Financial Accounting

Financial finance is a relatively broad term encompassing a variety of things regarding the study, creation, management, and allocation of funds. The study includes financial markets, banking, insurance, pension, lending, estate, and other financial activities. It also involves measurement of financial risk, allocation of capital, and treatment of securities and derivatives. Financial studies can be taught at both the graduate and undergraduate levels.

A major part of financial management is the ability to understand balance sheets, which are financial statements that show how much money is owed to whom, as well as how much is invested in terms of bonds, stocks, and other financial securities. Balance sheets are used by financial managers to predict how much money will be in a particular financial instrument, such as long-term funds or bonds, at a certain point in the future. They help managers reduce potential losses by providing information about the amount of risk that is involved in buying and selling those instruments. A key aspect of balance sheets is that they need to show how much money is owed to whom, as well as how much money is invested in terms of bonds, stocks, and other financial securities. A manager cannot effectively manage a company if he does not understand balance sheets.

The main function of financial accounting is to prepare and report on the financial statements of an enterprise. The financial statements include information such as income statement, balance sheet, and statement of cash flows. All financial accounting reports are prepared in relation to the requirements of U.S. Generally Accepted Accounting Principles (GAAP). The principles of GAAP are designed to allow businesses to issue reports that are both reliable and consistent with the information they are required to provide to their investors, which is why it is used as the standard accounting principle by financial reporting agencies such as the U.S. Securities and Exchange Commission (SEC).

Income statement, which shows the income and other financial statistics of a company, is one of the primary reports that financial accounting provides. The information on the income statement is the most important piece of financial accounting because it shows how revenue earned by a firm (the income part) is transformed into the net income or cash flow (cash is used for buying back securities and investing for growth purposes). Other financial statements, such as balance sheet, also show how revenues changed into assets and liabilities. The balance sheet shows how debt (e.g., bank loans, obligations, securities) is financed. It also illustrates how equity (equities held in stock, mutual funds, common equity shares) is utilized and how free cash flow (endowing cash to stockholders) is used to generate future earnings.

In order for balances to be shown on a balance sheet, however, certain requirements must be met. Initial equity should be reported only to the credit holders (mainly banks and other institutions). Ownership (in the form of equity shares) and retained earnings must be reported individually. Similarly, there must be separate reports for revenues and expenses, and all expenses reported under a single heading.

A significant portion of financial accounting is concerned with GAAP (Generally Accepted Accounting Principles), which is the standard accounting framework in which financial statements are prepared. Under this principle, all financial reporting transactions are made according to generally accepted accounting principles (GAAP). The major components of GAAP are: internal procedure, control of financial process, quality analysis, measurement of financial risk, and reporting of financial results. Other principles of GAAP include: double-entry bookkeeping, use of estimate, accrual or single-entry bookkeeping, uniform accounting system, insurance policies, internal and external fraud prevention, and recognition of deference.