“Accounting is business’ language.” — Warren Buffett
Financial accounting is an essential business language because it analyze financial information and communicates it to the stakeholders. Without business transaction data, you can’t communicate an organisation’s financial performance.
It provides a basis for preparing and presenting financial statements. However, there is no way organisations can keep records of financial transactions if they don’t have a process. Enterprises rely on financial accounting to record financial performance and position.
So, in this guide, we’ll discuss what is financial accounting and why is it important to maintain and prepare financial statements.
Financial Accounting: What It Is and Why Is It Important?
Financial accounting process may seem boring or esoteric, but it is important to track all financial activities of a business. Let’s find out what is financial accounting and why is it important:
How Financial Accounting Works?
Financial accounting is the process of recording, summarising, and reporting of millions of transactions occurring over time.
The preparation of such financial results summarises the company’s operating activity and financial health over a specified period. Financial accountants can work in the public and private sectors. According to a survey, almost half of firms found it difficult to create financial statements and legislative changes. Therefore, financial institutions need an accountant to prepare accounts and tax returns and possibly do auditing.
Importance of Financial Accounting
The Accounting Service Global market is forecasted to be $735.94 billion by 2025 with a CAGR of 6%. Financial accounting provides many benefits to businesses and is essential for financial decision-making. Businesses won’t be able to operate without financial accounting. Here are some reasons why financial accounting plays a crucial role in shaping a company’s financial position:
External Communication
Financial accounting records serve the role of external communication of information. Financial accounting helps companies to report their financial status to those outside the company. This is critical for the day to day running of the business.
Moreover, companies need financial accounting practices to become qualified for loans and coordinate with suppliers. Before they do business together, these external companies want to know that the company has done well. Financial accounting allows such organisations or institutions to see financial records with the help of accounting software. This will define their capital and ability to pay for the institution or company.
Internal Communication
Companies also use financial accounting for internal communication. The communication in a company means between the employees and the finance team. Knowing how a business is doing is important for many reasons for the members of a company.
With the help of financial accounting information, you can know your company’s financial health. As a result, you can make employees feel stable in their jobs. If you’re doing well, then they must not be laying people off or downsizing.
Financial accounting is a specialised tool that creates transparency, enabling employees to be a part of the company as much as everyone can see its success. Employees know how well the company is doing and will continue to exert more effort.
Moreover, the company’s accurate financial report will also show whether it is performing or not. When financial accounting is used for internal communication, employees can participate through stock-based or profit-sharing compensation.
Comparing Financial Reports
Financial accounting is used by businesses to compare themselves to other businesses. However, financial accounting is standardised; consequently, the financial statements obtained from different companies may be compared. This lets businesses compare their success to their competitors and get ideas about areas that can be improved.
With this comparison, financial accounting enables businesses to learn to spot investment opportunities based on how other businesses have been successful.
To get more out of your company’s accounting than just the one you write for yourself, compare your company to other companies in the same field. Your company appears to be successful. However, if your business is compared to other businesses, it may be found that there is a lot of area for business development and extension of markets.
Recording Transactions
Another purpose of financial accounting is to record financial transactions in business. Financial accounting is vital to keep track of their expenses and show a company’s financial performance. Honestly, you might need different types of financial statements for audits or when you want to review your spending or budgeting.
Filing Taxes and Keeping By-laws
Financial accounting is useful for a business and equally important in ensuring your business complies with regulations and avoids legal issues. And that’s particularly true when it comes to a business’s taxes. Financial accounting ensures the business handles its taxes correctly and at the right time without having to undergo an audit or any disagreement with the law.
Budgets and Projections
The main purpose of financial accounting is to help companies to create budgets. To get a budget, you have to know how much money you have. The main objective of financial accounting is to do this thing for companies, informing them where their money is going. This enables companies to identify those areas that must be allocated more of the company’s budget.
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Types of Financial Accounting
There are 2 types of financial accounting: the accrual accounting method and the cash accounting method. The following table shows the difference between them.
| Accrual Accounting Method | Cash Accounting Method |
| This type of accounting method records benefit when received or liability matches that incurred. | Records transactions involving cash: when it is received or distributed. |
| This method in financial accounting aims to reflect actual business operations better. | A simpler accounting method which explains what has already happened in a company. |
| Important for larger public companies to prepare for annual financial reporting that is published externally. | Used mainly for smaller, private companies with little to no reporting requirements. |
What are the Principles of Financial Accounting?
The five principles that dictate how companies prepare their financial statements are the guiding principles of financial accounting. All financial accounting technical guidance is based on these generally accepted accounting principles. Following are the five main classifications of financial principles in the accrual method of accounting:
- Primary Revenue Recognition Principle – It is the analysis of revenue, including things such as amounts, nature, measurement, and timing. It sets forth how much of the income should be recognised when it should be presented in the balance sheet. Also, it defines under what circumstances it should not be reflected in a package of financial statements.
- Cost Accounting Principle – It is the basis on which costs are recorded. This includes how much should be expected in expenses (i.e. at transaction cost) as well as allowable expense recognition over time for appropriate scenarios (depreciation of an asset, for example, is recognised over its useful life).
- Matching Principle – It defines revenue and expenses as being recorded in the same period when both are incurred. The goal is to keep a company from recording revenue in 1 year and producing that revenue in another.
- Full Disclosure Principle – It states that people or companies should act according to the public interest, either voluntarily or under compulsion. They must provide full disclosure concerning such action. They should disclose all information relevant to their financial situation. For this, financial accounting guidance should be prepared with footnotes, schedules, or summarisation. This will tell what is being reported by a company and is transparently displayed in the financial statements of the company. It also states how much information is contained within financial statements.
- Principle of Objectivity – Accounting should not depend on evidence or personal experience. It should incorporate no biased personal opinion. The main purpose of financial accounting is to prepare professionally judged and factual financial statements.
Final Words
Understanding what is financial accounting and why is it important tells you how it can help a business run smoothly. Moreover, financial accounting tells you how it can watch the money, make the reports, and make important decisions at the time. Financial accounting is all about organising a business so it follows the rules and helps the business compare itself with other companies.
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FAQs
What Are Those 4 Financial Accounts?
The four financial accounts are assets, liabilities, equity, and income and expenses, tracking a business’s financial position and performance.
What Are The 4 Elements Of Financial Accounting?
The four pillars that make financial information reliable and useful are accuracy, consistency, relevance and timeliness.
What Are The 3 Main Types Of Finances?
The three major types of finance are personal, corporate, and public.
How To Calculate Net Income?
Net income is calculated by subtracting total expenses from total revenue: Net Income = Revenue – Expenses.
What Are The 4 Cs Of Accounting Examples?
The 4 Cs in accounting are the chart of accounts, calendar, currency, and accounting convention, which provide accurate and comparable financial data.
What Are The Four Basic Financial Statements Used In Accounting?
Income statements, balance sheets, statements of cash flow, and statements of owner equity are used to show the company’s financial performance and position.
