Learn About Financial Accounting and Financial Statements

Financial accounting is a type of accounting with a primary focus on compiling, analyzing, and publishing a business’s financial transactions through a series of financial statements. These financial statements, which include balance sheets and income statements, help shareholders, potential investors, lenders, suppliers, and government agencies make investing decisions or assess the business’s financial position and operating activities.

Financial accountants are subject to certain standardization accounting rules when compiling their financial statements. In the United States, these are the generally accepted accounting principles (or GAAP) by the Financial Accounting Standards Board (FASB). Accountants outside of the US are subject to international financial reporting standards (IFRS).

Financial statements are bookkeeping documents that financial accountants compile, summarize, and file to ensure their company keeps track of their business transactions and is compliant with transparency and regulatory laws. Balance sheets, cash flow statements, and income statements are common types of financial statements.

When creating financial statements, financial accountants usually conform to the double-entry accounting approach within the accrual basis of accounting—recording profits and expenses as they transpire—rather than the cash basis, in which transactions are only documented when funds are received or distributed. In the double-entry approach, accountants enter every transaction into the “accounts payable” balance as a debit and the “accounts receivable” balance as an equal credit. Accountants will periodically review the trial balance—a general ledger with the business’s debit and credit accounts—to ensure they are equal.

Here are the most common types of financial statements:

• Balance sheets: A balance sheet identifies a business’s present finances, including current assets, long-term assets, intangible assets, debts, or short- and long-term liabilities owed. Organizations that deal with a significant amount of money, such as banks, usually prepare financial reports every day, while small businesses might prepare quarterly statements or annual reports. Finances appear in three categories on a balance sheet: assets, liabilities, and equity.
• Cash flow statements: A cash flow statement shows how much cash enters and leaves a business over time. Also called a statement of cash flows, the cash flow statement includes cash inflow from operations, investing activities, financing activities such as bank loans, and revenue that a company has earned but has not yet received.
• Income statements: The income statement, sometimes called a profit and loss statement, illustrates profitability and financial information over a specific accounting period of time. The income statement shows a company’s revenue, operating expenses, the cost of goods sold (COGS), net income, depreciation and amortization, and gross profit.
• Stockholders’ equity statements: A stakeholders’ or shareholders’ equity statement is a financial document that details the shareholder equity accounts in a public company, including figures for retained earnings, cash payments, or common stock dividend payments. Private companies may compile equity statements according to stockholders’ equity standards.

Financial accounting and managerial accounting (or management accounting) are two fields of accounting that differ in a few key ways:

• Audience and purpose: Financial accounting focuses primarily on external parties—investors, regulators, and other external users outside of the business who use the documents to make decisions or analyze the business. By contrast, managerial accounting focuses on an exclusively internal audience (usually decision-making management in the business), compiling internal reports of financial data and confidential accounting information. This focus allows business owners and shareholders to make major business decisions to ensure the company’s financial success.
• Content: The financial accounting reports are usually predetermined and look at the company as a whole, while managerial accounting reports are usually more tailored to the individual company and include detailed breakdowns of products, spending, income, and investments.
• Standards: Since financial accounting publishes financial statements for external audiences to read and understand, the standardization principles are more strict and closely follow GAAP rules. On the other hand, managerial accountants usually only compile reports for internal audiences.

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