What is Financial Accounting and Why It’s Important

by | Mar 10, 2021

What is financial accounting and why is it important to a business? Sometimes called the “language of business”, financial accounting is the method of finalising financial accounts. It generally follows the three-step process which are:

  • Review – accountants review the financial accounts created by bookkeepers to make certain that the financial transactions are accurately documented and classified.
  • Reconciliations – ensures that the records of a business are the same as the records reported by the business’ suppliers and clients. In the event that the reconciliations are wrong or incomplete, it could result in audits or more tax liability from the Australian Taxation Office (ATO).
  • Adjustments – to precisely show the financial performance and position of a business based on the reporting structure. Such adjustments are necessary since they are used for a number of purposes such as paying income tax, validating business performance and position to investors and lenders, and validating solvency to the Australian Securities and Investment Commission (ASIC).

Why is Financial Accounting important?

Financial accounting is important for a business of any size, and here’s why.

It provides a technical approach to describing business activities

A significant use of financial accounting is for documenting business transactions, also referred to as bookkeeping. Business owners use financial accounting to note business activity in the business’ ledger. Since it utilises the double-entry system, each financial transaction impacts two accounts, which shows the two sides in a transaction. For instance, if a small business owner buys property, they would record a debit to the property account to show the receipt of the property, then a credit to the cash account to show the output of cash.

It assists in revealing financial information of the business to external parties

With financial accounting, business owners are able to communicate their financial information to external users such as banks, suppliers, and leasing companies. External users are those who use the financial information of a business but are not part of the business. Business owners are able to reveal their financial health and wellness to these external users by means of financial statements, which are the end-result of documenting financial accounting transactions. External users can then evaluate the financial statements and review the results to their own expectations, which helps in making an assessment of the business.

It also helps in communicating financial information of the business internally

Owners can make use of financial accounting to communicate the business’ strengths and weaknesses to its internal users such as their employees. This information is useful for businesses who provide profit-sharing or stock-based compensation arrangements with their staff. When it comes to small public businesses, a typical metric is the business’ share price. Small business owners may match bonus and compensation levels to share price and motivate employee performance as necessary.

Financial accounting can be used to analyse competitors and assess investment possibilities

Due to the fact that financial accounting is managed by generally approved accounting principles, the financial statements of various businesses are similar to each other. Therefore, this provides a standard method of analysis where business owners can compare their financial ratios to ratios and benchmarks of other competitors.

Need financial accounting for your business? Contact a Chan & Naylor accounting specialist here. We’ll be glad to help.