Financial Accounting Certificate India’s Top University

What is Financial Accounting?

Financial accounting is a specific branch of accounting involving a process of recording, summarizing, and reporting the myriad of transactions resulting from business operations over a period of time.

These transactions are summarized in the preparation of financial statements including the balance sheet, income statement, and cash flow statement that record a company’s operating performance over a specified period.

Work opportunities for a financial accountant can be found in both the public and private sectors. A financial accountant’s duties may differ from those of an accountant who works for many clients preparing their accounts, tax returns, and possibly auditing other companies.

Why Financial Accounting Matters

Financial accounting matters because it can help a business in various crucial ways:

• It helps create a standard set of rules that companies can use to maintain consistency in preparing financial statements across the business.

• It enables businesses to gain valuable insights into their operations, providing management with valuable information for forward planning and strategies. 

• It increases performance accountability and, therefore, reduces financial risk. It is key to have a clear picture of a business's health and to be able to show this to potential lenders and investors.

• It promotes transparency and trust. Companies can be clear and open regarding their financial operations and provide evidence of this through financial statements. 

• It provides a strong basis for planning and expenditure. For example, if your business is considering investing in AI for logistics to streamline and optimize deliveries, accurate financial accounting can provide evidence-based figures to justify and support this expenditure.

Objectives of financial accounting

According to principles of financial accounting, the main aim is to provide all internal and external stakeholders with an accurate view of profits and losses. This in-depth financial analysis allows organizations to protect stakeholders’ interests, meet legal requirements, and optimize resource allocation.

Here are a few objectives of financial accounting.

             - Compliance with statutory requirements

                  - Recordkeeping       

                  - Determine profitability

                  - Management decision-making

1. Compliance with statutory requirements

Through the process of financial accounting, organizations comply with tax regulations, the Companies Act, and other statutory requirements of the country in which it conducts business. 

2. Recordkeeping

It creates a systematic process for recording financial transactions in the books of accounts. Organizations use these transactions to analyze and optimize their financial performance. 

3. Determine profitability

Organizations maintaining financial accounts can also easily measure net income for a period from assets, liabilities, and equities. While a simple way to calculate profit and loss is to subtract spending from revenues simply, profitability also considers other factors, such as pricing of goods and services, purchases, rent, salary, general expenses, depreciation, interest paid, and taxes. 

4. Management decision-making

a robust accounting process enables stockholders, shareholders, creditors, and other parties to gauge an organization’s financial stability. Moreover, it aids the management team in making analytical decisions for maximizing sales and profits.

Features of financial accounting

Here are some of the features:

 * Monetary recordkeeping: Financial accounts don’t record non-monetary transactions, regardless of their importance from a business point of view.

* Historical transaction recording: Financial accountants only track transactions that have already taken place in the past.

* Legal requirements: As law mandates, organizations must keep their financial accounts up-to-date. They should also get financial statements audited to ensure accuracy.

* Made for external use: Financial accounting reports inform customers, investors, suppliers, and financial institutions about the financial performance of an organization.

*  Interim reports: Organizations treat financial account statements covering less than a year as interim reports. These reports are useful for conveying the financial performance before a full-year reporting cycle ends.

* Forms the basis of other accounting branches: Financial accounting deals with raw data from journals and ledgers. Therefore, it is the foundation for other accounting branches, such as management accounting, cost accounting, and other advanced accounting methods.

     Principles of Financial Accounting

Financial accounting follows a rulebook of five core principles that act like a recipe for preparing a company’s financial statements. These principles establish the foundation for all the technical rules accountants follow. Let’s break them down with real-world examples:

- Revenue Recognition Principle

Imagine you run a consulting firm. This principle dictates you record revenue when the service is delivered, not when you receive payment. So, if you complete a consulting project in December but your client pays in January, the revenue gets recognized in December’s financial statements.

- Cost Principle

This principle focuses on recording costs at their original purchase price. For instance, if you buy a new office printer for $500, that’s the cost you record, not what you think it might be worth in a few years. However, for assets like buildings or equipment that wear down over time (depreciate), the cost is spread out over their useful life. 

- Matching Principle

This principle ensures expenses are recorded in the same period as the revenue they helped generate. Let’s say you buy inventory in November for your retail store. You shouldn’t wait until you sell that inventory in December to record the cost as an expense. The matching principle requires recording the inventory expense in November alongside any sales revenue generated from that inventory. 

- Full Disclosure Principle

Imagine the financial statements as a story about a company’s financial health. This principle ensures the story is told completely and transparently. Financial statements often include footnotes or extra schedules that explain accounting choices or provide more context. Think of them as additional chapters that give a more complete picture. 

- Objectivity Principle

Financial accounting involves estimates and judgements, but this principle emphasizes avoiding bias. Imagine valuing a company’s brand name. There’s no set price tag. Objectivity requires accountants to use documented methods and avoid personal opinions when making these estimates. 

What are the main functions of financial accounting?

The significant advantages of financial accounting are to create financial statements that help investors, tax authorities, and lenders understand an organization’s financial position. Accountants create these reports (income statement, cash flow statement, and balance sheet) by tracking incoming and outgoing cash flow transactions.

Here are some of the functions of financial accounting.

Maintain systematic records: Financial accounting records financial transactions accurately while meeting accounting standards and regulatory guidelines.

Analyze and summarize financial records: Accounting teams create final accounts after analyzing and summarizing transactions in the trial balance. The final statement shows the profits or losses of an organization during a financial year.

Communicate results: Financial accounts help organizations share their annual financial performance with investors, shareholders, government bodies, lenders, creditors, and debtors.

 Meet legal requirements: Financial accounting ensures organizations fulfill their legal obligations, such as book auditing and tax liabilities.

    Types of Financial Accounting

    There are two types of financial accounting; cash accounting and accrual accounting.

1) Cash accounting means transactions are recorded when cash is received. The drawback with this form of accounting is that it doesn’t reveal whether revenue or expenses were generated before the cash was received. 

Cash accounting is suitable for small businesses with limited capital and a smaller workforce. It’s not a method that’s sophisticated and granular enough for larger businesses with more complex structures and financial transactions.

2) Accrual accounting, on the other hand, works on the principles of revenue recognition and matching revenue. It’s the most accurate form of accounting as it digitally records each transaction, with revenue earned but the amount not received being logged in the asset account, expense occurred, and cash not paid being logged in the liabilities account. It’s a far more detailed and accurate form of financial accounting for large-scale enterprises.

Who are all the users of financial accounting?

Public enterprises publish financial statements quarterly or annually to provide internal and external users with critical financial information.

In this section, we explore the purpose of these financial statements.

 • Lenders compare assets and liabilities to predict an organization’s ability to repay loans.

 • Investors analyze financial statements to estimate investment risks and predict future dividends.

 • Suppliers and trade creditors need financial information to measure the short-term liquidity of an organization.

 • Customers use statements to understand the long-run prospects of a business.

 • Employees and trade unions look at financial data to interpret an organization’s profitability and stability.

 • Company management leverages accounting information to evaluate progress and pinpoint areas of improvement.

 • Government agencies including income tax and sales tax departments, need financial information to levy and collect appropriate taxes.

 • Investment analysts use financial statements to analyze an organization’s competitive performance. 

Best practices for financial accounting

Efficient financial accounting enables organizations to unlock growth opportunities, monitor spending, and optimize resource allocation. However, it can be challenging without a well-planned strategy.

Here are a few best practices enterprises follow to mitigate risks and boost profit margins.

- Keep personal and business finances separate to prevent cash flow issues and tax filing complications.

 - Establish internal accounting policies to minimize risks.

- Determine the appropriate accounting principle, depending on organizational needs.

- Use accounting software to track and record transactions and cash flows.

- Create accurate financial statements for ease of sharing information with stakeholders.

- Manage accounts payable, receivable, and reconciliation processes efficiently. 

Conclusion

Financial accounting helps organizations with accurate recordkeeping, which is key to creating financial statements that meet accounting standards and legal guidelines. Organizations following accounting best practices evaluate and optimize their performance more efficiently. As a result, they remain in a better position to weather any financial hardship.