What is Financial Accounting?

Financial accounting is the practice of recording and aggregating financial transactions into financial statements. The intent of financial accounting is to distribute a standard set of financial information to outside users of the information, such as creditors, lenders, and investors. It is usually compared to management accounting, which focuses on an operational analysis of a business to explore how it can be made more efficient or profitable. Management accounting reports are only intended for internal use.

The key aspects of financial accounting are as follows:

Financial statement preparation. Financial accounting involves creating financial statements, which include the balance sheet, income statement, statement of cash flows, and statement of shareholders' equity. These statements provide a comprehensive view of a company’s assets, liabilities, revenues, expenses, and equity.
Adherence to standards. Financial accounting follows strict guidelines and standards, such as Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS). This ensures consistency, reliability, and comparability across financial reports.
Historical focus. Unlike managerial accounting, which often focuses on forecasting and internal decision-making, financial accounting is primarily concerned with recording past transactions and providing a historical perspective on a company's financial activities.
Objectivity and accuracy. The emphasis in financial accounting is on objective, verifiable data to ensure accuracy and reduce subjectivity. This is to provide confidence to external stakeholders that the financial reports are trustworthy and based on actual performance.
Legal and regulatory compliance. Financial accounting helps companies comply with legal and regulatory requirements. Accurate reporting and adherence to standards are often legally mandated, especially for publicly traded companies.

By focusing on these elements, financial accounting provides a transparent view of a company’s financial health, helping external users evaluate its viability, profitability, and overall financial stability.

The Application of Accounting Frameworks to Financial Accounting

Several accounting frameworks are available that provide the rules under which financial statements are to be constructed, so that the financials issued by the entities in an industry will be comparable. For a for-profit or nonprofit business, these rules are provided (in the United States) by the Generally Accepted Accounting Principles (GAAP) framework and (elsewhere) by International Financial Reporting Standards (IFRS) framework. If a company is publicly-held, additional rules are mandated by the Securities and Exchange Commission (SEC), if the business lists its shares on a stock exchange in the United States.

The Structure of Financial Accounting

Financial accounting involves the creation of a chart of accounts, so that financial transactions can be stored in a consistently-used set of accounts. There are also a number of policies and procedures that provide structure for how transactions are to be recorded into these accounts. Accounting software is used to store and organize the entered information. Once recorded, the financial statements and their associated set of disclosures are compiled and then released to users.

The Focus of Financial Accounting

The focus of financial accounting is outward - its work product is read by persons outside of a business, such as investors, creditors, and lenders. Since lawsuits can arise from the issuance of incorrect financial statements, a strong focus in financial accounting is on ensuring that the information presented fairly represents the financial position, cash flows, and results of a business.