Importance of Financial Accounting

Accounting is also described as the language of business since there is a standard means of assessing a business’s performance in design, production, and sales. Accounting assists organisations in getting an idea of how activities factor financially into an enterprise and makes it possible for them to understand the organisation’s health by putting such activities into a financial perspective. Financial management serves this process. They document business administrative activities and their resultant transactions, summarising and reporting almost infinite activities.

It is bounded by so much stability and constant jobs that anyone wants to practice in this speciality area. Any career path in this field is almost open to a business student who has specialised in financial accounting, be it in auditing and tax preparation, financial analysis and consulting, etc. After mastering accounting, students are bestowed with numerous skills. Thus, it is not incorrect to qualify accounting professionals as indispensable in any business today.

What is Accounting?

Accounting is the identification, measurement, processing, and communication of financial information that is relevant and valuable for particular users, such as businessmen. Its primary objective is to capture an organisation’s historical financial transactions, including revenues and costs.

Accounting involves sorting financial information to develop key reports, including the balance sheet, income statement, and cash flow statement. These reports explain how the business is performing and are a valuable resource for all parties it needs without prejudice or mistake.

Keeps a record of business transactions

Accounting is important because it systematically records the organisation’s financial information. Up-to-date records help users compare current financial information to historical data. With full, consistent, and accurate records, it enables users to assess a company’s performance over time.

Facilitates decision-making for management

Accounting is especially important for internal users of the organisation, including the people who plan, organise, and run the organisation. The management team needs accounting to make important decisions, from pursuing geographical expansion to improving operational efficiency.

Communicates results

Finance assists in presenting results to different users in an organisation. Unlike investors, lenders and creditors are the most external users of accounting information. Owners may choose to acquire equity in the business, whereas creditors must assess the risk they are willing to take before extending credit. Companies must provide relevant and reliable accounting data to gain credibility with external users.

Meets legal requirements

Accounting serves the purpose of making organisations report their financial assets and liabilities more accurately. Commonly accepted accounting records compiled by tax agencies like the Internal Revenue Service in the U.S.A. and the Canada Revenue Agency evaluate the company’s declared gross revenue and net income. Using an accounting system means that the financial statements of any company are legally and rightly prepared.

Also Read: Basic Accounting Terms

Types of Accounting

Accounting can be divided into two categories: Financial Accounting and Managerial Accounting. Here, we are mainly talking about Financial accounting.

Financial Accounting in Detail

Financial accounting entails recording any financial transactions available for a given firm. This information includes revenue, expenditure, production assets, liabilities, etc. The information is presented analytically for the convenience of the shareholders and the stakeholders who need to understand the information provided.

Financial accounting chiefly provides these important documents: income statements, balance sheets, statements of cash flow, and the position of the state of retained earnings. The information in such reports is specific, and it gives the stakeholders the right picture of the company’s financial status.

Types of Financial Accounting

• Cash-Basis Accounting: Records transactions only when the firm receives cash or pays cash for a product or service. This is very simple and can be adopted by most organisations with limited complexity and adopted by small business most often but provides no over view of the financial activities of an organisation.
• Accrual-Basis Accounting: This one records incomes and expenditures when they occur, not necessarily when actual cash is going through. It is a more realistic picture of financials and is mandatory from certain size organizations and for taxation.
• Government Accounting: This type is common among public sector organisations, given that it offers a correct gauge of the use of public funds. It facilitates government agencies’ accountability for the funds expended in their various projects.
• Forensic Accounting: Forensic accounting work, more specifically, involves auditing financial documents and records to expose fraud or embezzlement. It is frequently employed in lawsuits to provide monetary proof in court.

Also Read: Difference Between Financial Accounting and Management Accounting

Objectives of Financial Accounting

Financial accounting serves multiple objectives, which include:

• Provide Financial Information: The main goal is to benefit the stakeholders, especially the investors, creditors, and management, by providing quality financial information.
• Assess Financial Performance: Financial accounting presents a picture of the organisation for a given period and will thus show the company’s growth and issues.
• Support Regulatory Compliance: Every business organisation requires the preparation of records kept for various legalities, taxes, and audits, among others.
• Enable Financial Comparisons: This allows people to put the financial information for past years in the same format as their competitors or previous years and to get an idea of the company’s standing on the market at present.

Benefits of Financial Accounting

Maintains Accurate Records

Financial accounting records every business transaction in a systematic and organised way. This record-keeping enables companies to track their financial activities, which will be accessible upon need. Furthermore, it helps to keep financial action within the framework of laws and provides a basis for future financial analysis.

Prevents Fraud and Errors

Financial accounting facilities reduce the risk of errors and fraud by precisely documenting all financial data. Audits can more easily catch inconsistencies or suspicious activities with detailed and transparent documentation. These records can also be used as credible evidence if disputes or fraud cases arise.

Brings the Financial Picture in Clear View

The information in financial accounting packages is ‘complete’ for portraying a company’s financial health. The balance sheet or any income statement enables business owners, investors, or creditors to know the real situation of the business. It is applicable in arriving at proper, sound decisions in investment, loan applications, and business strategies.

Facilitates Growth Planning

Financial accounting presents trends by documenting the company’s cash inflows and outflows. These insights can give businesses greater insight into future performance and help them plan expansion or make strategic adjustments to reach their growth goals.

Drawbacks of Financial Accounting

Limited to Financial Aspects

The greatest weakness of financial accounting is that only financial transactions are included while non-financial factors are considered. These reports do not include market competition, economic trends, or shifts in consumer behaviour, which can greatly affect a business.

Lacks Detailed Information

Specifically, financial accounting doesn’t give insight into how individual departments or products perform. On the other hand, financial data are not broken down by segment, which makes it difficult for managers to decide what targeted action will improve specific parts of the business.

No Cost Control Mechanism

The first limitation is that financial accounting does not help to control or reduce costs. As the event occurs after the expense is made, it is not helpful for real-time monitoring to eliminate waste or misuse of resources. More importantly, it doesn’t address tasks such as material loss or errors in production.

Relies on Historical Costs

In financial accounting, assets are recorded at their original purchase cost and not at their current market value. This could mean that these records do not capture the value of assets, making it appear as if a company’s finances are distorted. This can impact decision-making, especially in a rapidly changing market environment.

Also Read: Limitations of Financial Accounting

Conclusion

Financial accounting is a need to organise and present a company’s financial data clearly and accurately. The main purpose of DCF is to provide a picture of a business’s performance and financial health that may inform stakeholders’ well-informed decisions. While cost and management accounting are involved yet different from financial accounting, they still play a vital role in the whole financial analysis of a business. Its practice can help one understand the strengths and areas of a company for growth, and the groundwork for making sound financial and strategic decisions can be laid out. To learn more about finances and financial accounting, complete the Certificate Program in Financial Analysis, Valuation, & Risk Management powered by Hero Vired with edX and Columbia University.