The financial accounting process is significant in the operations of business and provides to the organisation insights into its financial performance and state. The recording, summarisation, and reporting of financial transactions systematically to stakeholders in an organisation comprise financial accounting. This article analyses financial accounting, its underlying principles, and its significance for business use. Enroll now in a Financial Accounting course to enhance your skills in resolving disputes and fostering stronger collaborations.
While income statement, balance sheet and cash flow statement, financial accounting prepares company financial statements. In short, financial accounting serves the purpose of depicting the financial business activity of a certain company to different kinds of people who are interested outside investors, creditors, regulators, and even to management itself.
The purpose of Financial accounting has the ultimate goal of assuring transparency and accountability to third parties.
There are some critical principles guiding financial accounting, which help to keep the consistency and accuracy of financial statements. Set at the foundation, these principles develop the standardised presentation of financial statements so that comparability becomes possible. Some examples of the most significant principles of financial accounting include:
Under this principle, financial transactions should be recognised when they happen, and not when cash or cash equivalent is paid. Therefore, revenue is recognised when earned, and expenses incurred, irrespective of their payment; that is, when cash receipt and disbursement take place. The accrual principle helps in making a more realistic portrayal of the company's financial performance, especially in instances when there is a gap in the revenue receiving and earning.
According to the consistency principle, an organisation should adopt a method of accounting, including practices, and use the same method from one financial period to the next. From this, financial statements will become comparable with the previous year's records. For example, if, in a given year, a business adopted a specific method of valuing its inventories, then the same should be adopted in subsequent years unless there is a reason to change it. Consistency in accounting practices is at the core for investors and other stakeholders to evaluate historical trends in finance and make decisions that are sound.
Another primary principle is the going concern, meaning that an organisation will last within the foreseeable future. This is unless evidence can be shown otherwise. This principle is meant for the valuation of assets and liabilities. Example: a company will most likely be forced to sell its assets at lower prices, which brings a position regarding such a company's financial statement, where the company is not assumed to be able to continue as a going concern. Take for instance the going concern assumption, whereby it allows businesses to argue the purpose of preparing financial statements as if they will operate for a long period.
The prudence principle states that accountants should be conservative in their estimates, recognising liabilities and expenses as soon as they can be attached at a balance sheet date, but recognising income only when it is certain. That way, businesses do not overstate their financial position. Prudence allows financial statements to avoid being excessively optimistic so that they do not confuse users.
The matching principle states that expenses incurred must be matched to revenues that were earned as a result of these expenses for the same period.
Financial accounting makes up the lifeblood of business transactions. Financial accounting information is fed for decision making, strategizing, and accountability by stakeholders. Moving further in depth, here are some of the reasons why financial accounting is important.
It is also one of the main purposes of financial accounting. To have full disclosure of the financial affairs of an organization. When financial statements are found to be accurate and reliable, businesses can develop accountability to stakeholders, such as investors, lenders, and regulators. That is, by following the accounting standards and principles, an enterprise would be able to demonstrate its financial soundness, establish trust, and promote positive expectations from external parties.
Stakeholders are provided credible information to enable them make sound decisions by financial accounting. Investors take a keen look at financial statements in their quest to determine the investment return they can expect. Creditors analyse the company to determine its ability to repay them. Managers study financial accounting data to inform them on issues such as budget allocation, cost management, pricing decisions, and so on. Without the proper financial information, however, such decision making is rather a tacky affair fraught with risks.
Most countries require companies to keep accurate records of their finances and periodically file financial statements. Legislation on maintaining proper financial records and filing around-the-clock financial statements is often framed within specific legal frameworks, such as GAAP in the US and IFRS worldwide. When firms comply with these, they prevent future legal penalties against their establishments and, at the same time, help maintain good standing with regulatory authorities.
For the businesses aiming to mobilise investments, it is an indispensable part of their requirements. Investors and venture capitalists make use of financial statements to evaluate the financial strength or endurance of a company before committing resources to it.
Financial accounting enables businesses to gauge their performance over time. By comparing the financial statements from different periods, companies can get to know whether there are revenue, expense, profit, and overall financial health trends. Such information is essential in ascertaining what the improvement areas would be and what corrective actions may be needed. Monitoring financial performance through accounting also assists businesses in setting realistic financial goals and objectives.
In conclusion, financial accounting plays a very important part in the transparency, accuracy, and well-informed decision-making in a business. By following predetermined principles, it makes it easy for businesses to maintain consistency in reporting results and thus provides critical insights into the financial performance of a company. Financial accounting is also beyond the legal requirement to get investment, measure performance, and build confidence with stakeholders. The British Academy for Training and Development runs ultimate comprehensive courses in this subject for anyone seeking to excel in Financial Accounting.