What is Financial Accounting?

The process of documenting, compiling, and reporting the numerous transactions occurring from corporate operations over a particular period is known as financial accounting. The compilation of financial statements, such as the balance sheet, income statement, and cash flow statement, which document the operating performance of the company over a given time period, summarizes these transactions.

A number of accepted accounting principles are used in financial accounting. The choice of which principles to be applied during financial accounting is determined by the reporting and regulatory obligations that the company must meet. Businesses must undertake financial accounting in conformity with generally accepted accounting principles (GAAP).

The purpose of establishing these accounting rules is to give investors, creditors, regulators, and tax authorities’ consistent information.

Double Entry-Accounting

Every financial activity in a company has an impact on at least two accounts. The outcomes of a transaction can be recorded using the double-entry accounting method. In this method, the transaction is entered as a credit in one account while a debit in another. The increase in assets and costs, and the decrease in liabilities, equity, and income are accounted for by debit entries. While credit entries take into account changes in liabilities, equity, and income.

The most effective method for monitoring a company's financial development and reducing human error in financial accounting is double-entry bookkeeping.

Accural Basis vs Cash Basis

Timing is the primary difference between the accrual method and the cash method of accounting. Because it only records expenses and earnings when money has actually changed hands, the cash basis is instant. Because it's typically simpler than the accrual basis, private corporations or small businesses employ it most frequently. Furthermore, no calcultaions are required as you can tell exactly how much money there is in an account by just looking at the balance.  The drawback is that there might not be a fair assessment of how your company is performing. 

On the other hand, the accrual method is based on expected costs and income. Revenues are recorded once they are made, not when they are paid, and expenses are recorded when they are spent. The accrual technique is typically used by major corporations and publicly traded firms because it provides a more accurate financial picture over the course of a certain time. This technique makes projections simpler. However, it may or may not accurately reflect the actual cash flow and can have disastrous effects.

Importance of Financial Accounting

Within a company, financial accounting serves a variety of objectives and is crucial for making decisions. Businesses wouldn't be able to maintain a record of their finances without financial accounting, which would have an impact on how well they could function.

       i.            Information dissemination to external parties is the primary purpose of financial accounting. In order to undertake commercial deals, it is crucial for organizations to be able to communicate their financial situation to third parties through financial accounting. Financial accounting is necessary for businesses to be eligible for loans and to communicate with suppliers. Prior to starting business with a company, these outside entities want to be sure of its integrity. Companies can provide these organizations with a record of their financials through financial accounting, which identifies their capital and their trustworthiness to make payments.

 

     ii.            Businesses need financial accounting because it enables them to monitor their financial transactions. They can then decide how to spend their resources wisely. Financial accounting also enables a business to explain its financial situation to outside parties like creditors and investors. The financial statements produced give other parties all the information they need, which may or may not persuade them to engage with your company.

 

  iii.            For internal communication, businesses also employ financial accounting. The financial staff and employees of a company are involved in internal communication. For a variety of reasons, it is crucial for a company's members to be aware of how the firm is doing. The first is that understanding a company's financial situation can help employees feel secure in their positions. The financial report of a company can highlight the areas where it is doing well and those where it is having difficulty. When staff members are aware of this knowledge, they may meaningfully improve the business.

 

  iv.            Businesses can assess their performance in comparison to other firms using financial accounting. Financial accounting is a standardized method, allowing for comparison of the financial statements produced by various businesses. This enables companies to evaluate their performance in comparison to that of their rivals and identify opportunities for development. Based on the performance of other companies, this kind of comparison also enables organizations to find investment prospects.

 

Financial accounting can give you more information than just looking at your own report by comparing your business to competitors in the same industry. Even though your firm may appear to be a success, a comparison with companies may show that the market has a lot of opportunity for growth and expansion. You can use this to develop new strategies or set new goals.