Financial accounting is a type of accounting undertaken by businesses to report a company’s transactions via financial statements. Businesses have multiple transactions daily that need to be recorded and analyzed for important financial decisions, and that is exactly when financial statements prepared for financial accounting play a vital role.
What is Financial Accounting?
Definition:
The process of recording, classifying, reporting, and analyzing business transactions is called financial accounting. This is a necessary process required to analyze the overall financial health of the organization. All the transactions related to sales, purchases, accounts payable, and accounts receivable are recorded to be analyzed correctly.
Financial Accounting is recording, checking, and explaining all monetary activities of a business. It helps a business to keep track of income, expenses, profit, and loss in a clear and organised way.
In simple words, accounting tells you how much money flows in, how much money flows out, and what amount left.
Meaning of Accounting
The main idea of accounting is to keep proper records so that the business knows its real financial position.
This makes it easy to understand:
- How well the business is doing
- If it is earning a profit
- If costs are increasing
- If the business can grow safely
The main aim of financial accounting is to display a company’s profits and losses so that the stakeholders can make the right decisions.
What Are Accounting Concepts?
Accounting concepts are basic rules that guide how financial records should be made. They make sure all businesses must follow the same method, so financial statements stay clear, fair, and easy to compare.
These concepts act as the foundation of the entire Financial accounting system.
Major Accounting Concepts :
Accounting Concept |
Simple Meaning |
Why It Matters |
Example |
Business Entity Concept |
The business and the owner are separate. Their money should not be mixed. |
Helps show the true financial performance of the business. |
The owner’s personal expenses should not be recorded as business expenses. |
Money Measurement Concept |
Only things that can be measured in money are recorded. |
Keeps records clear and measurable. |
Employee skills or customer happiness are not recorded because they can’t be measured in money. |
Going Concern Concept |
The business is expected to continue operating in the future. |
Assets are recorded at normal value, not resale value. |
A building is recorded at its book value, not what it could be sold for today. |
Accrual Concept |
Record income and expenses when they happen, not when cash moves. |
Shows the real financial result of a period. |
You record service revenue today, even if the payment comes next week. |
Matching Concept |
Record expenses in the same period as the income they help generate. |
Helps show accurate profit or loss. |
If income is earned in April, related expenses should also be recorded in April. |
Dual Aspect Concept |
Every transaction has two sides: one gives, and one receives. |
Maintains the rule Assets = Liabilities + Equity. |
Buying furniture: the business receives furniture and gives cash. |
Read More: What is the Double Entry System in Accounting?
What Are Accounting Principles?
Accounting principles are basic rules and guidelines that explain how financial statements should be prepared. They help keep financial information clear, accurate, and credible so that investors, banks, and regulators can understand and rely on the data presented.
These principles make sure businesses follow the same standards, which improves transparency and comparability.
Major Accounting Principles
Accounting Principle |
Simple Meaning |
Why It Matters |
Example |
Revenue Recognition Principle |
Record income when it is earned, not when cash is received. |
Shows the true income of the period. |
You deliver a service today but get paid next week — record income today. |
Prudence / Conservatism Principle |
Do not overstate profit or assets; record losses early and gains only when certain. |
Keeps financial reports safe, honest, and realistic. |
If you expect a loss, record it now; if you expect a gain, wait till it happens. |
Materiality Principle |
Record important items; ignore very small or minor details. |
Makes statements clear and easy to understand. |
A ₹5 pen purchase may not need detailed reporting. |
Cost Principle |
Record assets at their actual purchase cost, not current market value. |
Keeps records consistent and verifiable. |
A machine bought for ₹50,000 is recorded at ₹50,000 even if its value changes. |
Full Disclosure Principle |
Share all important information that can affect decisions. |
Builds trust and transparency. |
Disclosing lawsuits, risks, or major financial events in reports. |
Financial Accounting Guidelines
Organizations need to undertake financial accounting following the Indian Accounting Standard (Ind AS) for credibility and uniformity across accounting processes. These guidelines are at par with the International Financial Reporting Standards (IFRS).
Who uses Financial Accounting?
Organizations are supposed to make their financial accounting data public via quarter and annual financial statements. This provides internal and external stakeholders with vital financial data.
Financial accounting is majorly done for external stakeholders like investors and creditors to understand the financial health of the organization and take decisions accordingly.
Financial accounting is used by the following stakeholders:
- Financial accounting data is used by suppliers and trade creditors to know the short-term liquidity of an organization
- Investors use data to estimate the possible investment risk and predict future dividends
- Lenders use data to predict the company’s ability to pay back loans
- Customers use financial statements to know the long-run prospects of a business
- Employees use data to know the company’s profitability and stability
- Company management evaluates progress and identifies areas for improvement
- Government agencies use data to levy appropriate taxes
- Investment analysts use financial statement data to know the company’s competitive position.
Importance of Financial Accounting for Businesses
- Financial accounting is important to track financial transactions and prepare financial statements.
- As financial accounting is done following the Indian Accounting Standard guidelines, it is easier for companies to create financial statements that are universally accepted.
- Financial statements are public documents that help improve a company’s credibility in the market.
- Businesses can invest and allocate their resources better following the analysis of their financial performance.
- Financial accounting defines rules that organizations must follow while making their financial performance public.
Types of Financial Accounting
Financial accounting is broadly divided into two types – Cash Accounting and Accrual Accounting.
The major difference between them is the timing of transaction recording.
- Cash Accounting
This method of accounting records transactions when they occur in cash. A company records income after receiving cash from sales. It requires transaction recording only when money moves in and out of the bank account.
Businesses with large inventories don’t use cash accounting as it doesn’t consider liabilities incurred but not paid yet. - Accrual Accounting
This method of accounting records transactions whether they are earned or incurred. Businesses use accrual-based accounting to create journal entries for sales and expenses even before collecting or making payments.
Accrual-based accounting is standard among businesses handling large volumes of credit transactions.
Objectives of Financial Accounting
The main aim of financial accounting is to provide accurate financial information to internal and external stakeholders. This analysis allows businesses to protect the interests of their stakeholders, fulfill legal requirements, and optimize resource allocation.
These are the objectives of financial accounting:
- Recordkeeping
- Compliance with statutory requirements
- Know profitability
- Facilitates management decision-making
Recordkeeping
Financial accounting facilitates a systematic process for recording financial transactions in the accounting books. Organizations use these books to analyze their financial performance.
Compliance with statutory requirements
Organizations comply with tax regulations and other statutory requirements following the process of financial accounting.
Know profitability
Businesses can know their net income from assets, liabilities, and equity with financial accounting.
Facilitates management decision-making
The accounting process allows stockholders, creditors, and investors to know the company’s financial position. It also helps the management while making analytical decisions for the company’s growth.
Features of Financial Accounting
- Financial accounting keeps a record of only monetary transactions from a business point of view.
- Financial accounting tracks transactions that have already taken place in the past.
- Organizations are required to keep their financial accounts updated with timely auditing of financial statements to ensure accuracy.
- Financial accounting informs customers, investors, suppliers, and financial institutions about the financial performance of an organization.
- Organizations consider financial accounting statements covering less than a year as interim reports. These reports are used to convey the financial performance before a full-year reporting cycle ends.
- Financial accounting is the foundation for other accounting branches such as management accounting, cost accounting, and other advanced accounting methods. This is so as it deals with raw data from journal entries and ledgers.
What are the main functions of Financial Accounting?
- Financial accounting helps create financial statements that allow investors, tax authorities, and lenders to understand the organization’s financial position.
- Financial accounting maintains a systematic record of financial transactions while following accounting standards and regulatory guidelines.
- Accounting teams analyze and summarize financial records in the trial balance. The final statement showcases the profits or losses of an organization during a financial year.
- Financial accounts enable organizations to share their annual financial performance with internal and external stakeholders.
- Financial accounting encourages organizations to fulfill their legal obligations, such as bookkeeping, auditing, and tax liabilities.
What are the 4 main financial statements?
The four main financial statements are
- Balance sheet
- Income statement
- Cash flow statement
- Statement of retained earnings (also known as the statement of owner’s equity)
Balance Sheet
A statement of net worth that showcases an organization’s assets, liabilities, and shareholders’ equity at a particular time. Also known as a statement of financial position, a balance sheet has an accounting equation that balances out the assets by adding liabilities and shareholders’ equity.
Assets = liabilities + shareholders’ equity
A balance sheet is used by accountants to calculate key financial ratios. It also helps investors know the capital structure of an organization and calculate rates of return.
Income Statement
A profit and loss or income statement showcases an organization’s gains, revenues, expenses, and losses in a particular period. Also known as a revenue and expense statement, it allows organizations to assess depreciation, figure out less-performing areas, and compare performance against their competitors.
Cash Flow Statement
A cash flow statement showcases incoming and outgoing cash and cash equivalents (CCE) to allow businesses to evaluate their operational abilities. Organizations use this financial statement to gauge their ability to generate cash for operating expenses.
A cash flow statement includes the following activities:
- Operating activities that showcase the incoming cash flow from selling goods and services
- Investing activities that help in cash generation from physical and non-physical property buying and selling
- Financing activities that include cash flow from debt and equity financing
Statement of Retained Earnings
The owner’s equity statement has the sum of earnings that an organization reserves for investing in business operations. Organizations use these earnings to pay debt, buy fixed assets, or use them as working capital.
Conclusion
Accounting plays an important role in helping every business understand its real financial position. By using accounting principles, accounting concepts, and financial accounting methods, companies can keep their records clear, correct, and easy to trust.
These rules make sure that income, expenses, assets, and liabilities are recorded in the right way, so that banks, investors, and business owners can make better decisions. They also help maintain transparency, avoid errors, and follow legal requirements.
Frequently Asked Questions
1. What is financial accounting?
The detailed process of recording, analyzing, and summarizing the financial transactions of an organization for an accounting period is financial accounting. It allows businesses to evaluate their financial health and stability.
2. What are the three major types of accounting?
Three types of accounting are:
- Financial Accounting
- Cost Accounting
- Managerial Accounting
3. What is the main aim of financial accounting?
The main aim of financial accounting is to create and share financial statements with external stakeholders so that they can evaluate the overall financial performance of the company.
4. What is an example of financial accounting?
A financial statement made public is the best example of financial accounting. Prepared using universally accepted accounting guidelines, it keeps a record of both incoming and outgoing financial transactions.
5. What is the difference between cost accounting and financial accounting?
Cost accounting is undertaken for internal management to make informed decisions related to product pricing and budget strategy.
Financial accounting is primarily concerned with external stakeholders and is made public for them to make decisions accordingly.
