Introduction
The real purpose of doing financial accounting is to get a real sense of just how healthy a company is – financially, that is. The numbers are used by all sorts of people – banks, investors, people with a stake in the business and even the business itself – but often they don’t really think them through before making a decision. It’s a key part of accounting that specifically helps get all the legal reports into shape so that people can tell if the business is eventually going to be profitable or not.
Let’s say you are a family-run business and you’re feeling pretty good about the fact that you’re selling things really efficiently. To you, the company is flying – but the truth is, you might not have a clue about the many different things that go into figuring out a business’s financial health. Just being good at sales isn’t enough to be financially healthy – you need a lot more than that.
Financial accounting is the foundation of any business, giving them the financial lowdown on how they’ve done for the year. It also helps make sure that everything is transparent when it comes to recording, summarizing and reporting on data. This blog is going to go over what financial accounting is all about, what the standards are and how important it is in the real world.
To take a look at how our solutions work in real life for businesses of all shapes and sizes, check out our case studies
What Is Financial Accounting?
Financial Accounting is the nitty-gritty of getting down on paper the financial ins and outs of a business over a particular stretch of time. We’re talking about every deal thats been done – be it the cost of raw materials, the day-to-day office expenses or even the paychecks – the whole shebang. Once you have all these transactions recorded, you can start piecing together the bigger picture – a financial snapshot that gives the lowdown to the people who care most – like investors, lenders, suppliers and all the other parties with a stake in the game.
Think of it like a personal diary – you write down each day what you’ve spent and what you’ve taken in. At the end of the month, its not hard to get a sense of where your money is going and if you’re coming out ahead or not. Same thing with a business – financial accounting gives you the inside scoop on your business’ financials: how much you’re spending, how much you’re making, how much you owe out – the works. The neat thing is that all this financial information gets crunched into statements that make sense – like your Balance Sheet, Income Statement and Cash Flow Statement – which give you (or anyone else who needs to know) a clear picture of the financial situation.
Financial Accounting Standards – GAAP – The Us Standard Every American Business Must Follow
In America, when a business’s wants to get its financials to a bank and investors they’re basically told they have to play by the rules. Those rules are called Generally Accepted Accounting Principles (GAAP) – they were cooked up by the Financial Accounting Standards Board (FASB) and watched over by the Securities and Exchange Commission (SEC). GAAP is do or die for all the big public companies and plenty of private outfits as well, who think credibility with the folks holding the cash is super important.
What makes GAAP tick
- GAAP is rules based: it gives them a clear set of instructions to follow – not a lot of grey areas. This way all the stateside business are following the same game plan.
- LIFO Is Allowed: US companies can do LIFO (Last In, First Out) for inventory – that is allowed whereas under international rules it’s a no no. It’s a tricky tax game, especially in times when costs are rising – a good way to cut tax bill in the short term.
- Historical Cost Rule: just record assets for what they were bought for – rather than the worth they’ve got now, keeps things nice and simple. Easy to verify and a good way to keep the books.
- You have to Say What You Did: GAAP means having to put down all sorts of extra information about how you tick financially – lots and lots of footnotes and all that jazz.
GAAP vs IFRS – A Key Comparison for US Businesses
US businesses are governed by GAAP but for those with international investors or operations, the International Financial Reporting Standards (IFRS) is something they need to be aware of. When it comes down to it, the two standards can differ significantly and nowhere more so than when it comes to inventory valuation
Under GAAP – Using LIFO
Imagine your company picks up 100 units in January at $50 each and another 100 in February at $60. By March theyve sold 150 of them – what would that look like?
- First 100 sold at $60 each (February stock) – thats $6,000
- Next 50 sold at $50 each (January stock) – thats $2,500
- Total COGS: $8,500 | Remaining Inventory: $2,500
- End result – higher COGS = less taxable profit = a tax advantage for US businesses
Under IFRS – Using FIFO
- First 100 sold at $50 each (January stock) – thats $5,000
- Next 50 sold at $60 each (February stock) – thats $3,000
- Total COGS: $8,000 | Remaining Inventory: $3,000
- The outcome – lower COGS = a higher reported profit and a more rosy appearance to international investors
Picking the right inventory method and understanding which standard applies to your business is pretty key – and one of the main reasons US companies benefit from working with expert accountants
Not sure which accounting standard applies to your business? Talk to our experts and get clarity in one call.
The Three Core Financial Statements Every US Business Needs
The output of financial accounting is a set of financial reports that tell the story of your business. Under GAAP, US companies have to produce three main statements.
1.The Balance Sheet
The balance sheet provides a snapshot of your company’s financial situation on a specific date (usually Dec 31st). Its organized around the simple accounting equation:
Assets = Liabilities + Shareholders Equity
The balance sheet is your chance to show investors and creditors what your company owns, what’s owed to vendors and suppliers, and what the net worth of the business is. Making mistakes here – often because of bad data entry or process gaps – can completely misrepresent your company’s position and get you into compliance trouble.
2.The Income Statement (Profit & Loss)
The income statement tells your company’s story of revenue, expenses and profit or loss over a specific period (a year, quarter or month). For US businesses using GAAP, its structured from the top down:
Revenue → Gross Profit → Operating Income → Net Income.
The income statement is the first document investors and lenders will look at when assessing a company’s profitability. Getting it right needs reliable financial reporting tools that integrate well with your accounting system and reduce the risk of human error.
3.The Cash Flow Statement
The cash flow statement tracks the actual flow of cash in and out of your business across three types of activity: operating (day-to-day business), investing (buying/selling assets) and financing (loans, equity and dividends).
This is important because being profitable on paper doesn’t always mean you’ve got cash in the bank. Lots of successful businesses fail because of poor cash flow management. Making sure your financial close process is running smoothly will get your cash flow statement completed accurately and on time every month and quarter.
Accrual vs Cash Basis Accounting – Choosing the Right Method for Your US Business
One of the key decisions a US business needs to make is which accounting method to use – accrual or cash basis accounting. The IRS and GAAP have clear rules about which method businesses must use, depending on the size and structure of the business.
Cash Basis Accounting
With cash basis accounting revenue and expenses are recorded only when cash is actually in your bank account, or when you make a payment. This is the simpler of the two methods and is often used by small businesses and large businesses that have annual gross receipts under about $27 million (according to the IRS). However, this method can be a bit rough – it doesn’t give you a clear picture of your long-term financial health, which can make it harder to get a big loan or attract institutional investors.
Accrual Basis Accounting
When using accrual basis accounting revenue is recorded when you’ve earned it, and expenses are recorded when you incur them – regardless of when the cash actually changes hands. This is the way that GAAP does things, and most private companies that carry inventory are required to follow it too. Accrual accounting gives you a much better picture of your financial health and is a must for businesses that are planning to grow, get funding or go public.
The right choice for you is going to depend on your revenue size, business structure, and ambitions for growth. Understanding the ins and outs of both methods is one of the key steps to building a solid accounting foundation for your business.
Record to Report: The Engine Behind Your Financial Accounting
Financial accounting doesn’t just happen magically – there’s actually a process called Record to Report Process that needs to happen before your financial statements can be produced. This is the end-to-end workflow that keeps your financial reporting ticking along – from capturing those individual journal entries
- General ledger management and recording individual journal entries
- Account reconciliations (to make sure everything adds up) and eliminating duplicate expenses
- End of month and end of year financial close activities
- Management reporting and putting together the official financial statements
When your Record to Report cycle is streamlined, you get financial statements that are not only accurate but delivered on time. Problems in this process can snowball and affect every report that comes after – which is why getting your financial close process in order is a top priority for US finance teams of all sizes.
Why Financial Accounting Standards Matter for Your US Investors & Stakeholders
When US businesses stick to GAAP it gives everyone a level playing field and benefits all parties:
- Investors can compare companies in the same industry without having to worry about accounting methods being different – it lets them make better decisions about where to put their money
- Lenders and creditors can trust that financial statements from different businesses are going to be reliable – and that’s a big help when it comes to deciding who to lend to
- Management gets a reliable tool for making decisions – they can spot departments that aren’t doing so well, get a handle on their ROI, and start planning for growth
- Regulators like the SEC and IRS can check on tax and reporting obligations with ease
For example, if two different manufacturing companies in the US both follow GAAP an investor can easily compare their gross margins, their debt-to-equity ratio and their cash flow performance – even if one company is based in one state and the other is in another. That kind of transparency is what makes GAAP-compliant reporting so powerful.
The Primary Purpose of Financial Accounting: Getting Beyond Just Compliance
At its core compliance is just the tip of the iceberg. For US businesses, financial accounting serves four far more important strategic functions.
- Making Decisions with Confidence: Your financial data is the key to knowing exactly where your business is making money and where it’s losing – its giving you the power to make smart corrections & investment decisions way before it’s too late.
- Building Investor & Lender: Trust A set of clean, GAAP compliant financial reports signals to the world that your business is well run. On the other hand, sloppy reporting sends up a big red flag, regardless of how well your business is actually doing.
- Nailing Tax Compliance & Optimization: Accurate accounting means you’re not getting taken to the cleaners by the IRS – it also opens up opportunities to save on tax through depreciation, inventory methods and expense timing.
- Getting a Fair Business Valuation: Your company valuation is basically just a snapshot of your financial statement – so having clean, accurate books will always give you a higher valuation than some mucked up records.
A Practical Guide to Getting Financial Accounting Right in Your Business
Whether you’re a founder starting from a blank slate or an established business trying to sort out your financial infrastructure, here’s the roadmap to follow:
Step 1: Get the Fundamentals Down
Start by understanding what an asset is, what a liability is – get to know your accounts, assets, liabilities, equity, revenue and expenses. figure out how to read those three core financial statements. You can get the SECs EDGAR database for free – its a treasure trove of financial reports from all publicly traded US companies – use that to learn from the real deal.
Step 2: Choose Your Accounting Method Wisely
Decide between cash or accrual accounting – it’s a matter of how your business works, whether your revenue is steady or erratic, and what the IRS expects. Most growing US businesses will end up having to do accrual accounting as they grow.
Step 3: Get Your Tools in Order
Get a reporting tool that integrates with what you’re already using, gives you real time visibility and minimizes the number of manual processes. Getting the tech right is what makes the difference between being able to get your financial statements when you need them and taking ages to get them & being stuck waiting.
Step 4: Streamline from Record to Report
Set up a solid Record to Report process with clear ownership, deadlines and review checkpoints. The difference is having financial statements when you need them – vs getting bogged down with ones that just delay making business decisions.
Step 5: Get the Right Help
Partner with an accountant that’s good with US GAAP & IRS regs and knows your industry inside & out – for businesses on a budget, there are affordable accounting solutions out there that deliver results way beyond what you’d expect for the price.
Conclusion
Financial accounting is so much more than just ticking the boxes on reporting – it’s a vital tool that helps drive real business strategy, build investor trust and keep your company on a stable footing for the long haul. Every single part of it – managing those accounts payable and accounts receivables, making sure financial reports are accurate and up to scratch with GAAP – adds up to one crucial thing: building credibility and unlocking your business’s growth potential.
At Corient Business Solutions, we have an awful lot of experience in providing bespoke financial and accounting services to US businesses – no matter how big (or small) they are. Whether you need help sorting out your accounts, or just want some reliable folk to handle all your finance stuff for you, or even an affordable accounting system that grows alongside your business – we are here to help your business stay compliant, make smarter decisions, and thrive in today’s competitive US market.
Join hundreds of US businesses that trust Corient for accurate, compliant, and stress-free financial accounting.
