At its core, financial accounting is a systematic process that captures business transactions, organizes them, and presents them in a structured manner.
We can think of a financial accountant as a conductor of a grand symphony, orchestrating a melody of numbers. Crafting financial statements is like composing a musical score. The result is a performance for everyone to enjoy. Here’s a basic breakdown of how it all comes together.
1. Recording Transactions
Every time a business engages in a financial activity, like a sale, purchase, or expense, it must be recorded. These transactions are the building blocks of financial accounting, much like the notes that musicians play.
In our example, when a manufacturer sells its goods, the revenue generated from the sale and the collection of applicable taxes are recorded. Financial accountants specializing in tax accounting can help when sales and other taxes come due. The book of transaction records relies on double entry accounting to drive data consistency.
2. Classifying and Categorizing
To make sense of business transactions, we can organize them into categories, such as revenue, expenses, assets, liabilities, and equity. Classification ensures that each transaction finds its rightful place in the financial landscape. Think of it like grouping brass or woodwind musicians in sections of an orchestra.
For example, cash received from sales is categorized as “sales revenue,” and cash received for taxes is categorized as “sales tax.”
Managerial accounting, or cost accounting, is a branch of this process. The name managerial accounting states that its audience is the management of private companies using it to operate the business.
3. Summarizing
Periodically, usually at the end of a financial period, financial transactions are summarized into quarterly or annual financial statements. These statements provide a snapshot of the company’s financial position and performance during the accounting period. Financial statement reporting includes the balance sheet, income statement, and cash flow statement. Imagine it as a musical performance.
For example, a goods manufacturer will have a variety of sales and payment categories. These categories can be summarized as “Revenue” or “Expenses” and put in financial statements for a specific period of time. The income statement compiles revenue, expenses, and other financial activities.
4. Communicating, Analyzing, and Interpreting
How do stakeholders assess the company’s state of health? They may analyze financial ratios and trends to make informed decisions. This analysis helps us to understand whether the business is profitable and solvent, and to model future cash flows. External parties gauge the level of reliability they want to see, like a symphony’s audience can appreciate the work of the conductor and the orchestral performance.
Suppose our manufacturer wants us, as a potential lender or investor, to be able to rely on the income statement, balance sheet, and cash flow statement to analyze and fund an expansion. The company will want financial accountants to give a quality opinion when preparing financial statements, using standards like Generally Accepted Accounting Principles (GAAP) set out by the Financial Accounting Standards Board (FASB) or other similar bodies. The goal is to meet our expectations when we interpret financial statements.
