Financial Accounting – Definition, Importance & How it Works

|Updated on: February 14, 2023

What is Financial Accounting?

Statement of final accounts or financial accounting is the process of preparing financial statements that companies use to show their financial performance and position to people outside the company, including investors, creditors, suppliers, and customers.

What are financial statements?

The preparer of financial statements generally put together a quarterly and annual financial statement, which they make available to shareholders and the investing public. There are four basic financial statements used in the accounting world to show a company’s financial performance:

Financial Statements


Income Statement or Profit and Loss Statement -

  • Period Covered: Generally covers a specific period of time (such as a quarter or year)
  • Equation : Revenues - Expenses = Net Income.
  • Accounting principles :

In accordance with the Generally Accepted Accounting Principals (GAAP), revenue is always recorded in the period of the sale of the goods and services, which may not be the same period when cash is actually received.

Balance Sheet -

  • Period Covered: It is a statement of assets and liabilities at the end of an accounting period
  • Equation : Assets = Liabilities + Stockholders’ Equity / Owners Equity
  • Accounting Principles :
  • Cost Principle: The cost principle requires that the asset be shown in the asset account at its original cost rather than at the recently appraised market value
  • Matching Principle: It requires expenses to be matched either with revenues or with the time period when they are used. The cost of the unused supplies/Raw material Inputs remains on the balance sheet in the asset account Supplies/ Input Raw material
  • Going Concern Assumption: A classic example to relate here is Prepaid insurance. It represents the cost of insurance that has not yet expired. On the expiry of insurance, the expired cost is moved to Insurance Expense on the income statement as required by the matching principle

The cost of the insurance that has not yet expired remains on the balance sheet (is "deferred" to the balance sheet) in the asset account Prepaid Insurance.

This is followed following the accounting principle of going concern entity which implies that the business entity will continue its operations in the future and will not liquidate or be forced to discontinue operations due to any reason.

An entity is a going concern if no evidence is available to believe that it will or will have to cease its operations in the foreseeable future.

  • Money measurement concept: To record only those assets that can be expressed in monetary terms

Cash flow statements (CFS) -

  • Period Covered: Generally covers a specific period of time (such as a quarter or year or even monthly statements)
  • Equation : CFS = Net cash flows from operating activities (+) investing activities (+) financing activities.
  • Accounting Principles :

International Accounting Standard (IAS 7) Statement of Cash Flows requires an entity to present a statement of cash flows as an integral part of its primary financial statements.

Cash flows are drafted and presented into operating activities (either using the 'direct' or 'indirect' method), investing activities or financing activities, with the latter two categories generally presented on a gross basis.

Statement of retained earnings -

  • Period: Generally covers a specific period of time imputed by users of information
  • Equation: Retained earnings (RE) = Beginning Period RE (+) Net Income/ Loss (–) Cash Dividends (–) Stock Dividends

Retained Earnings (RE) are the portion of a business’ profits that are not distributed as dividends to shareholders but instead are reserved for reinvestment back into the business.

These represent a useful link between the income statement and the balance sheet, as they are recorded under shareholders’ equity which connects the two statements.

How Financial Accounting Works?

Financial accounts give a clear picture of your company's financial stability. Different financial statements provide different insights, based on which a business owner can make informed decisions about his future investments. For example: Based on the payment performance of your debtors, you can define or modify your credit policies, etc. Your balance sheet will tell you the current working capital ratio, which will help you assess your liabilities and take actions, accordingly.

Find out more about Financial Statements – Meaning and Types Financial Statements

Where Do We Find These Financial Statements in TallyPrime and What are the Shortcut Keys to Assess them?

Financial Statements

Where do we find them?

Shortcut key

Income and Expenditure or Profit and Loss Account -

Where do we find them? On gateway of Tally screen

Income and Expenditure Account :

Income & Expenditure Statement is suitable for organizations that do not engage in the trading of goods or services.

We can toggle between Income and Expenditure Statement and Profit & Loss A/c by pressing F 11 on the keyboard and setting the option Use Income and Expenses A/c instead of Profit and Loss A/c? to Yes/No as, as required.

For Profit and Loss Account = Letter “P” on the keyboard

For Income and expenditure Account = Letter “N” on the keyboard

Balance sheet -

Where to find it? On the gateway of Tally screen.

Letter “B” on the keyboard

Cash flow statements -

Where to find it? Gateway of Tally > Display > Cash/Funds Flow > Cash Flow .


What Purpose Does Financial Accounting Serve?

The main objectives of financial accounting could be

  • To ascertain the operating results of the enterprise
  • To exhibit the financial position of the business; and
  • To thrust control over the operation as well as the resources of the business

Apart from the above there are some objectives of financial accounting which could be derived from the above and they are:

Systematic Record maintenance

Financial Accounting is to report the results of most business events. Hence, it becomes important to keep a systematic record of these events. This function embraces recording transactions in the journal and subsidiary books like cashbook, sales book etc., posting them to ledger accounts and ultimately preparing the financial statements [final accounts].

Communicating the Results

The other main function of financial accounting is to communicate the financial facts of the enterprise to the various interested parties like owners, investors, creditors, employees, government, and research scholars, etc.
The cause of this function is to enable these parties to have a better understanding of the business and make sound and realistic economic decisions.

Meeting the Legal Requirements

Financial accounting aims at fulfilling the legal requirements, especially of the tax authorities and regulators of the business by discharging this function in accordance with certain fundamental truths and uniform enforcement of generally accepted accounting principles.

Why Is Financial Accounting Important?

Here are some of the importance of financial accounting:

Recording financial transactions: The primary function of financial accounting is to write, maintain, and record financial transactions within the company's accounting ledger. 

Comparing and analyzing financial data: Another key aspect of accounting is that it allows business owners to compare and analyze financial data that helps improve decision-making. 

External communication: Accounting allows businesses to communicate their financial information to external stakeholders like investors - an essential element for conducting business. This further helps companies showcase their financial standpoint and reliability to repay loans and make payments.

Comparing financial reports: Accounting further aids businesses in assessing their health by comparing financial statements, thereby enabling them to analyze their success.

Recording transactions: Financial accounting is key to keeping a detailed record of financial transactions, thereby enabling them to stay organized. Furher this helps businesses in the audit process and even reevaluating the spending and budgeting. 

Financial Accounting with Tally Accounting Software

Tally Accounting is software used for financial accounting purposes. It is provided by Tally Solutions and is a standard business accounting software. TallyPrime is a very robust ERP product and is a complete business management solution.

All the accounting activities, such as financial records of a business, the generation of statements concerning the liabilities and assets of a business, all are easily managed with the Tally solution.

The name of the business solution, Tally, is inspired by the meaning of the word "tally", which is to count, to keep the record.

Accounting is the activity or the system of keeping records of transactions of a business or any other organizations in monetary terms. It records the money or value for money received by or given to different persons or entities from time to time. It enables an organization to ascertain facts such as money owed to or by different entities, the assets and liabilities of the organization in different forms and the profit or loss made by it during specified periods.

Tally is a trading name of accounting software maintaining accounts, and for performing additional accounting and other analytical operations helpful in the management of an organization.


What are the types of financial accounting?

There are primarily two types of financial accounting: cash and accrual accounting. Both methods use double-entry accounting to accurately record financial transactions.

What is the main purpose of financial accounting?

The main purpose or use of preparing financial statements of a business organisation is to understand its financial position. For any business to have constant growth, a careful and periodic check on its cash inflow and outflow is crucial. Thus, with financial accounting, a business owner can keep a tab on how much his revenue is against his expenses, to ensure positive working capital.

Who uses financial accounting?

Financial statements can be used by several stakeholders who are involved in critical decision-making. From business owners, managers, and employees to external users like; suppliers, banks, customers, investors, potential investors, and tax authorities, use financial statements to arrive at major business decisions.

Read More on Accounting

Accounting Software, Accounting Equation, Accounting Principle, Accounting Methods, Accounting Rate of Return, Cash Accounting, Accrual Basis of Accounting, Cost Accounting, Golden Rules of Accounting, Accounting Standard, Cash Accounting vs Accrual Accounting, Cost vs Management Accounting

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