What is Financial Accounting?

what is financial accounting

If you’re starting a business, you’re probably asking, ” What is financial accounting?” Long story short is, this is about recording transactions. All your small business debits and credits.

What Exactly is Financial Accounting?

This covers all business operations over a specific time. There are categories detailing the financial transactions involved. Like revenue, expenses, liabilities and equity. This type of financial accounting aims to corral the numbers. To give a good picture of small businesses’ financial position over a specific period.

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There are three statements included in a final report. Financial accounting brings all the necessary information into one place. That makes it more user-friendly and easier to understand. Without this type of financial reporting, SMBs would have a hard time operating.

Types of Financial Accounting

There are several different types of accounting methods involved. Learn more about the accrual method and cash accounting below.

Accrual Accounting

The accrual method is specific. Expenses and revenue are recorded as soon as a transaction occurs. As opposed to cash accounting which notes when payment is made or received. Accrual accounting is more common.

Cash Accounting

The cash method is different. The financial information recorded is more immediate. Revenue and expenses are recorded as they happen. There’s a drawback with this. The cash basis of accounting doesn’t always provide accurate financial results for bigger companies and ones with larger inventories.

The cash basis method is good for sole proprietors.

Main Financial Statements in Financial Accounting

Financial accounting statements have reporting requirements. This type of accounting is the process of seeing how the following financial statements interact.

Income Statement

This shows profitability for a specified period. It’s also called a profit and loss statement. Included are revenue from sales and expenses to arrive at a net income. A big indicator of financial health.

Balance Sheet

A balance sheet is one of the most important financial statements. It’s a summary of the current assets, liabilities, and shareholder’s equity. Public companies include accounts payable and accounts receivable.

A retained earnings statement is added, along with stockholder’s equity.

Statement of Retained Earnings

This financial statement is in between the income statement and the balance sheet. It’s another one of the accounting practices focusing on transactions. It reports on any deductions like dividends paid and the net amount left.

Cash Flow Statement

Financial statements dealing with cash flows are big indicators of how well a small business is doing. A statement of cash flow on any balance sheet should be positive. A good cash flow has more money coming in than going out. A negative cash flow on basic financial statements can lead to bankruptcy.

A cash flow statement also looks at how well you generate money. These financial statements use an indirect or direct method to gauge business operations. A cash flow statement complements the income statement and balance sheet.

Read More: what is cost accounting

Why Financial Accounting is so Important

Recording a company’s financial transactions over a period of time is critical. Financial accounting rules cover several important aspects in the same period. Like stockholders equity.

Here are five reasons why these financial statements matter.

  • They Detect Fraud: These accounting rules weed out fraud. And suspicious activity. Like an income statement full of fake revenues.
  • They Highlight Performance: A company’s annual report accesses its performance in relation to previous years and industry averages. The net income measures sales revenue.
  • They Determine Taxes: The accounting principles involved determine the taxes a small business needs to pay.
  • They Help With Decisions: Any company’s management uses these financial accounting reports to move forward with decisions about loans, expansions, etc.
  • Double-entry accounting: It provides a comprehensive income picture. Management can trust numbers like these since there are at least two accounts. One debit and one credit.

A trial balance detects any errors. Using the accrual basis also helps to see which months are profitable.

They Are Legal

The GAAP ( see below) are accounting standards adopted by the securities and exchange commission. These records can be presented in court.

Financial Accounting Vs. Cost Accounting

There are some differences between these two types.

  • Cost accounting handles cost records. Financial accounting cuts a bigger swath. It handles all of a small businesses’ financial data.
  • The period of time these get reported is different too. Costs get reported at frequent intervals while a financial report comes at the end of a fiscal year.

Similarities include the fact they both use the double-entry method to record a company’s business transactions.

Financial Accounting Vs. Managerial Accounting

There are similarities and differences between these two methods too. The differences come down to the purpose for each.

  • Financial accounting collects data that gets turned into financial statements.
  • Managerial accounting is internal. It’s used to look at business transactions.

Both of these look at the numbers for a small business. They are similar in that they show how any transaction affects a bottom line.

How Much Does it Cost to Hire a Financial Accountant?

As you might imagine, the cost to hire one of these professionals varies. Location, experience, and the type of work that needs to be done all factor in. According to ZipRecruiter, the national average is $55,045 a year which translates into about $26 per hour.

Deciding on the features you need will affect the cost. Maintaining financial records and tax planning advice are just a few to think about. Managing equity accounts that highlight performance is another.

Is Financial Accounting Right for Your Business?

Every business needs a comprehensive income statement along with having other types of financial statement boxes checked. An accountant can decide what works best. Whether to use the accrual basis or cash accounting for your enterprise. But there’s a DIY option that can handle any accounting, such as FreshBooks or Quickbooks.

Do financial accountants follow generally accepted accounting principles?

The short answer is yes. The Financial Accounting Standards Board works to improve the quality of financial reporting. They develop standards and monitor their implementation. They follow the Generally Accepted Accounting Principles ( GAAP). They monitor both private and public companies.

Image: Depositphotos

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Rob Starr Rob Starr is a staff writer for Small Business Trends. Rob is a freelance journalist and content strategist/manager with three decades of experience in both print and online writing. He currently works in New York City as a copywriter and all across North America for a variety of editing and writing enterprises.

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