Financial accounting is an essential exercise for companies. Often dreaded by uninitiated entrepreneurs, it is nevertheless very useful for the accounting and financial management of the company. Its role is to ensure the balance of the accounts and to record the company's commercial transactions over a given period. In this article, we in Beinfinance, will take a look at what is financial accounting? and know its key financial statements, its use and its key principles. Let us move together for more details and we answer all your questions.
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| What Is Financial Accounting |
What Is Financial Accounting?
Financial accounting is by definition a type of accounting that allows you to list all the resources and products resulting from commercial transactions, over a given period. This is called the accounting year. This data is summarized in different accounting documents.
Throughout the accounting year, the accounting journal and the accounting ledger are completed, then at the end of the year are established:
- The accounting balance sheet.
- The income statement.
- The cash flow statement.
- The accounting annexes.
Financial accounting is to be distinguished from financial management. Indeed, financial accounting allows to make a retroactive summary of the financial situation of the company, while financial management allows to envisage the future.
Financial accounting and management accounting are also distinguished. Thus, management accounting allows to determine the cost of a production of products or a provision of services.
Finally, it also differs from analytical accounting. The latter is based on the results of financial accounting to analyze the data. It allows the company to optimize its expenses and profits.
Is It mandatory to Keep Financial Accounts?
Financial accounting is a legal obligation for the majority of companies. Thus, it concerns companies covered by the regime (industrial and commercial profits):
- Limited liability company.
- Single-member limited liability company.
- Public limited company.
- Simplified joint stock company.
- Single-member simplified joint stock company.
- Limited partnership.
- Limited partnership with shares.
- General partnership.
- Professional practice company.
It also concerns all companies that fall under the regime (non-commercial profits), excluding micro-enterprises:
- Individual entrepreneur with a liberal activity.
- Holders of offices and charges.
What Is Financial Accounting Used For?
Financial accounting allows you to assess the financial health of the company and its development. By consolidating the various pieces of information, managers can identify the most profitable activities, or on the contrary those that are less profitable.
This overall knowledge of the company's financial situation allows them to decide on the investments to be made, but also on the means of financing the following:
- Self-financing.
- Bank loan.
- Capital increase.
This allows them in particular to take advantage of the leverage effect.
Financial accounting is useful for checking that the company is able to pay its suppliers and short-term debts. This means ensuring that the company is not in a state of cessation of payments. It can also be a good basis for working on the company's debt structure and distributing short, medium and long-term financing.
The accounting documents provided by financial accounting are also useful to other stakeholders:
- Shareholders who can then check the profitability of their investments.
- Banking institutions that can rely on them to grant or not new financing.
- The tax administration.
In addition, on an ad hoc basis, it may be interesting to carry out an accounting and financial audit. After a preparation and implementation phase, the auditors share their conclusions. The objective is to check the proper compliance with international accounting standards such as the transparency, sincerity and regularity of the company's accounts.
What Are The Limitations of Financial Accounting?
Financial accounting is certainly very useful, but it also has some limitations.
On the one hand, it does not allow you to determine the exact cost of a product, nor to know the margin generated by its sale. On the other hand, financial accounting is particularly rigid.
It does not take into account certain variables such as currency fluctuations. Similarly, it does not allow you to update the value of transactions or record results that vary randomly.
Key Financial Accounting Statements
If you want to understand financial accounting clearly, you need to its statements. Financial accounting documentation always contain these five key statements:
- The balance sheet.
- The income statement.
- The statement of cash flow.
- The statement of shareholders’ equity.
- The statement of retained earnings.
We in Beinfinance will discuss these statements to shed more light as below:
1. Balance Sheet
The balance sheet describes the business's assets ("assets"), obligations ("liabilities"), and shareholder equity.
Assets
Assets of all kinds can be owned by businesses, and each is listed on the balance sheet. Any type of capital that the company owns or that another party owes it is considered an asset. Among the examples are:
- Accounts receivable.
- Buildings (separate from real estate investments).
- Cash.
- Intellectual property and other intangible assets.
- Inventory.
- Investments, which can include real estate assets owned specifically for the purpose of financial investment.
- Machinery and equipment.
- Notes receivable or money that is due to the business and should be received during a year.
- Prepaid expenses.
- Vehicles.
Liabilities
We have provided an overview of the components that make up a company's assets above. The components of liabilities in any firm will now be covered. Any type of monetary commitment a company has to another party is referred to as a liabilities. These components are:
- Accounts payable.
- Current taxes.
- Deferred tax.
- Loans payable.
- Mortgages.
- Notes payable.
- Payroll.
- Unearned revenue, alternatively referred to as a good or service that a customer has paid for but has not yet gotten.
- Warranty obligations.
Shareholder Equity
All capital owned by the company's owners is referred to as shareholder equity. Equity held by shareholders may consist of:
- Common and preferred stocks.
- Money available to invest in the firm (retained earnings).
- Profit or loss on corporate investments over the reported time period (comprehensive income).
Every dollar is recorded in either assets, liabilities, or shareholder equity since the balance sheet shows the company's financial situation. Consequently, a company's liabilities plus shareholder ownership equals the total worth of its assets.
2. Income Statement
The income statement shows the company's net income for the given time frame. This covers every type of income (from the sale of products or services, rental income from real estate holdings, intellectual property licensing money, and more) as well as every expense (debt payments, payroll, property costs, and more).
The income generated by the business may be clearly seen by comparing revenue to expenses in the income statements. Another name for the income statement is a profit and loss statement.
3. Statement of Cash Flow
An organization's income and debt over a given time period—typically a year—are detailed in a statement of cash flow. Amortization and depreciation, two significant entries on the income statement, are not included in this statement since it is solely focused on cash. The statement of cash flow shows the organization's short-term sustainability and its ability to pay off existing debts by concentrating only on cash coming into and going out of the business.
4. Statement of Shareholders’ Equity
The change in ownership value, or shareholder equity, throughout the given time period is detailed in the statement of shareholder's equity. The time span for the statement of shareholders' equity is normally one year, much like the other filings.
Also Read About: What is Lease Accounting Meaning?
The difference between the company's total assets and its liabilities is used to determine shareholder equity. Greater values show that the company is worth more money because it has more assets than liabilities. Examining the shareholders' equity statement in detail might reveal whether parts of the business are seeing annual equity increases or decreases.
The following factors are commonly found in a statement of shareholders' equity:
- Common Stock: For many businesses, this is the most widely accessible type of stock. Common stock owners are less likely than other stock owners to receive dividends or a portion of liquidation profits in the event that a firm goes out of business since it usually ranks lower on the list of priorities.
- Preferred Stock: Owners of preferred stock, a unique type of stock, are entitled to dividends and earnings before owners of common stock. Usually, this stock is shown on the statement at face value.
- Treasury Stock: This is stock that the business has bought back. If a company is trying to prevent a hostile takeover by another company, it may buy back its stock. The cost of purchasing treasury shares is deducted from shareholder equity.
- Additional Paid-Up Capital: This is the additional funds that investors spend over face value in order to purchase firm stock.
- Retained Earnings: This is the sum of the business's revenue that hasn't been paid out to meet expenses or given as dividends to investors.
- Unrealized Gains and Losses: The price change for investments that haven't been sold yet is shown by this entry. Unrealized gains occur when stock values rise before a sale, while unrealized losses occur when stock values fall before a sale. Gains or losses are realized when the stock is sold.
5. Statement of Retained Earnings
The amount of profits that the business has amassed and held since its founding is displayed in the retained earnings statement. This is the total amount of cash left over after expenses and dividends to shareholders have been paid. Based on the company's retained cash from the prior year, the retained earnings displayed on the statement vary annually.
Because it offers insights into the motivations and thinking of the company's management team, investors respect retained earnings statements. A company with higher retained profits values has more cash on hand to fund expansion and new projects, which appeals to investors.
Potential investors may be concerned about low retained earnings since they could mean that the company is losing money or that the management is giving out large payouts to shareholders.
What Are The Basic Principles of Financial Accounting?
After taking a quick look at the importance of key statements in financial accounting, we now turn to the most important principles of financial accounting. Financial accounting has eight general principles.
To guarantee that the documents are truthful, reasonable, and give readers relevant information, these guidelines should be adhered to. Below we will discuss these principles together:
- Conservatism Principle: According to this principle, liabilities and expenses must be recorded as soon as feasible. Only when an accountant is certain that profits and assets will be received are they registered. This avoids giving readers excessively optimistic estimations and produces a conservative assessment of the company's health.
- Accrual Principle: Instead of entering the amounts when the associated cash flow occurs, all amounts should be recorded as they occur in this principle. This produces a thorough financial record that enables external observers to track events over time.
- Cost Principle: The original purchase prices of all equities, contributions, earnings, and liabilities must be documented. Inflation or gains in market value cannot be used to raise the reported quantities.
- Consistency Principle: All facets of the business should use the same accounting procedures. This makes it possible for a business to apply the same standards and accounting procedures for both internal and external publications.
- Economic Entity Principle: The operator of a business is subject to different legal obligations and needs to be handled differently from the company. The buyer and seller must be clearly defined in order to trace transactions between the operator and the business.
- Matching Principle: According to this, financial statements must accurately reflect expenses and receipts. By adhering to this approach, expenses are precisely recorded at the moment they were incurred.
- Going Concern Principle: According to the going concern principle, the business can continue for a predetermined amount of time, often a year.
- Principle of Full Disclosure: The going concern principle states that the company can stay in operation for a set period of time, usually a year.
With this, we in Beinfinance have provided you with a clear overview of the most important principles in financial accounting. Companies’ adherence to these principles ensures that accounting records are clear and highly accurate for all interested parties.
Financial Accounting vs. Managerial Accounting
What are the differences between financial accounting and managerial accounting? The main differences between financial accounting and management accounting
Among the largest branches of the accounting sector, there are financial accounting and management accounting. While these two variants have many similarities in terms of approach and use, several points differentiate them. Their scope and function are distinct, even if they are more or less linked. The main distinctions relate in particular to targets, accounting standards and compliance.
Managerial accounting is a practice that is used to identify, analyze, measure, interpret, and communicate information. It involves financial data that is shared with decision-makers in a company to achieve the objectives set upfront. Financial accounting, on the other hand, is useful for recording, summarizing, and communicating transaction flows. It also involves economic activities that are the result of business operations over a given period. Basically, managerial accounting is different from its financial variant, as it is designed for business decision-making in an organization.
The Main Objectives of Financial and Managerial Accounting
The purpose of managerial accounting is to generate data that is essential to an organization. These are collected in order to plan strategies and set realistic objectives. This accounting practice then allows business leaders to set up an effective orientation that is consistent with their company's resources. Financial accounting, on the other hand, mainly concerns the sharing of information for people outside a company.
It therefore consists of producing financial statements or final accounts. The objective is to reveal the financial health of companies as well as their commercial performance. Managerial accounting is therefore useful for the management of an organization. Financial accounting, on the other hand, is intended for sector regulators, creditors and investors.
Conclusion
In today's fast-paced business environment, understanding financial accounting is more critical than ever. By grasping the meaning of financial accounting, the key principles, the differences between financial and managerial accounting, processes, and financial statements discussed in this article, you are better equipped to make informed decisions that can drive your business forward. Whether you’re managing your own finances, analyzing investment opportunities, or working in a financial role, a solid understanding of financial accounting will empower you to navigate the complexities of the financial world with confidence.
Don’t stop here—take the next step in your financial journey! Explore additional resources, connect with financial professionals, or dive deeper into specific topics that interest you. Your path to financial literacy starts now!