Financial accounting - What is financial accounting?

Financial accounting is an accounting method in which financial statements are prepared for a business covering a specific period of time. It is most often used to gather information for potential investors.

Want to learn more about different accounting methods? Take a look at our article on cost accounting.

Financial accounting is used to show the financial health and stability of a company. It is most commonly used for investors, however, it may also be used to provide information to creditors, customers, and suppliers.

Financial accounting vs management accounting

Financial accounting and management accounting are both different types of accounting methods. Management accounting refers to preparing financial documents for the management team to set a budget and forecast outcomes in the future.

While both methods involve preparing financial statements, management accounting is focused on detailing financial status for a management team within a company, while financial accounting provides information to external parties.

Documents and statements included in financial accounting

The majority of companies gather quarterly and yearly financial statements to keep track of the overall performance of the business. With financial accounting, there are several documents that you can provide to investors or external entities to explain the businesses finances.

The balance sheet

The balance sheet is one of the main accounting reports which outlines what the company is worth at any given time.

The balance sheet has three sections:

• Assets
• Liabilities
• Owner’s equity

This data will provide a general overview of the financial state of the company, as well as the leverage and return on investment.

The profit and loss statement

The profit and loss statement indicates the revenue and losses (expenses) over a period of time (generally over a quarter or a year).

In other words, it shows the net profit which is the total amount earned after all relevant costs have been paid.

This is important for investors to see the profitability of a company and trends for certain time periods.

The statement of retained earnings

The statement of retained earnings is a document that outlines the changes in retained earnings over a period of time.

This statement describes how profits are distributed and how much is retained by taking the net profit over a specified period and showing the amount retained as well as the amounts paid out in dividends.

The statement of retained earnings can either be a standalone document or included in the balance sheet.

The statement of cash flows

The statement of cash flows summarises the cash transactions within a specific period.

The statement includes both incoming and outgoing cash and divides it into categories, such as operating activities, financing activities, and investing activities.

This can be used to show potential investors the company’s liquidity and the ability to pay off short-term debts or obligations.

Financial accounting standards

The International Financial Reporting Standards (IFRS) identify how financial statements and transactions should be reported.

Although most EU companies should be using the IFRS, the most commonly used financial standards in the UK are the UK Generally Accepted Accounting Practices (GAAP).

There is work being done to align the two practices, however, as it stands, the IFRS has limited scope within the United Kingdom.

Financial accounting and invoicing software

Invoicing software can help you create professional invoices and quotes, but it can also help you create important accounting documents!

With Debitoor, you can quickly create the balance sheet, profit and loss statement, and VAT report all in a few clicks.

The information is easily laid out on the software so you can gather the information you need for your documents.