What's financial accounting and why is it important?
Financial accounting holds significant importance in business, regardless of the company's size. Accurate financial accounting provides insights into the overall financial health of your company and assists in securing credit, loans or investors as you grow.
In this guide, you'll learn about financial accounting, its importance and how to apply it to your business.
What is financial accounting?
Financial accounting summarises and reports all the transactions for your business. It's primarily used to give external stakeholders a snapshot of the financial health and profitability of your business.
It's done using several core financial statements. These include the balance sheet, income statement, cash flow statement and statement of retained earnings.
Financial accounting generally covers transactions over a fiscal or calendar year, but other time ranges such as weeks, months and quarters can also be used.
Why is financial accounting important?
Financial accounting is important for letting you and other stakeholders gauge your overall business performance.
Accurate reporting of your business transactions, profitability and financial status is crucial for external stakeholders or possible creditors in order to gauge your likelihood of generating profit.
Types of financial accounting
The two main types of financial accounting are accrual-basis accounting and cash-basis accounting.
Accrual basis accounting
Accrual-basis accounting records your revenue and expenses when you send invoices or receive bills, rather than when you pay them.
Cash-basis accounting
Cash-basis accounting records revenue when you bring it in and expenses when you pay them, regardless of when the transactions occurred.
Statements used in financial accounting
Statements used in financial accounting give you a full picture of how much money you have and owe, and any profit you're making. These four types of financial statements are:
Cash flow statement
Your cash flow statement records the money moving in and out of your business.
Balance sheet
The balance sheet provides an overview of your business's current financial status, including assets, liabilities and equity.
Income statement
The income statement is sometimes referred to as a profit and loss statement. This shows your business revenue and expenses over time, and whether your company is making a profit or loss.
Statement of retained earnings
The statement of retained earnings shows how much money you have left after shareholders have been paid. This adds all the money you've kept in the business since you began trading.
Financial accounting principles
Financial accounting principles are a collection of rules to follow that ensure reporting is consistent, accurate and easy to examine. Here are some of them:
Cost principle
The cost principle dictates that your assets be recorded at the prices you paid for them. These don’t change, even if market values change.
Revenue recognition principle
The revenue recognition principle dictates that you record anything you spend or make using accrual-basis accounting. So, you record money in and out when invoices are generated, not necessarily when money changes hands.
Objectivity principle
The objectivity principle makes any reporting of accounts objective, without any personal opinion or bias. This means your final reporting is more credible and useful for analysis.
Matching principle
The matching principle ensures you record your money in and out as transactions happen. This means you can’t record the money made in one year and the expenses from those earnings the next year.
Full disclosure principle
Under the full disclosure principle, reporting should include all relevant and necessary information in financial statements. This ensures anyone reading the statements has a complete picture of the financial position of your business.
Financial accounting beneficiaries
Financial accounting beneficiaries — that is, those who benefit — include:
Customers
Customers will want to know that your business is financially stable and can deliver what they need.
Employees
Employees benefit from accurate financial accounting. Transparent and accurate recording and reporting of income, loss and profitability supports business growth and employee security.
Investors
Investors in your company will use financial accounting reports to predict your future success. The reporting gives a snapshot of your business's overall performance and any current debts or shortfalls.
Creditors
Creditors will need accurate financial reports before lending you money. Financial accounting helps show that your business is viable and that you can repay loans.
Management
Your business management will use the reporting to make informed financial decisions.
Regulators
Regulators, whether industry-specific or government, need financial accounting reports to examine how your business operates and its viability.
Financial accounting FAQ
What is the difference between financial accounting and managerial accounting?
The difference between financial accounting and managerial accounting is that financial accounting gives external stakeholders insight into your company's financial health.
Managerial accounting is used internally for decision-making and risk assessment.
What is the difference between bookkeeping and financial accounting?
The difference between bookkeeping and financial accounting is that bookkeeping records transactions, while financial accounting summarises and reports on them.
What are the different types of accounting?
There are several types of accounting. The most common are tax, managerial, financial and cost accounting. There are highly specialised kinds of accounting too, like forensic or audit accounting.
Get a clear picture with financial accounting
Accounting software can make running a business and managing your finances as easy as possible. Using core financial statements – cash flow statement, income sheet, balance sheet and retained earnings – you can have an accurate picture of how much money you're making and spending, and how likely you are to generate a profit.
MYOB Business has everything you need to simplify your financial accounting – get started today.
Disclaimer: Information provided in this article is of a general nature and does not consider your personal situation. It does not constitute legal, financial, or other professional advice and should not be relied upon as a statement of law, policy or advice. You should consider whether this information is appropriate to your needs and, if necessary, seek independent advice. This information is only accurate at the time of publication. Although every effort has been made to verify the accuracy of the information contained on this webpage, MYOB disclaims, to the extent permitted by law, all liability for the information contained on this webpage or any loss or damage suffered by any person directly or indirectly through relying on this information.