With the help of financial accounting we record, maintain, and process every purchase, sale, or due transaction in a company. As a business, you must have proper documentation of the exchange of goods and services you have with your customers.Â
It helps you monitor your sales and benefits and also helps you maintain an informed report of all transactions taking place in a time period range. In this article, we will learn more about financial accounting and its importance in businesses.Â
Financial Accounting Meaning
Financial recording is documenting, analysing, and managing all your financial transactions, liabilities, assets, and more in a business for a specific time range.Â
Financial accounting is an important practice in a business right from the start, as it is a vital indicator of the financial health, profitability, and performance of an enterprise. Accounting consists of all financial transactions in a business while financial accounting is based on accurate records and general accounting principles. Â
You will need financial accounting when you need to calculate your business performance and know whether you are making significant profit or not. With proper documentation as per the guidelines, you will also know which areas you need more focus on.Â
Financial Accounting Key Takeaways
- Financial Accounting is a strong indicator of the financial health, profitability, liability, and performance of an enterprise.Â
- The main objective of financial accounting is to record the profit and loss made by an enterprise over a specific period of time.Â
- Financial Accounting takes place through financial statements such as balance sheets, cash flow statements, income statements, and more.Â
- The five basic components of financial accounting revolve around assets, liabilities, expenses, income, and equity.Â
What are Generally Accepted Accounting Principles (GAAP)?
Generally Accepted Accounting Principles are a set of rules, guidelines and standards issued by the Financial Standards Board (FASB) in a country. GAAP is considered while creating financial statements. These principles are important for accuracy, consistency, and transparency in an enterprise’s financial structure.Â
Without GAAP, companies would be free to draft financial statements as per their will which might cause a lot of discrepancies and defaults in the financial recordkeeping. Investors would be prone to cheating and fraud. Check out the eight major Generally Accounting Principles (GAAP) below.
Principles of Financial AccountingÂ
Financial accounting ensures that every financial information is recorded as per the accounting principles and norms. The eight major principles of financial accounting are given below.
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- Principle of Accrual: Maintaining records when the transaction occurs or is approved. All transactional amounts must be updated once they occur rather than when the cash flow takes place. This practice helps stakeholders and businesses better manage their finances.Â
- Principle of Conservation: All expenses and liabilities must be reported as soon as possible. All profits or assets must be recorded only when confident that they will not back off. If it is not certain then the transactions must be kept under the loss category for the time being. This helps create a detailed record of all financial transactions and helps businesses get a detailed real-time overview.
- Principles of Consistency: Accounting principles are a consistent practice that must be followed throughout all aspects of business. All accounting methods and procedures must be consistent from one financial period to the next to ensure comparable financial statements over time.
- Principle of Cost: All costs, liabilities, profits, and other financial transactions must be recorded at the early stage of a transaction.Â
- Principle of Matching: All registered records and cash memos must match and there should be no discrepancy in financial statements. This principle ensures that all the costs are properly reported.
- Principle of Full Disclosure: Enterprises are responsible for providing transparent and accurate information to their consumers without faking any of it.Â
- Going Concern Principle: This principle ensures that a company can sustain itself in the market for a longer period of time. They will continue to operate in the foreseeable future.
- Principle of Time Period: Financial reports of companies must be carried out for a specific period of time such as monthly, quarterly, and annually.Â
Importance of Financial AccountingÂ
Financial accounting is a process of documenting, summarising, and maintaining various financial entities of a business. Let us highlight some of the major importance of financial accounting in business.
- Financial accounting helps businesses make proper financial planning after analyzing the financial statement and cash flow records.
- It provides updated and accurate records of financial accounts to help businesses calculate profit or loss made over a specific period of time.Â
- It is also used to calculate the financial performance of a company throughout the year.
- Financial accounting helps businesses maintain records as per the standard rules and guidelines.
- These documents are used by the management team, and accounting team to help them formulate financial plans for the organization’s future.Â
- Government bodies use this documentation to understand the financial status of a company.
- Shareholders, investors, and suppliers require updated financial accounting information to review business finances before tying any contract with the company.Â
- As financial accounting provides information about the financial health of a company, it is used to raise loans or capital for investments from the banks.
Types of Financial Accounting
There are two major types of financial accounting, check them below.
- Cash Accounting: This type of accounting is mentioned under the GAAP guidelines. It considers cash transactions while keeping records of different company transactions.
- Accrual Accounting: Accrual accounting is a method of accounting where revenues are recorded before taking payment. This method provides a more accurate and comprehensive view of a company’s financial position and performance.Â
Financial Statements and Its ComponentsÂ
Financial Statements are records that convey the financial activities of an organization. It includes the four major components given below.
1. Income Statement
These statements are used to evaluate the net income made by a company in a financial year. It takes into account all cash and non-cash transactions to determine the performance throughout the year.
2. Balance Sheet
The balance sheet is a financial document that presents a relationship between assets, liabilities, and shareholder equities over a specific time. It is used to measure the company’s financial health over a period of time. It tells what assets a company owns, liabilities, etc.
Assets are determined by the following relation: Assets = Liabilities + Shareholder’s equities
3. Cash Flow StatementÂ
The cash flow statement is used to combine all the transactions from operations, financial activities, and investments in a business.Â
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Financial Accounting FAQs
Q1. What is Financial Accounting?
Ans: Financial accounting is a method of recording, summarizing, and interpreting different financial transactions in a business. It consists of expenses, earnings, purchases, sales and equities documented in the company’s book of amounts.
Q2. What is the objective of financial accounting?
Ans: Financial accounting ensures that all financial transactions inside a business are recorded according to set rules or standards that can be followed and interpreted by other institutions and shareholders. It is also used to calculate the profitability, financial health, and performance of a company.
Q3. What are the types of financial accounting?
Ans: There are two types of financial accounting, i.e., Accrual and cash accounting.
