Accounting has been called the language of business and is used in many different situations. Cost accounting is used to streamline manufacturing operations. Managerial accounting is used to compile data necessary for sound management decisions. Financial accounting is used to report the financial result of a company’s operations. Public companies are required to report their results to the public while private companies report to their owners. In either case financial statements are created and the results are analyzed. That process is financial accounting.
Financial accounting is used to report the outcome of business operations in monetary form. To do this the accounting department uses financial accounting techniques to create an income statement. The income statement is also called the profit and loss statement. As the name indicated it reports whether or not the company had a profit or a loss over a given period of time. Public companies report and publish their income statements with the Securities and Exchange Commission (SEC). Private companies perform the same procedures but they do not publish the outcome.
Financial accounting is also used to determine a companies financial position for a specific period in time. This process is repeated monthly, quarterly and annually. The accounting department creates a balance sheet which provides the financial position of the company at a given time. The balance sheet contains the status of the companies asset, liability and equity accounts. This information is critical in determining liquidity, solvency and the future viability of the business continuing operations.
Different businesses in different industries have varying monthly cash needs. However, using financial accounting, the accounting department, has the ability to create cash flow statements. Used for managerial accounting as well, cash flow statements examined over a period of time can generate a history of cash fluctuations. This data can be used to report the company’s cash position and going concern theory. The going concern theory is a test of whether a company can continue operations.
Financial ratios are computed when the financial statements are created. These ratios tell an investor or manager how well positioned an organization is to continue operations. These ratios determine a company’s liquidity. Liquidity is the measure of a company’s ability to pay their short term debt when it comes due. Solvency is the measure of how well a company will be able to meets its long term debt obligations. These ratios are critical in determining the health and long term vitality of a company since the financial statements only report for a certain period.
Decisions require information. Making a decision without a basis or intelligence on the subject matter is called gambling. All of the financial accounting tools mentioned here are used to make solid management decisions. Decisions on whether to borrow to cover cash needs, invest surplus cash and expand production or possible the production line. This financial data is instrumental in these decisions.
Financial reporting is required by all public US companies. This process is complex and time consuming. However, it is easier to explain. Quarterly and annually public companies report their results and publish their outcomes with the SEC, mentioned earlier in this article. This is the most obvious use of financial accounting data.