financial accounting class

financial accounting class

The Importance of Financial Accounting in the Business World

1. Introduction to Financial Accounting

Numerous independent researchers are interested in examining the operations and accounting of firms. Governmental regulatory bodies, creditors, suppliers, taxing authorities, and other participants in the economy have called for more comprehensive accounting data and reporting practices. There exists a need for more comprehensive and relevant accounting information in the business world. With the increased public need for complete and accurate financial information, the profession of accounting is performing an increasingly important role in the preparation and generation of such increasing quantity and quality of accounting data.

Our discussion of the importance of financial accounting in the business world will begin with an understanding of the fact that accounting presents a large picture of the economic activities of a firm. A person with little accounting background who examines the balance sheet of a firm quickly becomes aware of the knowledge that is available on the types and amounts of assets a business employs in its activities, the types and amounts of claims of the various interest groups against the assets, the liquidity position of the firm, the sources and maturities of its financings, the profitability of the operations, and the extent to which the firm is employing financial leverage in the conduct of its business.

2. Key Principles and Concepts in Financial Accounting

What basic accounting concepts are used in making accounting policy decisions and in user analysis of accounting? In order to record business transactions and summarize results for analysis and decision making, business is converted into monetary units of measure. Recognition of revenue occurs in the period earned and is usually related to the revenue-producing activities of the entity. Revenue does not have to be received in cash to be recognized, nor does it have to be billings to customers. To recognize expenses in the period in which matches are in common, usually means that benefits in the form of revenues have been received. If a good or service has been received, although funds for its payment may not be forthcoming until a later period, recognition of an expense is usually appropriate based on the “benefits received” concept. Businesses learned long ago that effective controls could not be maintained so long as specific distributions could be identified with specific controls. Therefore, the monetary unit of measure is founded upon the delineation of the entity concept, which means that the activities of an entity are separate and distinct from the activities of its owners, creditors, and other business entities.

Financial accounting represents the aspect of accounting directed toward providing external financial statements of corporations and other unincorporated businesses and not-for-profit organizations. Financial statements are prepared from the records of an entity and provide a summary of the entity’s operating activities. The financial statements are prepared at the end of an accounting period and are affected by the revenue recognition, matching, and time-period concepts.

3. Financial Statements and their Significance

Cash Flow Statement The cash flow statement shows the flow of cash into and out of a business or other organization. It consists of three components or activity sections (the operating, investing, and financing activities) which are analyzed separately. These sections indicate where an organization’s cash came from and where it went. The cash flow statement is useful in assessing both the organization’s short-term and long-term viability. Furthermore, it indicates the enterprise’s ability to pay dividends and interest. Consequently, this statement has become very important to investment analysts, lenders, and others making credit decisions.

Income Statement The income statement or profit and loss statement shows the performance of the enterprise over a period of time (for example, a month, a quarter, or a year). An income statement reports the company’s revenues and expenses and the resulting net income (or net loss, if the enterprise has performed poorly). The income statement reports how successful the enterprise was in achieving its various goals and objectives. For example, the income statement reads much like a sports page and tells which player or team (the production or sales departments in a business) has scored a goal or run or touchdown (earned some net income for the entrepreneurs and stockholders).

Balance Sheet This is a statement regarding the financial position of an enterprise at a particular point in time (on a particular date). To put it simply, the balance sheet indicates what an enterprise owns (its assets), what it owes (its liabilities), and the owners share (referred to by accountants as stockholders’ equity). This relationship is expressed by the following equation: Assets = Liabilities + Stockholders’ Equity.

4. Analyzing Financial Data for Decision Making

Once available, the financial statements are used by business managers, analysts, and other people to address a wide array of questions. Some of these questions are: What investments have been made in resource assets by a business? How well are these resources being protected from excessive debts? What is the business’s ability to survive and prosper into the future? What value can the business return to its owners? Has the business been careful in its use of capital assets and other investments? What are the trends in the business’s sales, expenses, and net income? How is the business performing when compared to similar types of businesses? How has the business complied with its social responsibilities?

Business owners, investors, and managers use financial information to help them make informed decisions. Whether running a small business, a multinational corporation, an investment firm, a governmental agency, or a charitable organization, business professionals rely on financial data to help them control and direct their activities. Financial accounting provides the financial statements that make up a core set of financial information that third-party users (such as investors and creditors) use to make informed decisions about an organization.

5. Ethical Considerations in Financial Accounting

While the responsibility for adherence to ethical standards is foremost on the individual pursuing the public interest, the entire financial accounting system contributes in maintaining and developing ethical standards. Over time, the public trust invested in the financial accounting system is proven by the integrity of the accounting profession, educated by institutions of higher learning, and monitored by governmental regulatory agencies. It is an ongoing obligation of all of these groups to educate and to measure societal compliance with ethical standards. By doing so, the financial accounting profession helps preserve and develop the trust which is so vital to a viable economic system. By providing unbiased financial information, the financial accounting profession helps promote informed decisions in the conduct of business activity.

As accounting professionals, we may at times be faced with occupational opportunities that challenge our loyalties in providing unbiased financial information. It is during these times of ethical conflict that we must test our ethical judgment against the acceptable professional standards outlined within the context of our accounting universe. We must not sacrifice our integrity or objectivity to please someone who values business profits above responsible business practices. As an independent profession, we must perform our duty to provide unbiased financial information to users of our financial statements. By adherence to these professional standards, we, as accounting professionals, help promote informed decisions in the conduct of business activity.