Financial accounting is an essential process for any business, and one that needs to be carried out with diligence. Financial accounting is required by law, and comes in the form of a set of mandatory documents that registered companies must put together and present, generally in their annual report.
In this introduction to financial accounting, we’ll explore what exactly financial accounting is, the difference between financial accounting and management accounting, and most important financial statements you must put together for financial accounting and reporting.
What is financial accounting?
Financial accounting is a branch of accounting wherein an organisation records, summarises, and reports their business transactions over a certain time period. Most commonly, this time period is a financial year, three months, a month, or weekly, but there isn’t any set period of time that financial accounting must cover.
Financial accounting is summarised and presented in the form of financial statements, which include a balance sheet, an income statement, a cash flow statement, and sometimes a statement of retained earnings. These statements are used to inform stakeholders, creditors, tax authorities, and regulators of an organisation’s financial activity and performance, and can be used to identify malpractice and fraud.
There are five main classifications that are reported on in financial accounting: revenue, expenses, assets, liabilities, and equity.
Management accounting vs. financial accounting
There’s a difference between financial accounting and management accounting. Management or managerial accounting is when a business’s accounting team presents financial information internally to the management team, while financial accounting is presented to external parties. Management accounting gives your company’s leadership team accurate information about spending and costs to help them make informed financial decisions.
What is Generally Accepted Accounting Practice?
There are a number of established principles that guide the financial accounting process.
The term Generally Accepted Accounting Practice (GAAP) refers to the specific principles, rules, and legislation that companies must abide by when undertaking financial reporting. Accounting standards in the UK are defined by the Financial Reporting Council, as well as the International Financial Reporting Standards when trading globally.
What is a balance sheet?
A balance sheet is a report that outlines the assets and liabilities of an organisation, in addition to the equity of its shareholders. Assets include cash, inventory, investments, equipment, property, and accounts receivable, among other accounts. Liabilities may include accounts payable, loans, current taxes, owed payroll, mortgages, and unearned revenue. Equity may include stocks owned by shareholders, retained earnings, or comprehensive income.
What is an income statement?
The income statement, also known as a profit and loss statement, presents an organisation’s net income over a set period. This is calculated by subtracting total expenses from total revenue. It will display revenues, expenses, gains, and losses.
What is a cash flow statement?
A cash flow statement presents a detailed report of the organisation’s income and debts, but relates only to cash transactions. Cash flow statements are divided into three sections: operating activities, investing activities, and financing activities. While an income statement outlines gains, losses, revenues, and expenses, it doesn’t deal with cash directly.
Cash flow represents the cash an organisation has available at any given time, and indicates the viability of the organisation's operation and profit.
What is a statement of retained earnings?
Financial accounting may also include a statement of retained earnings, which shows dividends paid from earnings to shareholders, as well as earnings retained by the company over a certain period of time.
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