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Financial
Accounting:
Definition,
Types, Functions
& Examples
by Team Happay — March 7, 2024

in Accounting, Finance

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Introduction to financial accounting

“Accounting is the language of business.” — Warren Buffett

Accounting is an essential business language, as it clearly communicates key financial

information to stakeholders. Business transaction data is integral to communicating an
organization’s financial performance.

This data serves as the basis of efficient decision-making. But organizations can’t capture it
without a structured process. That’s precisely why enterprises use financial accounting to
record financial transactions.
Financial accounting is the process organizations use to record, summarize, and report
transactions resulting from their day-to-day operations. In this article, we explore how
organizations deep dive into financial accounting.

Must Read: Accounting vs Finance: What’s the Difference?

What is financial accounting?

Indian accountants follow the Indian Accounting Standard (Ind AS) to maintain credibility and
uniformity across accounting processes. These guidelines are at par with the International
Financial Reporting Standards (IFRS).

In the US, financial accountants follow the Generally Accepted Accounting Principles (GAAP)
principles set by the Financial Accounting Standards Board (FASB).

Financial accounting meaning

Financial accounting definition refers to the process that documents, classifies, reports, and
analyzes business transactions to assess the financial health of an organization. In other
words, it’s a bookkeeping process that captures all sales, purchases, accounts payables, and
receivables transactions.

Accounting teams summarize these financial transactions to create different financial

statements, such as cash flow statements, balance sheets, income statements, and
shareholder’s equity statements. Financial accounting aims to display profits and losses so
that stakeholders can make the right decisions.

Quick Read: 10 Best Expense Reporting Software

Who are all the users of financial

accounting?
Public enterprises publish financial statements quarterly or annually to provide internal and
external users with critical financial information.
In this section, we explore the purpose of these financial statements.

Lenders compare assets and liabilities to predict an organization’s ability to repay loans.

Investors analyze financial statements to estimate investment risks and predict future
dividends.

Suppliers and trade creditors need financial information to measure the short-term
liquidity of an organization.

Customers use statements to understand the long-run prospects of a business.

Employees and trade unions look at financial data to interpret an organization’s

profitability and stability.

Company management leverages accounting information to evaluate progress and

pinpoint areas of improvement.

Government agencies including income tax and sales tax departments, need financial
information to levy and collect appropriate taxes.

Investment analysts use financial statements to analyze an organization’s competitive

performance.

Importance of financial accounting for your

organization
Financial accounting is important for tracking financial transactions and preparing financial
statements.

Here are a few reasons why organizations opt for it.

Consistent standards: Financial accounts make it easy for organizations to create

financial statements that follow universally accepted standards.

Improved accountability: Financial statements improve an organization’s credibility

among regulatory bodies, tax authorities, and lenders.

Efficient decision-making: Financial performance analysis enables enterprises to invest

and allocate resources better.
 Transparent financial reporting: Financial accounting also promotes transparency by
setting rules that organizations must follow while disclosing financial performance.

A reliable source of information: The rules set by independent governing bodies

ensure accurate reporting practices among organizations.

Types of financial accounting

There are two types:

Cash accounting

Accrual accounting.

The key difference between them is the timing of transaction recording.

1. Accrual method
The accrual accounting method records transactions as they occur, regardless of when the
money exchange happens. Organizations use accrual basis accounting to create journal
entries for sales and expenses even before collecting or making payments.

Accrual-based accounting follows the revenue matching principle, which requires revenue
and expense recording in the same period of time. It also uses double-entry accounting to
record liabilities for debit incurred (but cash not paid) and assets for income earned (but
money not received).

The accrual method is standard among enterprises handling large volumes of credit
transactions.

Example of accrual method

An example of accrual accounting is how an organization records revenue using accrual
accounting. Imagine XYZ Pvt. Ltd. delivered goods and services worth INR 50,000 to ABC
Pvt Ltd. on 15th February. Now, XYZ Pvt. Ltd. records revenue as they make a sale, meaning
they add revenue to their books before receiving cash. ABC Pvt. Ltd. receives an invoice they
must pay within 20 days.

Cash journal entry

February Debit Credit

Accounts receivables, ABC Pvt. Ltd. ₹ 50,000

Revenue ₹ 50,000

March

Cash ₹ 50,000

Accounts receivables, ABC Pvt. Ltd. ₹ 50,000

The cash journal entries for this transaction require XYZ Pvt. Ltd. to capture service revenue
in February and record payment in March.
Quick Read: CapEx vs. OpEx: A Guide to Understanding the Differences

2. Cash method
The cash accounting method records transactions when the money exchange happens. For
example, an organization records income after receiving cash from sales and expenses after
processing accounts payables.

Cash basis accounting requires transaction recording only when money goes in or out of a
bank account. This method suits small businesses. Enterprises with large inventories don’t
use cash accounting as it doesn’t capture liabilities incurred but not paid yet.

Example of cash accounting

Here is an example of how enterprises record revenue and spending using the cash-based
method. Imagine Kurtis Pvt. Ltd. sells curtains worth ₹ 30,000 to Ariz Pvt. Ltd. on April 10. The
cash journal entries below show how Kurtis Pvt. Ltd. records the revenue only after they
receive payment from Ariz Pvt. Ltd. on April 11.

Cash journal entry

Date Transaction Revenue Expense Balance

April 10 Cash balance ₹ 50,000

April 10 Raw material ₹ 5,000 ₹ 45,000

April 10 Labor charges ₹ 3,000 ₹ 42,000

April 11 Ariz Pvt. Ltd. ₹ 30,000 ₹ 72,000

Objectives of financial accounting

According to principles of financial accounting, the main aim is to provide all internal and
external stakeholders with an accurate view of profits and losses. This in-depth financial
analysis allows organizations to protect stakeholders’ interests, meet legal requirements, and
optimize resource allocation.
Here are a few objectives of financial accounting.

1. Compliance with statutory requirements

2. Recordkeeping

3. Determine profitability

4. Management decision-making

1. Compliance with statutory requirements

Through the process of financial accounting, organizations comply with tax regulations, the
Companies Act, and other statutory requirements of the country in which it conducts
business.

2. Recordkeeping
It creates a systematic process for recording financial transactions in the books of accounts.
Organizations use these transactions to analyze and optimize their financial performance.

3. Determine profitability
Organizations maintaining financial accounts can also easily measure net income for a period
from assets, liabilities, and equities. While a simple way to calculate profit and loss is to
subtract spending from revenues simply, profitability also considers other factors, such as
pricing of goods and services, purchases, rent, salary, general expenses, depreciation,
interest paid, and taxes.

4. Management decision-making
a robust accounting process enables stockholders, shareholders, creditors, and other parties
to gauge an organization’s financial stability. Moreover, it aids the management team in
making analytical decisions for maximizing sales and profits.

Features of financial accounting

Here are some of the characteristic features:
 Monetary recordkeeping: Financial accounts don’t record non-monetary transactions,
regardless of their importance from a business point of view.

Historical transaction recording: Financial accountants only track transactions that

have already taken place in the past.

Legal requirements: As law mandates, organizations must keep their financial accounts
up-to-date. They should also get financial statements audited to ensure accuracy.

Made for external use: Financial accounting reports inform customers, investors,
suppliers, and financial institutions about the financial performance of an organization.

Interim reports: Organizations treat financial account statements covering less than a
year as interim reports. These reports are useful for conveying the financial
performance before a full-year reporting cycle ends.

Forms the basis of other accounting branches: Financial accounting deals with raw
data from journals and ledgers. Therefore, it is the foundation for other accounting
branches, such as management accounting, cost accounting, and other advanced
accounting methods.

Financial accounting concepts

Financial accountants use the following concepts or fundamentals while analyzing an
organization’s operational performance over some time.

Economic entity concept mandates that organizations keep their financial transactions
separate from business owners’ personal transactions.

Going concern principle assumes that an enterprise will remain in business in the
foreseeable future. Therefore, there’ll be no reason for liquidation or operation
discontinuance.

Matching concept emphasizes that an organization must record and match related
revenues and expenditures in the same period.

Materiality principle states that financial statements should report all material item
transactions. Material transactions are those that significantly impact financial decision-
making when included or excluded.

Conservatism requires organizations to record losses when discovered and profits only
 when fully realized. It also states that accountants must practice caution and verification
even while preparing basic accounting statements.

Revenue recognition principle dictates that enterprises should recognize revenue as

they earn it, not when they receive it. Accurate revenue recognition impacts the integrity
of an organization’s financial reporting.

Verifiable objective concept states that accounting data should be verifiable and free
from personal bias.

What are the main functions of financial

accounting?
The significant advantages of financial accounting are to create financial statements that
help investors, tax authorities, and lenders understand an organization’s financial position.
Accountants create these reports (income statement, cash flow statement, and balance
sheet) by tracking incoming and outgoing cash flow transactions.

Here are some of the functions of financial accounting.

Maintain systematic records: Financial accounting records financial transactions

accurately while meeting accounting standards and regulatory guidelines.

Analyze and summarize financial records: Accounting teams create final accounts
after analyzing and summarizing transactions in the trial balance. The final statement
shows the profits or losses of an organization during a financial year.

Communicate results: Financial accounts help organizations share their annual financial
performance with investors, shareholders, government bodies, lenders, creditors, and
debtors.

Meet legal requirements: Financial accounting ensures organizations fulfill their legal
obligations, such as book auditing and tax liabilities.

Quick Read: Cash Flow Forecasting: Definition, Advantages, and How to Ace It

What are the 4 main financial statements?

The four main financial statements are

1. Balance sheet

2. Income statement

3. Cash flow statement

4. Statement of retained earnings (also known as the statement of owner’s equity)

What are the financial accounting

examples?
This section explores how different financial statements play a key role in helping
organizations deliver a complete picture of their financial performance.
1. Balance sheet
A balance sheet or a statement of net worth reveals an organization’s assets, liabilities, and
shareholders’ equities at a particular time. It’s also known as a statement of financial
position.

Balance sheets follow a three-part accounting equation to balance out assets by adding
liabilities and shareholders’ equity. That’s why it’s known as a balance sheet.

Assets = liabilities + shareholders’ equity

SOLUTIONS 

Accountants use balance sheets with other statements to calculate key financial ratios.
CARD STACK
Balance sheets also help investors assess the capital structure of an enterprise and calculate
rates of return.
RESOURCES 

Example of balance sheet

COMPANY 
Here is the balance sheet of State Bank of India as of December 31, 2022. All values are in
millions of INR. 

Particulars Value

Total current assets 2,868,586.60

Total assets 57,513,773.20

Total current liabilities 42,303,422.20

Total liabilities 53,879,346.30

Total Equity 3,452,832

Total liabilities and shareholder’s equity 57,513,773.20

Total common shares outstanding 8,924.61

This example shows that the total assets always balance out the total liabilities and
shareholders’ equity.
2. Income statement
An income or profit and loss statement reveals an organization’s revenue, gains, expenses,
and losses for a particular period. It’s also known as a revenue and expense statement.
Income statements help organizations analyze depreciation, identify underperforming areas,
and measure performance against competitors.

Example of income statement

Here is an example that shows State Bank of India’s income statement for December 2022.
All values are in millions of INR, except for per-share items.

Particulars Value

Net interest income 392,306.80

Loan loss provision 61,963

Net interest income after loan loss provision 359,553.70

Non-interest income, bank 303,196.10

Non-interest expense, bank -454,974.10

Net income before taxes 215,739.30

Provision for income taxes 53,252

Net income after taxes 152,967.10

Minority interest 121,597.80

Equity in affiliates 1,974.93

Net income before extraordinary items 147,520

Net income 154,772.20

Income available to common excluding extraordinary items 147,520

Diluted net income 154,772.20

 Diluted weighted average shares 8,925.73

Diluted EPS excluding extraordinary items 16.53

DPS common stock primary issue 7.10

Diluted normalized EPS 13.83

This example shows how an income statement arrives at the net income available to all
stakeholders and basic earnings per share (EPS).

3. Cash flow statement

A cash flow statement (CFS) summarizes incoming and outgoing cash and cash equivalents
(CCE) to help organizations evaluate their operational abilities. Enterprises use this financial
statement to assess their ability to generate cash for paying debt and operating expenses.

A statement of cash flows includes three types of activities.

Operating activities reveal the incoming cash flow from selling goods and services.

Investing activities refer to cash generated from physical and non-physical property
buying and selling.

Financing activities include cash flow from debt and equity financing.

Cash flow from these activities helps organizations visualize how much cash they generate
and make decisions accordingly.

Example of cash flow statement

The below is the cash flow statement of SBI as of December 31, 2022.

Particulars Value

Net income 487,563.43

Cash from operating activities 576,948.46

Cash from investing activities -36,185.13

Cash from financing activities -38,445.14

 Foreign exchange effects 9,662.67

Net change in cash 511,980.86

Beginning cash balance 2,341,041.90

Ending cash balance 2,341,041.90

This example shows how a cash flow statement considers depreciation, taxes, interests,
working capital changes, capital expenditures, and cash dividends paid to summarize all
CCE transactions.

Quick Read: 6 Best Cash Flow Management Software

4. Statement of retained earnings

A retained earnings or owner’s equity statement reveals the sum of earnings that an
organization has reserved for investing in business operations. Organizations generally use
these earnings for paying debt, buying fixed assets, or as working capital.

Retained earnings statements reconcile starting and ending earnings for an accounting
period. Analysts use these statements to understand how an organization uses corporate
profits.

Example of retained earnings statement

Let’s look at a retained earnings statement for a company that pays cash dividends to
stockholders.

Particulars Value (INR)

Retained earnings on April 1, 2023 50,00,000

Net income for the year ended on March 31, 2022 38,00,000

Dividends paid (₹100 on every 10,000 shares) 10,00,000

Retained earnings on April 1, 2024 78,00,000

This example shows how a retained earnings statement looks at starting and ending earnings
of a period to summarize the reserved capital.
Read More: Difference Between Cost Accounting and Financial Accounting

Best practices for financial accounting

Efficient financial accounting enables organizations to unlock growth opportunities, monitor
spending, and optimize resource allocation. However, it can be challenging without a well-
planned strategy.

Here are a few best practices enterprises follow to mitigate risks and boost profit
margins.

Keep personal and business finances separate to prevent cash flow issues and tax filing
complications.

Establish internal accounting policies to minimize risks.

Determine the appropriate accounting principle, depending on organizational needs.

Use accounting software to track and record transactions and cash flows.

Create accurate financial statements for ease of sharing information with stakeholders.

Manage accounts payable, receivable, and reconciliation processes efficiently.

What is financial accounting software?

Financial accounting software solutions are cloud-based tools that record and manage the
day-to-day financial transactions of an organization. Moreover, these tools also help
organizations manage revenue, fixed assets, accounts receivables, and accounts payables.

Best-in-class financial accounting software packs the following features.

Transaction recording and processing: Financial accounting tools record, process, and
reconcile all types of transactions, including AP, AR, cash, and fixed assets.

Reporting: These software solutions help organizations create custom dashboards for
cash books, customer ledgers, final account statements, payables, and receivables.

Multi-currency support: Most accounting solutions also support multiple currencies,

meaning organizations can use a single system to manage finances across locations.
 Real-time reconciliation: Financial accounting software reconciles ledgers and sub-
ledgers in real-time. As a result, it becomes easier for organizations to create provisional
statements for financial performance analysis.

Analytics: These tools automatically analyze transactions to discover hidden expenses

and monitor capital utilization — both key to optimizing organizational cash flow.

Centralized system: Financial accounting systems centralize all financial data, so

anyone can access data from anywhere.

Modern enterprises and financial consultants use financial accounting software to organize
data, create financial reports, and allocate resources efficiently.

Quick Read: 10 Best Accounts Payable (AP) Software

How does financial accounting software

help?
Financial accounting software solutions automatically capture incoming and outgoing
financial transactions. As a result, organizations can effortlessly access all financial records
from a centralized platform.

These tools also enable organizations to manage fixed assets, ledger, budgeting, cash
management, and bank-related activities. Moreover, these tools monitor capital expenditure
and identify hidden expenses to help organizations optimize cash flow.

Best financial accounting software

Oracle Fusion Cloud ERP

Zoho Books

NetSuite Cloud Accounting Software

myBillBook

DataSnipper
Quick Read: Difference Between Financial Accounting and Management Accounting

Conclusion
Financial accounting helps organizations with accurate recordkeeping, which is key to
creating financial statements that meet accounting standards and legal guidelines.
Organizations following accounting best practices evaluate and optimize their performance
more efficiently. As a result, they remain in a better position to weather any financial
hardship.

FAQs
1. What is meant by financial accounting?
Financial accounting is the process of recording, analyzing, and summarizing the financial
transactions of an organization for an accounting period. It helps enterprises evaluate their
financial health and stability.

2. What are the 3 types of accounting?

Three types of accounting are:

1. Financial accounting
2. Cost accounting
3. Managerial accounting

3. What is the main purpose of financial accounting?

The purpose of financial accounting is to prepare and share financial statements with
external parties, so they can effortlessly evaluate the financial position of an organization.

4. What are the 4 types of financial accounting?

Four types of financial accounting statements are:

1. Balance sheet
2. Income statement
3. Cash flow statement
4. Retained earnings statement

5. What is an example of financial accounting?

The best example is a public company’s financial statement. It follows universally accepted
accounting guidelines to capture incoming and outgoing financial transactions.

6. What is the difference between financial accounting and management accounting?

Financial accounting offers an organization’s financial performance overview to internal and
external stakeholders. On the other hand, management accounting creates reports and
statements to help company managers maximize profits and minimize losses.

7. How is financial accounting different from managerial accounting?

Financial accounting shares financial statements with third parties, whereas managerial
accounting does the same but with company managers.

8. What is the difference between cash and accrual accounting?

Cash accounting records revenue or spending when the cash exchange happens. Accrual
accounting records revenues and expenses as they incur. Accrual-based accounting doesn’t
consider when the actual money is received or dispensed.

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1 Introduction to financial accounting

 2 What is financial accounting?

3 Who are all the users of financial accounting?

4 Importance of financial accounting for your organization

5 Types of financial accounting

6 Objectives of financial accounting

7 Features of financial accounting

8 Financial accounting concepts

9 What are the main functions of financial accounting?

10 What are the 4 main financial statements?

11 What are the financial accounting examples?

12 Best practices for financial accounting

13 What is financial accounting software?

14 How does financial accounting software help?

15 Best financial accounting software

16 Conclusion

17 FAQs

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