If you are an accountant or someone who studies accounting, you must have often heard about financial accounting. This field of accounting turns out to be important not only for those who struggle with finances daily but also for business owners, especially those who have just started their business so that they can manage their business finances well. Here, we discuss what financial accounting is, what are its components, the difference between managerial accounting, and the benefits of using accounting and financial applications to facilitate the processes in it in a complete but very simple way.
Table of Contents
- Understanding Financial Accounting
- Components of Financial Accounting
- Types of Financial Statements
- Definition of Double Entry, Debits & Credits
- The Benefits of Accounting Software
Understanding Financial Accounting
Financial accounting is the branch of accounting that tracks a company’s financial transactions. This branch refers to bookkeeping by classifying, analyzing, summarizing, and recording financial transactions such as purchasing, sales, accounts receivable and accounts payable, and financial statement generation.
Financial statements will later be shown to people outside the company, with the owner, shareholders, and investors as the primary recipients. However, if the company’s shares are traded publicly, its financial statements are usually widely circulated. As a result, the information will likely reach secondary recipients such as competitors, customers, employees, and investment analysts.
That is what distinguishes financial accounting from managerial accounting, which involves preparing detailed reports and forecasts for all managers in the company to make better decisions. However, it’s important to point out that the purpose of financial accounting itself is not to report the company’s value. Instead, the goal is to provide enough information for others to assess the value of a company.
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The Main Components of Financial Accounting
In bookkeeping, transactions are recorded and grouped according to specific categories. There are five main components in financial accounting:
Assets are all company resources that have value to enable the company to run its business short and long term.
A liability is a company’s obligation to pay a certain amount of money to external and internal parties.
The equity represents the amount of money that will return to the company’s shareholders if all of the assets were liquidated and all of the company’s debt was paid off.
Income (also called revenue) is the money that a company earns from operating its business, such as the sale of goods or services.
Costs are money spent by a company to support its business operations.
Types of Financial Statements
Generally, every investor, trader, or financial professional needs to understand what financial statements are. Also, financial statements are an accurate description of a company’s finances in a given year. These are prepared using financial data collected by accountants or financial analysts of the company. Therefore, they need to be presented by following established and standardized accounting principles to put everyone on the same page.
Obviously, there are four types of financial statements; the income statement, the cash flow statement, the statement of changes in equity, and the balance sheet.
The income statement shows the income and expenses of a company in a specific period. If the income is higher, the company can be declared profitable, but if the expenses are more significant, the company is experiencing losses.
Cash Flow Statement
The cash flow statement shows the company’s incoming and outgoing money within a certain period. With this, you can estimate your business income and expenses in the future. You can also use it as accountability to the company’s stakeholders.
Statement of Changes in Equity
The statement of changes in equity provides information about the amount of capital a company has in a certain period. With this, you can find out about changes in the capital that occurred, the amount, and the causes of these changes.
The balance sheet shows the overall condition and financial position of your business for a certain period. This statement helps you find out the company’s total assets, liabilities, and equity.
For complete information about each type of financial statement, please read the following article: 4 Types of Financial Statements Every Business Owner Should Know
Definition of Double Entry, Debits & Credits
In most companies, the standard method used to record transactions is a double-entry which means that each transaction will involve at least two accounts. The double entry refers to an accounting concept in which assets result from liabilities plus owner’s equity. Double-entry bookkeeping was developed in the European trading period to help rationalize commercial transactions and make trading more efficient.
It also allows traders and bankers to understand their costs and profits. In the double-entry bookkeeping method, transactions are recorded in the form of debits and credits. Because debits in one account offset credits in another account, consequently all debits must equal the sum of all credits.
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What are Debits and Credits?
Debits and credits play an important role in double-entry bookkeeping. Debits refer to entries on the left side of the account ledger, and credits refer to entries on the right side of the account ledger. Total debits and credits for transactions must be equal. Therefore, debts are not always the same as increases, and credits are not the same as decreases.
A debit may increase one account while decreasing another. For example, a debit increases asset accounts but decreases liability and equity accounts. Debits increase the balances in expense and loss accounts on the income statement, while credits decrease their balances. Debits decrease revenue and profit account balances, while credits increase their balances.
The Benefits of Accounting Software
When it comes to financial accounting, it’s important to include accounting software. In this technological era, most companies have abandoned error-prone and time-consuming manual accounting processes. In short, the role of accounting apps is crucial because they are proven to increase efficiency, minimize human error, optimize accuracy, and even reduce costs.
What Great Accounting Software Does
Have you ever wondered why so many successful companies use accounting software? Here are a few benefits of sophisticated accounting software.
Improves accuracy & speeds up report generation
Manually generating financial statements is vulnerable to human error, often resulting in inaccurate data. Not to mention time-consuming, which leads to low productivity in the workplace. Accounting software allows instant financial report generation. In addition, great accounting apps provide real-time reporting that follows government regulations.
Estimates business cash flow accurately
Complete accounting software can help companies forecast their revenues, profits, expenses, and losses. This benefit is beneficial for businesses to manage and allocate their budgets. In addition, estimated cash flows are helpful for companies looking for investors because external stakeholders need to review the company’s prospects before deciding to invest.
Better Accounts Receivable & Payable Management
Accounting software makes it easier for you to record accounts receivable and payable. You will have a complete record of all bills and invoices. It also helps you avoid bad debts and any late fees from paying off your debts.
Accurate and easier depreciation calculation
Powerful accounting software enables you to calculate fixed asset depreciation automatically and accurately. You can calculate the depreciation of fixed assets using various methods according to your company’s policies and applicable tax and accounting standards.
Quick Bank Account Reconciliation
With a robust accounting app, you can automatically match transactions, balances, and cash directly with your bank account and provide recommendations for matching transactions based on the nominal.
Financial accounting is not only crucial for accountants or financial staff, but it is also critical for every business owner. In other words, understanding financial accounting can help business owners better understand their financial position, allocate their budgets more wisely, and choose suitable investments.
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