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Financial Accounting

Financial accounting is a field or branch of accounting that works on the summary, analysis, and reporting of financial transactions that take place in the business. In the financial amounting, an accountant prepared the various financial statements for public use which shows the company's financial position. This information is useful for many parties who have an interest in the business like stockholders, supplies, banks, employees, business owners, Government agencies, etc. Financial accounting works by using both local and international standards.

Financial Accounting

Objectives of Financial Accounting

  • Recording Transactions Systematically
    The most important objective of financial accounting is too keeping a proper record of the financial aspects of business transactions. These transactions are later used for the preparation of financial statements, their analysis, and interpretation after classifying and summarizing them logically.
  • Ascertaining the Results of Recorded Transactions
    Profit and loss account is useful for understanding the result of business operations for a certain period. If the business expenses are more than the revenue generated by the business then the company is running under loss. This analysis helps the management in investigating and taking required steps to cover this loss. Other than the management, P&L Account helps the stakeholders also in taking rational decisions. For example, if the business is not remunerative or profitable then the stakeholders will not invest and search for another company which will provide a reasonable rate of return at their investment.
  • Ascertaining the Financial Position of Business
    Financial statements are used to know what does the business owns and what does it owes, i.e., assets and liabilities on a certain date. This helps in knowing the financial position of the business in the market. For this purpose, the accountants prepare a financial position statement of assets and liabilities which is known as the Balance Sheet.
  • Providing Information to the Users
    There are various parties which are interested in the business and keep their eyes on the performance of the business. Accounting as a 'language of business' communicates the financial results of the business to various stakeholders, management, banks, and other parties by means of financial statements. Financial accounting fulfills the objective of meeting the financial information to these parties so that they can make a rational decision before investing their funds in the company or in any project.
  • Understanding the Liquidity and Solvency Position
    The balance sheet is not only helpful in calculating the total assets and liabilities of the business but it also determines the concerns ability to meet its liabilities in the short run which is known as liquidity position and also in the long run which is known as solvency position as and when they fall due.

Basic Financial Statements

There are four basic financial statements used in financial accounting which include the following:

1. Income Statement

An income statement is a statement that shows the company's net income differing a certain period. This net income is calculated by deducting total expenses from total revenue. Numerically, it can be represented as follows:

Net Income = Total Revenue - Total Expenses

Sometimes, income statement is also referred to as the Profit and Loss Statement.

2. Balance Sheet

A balance sheet represents a company's assets (items which are owned by the company) and liabilities (items which are owed to the company) along with the shareholders' equity as of a particular date, generally prepared at the end of the financial year, i.e., 31st March.

On a balance sheet, the combined balance of liabilities and equity is equal to the balance of assets. Numerically,

Assets = Liabilities + Shareholders' Equity

Items to be Presented on Shareholders' Equity

  • Stocks: Preferred and Common Stocks
  • Retained Earnings: Amount of profit that is retained by the company for further growth and development.
  • Comprehensive Income: Profit and loss occurred in a company's investment during a specific period.

3. Cash Flow Statement

The cash flow statement is a document that represents the complete detail related to the income and debts off a company over a particular period. Add the name clears, the cash flow statement is related to the inflow and outflow of cash only and it does not include depreciation and amortization costs like an income statement.

This statement represents the company's short-term viability by indicating the liquidity of the company or can say availability of the working capital on hand to pay the employees and debts on time.

4. Statement of Retained Earnings (Statement of Changes in Equity)

It is additional statement the represents the effect of distribution of income and transfer of dividends over the wealth of the shareholders in the enterprise. Retained earnings refer to the previous year's profits that are accumulated till current period. In simpler terms, it is that part of profit which is not distributed among the shareholders and kept in the business for reinvestment. The numerical formula for calculating the retained earnings is as follows:

Retained Earnings at the end of period = Retained Earnings at the beginning of period + Net Income for the period - Dividends

Methods of Financial Accounting

There are two methods which a company can use to record its transactions. The company can use any one of them or a combination of both. These methods are:

1. Cash Accounting

Under this method, only cash transactions are recorded which are made by the employees of an organization. For example, if an employee is on a business trip, he/she can make cash transactions by meals and lodging and incidental expenses. After these cash transactions, the employee can report them to the manager with the receipts. These transactions are logged in the books after the approval.

2. Accrual Accounting

Under this method, all data is recorded by the book-keeper from the transactions. Accrual accounting includes the cash transactions as well as credit, debit, and other forms of payment for transactions made by employees. Because of this, accrual method is said to be an expansion of cash accounting. This category also incorporates the account payable and account receivable which can show the capital owed to by a customer. This method gives a clear picture of the company's cash flow and in determining the current assets and liabilities.

Circulation of Accounting Statements

Financial statements are often used by various parties who have an interest in the company whether they are insiders or outsiders. They include the following:

  • Management
    Financial statements helps a company's management in dealing with various issues related to funds, making a plan for their future use, deciding where should you invest the money and where should not, etc.
  • Investors
    Financial statements are supportive for the investors in knowing the company's financial position. With this, they can decide what amount of return they can get on their investment and whether they should invest in the company or not. It also tells them about the ratio of company's profit distributed among investors and the share of profit that is kept as reserve by the company in the form of retained earnings.
  • Auditors
    These statements play a vital role in the case of IRS audit also. If the company wants to have such audit then government auditors start their analysis by using these statements of the company.
  • Lawyers
    Financial statements are used by the lawyers also in the case of any lawsuit or other legal action which is focused on the company's income or expenses. For this purpose, the lawyers collect the information from these statements and analyze it to solve the case.
  • Suppliers
    Suppliers are also interested in knowing the financials of a company before they supply goddess one services. This is because they want to ensure that whether the company will be able to pay their invoices one credits or not. Other than this, the suppliers can also collect the information about the company's current credit status and the time taken by the company in paying the previous debts. Financial statements also tell about the company's Goodwill in the market.
  • Banks
    If a company wants to raise a loan from the bank, then the bank may ask for the financial statements of the company. This is necessary for the bank to check the company's financial status and creditability in the past which is further helpful in knowing the company's ability to pay back the loan on time.
    However, it is not necessary for a private company to share its financial statement in front of the general public. It is mandatory only give the registered or public companies to provide the information about their financial status. Here the registered companies are those companies that issues shares on the stock exchange.

Tips for Recording Financial Transactions

It is necessary for an accountant to be careful while recording the financial transactions. There are three tips given to reduce the possibility of any mistake:

1. Understanding the Types of Accounting

It is most important to understand both the types of financial accounting , i.e. accrual and cash accounting. It helps you in applying the specific type of financial accounting for the specific use.

2. Know which Financial Statements to Use

The need of financial statement is based on the size of your business. If you are seeking for an investor then it is good too usse all the financial statements because it shows a clear picture of company's financial status.

This transparency brings a higher potential for investors to build a trust on your company. And for this balance sheet is important for them to know about the assets and liabilities of the company.

3. Apply Accounting Principles

Amounting principles are applied at every scenario of the accounting. These principles improves the quality of your records and efficiently register quarterly and annual costs.

Next TopicCost Accounting

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