What are the Basics of Financial Accounting?

The basics of financial accounting centers around a basic equation: assets equal liabilities plus owner’s equity. This equation provides the building blocks for the remainder of accounting principles. Other basics include debits and credits, selecting an accounting method for recording financial transactions, maintaining the general ledger, and preparing financial statements. Individuals often learn the basics of financial accounting by either working at a job that involves accounting or pursuing an educational degree with an accounting specialization. Through these options, individuals will learn what is often called the language of business: accounting.

The accounting equation includes the three main categories for all financial information: assets, liabilities and owner’s equity. Assets are all items a company owns and uses to generate sales revenue and profit. Current assets last 12 months or less, and include items like cash, inventory, short-term securities and accounts receivable. Long-term assets represent buildings, equipment, vehicles, land and other major purchases that help the company transform raw materials into sellable products. Liabilities include money borrowed and owed to other individuals or businesses. These are also current or long-term, with the former including accounts payable, credit lines and short-term loans, and the latter including mortgages or long-term loans. Owner’s equity represents the portion of income the business owner retains as his portion of net income.

Under the basics of financial accounting, companies must select an accounting method. The two most common are the cash basis method and the accrual accounting method. Cash basis accounting requires companies to record financial transactions whenever cash changes hands. Many small businesses use this method; large companies, however, are not allowed to use this method per national accounting standards. The accrual accounting method requires companies to record transactions as they occur, regardless of cash changing hands during the transaction. This method creates a better historical record of financial transactions.

The basics of financial accounting also require each transaction entry to have a debit and credit. Debits represent the left side of T accounts in the general ledger and credits represent information on the right of the account. Debits increase asset accounts and decrease liabilities or revenue accounts; credits have the opposite effect of debits for these accounts.

The basics of financial accounting also helps a company to keep an accurate ledger that consists of all the accounts it will use to record financial transactions. The aggregation of these accounts will result in a financial statement providing all users of the statement with an accurate presentation of the company’s financial health. Income statements list the revenue and expenses; balance sheets list the assets, liabilities and owner’s equity; and the statement of cash flows includes all movements of cash within the company.