The Fundamentals of Financial Accounting

Did you know that every company, whether a multinational organization or a small “mom and pop” outfit, need tracking and presentation of its various financial transactions? It is worth noting that this is where financial accountants come in. Financial accounting helps the public. In this context, the public includes investors, customers, suppliers, lenders or creditors, and government agencies.

What is Financial Accounting?

Note that keeping track of financial records and creating a comprehensive summary of a company’s financial transactions is known as bookkeeping. However, when accountants produce and display this financial information in various reports, such as a balance sheet, for public use, this process is known as financial accounting. It is worth noting that the focus of financial accounting is external. The process aims to create accurate financial statements that management can easily share outside the company.

Keep in mind that for most public companies, various financial accounting processes have to adhere to a specific set of principles and rules stipulated by the GAAP (Generally Accepted Accounting Principles). These are the accounting standard adopted by the US SEC (Securities and Exchange Commission) framework.

You should know that financial accounting in any organization uses a chart of accounts. It has set procedures and policies in place that govern the way financial transactions, such as investments or the purchase of fixed assets, are to be posted using these accounts. Note that the goal to develop factual financial statements for a specific period, such as one year.

So, we can say that financial accounting entails the preparation of reports, such as a cash flow statement, of a company’s financial information regularly, such as quarterly or yearly. However, it is worth noting that these reports do not convey a specific conclusion or argument about the company. Rather, they solely present data that several external recipients, such as investors, of these reports can use to draw their conclusions about an organization’s financial health.

Objectives of Financial Accounting

There is no doubt that financial accounting involves more than just systemically recording all of a company’s financial transactions. Financial accounting is important as it provides valuable and relevant information for the owners or managers of a company about its current financial status or position, whether unhealthy or healthy and is important for decision-making in the future.

The information is important as it lets owners and other stakeholders, such as lenders, know the firm’s liquidity or the ability to meet its short-term obligations and its financial solvency in the long-term. Note that some of the main purposes that financial accounting serves include:

• Creating financial statements
• Creating information that the management of a company uses for decision making, planning, and performance evaluation
• Creating financial statements to meet various regulatory requirements

What are the Financial Statements?

The financial accounting process in an organization revolves around financial statements, such as a balance sheet, which reflect a company’s overall financial health and position. Keep in mind that shareholders, employees, and current and prospective customers read these financial statements. They give these readers a close look into the state of finances within the company at a given time.

Did you know that there are three standard reports? These are the income statement, a report that describes the revenues, expenses, profits or losses, and gross proceeds over a specific period. On the other hand, the balance sheet shows the company’s assets (what it owns) and its liabilities (what it owes) at a given point in time. Finally, the cash flow statement analyzes the flow of cash out and into the firm.

Key Elements of Financial Accounting

Here are some of the basics of financial accounting in a company and why they are essential for reporting its financial information.

Accrual Basis of Accounting

It is worth noting that financial accounting has to follow the standards and rules of accrual basis accounting. This is where assets, such as inventory, are taken into account on the agreement of a financial transaction, rather than the physical or tangible exchange of assets.

Accrual basis is different from cash basis accounting and allows shareholders, investors, and other readers of financial statements to gain valuable insight into a bigger picture of the company’s financial health. Keep in mind that most companies prefer an accrual basis of accounting over the cash-based system because of the following important reasons:

• It provides a complete and reliable picture of a company’s financial transactions
• It helps avoid misleading and unreliable income statement results that might occur because of the specific timing of cash payments and receipts
• The accrual basis of accounting allows accountants to easily combine the current cash outflows and inflows with expected cash outflows and inflows

Double-entry Bookkeeping

Did you know that financial accounting in any company relies on the principle of double-entry bookkeeping? An Italian monk Luca Pacioli introduced this concept in financial accounting back in 1494. Note that according to this system, all business transactions involve at least 2 accounts. We can also say that every financial transaction has an equal and opposite effect that affects at least two different accounts. For instance, when a company borrows from a bank, it results in an increase in its cash account as well as an increase in the accounts payable.

Keep in mind that another key aspect or feature of double-entry bookkeeping is credits and debits. This means that for each financial transaction, there should be a credit and debit, and they have to be equal. This maintains a balance between the cash the firm has and the amount it owes to the bank.

Explore the core financial accounting tools that will help you understand annual reports and footnotes – creating a solid understanding of the financial statements.

 The New York Institute of Finance (NYIF) is a global leader in professional training for financial services and related industries. NYIF courses cover everything from investment banking, asset pricing, insurance and market structure to financial modeling, treasury operations, and accounting. The New York Institute of Finance has a faculty of industry leaders and offers a range of program delivery options, including self-study, online courses, and in-person classes. Founded by the New York Stock Exchange in 1922, NYIF has trained over 250,000 professionals online and in-class, in over 120 countries.

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