Financial accounting is the documentation of your business finances using various reports and statements. These statements detail your business income, expenses, assets and liabilities. Managers and shareholders often use this information to make decisions about your business and its operations.
Although some conceptual aspects of financial accounting can be somewhat technical, it is much easier in practice with modern accounting software. Some of the best accounting software solutions help your managers track their transactions and create custom reports. Financial accounting is essential because it helps you and your managers make informed decisions about your business.
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What is financial accounting?
In business, accounting is the process of creating financial systems and procedures and tracking your business income and expenses. Financial accounting goes further; it involves compiling records of individual transactions into comprehensive reports that management, shareholders and others can review.
Financial accounting is often required by law if your company generates financial statements as part of its annual reports or shareholder reports. These financial statements are also useful for making management decisions and deciding on tax strategies. (Note that while financial statements are useful during tax time, actual tax returns require special reports prepared separately.)
Financial accounting might sound complicated, but it really isn’t, especially if you have great accounting software and get a little help setting up your books and records. Once you are set up, you will only have to follow your current transactions and prepare relevant reports periodically.
What is the difference between accounting and financial accounting?
Basic accounting for small businesses is the process of establishing policies and procedures regarding the treatment of income, expenses, assets, and liabilities. Financial accounting is all about taking all of this data and compiling it into a usable format – concise financial statements that summarize your business’ financial condition.
Small Business Accounting implies the following:
- Setting up books and records
- Recording of all your business transactions – cash and non-cash
- Implement policies and procedures for the treatment of income, expenses, assets and liabilities
- Manage all your company’s financial data, such as accounting documents
Finally, small business accounting requires having a process in place to generate reports that reflect the financial situation of your business, which is where financial accounting comes in.
Financial Accounting is to compile all transactions recorded as part of normal accounting activities. With accounting software, these records are consolidated into reports. Here are some of the main reports that financial accounting will generate:
- income statement: This shows all income, expenses, gains and losses of your company, team, department or project for a defined period of time.
- Balance sheet: This provides an overview of your company’s current financial situation – including net worth – by totaling up assets and debts on any given day.
- Cash Flow : Cash flow statements summarize how money flows in and out of your business over a period of time. This includes cash inflows and outflows in the form of income (collected) and expenses (paid).
- Statement of retained earnings: This shows the value that shareholders hold in a company based on initial capital contributions and net profits that have not been distributed as dividends.
How does financial accounting work?
Financial accounting involves recording all of your business transactions in accounting software. This software – or an accountant – reconciles these individual transactions into appropriate accounts or categories and then generates reports based on these consolidated transactions. These reports summarize the financial situation of your company.
Despite the many nuances for some industries, bookkeeping and financial accounting is not difficult; both just require dedication and perseverance. Either way, you need to tackle the challenges of small business accounting head-on.
It’s relatively easy to generate the reports that you and your staff will use to assess the financial health of your organization. Among the standard features of accounting software is the ability to generate reports with just a few clicks. It is difficult to know what to do with the information and what decisions to make based on these files.
Types of Financial Statements
Here is an overview of the main types of financial statements and what they reveal about your business.
|Declaration||what it shows|
|income statement||Your business income and expenses over a period of time|
|Balance sheet||An overview of your organization’s assets, liabilities and net worth|
|Cash Flow||The flow of money in and out of your company’s coffers over a period of time|
|Retained earnings||The amount of your company’s profits that have been retained – not distributed to shareholders or creditors|
|Equity||The total liquidation value of your business for its individual owners|
These are just a few of the basic financial statements your business can produce using standard financial accounting practices. Although each type of statement has a standard format, you can customize the statements to suit your specific business needs.
You’ll use each type of financial statement in different scenarios because they provide unique details about your business’ financial condition. Some, such as the balance sheet or statement of equity, provide snapshots of specific accounts at a given time. Others, like an income statement or a cash flow statement, show changes over a period of time.
Because of their differences, these financial statements tell very different stories and you will use them to make very different decisions. For example, the right combination of statements might indicate if your business makes a lot of money but has little real value; while another combination of statements can show if your business (asset-based) is making very little money each year relative to its size.
Types of accounting: accrual method or cash method
Financial accounting involves many different processes and reports, but all depend on the type of accounting used by your business – cash or accrual. These accounting policies determine when your business recognizes new income and expenses.
Under accrual accounting, your business would accrue all transactions when they are agreed upon. For example, when your business receives an invoice, you or your accountant records the invoice as an expense.
If your business uses cash accounting, on the other hand, you will record transactions not when they accept a transaction, but when the money changes hands. In this case, items such as unpaid bills may still be recorded in your financial records, but may be filed separately until paid. An unpaid invoice, for example, would appear as a liability rather than an expense.
Unfortunately, you may not be able to use cash accounting due to IRS restrictions. According to the IRS, several types of businesses are prohibited from using cash accounting:
- AC Corporation with average annual gross revenue of $25 million or more over the past three years
- A partnership with a C Corporation where the partner’s average annual revenue is greater than $25 million over the past three years
- A tax shelter under section 448(d)(3)
- Any company that sells on credit
Although these businesses are required to use accrual accounting, your business may Choose to use it. Therefore, most businesses licensed to use cash accounting do so because it is easier to implement. Nevertheless, most small businesses use accrual accounting.
The differences between cash and accrual accounting may seem semantic, but they determine when to recognize income and expenses. This can have a significant impact on the state of your business as it appears on paper – and therefore has serious implications if you are looking to buy or sell the business, or raise or borrow money. money.