Financial Accountance

Financial accounting is the area of accounting that focuses on providing external users with useful information. In other words, financial accounting is a way of reporting business activity and financial information to investors, creditors, and other people outside the business organization.

Investors and creditors are often called external users because they are people outside of the organization who use the company financial information to make decisions. The most common form of financial information issued to external users by companies is a general purpose set of financial statements.

These financial statements, along with financial accounting standards in general, must be held to strict rules, so the financial statements will be useful and of high quality. That is why GAAP governs the principles and standards of financial accounting. GAAP requires that accounting information be relevant, reliable, and consistent among other things. This insures that external users will be able to have quality information to base their financial decisions on.

All external users have different needs when it comes to financial information. For instance, a lender is primarily concerned with a company’s cash flow and ability to repay loans with interest. An investor, on the other hand, is more concerned with company profit performance and longevity.

The overall purpose of financial accounting is to create information or financial statements that can be used by all external users to base their financial decisions on whether or not these decisions involve lending money or investing money.

Accounting for internal users is typically considered managerial accounting and is subject to less stringent standards and requirements.

Financial Statements

Financial statements are reports prepared by a company’s management to present the financial performance and position at a point in time. A general-purpose set of financial statements usually includes a balance sheet, income statements, statement of owner’s equity, and statement of cash flows. These statements are prepared to give users outside of the company, like investors and creditors, more information about the company’s financial positions. Publicly traded companies are also required to present these statements along with others to regulator agencies in a timely manner.

Financial statements are the main source of financial information for most decision makers. That is why financial accounting and reporting places such a high emphasis on the accuracy, reliability, and relevance of the information on these financial statements.

Example

The balance sheet a summary of the company position on one day at a certain point in time. The balance sheet lists the assets, liabilities, and owners’ equity on one specific date. In a sense, the balance sheet is a picture of the company on that date. Investors and creditors can use the balance sheet to analyze how companies are funding capital assets and operations as well as current investor information.

The income statement shows the revenue and expenses of the company over a period of time. Most companies issue annual income statement, but quarterly and semi-annual income statements are also common. Users can analyze the income statement to see if companies are operating efficiently and producing enough profit to fund their current operations and growth.

The statement of owner’s capital summarizes all owner investments and withdrawals from the company during a period. It also reports the current income or loss recorded in retained earnings.

Financial Reporting

Financial reporting refers to the communication of financial information, like financial statements, to the financial statement users, like investors and creditors. Financial reporting is typically viewed as companies issuing financial statements. A general purpose set of financial statements include a balance sheet, income statement, statement of owner’s equity, and statement of cash flows, but financial reporting is much more broad than just as set of financial statements. Financial reporting includes all financial communication from the business to outside users including press releases, shareholder minutes, management letters and analysis, auditor reports, and even the notes of the financial statements. Basically, anything that can convey financial information to the public is considered financial reporting of some kind.

Example

One of the most common forms for financial reporting, other than financial statements, is management’s discussion and analysis or MD&A. This is a report issued by management that discusses not only the current financial position of the company, but it also speculates on future performance and possible market opportunities. Management can also discuss debt arrangements as well as the liquidity and capital resource position of the company.

MD&A is a great way for investors and creditors to get additional information about the company to predict how well it will perform in the future. Financial statements along with MD&A and the other publicly available financial reports listed above, should give potential investors and creditors enough information to make their financial decisions about the company.

Publicly traded companies are not only requited to make these report available to the public, they must also issue these reports to the regulator agencies.

Balance Sheet

A balance sheet is one of four basic accounting financial statements. The other three being the income statement, state of owner’s equity, and statement of cash flows. The balance sheet uses the accounting equation (assets = liabilities + owner’s equity) to show a financial picture of the business on a specific day. In other words, a balance sheet lists all of the assets that a company owns as well as the debts owed by the company and the owner’s interest or ownership share in the company. Assets are listed separately first and liabilities and owner’s equity are listed together second. Think about the accounting equation. Assets = Liabilities + Owner’s equity. Assets have to total the sum or liabilities and owner’s equity. This is where the “balance” in balance sheet comes from. Assets have to balance with liabilities and owner’s equity.

Income Statement

The income statement also called a profit and loss statement is a report made by company management that shows the revenue, expenses, and net income or loss for a period. The income statement is one of the main four financial statements that are issued by companies: balance sheet, income statement, statement of owner’s equity, and statement of cash flows.

The income statement shows income and expenses for a specific period of time. This could be monthly, quarterly, semi-annually, or annually. A January income statement for example would show all the income and expenses for the month. It would also show the net income or loss at the end of January. Income statements created for management are usually shorter in time frame. These weekly or monthly income statements help management evaluate the company’s performance. Quarterly and annual income statements are more commonly used by investors and creditors to track the overall performance of the company.

Income statements usually include a heading with the name of the company, the title of the statement, and the time period. Depending on the company’s size and complexity, the income statement can be large or small. A condensed income statement will have three main categories: revenues, expenses, and net income or loss. Revenues are listed and totaled first with expenses following. The expenses are usually sorted either alphabetically or by dollar amount. After the expenses are totaled, net income can be calculated by subtracting the total expenses from the total income.

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