Financial accounting is the process by which an organisation's revenues, receivables, and expenses are collected, measured, recorded, and finally reported into a financial statement.
Financial accountants collect, summarise, and present financial information that relates to all business transactions in a company.
At the end of each fiscal year, the government mandates us to file our taxes in order to account for our earnings and assets, our gains and losses and, of course, taxes on our property. For businesses, however, this process is not an annual event. Rather, that accounting takes place throughout the year, over regular intervals of time. Shareholders, investors and the government all have an interest in the financial health of the company. A company's financial statement is made public every 3 months, that is in every quarter the company's financial status is assessed.
For the purposes of this financial reporting, companies need qualified management and financial accountants, to facilitate this process throughout the year. A certified financial accountant plays the important role of keeping all financial data in place and on record. In India, The Institute of Cost Accountants is one of the premier institution to get this certification.
Let us now explore the nuances of financial accounting a little bit more.
Objectives of Financial Accounting
In order to understand the roles and responsibilities of a financial accountant, it is important to first familiarise yourself with the types of accounting:
- Accrual Concept: Company finance can be recorded either in accrual or cash basis. While the latter captures financial data in case of cash transaction, accrual accounting accounts for all transactions that results in revenue for the business.
- Economic Entity Concept: In some cases, financial accounting separate owners from business to delineate between legal identities. This allows for excluding personal transactions from financial statements.
- Going Concern Concept: An organisation is assumed to be in business for a long time, and hence revenue might be deferred.
- Matching Concept: To ensure that a transaction is fully accounted for, this method emphasises that expenses related to a specific income be recorded at the same period of time.
- Conservatism: This is a more traditional method of accounting. It states that a transaction might only be recorded as and when the resulting revenue is realised in the near future.
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In addition to the above key concepts, it is important to build a sound knowledge bases on the Generally Accepted Accounting Principles India, informally called GAAP, is the body of accounting standards that govern how a company must prepare their accounts for reporting.
GAAPs are basic accounting principles and guidelines which provide the framework for more detailed and comprehensive accounting rules, standards, and other industry-specific accounting practices.
Financial Accounting Objectives:
- Statutory Compliance: This is one of the primary functions of a financial accountant. They ensure that companies adhere to applicable tax laws and mandates of the Companies Act of 2013.
- Protecting Stakeholders' Interest: A business has several stakeholders including investors, shareholders, customers, and creditors. The job of a financial accountant is to provide necessary information related to company finance to these stakeholders, periodically.
- Policy Control: Another critical role of a financial accountant is to exercise control over the financial policies in a company. This has a direct impact on stakeholders as well.
- Profit and Loss Accounting: Financial statements and balance sheets are reflective of company earnings, revenue, assets, equity, and losses. This helps generate data to account for profit and loss and make necessary course corrections.
- Coverage of All Transactions: Financial accounting encompasses all types of business transaction including all external interactions with entities such as creditors and customers.
- Periodic Reporting: Financial accounting statements are recorded and made available throughout the year at regular time intervals. Usually, these data are publicly shared quarterly, half-yearly, and annually, keeping its relevance intact.
- Supplements Other Accounting: Other accounting methods like management or cost accounting, relies heavily on the reports and data furnished by a financial accountants. Put together, they drive important business decisions including expansion, or merger.
- Comprehensive Accounting: Another important objective of financial accounting is to prepare reports that are easy to understand and important.
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Scope of Financial Accounting
A financial accountant records every financial transaction, using the Generally Accepted Accounting Principles, and prepare reports to that effect. This transactions are then analysed to investigate variances.
Working with managerial accountants, financial accountants provide financial advice by analysing operational issues; they develop recommendations and procedures to protect the company’s financial health.
Financial accountants also concern themselves with calculating quarterly estimated tax payments and prepare annual tax returns.
Perhaps, the most important role of a financial accountant is to prepare financial statements for a company. This requires a sound understanding of five components of financial accounting:
An income statement records the components of revenue and expense. This statement essentially reflects the operating wellness of a business or in other words, how well the business has performed over a period of time.
Also called a net income statement, or a statement of earnings, the income statements is one of the three most important financial statements, along with the balance sheet, and the cash flow statement.
The remaining three components of asset, liability, and equity are reflected in the balance sheet.
A balance sheet gives a snapshot of your company's financials at a particular moment, incorporating every journal entry since your company launched.
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Skillsets of a Financial Accountant
Great accountants look at the output and judge whether it is reasonable, so as not to waste everyone's time on an analysis that makes no sense when you take a step back, and look at it from a common sense standpoint.
Financial accounting is so much more than just basic accounting and number crunching. A financial accountant must demonstrate specific skills and be able to use them well in relevant situations.
Knowledge of cost accounting, management accounting and principles of accounting in general, as they apply to the employing institution: those are accounting basics. Needless to say, that a financial accountant is presumed to be well-versed with and adept at these skills.
Beyond the basics, financial accounting also demands other top skills that are at par with industry standards and requirements:
- Research Skills: Research and analysis are core to financial accounting. They allow for efficient investigating of financial matters and staying abreast of financial and accounting regulations.
- Statistical Analysis: Financial accountants are expected to recognise business trends and advise for or against them. Businesses depend on these recommendations to make forecasts based on historical data and recognise outliers – a single event that impacted the business.
- Analytical Skills: Accounting demand a meticulous eye for detail. This helps in sifting through big chunks of data, make sense of it for yourself and more importantly, for the business.
- Organisation Skills: Financial accountants are, almost always, swamped with deadlines and multiple clients. This requires the incumbent to have excellent organisation skills so as not to be swept away by the sheer volume of work.
- Critical Thinking: Errors, discrepancies, and inaccuracies, if not detected by an accountant, may lead to terrible mistakes in business decisions that may have serious consequences.
- Interpersonal Communication: Following the need to handle multiple clients and internal stakeholders, a financial accountant needs to have excellent interpersonal skills that can get the job done easily.
- Adaptability: The accounting profession is constantly evolving thanks to changing statutes and laws. The financial accountant must make room to adapt to these changes constantly.
- Time Management: Another key skill that can decide the fate of a business. Financial statements, and data analysis, if not done in time, can lead to disastrous results for company finances.
- Industry Knowledge: It is needless to say that the theoretical knowledge of the incumbent must be sound and up to date about industry rules, regulations, laws, and statutes.
In addition to the above, because a part of the financial accountant’s duties involves making recommendations for the better health of the company, the person must know a bit about the business and how to make it grow.
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Limitations of Financial Accounting
Despite the importance and criticality to business growth and operations, the domain of financial accounting comes with its own set of challenges.
Challenges of Financial Accounting:
- Dependence on Past Data: Due to its dependence on previous financial data, especially costs, the financial reports thus furnished may have elements of irrelevance and inaccuracy.
- Effects of Inflation: High inflation rates may reflect in inordinately low amounts of assets and liabilities, as reflected in the balance sheet.
- Intangible Assets: Many expenses related to intangible assets are charged immediately, while such assets themselves do not find space in the report of a financial accountant.
- Fraud Risk: Financial reports may be skewed to work in favour of the company, especially at times of undue pressure like bonus payouts etc.
Financial accounting, irrespective of these limitations, still remains a key pillar of a company. Financial accountants, along with management accountants, although different, are what drive businesses to growth and success.