Financial Accounting Basics

Table of Content

What are the Basics of Financial Accounting?

For readers who are not accountants, this article provides a basic overview of financial accounting. It is geared for capturing financial data about a company. What do we understand by "financial" accounting, first of all?

This relates to the documentation of financial data. Because the second case does not involve a specific transaction involving money, we will not discuss any change in the worth of a company's total business. Instead, we will discuss issuing an invoice to someone and their payment of that invoice.

Transactions

Any business activity with a financial component is referred to as a "transaction," such as selling products to customers or purchasing supplies from suppliers. A transaction in financial accounting causes the recording of data regarding the money involved in the event.

As an illustration, we might document the following transactions and occurrences in the accounting records:

Incurring debt from a lender
The receipt of an expense report from an employee
The receipt of an invoice from a supplier
Selling goods to a customer
Remitting sales taxes to the government
Paying wages to employees
Remitting payroll taxes to the government

Accounts

We keep track of this data in "accounts." An account is a distinct, comprehensive record regarding a single item, such as office supply costs, accounts receivable, or accounts payable.

There are numerous possible accounts, the most prevalent of which are:

Cash. This is the current balance of cash held by a business, usually in checking or savings accounts.
Accounts receivable. These are sales on credit, which customers must pay for at a later date.
Inventory. This is items held in stock, for eventual sale to customers.
Fixed assets. These are more expensive assets that the business plans to use for multiple years.
Accounts payable. These are liabilities payable to suppliers that have not yet been paid.
Accrued expenses. These are liabilities for which the business has not yet been billed, but for which it will eventually have to pay.
Debt. This is cash loaned to the business by another party.
Equity. This is the ownership interest in the business, which is the founding capital and any subsequent profits that have been retained in the business.
Revenue. This is sales made to customers (both on credit and in cash).
Cost of goods sold. This is the cost of goods or services sold to customers.
Administrative expenses. These are a variety of expenses required to run a business, such as salaries, rent, utilities, and office supplies.
Income taxes. These are the taxes paid to the government on any profits earned by the business.

Transaction Data Entry

How do we enter information about transactions into these accounts? There are two ways to do so:

1. Software module entries

There will likely be online forms that you can complete for each of the important activities, such as generating a customer or invoice or recording a supplier invoice, if you utilize accounting software to record financial accounting operations. The software automatically populates the accounts for you each time you complete one of these forms.

2. Journal entries

You can manually enter a journal entry or use the journal entry form in your accounting program. The value of keeping a journal is enormous. A journal entry must, in general, affect at least two accounts, with a debit entry being made against one account and a credit entry being made against the other.

There can be many more accounts than simply two, but the total dollar amount of debits and credits must be equal. For further information, see the journal entries article.

3. The General Ledger

The general ledger contains the accounts. All business transactions that have been recorded in the accounts through journal entries or software module entries are kept in this master set of all accounts. The general ledger is the go-to record for all of the specific financial accounting data about a company, as a result.

You would consult the general ledger to learn more about the specifics of a given account, such as the current balance of accounts receivable that are still owing. Additionally, the majority of accounting software systems offer a variety of reports that offer deeper insights into the company than simply reviewing the accounts.

For figuring out the current list of uncollected accounts receivable and unpaid accounts payable, respectively, there are aged accounts receivable and aged accounts payable reports that are helpful.

The Financial Statements

The general ledger is also the source document for the financial statements. There are several financial statements, which are:

Balance sheet

This report lists the assets, liabilities, and equity of the business as of the report date.

Income statement

This report lists the revenues, expenses, and profit or loss of the business for a specific period of time.

Statement of cash flows

This report lists the cash inflows and outflows generated by the business for a specific period of time. It may be formatted using the direct method or the indirect method.

The statement of retained earnings and numerous supporting disclosures are other less-used components of the financial statements.

In conclusion, we have demonstrated that financial accounting entails the recording of business transactions in accounts, which are then compiled in the general ledger, which is used to produce financial statements.

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