Financial Accounting: A Comprehensive Guide to Recording, Reporting, and Analyzing Financial Transactions
Bookkeeping: Recording Financial Transactions
Bookkeeping is the process of recording financial transactions, including sales, purchases, income, and payments. It is typically performed by a bookkeeper, who is responsible for maintaining day-to-day financial records.
Accounting: Communicating Financial Information
Accounting is the art of communicating financial information about a business entity to users such as shareholders and managers. Accountants create reports based on the financial transactions recorded by bookkeepers.
Financial Transactions
Financial transactions occur when goods or services are exchanged for money. Common types of transactions include sales, purchases, deposits, and withdrawals.
Double-Entry Bookkeeping
Double-entry bookkeeping requires recording each transaction twice, using debits and credits. This ensures that the total debits equal the total credits, maintaining the accounting equation.
Chart of Accounts
A chart of accounts is a list of the accounts used by an organization to track financial transactions.
Depreciation
Depreciation is the process of allocating the cost of an asset over its useful life. This expense is matched against the revenues generated by the asset.
Accrual Basis Accounting
Under the accrual basis, revenues are reported when they are earned, not when cash is received. Expenses are recorded when they are incurred, not when cash is paid.
Balance Sheet
A balance sheet is a financial statement that shows the value of a firm’s assets and liabilities at a particular point in time.
Income Statement
An income statement shows the revenues, expenses, and profits or losses of a business over a period of time.
Profitability
Profitability refers to a company’s ability to generate income and sustain growth.
Legal Duties
Companies are required to close their accounting year, generate financial statements, and distribute profits to shareholders.
Dividends and Retained Earnings
Dividends are payments made by a corporation to shareholders. Retained earnings are the portion of net income that is kept by the company for reinvestment.
Departments of a Company
Most companies have departments involved in creating revenue (direct costs) and general administration (indirect costs).
Break-Even Point
The break-even point is the point at which a company’s revenues equal its expenses.
Expense Classification
Expenses can be classified as variable or fixed. Variable expenses increase with sales, while fixed expenses remain constant.
Improving Profitability
Profitability can be improved by reducing fixed costs, variable costs per unit, or increasing selling prices.
Cost Accounting Methods
There are two main cost accounting methods: direct costing and full costing.
Direct and Indirect Costs
Direct costs can be easily identified with a product or activity. Indirect costs are allocated to products or activities based on their usage.
Financial Analysis
Financial analysis assesses a business’s viability, stability, and profitability.
Financial Ratios
Financial ratios are useful indicators of a firm’s performance and financial situation. Common ratios include liquidity ratios, asset turnover ratios, financial leverage ratios, and profitability ratios.
Liquidity Ratios
Liquidity ratios measure a firm’s ability to meet its short-term financial obligations. Common liquidity ratios include the current ratio and quick ratio.
Financial Leverage Ratios
Financial leverage ratios indicate a firm’s long-term solvency. Common financial leverage ratios include the debt ratio.