Financial Accounting

Introduction to Financial Accounting and Financial Statements

Introduction to Financial Accounting and Financial Statements

Financial Accounting function (or accounting in general) act as a part of the information system for the business. Organisations invest large amounts of money in information system to collects relevant data which can be beneficial for them. This data is then converted into information by using analytical tools and technical processes. The information acquired is vital for businesses to exist and grow, for example, data gathered by marketing research enables businesses to develop new products required by the market.

Financial Accounting function of the business is as important a function as any other function of the business like buying, selling, producing, marketing etc. Main purpose of the financial accounting department is to record all business’s financial dealings i.e., transactions and to present those in the form of “financial statements.” As production of financial statements is a legal requirement in the UK (or any other country), financial accounting department is also a legal necessity for businesses. All businesses must prepare their accounts for tax purposes while an incorporated business (limited company) must prepare their accounts following the rules set for financial accounting in the relevant countries which are usually based on International Financial Reporting Standards (IFRSs) and present them to relevant government bodies, mainly HMRC and The Companies House in the UK.

Financial statements

Financial statements are an output of financial accounting processes and give information on the business’s state of affairs. These statements are a summarised record of all business transactions occurred during the year. The main function of financial statements is to present financial performance of the business to its owners.

There are five major parts of financial statements which present information on important aspects of the business as below:

Statement of Profit or Loss

This previous name for this statement was Income statement (also called Statement of Comprehensive income) which many annual reports still use as the name has changed quite recently. This statement outlines all the expenses and incomes of the business and gives a final figure for profit or loss.

Statement of Financial Position

This statement is also called Balance Sheet and gives the book values for owners’ investment in the business, what business owns and its obligations.

Statement of cash flow

This statement gives a detail analysis of the cash movement for the business during the year.

Statement of changes in Equity

This statement gives the detail analysis of the owners’ money within the business and any increase or decrease in it.

Notes to the accounts

The first four parts are presented in a statement format in brief version, “The financial statements”. Although, these statements do provide some basic, important, and surface level information, which can be useful for financial experts and experienced investors, do not give the necessary information for a detailed financial analysis. Many figures which are required to carry out further analysis (Ratios Analysis) are not available on these statements or given but presented and worded in ways which confuses students from non-financial background.

Therefore, notes to the accounts are essential to understand the financial statements. These notes give detailed version of the information provided in the financial statements, explain the figures and rational behind these figures. Notes to the accounts are the biggest part of the financial statements whereas the first four parts (statements) take only 4 pages, these notes could take 50 or even more pages depending on the size of organisations and complexity of information.

This article is written by Raja Mizan who is a senior lecturer in accounting & finance in a UK university. He is an ACCA member and also runs his own accountancy practice RMR Accountants & Business Advisors.

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