Financial accounting is the documentation of your business finances using various reports and statements. These statements detail the income, expenses, assets and liabilities of your business. Executives 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 keeping track of your company’s income and expenses. Financial accounting goes further; it involves compiling records of individual transactions into comprehensive reports for management, shareholders and others to review.
Financial accounting is often legally required if your business produces financial statements as part of its annual reports or reports to shareholders. These financial statements are also useful for making management decisions and deciding tax strategies. (Note that while financial statements are useful during tax time, actual tax returns require special reports prepared separately.)
Financial accounting may 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’re set up, all you need to do is track your ongoing transactions and periodically prepare relevant reports.
What is the difference between accounting and financial accounting?
Basic accounting for your small business is the process of establishing policies and procedures regarding how income, expenses, assets and liabilities are handled. Financial accounting is all about taking all of this data and compiling it into a usable format, which is precisely concise financial statements that summarize the financial condition of your business.
Small business accounting involves:
- Establishment of books and records
- Recording of all your business transactions – in cash and not in cash
- Implement policies and procedures for the treatment of income, expenses, assets and liabilities
- Manage all your company’s financial data, such as accounting records
Finally, small business accounting requires setting up a reporting process that reflects the financial condition of your business, this is where financial accounting comes in.
Financial accounting is the compilation of all transactions recorded as part of normal accounting activities. Using accounting software, these records are consolidated into statements. Here are some of the main reports that financial accounting will generate:
- Income statement: This shows all the income, expenses, gains and losses for your business, team, department or project for a defined period of time.
- Balance sheet: This gives an overview of your business’ current financial position – including equity – by adding up the assets and liabilities 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 inputs and outputs in the form of income (collected) and expenditure (paid).
- Statement of retained earnings: This shows the value that shareholders hold in a company based on the initial capital contributions and the net profits that have not been distributed as dividends.
How does financial accounting work?
Financial accounting is the process of recording all of your business’s transactions in accounting software. This software – or an accountant – reconciles these individual transactions into appropriate accounts or categories, and then generates reports based on those consolidated transactions. These reports summarize the financial situation of your business.
Despite the many nuances of some industries, accounting and financial accounting is not difficult; both just require dedication and persistence. Either way, you need to tackle the challenges of small business accounting head-on.
It is relatively easy to generate the reports that you and your staff will use to assess the financial health of your organization. One of the standard features of accounting software is the ability to generate reports with just a few clicks. Knowing what to do with the information, and what decisions to make based on these records is difficult.
Types of financial statements
Here’s an overview of the main types of financial statements and what they say about your business.
|Declaration||What it shows|
|Income statement||The income and expenses of your business over a given period|
|Balance sheet||An overview of your organization’s assets, liabilities and equity|
|Statement of cash flows||The flow of money in and out of your business coffers over a period of time|
|Retained earnings||The amount of your business’s profits that have been retained – not distributed to shareholders or creditors|
|Equity||The total liquidation value of your business to its individual owners|
These are just a few of the main financial statements your business can produce using standard accounting practices. And, while each type of statement has a standard format, you can customize statements to suit your specific business needs.
You will use each type of financial statement in different scenarios because they provide unique details about your business financial condition. Some – like the balance sheet or statement of equity – provide snapshots of specific accounts at a given time. Others, like an income statement or cash flow statement, report 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 can indicate if your business is making a lot of money but has little real value; while another combination of statements can show if your business (based on assets) is making very little money each year relative to its size.
Types of accounting: accrual method vs cash method
Financial accounting involves many different processes and reports, but all depend on the type of accounting your business uses – cash or accrual. These accounting methods determine when your business recognizes new income and expenses.
Under accrual accounting, your business would account for all transactions when they are agreed to. For example, when your business receives an invoice, you or your accountant record the invoice as an expense.
If your business uses cash accounting, on the other hand, you’ll record transactions not when they accept a transaction, but when the cash actually changes hands. In this case, items such as unpaid invoices may still be recorded in your financial records, but could 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. These companies include:
- AC company with average annual gross revenue of $ 25 million or more over the past three years.
- Partnering with a C Company – As a partner, the average annual revenue is over $ 25 million over the past three years.
- A tax shelter under section 448 (d) (3).
- Any business that sells on credit.
Although these businesses are required to use accrual accounting, your business may Choose to use it. Therefore, most companies licensed to use cash accounting do so because it is easier to implement. However, most small businesses use accrual accounting.
The differences between cash and accrual accounting may seem semantic, but they determine when to record 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.