If you’re starting a business, you’re probably wondering, “What is financial accounting?” In short, it’s 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 income, expenses, liabilities and equity. This type of financial accounting aims to bring the numbers together. Give a good picture of the financial situation of small businesses over a given period.
There are three statements included in a final report. Financial accounting brings together all the necessary information in one place. This makes it more user-friendly and easier to understand. Without this type of financial reporting, SMEs would struggle to operate.
Types of financial accounting
There are several types of accounting methods. Learn more about the accrual method and cash basis of accounting below.
The exercise method is specific. Expenses and income are recognized as soon as a transaction takes place. Unlike cash accounting which records when payment is made or received. Accrual accounting is more common.
The cash method is different. Recorded financial information is more immediate. Income and expenses are recorded over time. There is a downside to this. Cash accounting does not always provide accurate financial results for larger businesses and those with larger inventories.
The cash method is good for sole proprietors.
Main financial statements in financial accounting
Accounting financial statements have reporting requirements. This type of accounting involves seeing how the following financial statements interact.
This shows the profitability for a specified period. This is also called a profit and loss statement. Included are revenues from sales and expenses to arrive at net income. A great indicator of financial health.
A balance sheet is one of the most important financial statements. This is a summary of current assets, liabilities and equity. Public companies include accounts payable and accounts receivable.
A statement of retained earnings is added, as well as shareholders’ equity.
Statement of retained earnings
This financial statement sits between the income statement and the balance sheet. This is another transaction-oriented accounting practice. It accounts for all deductions such as dividends paid and the net amount remaining.
Cash flow statement
Cash flow financial statements are important performance indicators for a small business. A statement of cash flows on any balance sheet must be positive. A good cash flow has more money coming in than going out. A negative cash flow on the basic financial statements can lead to bankruptcy.
A cash flow statement also looks at how well you generate cash. These financial statements use an indirect or direct method to value business transactions. A cash flow statement completes the income statement and the 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 essential. Financial accounting rules cover several important aspects in the same period. Like equity.
Here are five reasons why these financial statements are important.
- They detect fraud: These accounting rules eliminate fraud. And suspicious activity. Like an income statement full of false income.
- They highlight performance: A company’s annual report shows its performance relative to previous years and industry averages. Net income measures turnover.
- They determine the taxes: The accounting principles involved determine the taxes a small business must pay.
- They help to make decisions: The management of any business uses these financial accounting reports to advance decisions regarding loans, expansions, etc.
- Double-entry accounting: It provides a complete income picture. Management can trust numbers like these since there are at least two accounts. A debit and a credit.
A trial balance detects any error. Using accrual accounting also helps to see which months are profitable.
They are legal
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 a few differences between these two types.
- Cost accounting manages cost records. Financial accounting occupies a more important place. It manages all the financial data of a small business.
- The period during which they are reported is also different. Costs are reported at frequent intervals while a financial report is presented at the end of a fiscal year.
The similarities include the fact that they both use the double entry method to record a company’s business transactions.
Financial Accounting Vs. Management Accounting
There are also similarities and differences between these two methods. The differences come down to the purpose of each.
- Financial accounting collects data which is transformed into financial statements.
- Management accounting is internal. It is used to review business transactions.
Both of these look at the numbers of 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 can imagine, the cost of hiring one of these professionals varies. Location, experience and the type of work to be done are all factors. According to ZipRecruiter, the national average is $55,045 per year, which translates to about $26 per hour.
Deciding what features you need will affect the cost. Financial record keeping 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 complete income statement along with other types of financial statement boxes checked. An accountant can decide what works best. If you want to use accrual accounting or cash accounting for your business. But there is a DIY option that can handle any bookkeeping, like 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 information. They develop standards and monitor their implementation. They follow generally accepted accounting principles (GAAP). They monitor private and public companies.
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