Financial accounting is a phenomenon that involves gathering, organizing, and presenting the financial data of an organization in a pre-determined format. Most business organizations are carrying out their activities to generate profits. The sponsors/shareholders need to know at regular intervals how much profit their company has made during any given period, and it can only be made possible through the use of financial accounting methods.
The reports generated through financial accounting serves to highlight the efficiency of the management responsible for running business operations. These reports offer all the relevant facts and figures and are published regularly. The reliability of these financial reports is ascertained through checks and balances and regular external audits.
The term managerial accounting vs. financial accounting is very popular these days. However, to differentiate between the two, we must first understand what accounting is.
Every company also releases its annual statements that offer sponsors, shareholders and investors with the assessment of past performance and the prospects of the company.
Financial Accounting Defined
Financial Accounting is known as a part of accounting, which is used for tracking, organizing and recording the financial transactions of a company.
The financial accounting concept is based on the double-entry accounting system. Every business transaction is recorded in the company books with the help of this system.
What is the double-entry System?
The phrase double-entry means that every financial transaction will be recorded in at least two accounts. Take, for example, the following case:
The company borrows a sum of $10,000 from a bank or a financial institution. This increase in the company’s cash account will be recorded in the cash account. Simultaneously, another entry will be recorded in the company’s liabilities account to reflect that it has to pay back the amount at a later date.
The debits and credits for any financial transaction must be equal at all times. If the debit and credits of an entry do not match, it would mean that the entry hasn’t been posted correctly.
Recording of Income, Expenses, and Accruals
Financial Accounting allows the recording of incomes generated through business activities, as well as the expenses incurred. It is simple. However, the accrual concept of financial accounting also allows companies to record the costs that they will be required to pay in the future.
Take, for example, a company that has been using electricity in its offices. However, the bill for the electricity consumed will be received by the company after the end of the month.
To account for this expense, the account would pass an accrual entry at month end, and charge the cost to the proper head. The payment will be made from the accrual account when the company receives the bill.
The Uses of Financial Accounting
Financial Accounting is carried out to prepare the following three statements as well as the accompanying notes to the accounts.
Cash Flow
The cash flow statement offers all the information regarding the incoming and outgoing cash from the company. In fact, the report does not only show the receipts and payments of money, it also accounts for the all-cash equivalent items.
There are three significant aspects of the cash flow statement: operations, investment, and finance.
The cash flow statements let the reviewer know how much of the cash generated through business activities was used for carrying out business operations during the period.
Investment portion states how much cash was invested in obtaining returns from investment, and the finance portion lets us know what kind of financial activities were carried out.
From the business perspective, the cash flow statements serve as a tool for gauging the short-term viability of the entity. In short, it lets us know if the company will be able to discharge all its liabilities without encountering any problems.
Income statement or Profit and Loss statement
The income statement is the most critical piece of information from the perspective of the owner/shareholder. It shows the revenues generated through business operations, and the expenses incurred during any given period. It is this statement that allows the owner/shareholders to know whether their company is making profits or incurring losses over any specified period.
It also lets the reviewer know how much revenue the company had generated before incurring the listed expenses, and how much net profit was made over the given period. The income statement serves as a potent tool for the seniors to decide its future course of action, and how what they would deem fit for better management of the company.
The Balance Sheet.
If you ask for a financial account of the annual report card of the company, he will most probably show you the Balance Sheet. It is a bird’s eye view of the company’s financial position within any given point in time. The balance sheet shows the Equity, Assets, and liabilities of the company. Ideally, the assets of the company always sum up to the liabilities, and the equity initially put into the business by the owners.
International Financial Principles of Accounting
For the financial reports of the company to be authentic, easily understandable and concise, a series of accenting standards have been developed. These standards also make it easy for the financials of several companies to be compared to each other easily. There are International Financial Reporting Standards (IFRS) that are followed by most countries while preparing their books of accounts.
It is also important to note that Accounting principles are not static. Constant changes are being incorporated into the IFRS to cater to the changing business dynamics worldwide.
The Final Word.
Financial Accounting has rendered it very easy to record and present business transactions. The best aspect of the financial accounting is the double-entry system that it follows. This system makes it impossible to make incomplete entries and thus, eliminated the chances of incomplete or wrong repowering.
Financial Accounting and the reports generated through its internationally accepted principles allows owners/ shareholders of a company to understand the factual financial position of their company. It also lets them know whether the company is making reasonable profits. However, the financial statements are also beneficial for the employees of the company, its creditors, customers, and the regulator. All of these people and entities review the audited financial statements of the company to understand and gauge how the company is working and whether it is better to invest in that company.
