If you are an accountant, you’ve most likely heard of financial accounting. This field of accounting is not only important for those who deal with finances on a daily basis, but also for business owners, especially those who have just started their business. Understanding financial accounting helps you understand your company’s financial position better.
Through this article, you will get to learn about what financial accounting really is, all its components, what distinguishes it from managerial accounting, as well as software that facilitates its procedures.
Table of Contents
- Understanding Financial Accounting
- The Main Components of Financial Accounting
- Types of Financial Statements
- Definition of Double Entry, Debits & Credits
- The Benefits of Accounting Software
1. Understanding Financial Accounting
Financial accounting is the branch of accounting that tracks a company’s financial transactions. This 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 main recipients. However, if the company’s shares are traded publicly, its financial statements are usually widely circulated. 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, so that they make better decisions. However, it’s important to point out that the purpose of financial accounting itself is not to report the value of the company. Instead, the goal is to provide enough information for others to assess the value of a company.
2. The Main Components of Financial Accountin
In bookkeeping, transactions are recorded and grouped according to certain 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 in the short and long term.
A liability is a company’s obligation to pay a certain amount of money both to external and internal parties.
The equity represents the amount of money that would be returned to a 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, for example from the sale of goods or services.
Costs are money spent by a company to support its business operations.
3. Types of Financial Statements
Every investor, trader, or financial professional needs to understand what financial statements are.
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. They need to be presented by following established and standardized accounting principles to put everyone on the same page.
In general, 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 certain time period. If the income is greater, then the company can be declared profitable, but if the expenses are greater, 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 an 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 of time. With this, you can find out about changes in 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 more complete information about each type of financial statement, please read the following article:
4. Definition of Double Entry, Debits & Credits
In most companies, the standard method used to record transactions is the double entry. This means that each transaction will involve at least two accounts. The double entry refers to an accounting concept in which assets are the result of 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 helps traders and bankers 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, the sum of all debits must equal the sum of all credits.
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 to the right side of the account ledger. To be balanced, total debits and credits for transactions must be equal. Debits are not always the same as increases and credits are not always 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. On the income statement, debits increase the balances in expense and loss accounts, while credits decrease their balances. Debits decrease revenue and profit account balances, while credits increase their balances.
5. 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. 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. This leads to low productivity in the workplace.
Accounting software allows instant financial report generation. Great accounting apps provide real-time reporting that is in accordance with government’s regulations.
Estimates business cash flow accurately
Complete accounting software can help companies forecast their revenues, profits, expenses, and losses. This is very helpful for businesses to manage and allocate their budgets. Estimated cash flows are beneficial for companies that are 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 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. Depreciation of fixed assets can be calculated using various methods in accordance with your company’s policies as well as 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 important for accountants or financial staff, but it is also critical for every business owner. Understanding financial accounting can help business owners better understand their financial position, allocate their budgets more wisely, and choose the right investments.