Behind every good businessman, there is a great accountant.
Accountants are indispensable to the business. Whether you prepare financial statements for the company, or maintain invoice records, or just compile financial data, or even conduct a financial audit, no company or organization can function without the contribution of the accountancy domain. While the accounting sector is vast, there are a few types that are critical to the functioning and financial wellness of a firm.
Here is a sneak peek into accounting and its key terms.
What is Financial Accounting?
Financial accounting is the process of tracking and accurately documenting financial records in a company. This process allows you to account for an organization's revenues, receivables, and expenses. They are finally consolidated and drafted in the financial statement, to be presented to the management for decision-making regarding company strategies.
Why is Financial Accounting Important?
This process is extremely important to allow businesses to meet legal compliances and helps companies adhere to fiscal and statutory requirements as mandated by domestic laws. For business owners, this is the key to informed and effective decision-making. A financial accountant will provide in-depth analysis through income, cash, and expenditure statements, which in turn, will facilitate efficient resource allocation.
Financial accounting is also important to understand the profit and loss situation in a company.
What are the Objectives of Financial Accounting?
The basic premise on which financial accounting functions is that it should help the company finance stay in a healthy shape. With this as a starting point, a financial accountant prepares a company's financial statement summarizing the financial accounts for a specific period of time. These financial statements contain three important components, namely:
- Income statement that reflects the company's profit and loss account, and its revenue and expenses over a period of time.
- Balance sheet or the statement of the company's assets, liabilities, and stockholders' equity.
- Statement of cash flows that contains information about each and every cash inflow into and cash outflow out of the company over a period of time.
Financial accounting serves several important purposes:
- It provides critical information on financial transactions to investors and creditors.
- The accuracy and efficiency of financial reports prepared by financial accountants can potentially increase investment interest.
- The internal management team uses the financial statements to decide on budget and cost controls, as well as performance management processes.
- Using trends, ratios, and industry comparisons, investors analyze financial reports to gather important business information.
Also learn about the double-entry bookkeeping method used by financial accountants.
What is Cost Accounting?
Cost accounting is a method that records and analyzes the cost incurred per unit, during the production of goods.
Accountants are constantly learning on the job. They have to or else businesses would collapse. Cost accountants, for example, have to constantly keep up with market trends and analyses, build their knowhow about changing accounting standards, all this while keeping a tab on the flow of production to accurately gather cost information in each step.
You can prepare cost accounting statements using accounting software.
Difference Between Cost Accounting and Financial Accounting
An introduction to the world of accounting would make you feel that all types of accountants are involved in similar reporting processes and value-added roles. But there are important differences. Below are the primary dissimilarities between cost and financial accounting:
- Nature of Accounting: While financial accounting records all types of transactions related to company finance, cost accounting is only concerned with documenting production-related costs.
- Nature of Costs: Financial accounting depends on historical data for preparing its reports and statements. Cost accounting, however, involves both historical as well as forecasted data. The latter can include current orders that are yet to be paid for.
- Objective of Accounting: Cost accounting has a very specific task of recording all production costs only. Financial accounting, of course, is a much larger domain. It has to track all sorts of business transactions in order to assess the financial well-being of a company.
- Purpose of Accounting: While financial statements are meant for a larger audience, which includes external company stakeholders like investors or tax authorities, cost accounting reports are shared with an internal management committee, who use them to make business decisions.
- Type of Reports: A financial statement includes a profit and loss account, balance sheet, and cash flow statement. A cost analysis report includes the components of variance analysis, marginal cost, and break-even analysis.
- Compliance: Financial accounting is mandated by law, and as such the reports need to be made public. There is no such need for cost accounting.
- Frequency of Reporting: Cost accounting reports are prepared on an ad hoc basis, as deemed important by management. Financial accounting reports have to be filled at the end of a fiscal year, by law.
- Type of Information: While financial accounting only records monetary information, there might be non-monetary elements in cost accounting.
What is Management Accounting?
Management or managerial accounting is the practice of identifying, measuring, analyzing, interpreting, and communicating financial information to managers for the pursuit of an organization's goals.
Managerial accountants rely on reports furnished by cost accountants and financial accountants to arrive at trend analysis, which they use to make recommendations to management executives. These recommendations are considered for important decision-making related to:
- Budget controls.
- Performance management.
- Scale and expansion.
- Shutting down a business.
- New product launch.
Note that cost accounting is a sub-set of managerial accounting that focuses specifically on production costs. Management accountants use this information to be able to reduce costs and increase efficiency in production.
Difference Between Financial Accounting and Management Accounting
As the financial accounting definition suggests, it is a process that captures all finance-related data of an organization. Managerial accounting, on the other hand, analyses this data to provide financial advice to businesses. Below is a comparison between the two concepts to highlight their differences:
- Objective of Accounting: Financial accounting reflects the financial wellness of a firm, while management accounting uses that information to set business goals and drive decision-making.
- Reporting: Management accounting, like cost accounting, is meant for an internal purpose, and as such do not get reported outside the company. This is just the opposite in the case of financial accounting.
- Compliances: Unlike financial accounting that is bound by law and legal statutes, managerial accounting does not need to adhere to any such compliances or rules.
- Components of Reporting: Financial statements are meant to give an overview of the entire company finance. On the other hand, management accounting concerns itself with individual departments. It ensures performance and budget controls are adhered to by different departments so that it contributes to the overall well-being of the company.
- Type of Data: Financial accounting uses previous data from past transactions. Management accounting, by definition, is a futuristic process and thus used for forecasting.
- Standard Formats: Management accounting being an internal process, does not follow any prescribed formats and can be presented as per the internal requirements. Financial statements, on the other hand, of course, have to follow certain standards for reporting.
- Accounting Principles and Standards: This is a significant difference between the two types of accounting. Financial accountants have to abide by the Generally Accepted Accounting Principles (GAAP), but management accountants have no such obligations.
You can learn more about the basic accounting concepts to build more clarity.
Is Financial Accounting a Promising Career Move?
The answer is a resounding yes! The simple reason is that accountants will always be in demand. As long as economies grow and flourish, the need for industries and businesses will persist. This will increase the demand for all types of an accountant, but especially those who are adept in financial accounting. Their expertise in the finance market, documentation processes, and financial software will continue to contribute significantly to business growth and company expansion.
Financial accountants possess some niche skills that no other individual can offer:
- Knowledge of tax laws and liabilities.
- Financial statement preparation.
- Internal controls.
- Financial auditing.
- Cost management.
- Accounting information systems.
These top domain skills, coupled with some critical soft skills of problem-solving, design strategy, and research and analysis, can set you apart from other accountants. Of course, there is also the incentive of a lucrative compensation package that any average financial accountant can earn.
Still in two minds about which accounting courses to choose from? Check out these colleges in India offering accounting courses to set your career rolling. You can also check out online platforms like Superprof and find an online tutor to start building your accountancy knowledge.