Finance and accounting functions in business

What Is Financial Accounting

Financial accounting is a branch of accounting that involves recording, summarizing, and reporting business transactions over time. These transactions are summarized in financial statements like balance sheets, income statements, and cash flow statements, which record a company’s operating performance.

A financial accountant can work in both public and private sectors, with duties varying from those of an accountant working for multiple clients, preparing accounts, tax returns, and potentially auditing other companies.

How Financial Accounting Works

Financial accounting follows established principles based on business regulations and reporting requirements, often outlined in an accounting manual for companies and organizations.

U.S. public companies are mandated to adhere to GAAP financial accounting principles to ensure consistent information for investors, creditors, regulators, and tax authorities.

Financial accounting statements categorize financial data into five main classifications

• Revenues : This includes income from product and service sales, as well as other sources like dividends and interest.

• Expenses : The costs of producing goods and services, including research, development, marketing, and payroll, are referred to as production costs.

• Assets : This refers to owned property, which can be tangible (buildings, computers) or intangible (patents, trademarks.

• Liabilities : This includes all outstanding debts, including loans or rent.

• Equity : By paying off a company’s debts and liquidating its assets, you would gain its equity, which represents its true worth.

The income statement accounts for revenues and expenses, determining net income, while the balance sheet reports assets, liabilities, and equity, utilizing financial accounting to report ownership of the company’s future economic benefits. Finance and accounting functions in business

Balance Sheet

A balance sheet is a financial statement that outlines a company’s financial position, including assets, liabilities, and equity, and is based on financial accounting guidance, which dictates how cash is recorded, assets are valued, and debt is reported.

A balance sheet is utilized by management, lenders, and investors to evaluate a company’s liquidity and solvency, enabling comparison of accounts through financial ratio analysis.

The current ratio is a financial measure that compares a company’s current assets to its current liabilities, indicating its ability to meet short-term debt obligations.

Income Statement

An income statement, also known as a profit and loss statement, provides a detailed overview of a company’s operating activities over a specific period, typically issued monthly, quarterly, or annually. It outlines revenue recognition, expense recording, and expense classification, following financial accounting guidance.

Managerial accounting provides better insight into production and pricing strategies than financial accounting, while financial accounting rules are more useful for investors and external parties seeking to assess a company’s profitability and risk or consistency of operations.

Cash flow statement is a crucial financial

A cash flow statement is a financial report detailing a company’s use of cash over a specific period, categorized into three sections.

• Operations : The costs associated with a company’s primary business activities.

• Investments : This refers to the revenue generated by the company by buying and selling its investments, such as securities or fixed assets.

• Financing : The company’s revenue includes the money it earns from loans or shares, as well as interest on loans and dividends paid to investors.

Financial accounting guidance dictates recording times for transactions, but there is limited flexibility in reporting cash amounts per transaction.

A cash flow statement is a financial tool used by management to analyze how cash is spent and received, focusing on items that directly impact cash, a process that can be challenging when using accrual accounting.

Accrual Method vs. Cash Method

The accrual method and cash method are two main types of financial accounting, with the main difference being the timing of transaction recording.

Accrual Method

Accrual accounting is a financial accounting method that records transactions without considering cash usage. It records revenue and expenses when they are earned, not when they are paid, and recognizes the impact of a transaction over time.

A company receiving a $1,000 payment for a consulting job cannot recognize it as revenue under accrual accounting as it has not yet performed the work and earned the income.

The company records transactions as a debit to cash and a credit to unearned revenue, clearing the unearned revenue credit when revenue is earned, and erasing the debt to cash.

The accrual method of accounting is used to account for unpaid expenses, such as a $5,000 utility usage invoice received in July.

The company records utility expenses in July, debiting them, and credits them to accounts payable, despite not paying the bill until August, as per accrual accounting.

Cash Method

The cash method of financial accounting is a simpler and less stringent approach to financial statement preparation, recording transactions only when cash is involved and revenue and expenses only when transactions are completed through money facilitation.

The cash method requires revenue to be recognized when cash is received, and no journal entry is recorded when the company performs the work in the following month, as the transaction will have been recorded in full the previous month.

The utility expense would have been recorded in August, despite the charges relating to services incurred in July, as the cash method of financial accounting requires expenses to be recorded when they are paid, not when they occur.