Business should evaluate the right depreciation methodology for each of their individual physical assets and choose the right approach accordingly.
Small Companies
If you are running a small business, cash flow is likely the most important measure of your health. So, if you’re having difficulty staying afloat, it may be time to expand your accounting options.
In order to do so, many small companies turn to accrual accounting. Accrual accounting allows companies to use a system that looks at the company’s financial transactions in a more holistic way. In this way, you can see how paying bills will affect your company in the long term.
Accrual accounting also allows for a more flexible input of transactions since it can take into account deferred revenue and expense—something that just wouldn’t work with a cash-based system.
Another benefit is that accrual accounting systems typically allow for more transactions than financial accounting systems—allowing you to better track all of your business’s financial activity.
Number of Transactions
The number of transactions a company can input into the system is limited. That means if your company has more than the allotted amount, you will not be able to input any more. This may pose a problem for companies that are growing quickly and need accurate financial records. But there are ways to overcome this issue.
For example, you could use Excel spreadsheets to track your company’s finances outside of the system. You can then export this information into the system when it’s time to do your quarterly reports. Once you’ve reached your maximum limit in the system, you could even hire an accountant to help manage your books.
Another option is to break up larger transactions into smaller ones so that they don’t exceed your limit for one transaction (i.e., charge $1,000 for three separate transactions). This way, all three charges would show up as individual transactions on each day instead of one large transaction on one day.
Confusing Information for Users
One of the biggest problems with financial accounting is that it doesn’t tell you how to value your company. Users of this system need to understand its limitations and how to think critically about the information provided.
An example would be that if two companies, Company A and Company B, are both valued at $100 million dollars, then Company A may have a higher net worth because it has invested more money in stocks, bonds, or other investments. This doesn’t necessarily mean Company B is not worth as much as Company A. You also can’t rely on financial accounting for accurate information on revenue comparisons between two different companies.
This leads us to our next limitation: There’s a limit on how many transactions you can input into the system. For smaller companies with fewer transactions per year, this may not be a problem. However, larger companies might want more options for tracking their financial transactions in order to get a better understanding of their performance over time.
Some experts believe that there should be some changes made to the current system so it takes into account more variables when assessing company performance. For example, they believe users should have access to more options on depreciation methods so they can see how the time value of money plays into their business decisions over time.
How to Overcome the Limitations
Financial accounting has a number of limitations. However, there are also simple ways to work around these limitations and get the most out of your accounting system.
1) The time value of money is not taken into account
In order for this limitation to be overcome, it’s important to weigh the present value of an investment against its future value by considering the time period between now and when the investment will be made. This way, you can make a more informed decision as to whether or not it’s worth investing in a particular project.
2) Different depreciation methods may be used by different companies
Although one depreciation method may be more useful for some companies than others, there is no limit on how many different methods a company can use. This limitation can easily be overcome by simply choosing a depreciation method that makes sense for your company.
3) Smaller companies may have difficulty using the current system
It is possible for smaller companies to use the current system if they work with a financial professional who can input data directly into their system. This way, they don’t have to worry about calculating anything themselves and can focus on what they do best – running their business!
Use a Spreadsheet or Desktop App
The limitations of financial accounting can be overcome by using a spreadsheet or desktop app. This way, you can take into account the time value of money and use different depreciation methods.
A desktop application that specializes in tracking business finances is Bookkeeper. It’s easier to input transactions and calculates the net present value (NPV) for you. One advantage of this app is that it can handle a much larger number of transactions than most other apps on the market. The app also provides all relevant financial data in one place, so you can check your company’s performance at any time. You will also get instant notifications for all changes made.
If you’re looking for a spreadsheet solution, consider Zoho Books which offers unlimited accounts and users as well as access to industry experts through its premium plan. You can also integrate your accounting system with your CRM, ERP, or POS system to make it easier to track where your money is going and measure how well it’s performing.
Hire an Expert
Hiring a company or individual to take care of your bookkeeping can be a very beneficial. Accountants and bookkeepers have the knowledge and expertise to handle your finances so you don’t have to.
Conclusion
The limitations of financial accounting are what make it difficult to use. However, if you can combat these limitations then you will find that this type of accounting is helpful for your company.
One way to overcome these constraints is to use an accountant who specializes in dealing with them. Another option is to set up a new system that does not have the limitations of this one. This could be in the form of an online accounting software or converting to a different accounting system altogether. If you need help with setting up either of these options, take up our course on financial accounting! We can help you design and implement your new company’s accounting system or find an accountant to take care of your time-consuming tasks.
Read more about this post on our LinkedIn page as well:
