What Are Generally Accepted Accounting Principles?

Every day, accountants make judgments about how to record business transactions. They often base their decisions on the financial objectives of the companies for which they work. Other times they turn to generally accepted accounting principles (GAAP) to steer their decisions.

GAAP are not a fixed set of rules. They are guidelines or, more precisely, a group of objectives and conventions that have evolved over time to govern how financial statements are prepared and presented. The Financial Accounting Standards Board, the American Institute of Certified Public Accountants, and the Securities and Exchange Commission provide guidance about acceptable accounting practices.

Good Reasons to Use GAAP
Every business that expects anyone outside the company to look at its financial data should use GAAP. Compliance with GAAP helps maintain creditability with creditors and stockholders because it reassures outsiders that a company's financial reports accurately portray its financial position. Plus, anyone who reads your financial statements — stockholders, creditors, security analysts or outside companies — will assume that the reports comply with GAAP.

Certified public accountants routinely audit companies to determine if their financial statements are prepared according to GAAP. These audit findings are typically included with companies' financial statements.

There has been some discussion in recent years about changing or doing away with GAAP. Some of the criticism stems from the challenge that GAAP poses to small businesses, and you can get a sense of the debate in Widening the Gap: Big GAAP vs. Little GAAP.

Still, even banks and finance companies often require their clients to use GAAP or have audited financial statements. And investors who are accustomed to using financial information prepared according to GAAP might balk if your statements don't meet their expectations.

Another aspect of business finance is cash-flow management, which is tightly tied to your other accounting practices. Our buyer's guide to business cash-flow management tools gives you a plain-English explanation of the basics of analysing cash flow, and it also tells you how to choose programs that can help you track your cash accounts.