What is financial accounting?
Financial accounting is the official record. Every sale, purchase, payment and payroll run is recorded, classified and summarized into a set of statements: the profit and loss statement (what was earned and spent over a period), the balance sheet (what the business owns and owes at a point in time) and the cash flow statement (where the cash came from and went). The statements follow accepted standards so that anyone reading them, from a bank to a buyer to the tax office, can trust that they mean what they appear to mean.
It is distinct from managerial accounting, which produces internal reports in whatever form helps run the business. Financial accounting answers to outsiders; managerial accounting answers to the people in the room.
Why it matters
Why financial accounting matters
It is required by law, which is reason enough, but it also underpins everything else an agency does with money. The profit and loss statement is where an owner learns whether a good year was actually profitable. The balance sheet is where a lender decides whether to extend a credit line. The cash flow statement is where the gap between profit and cash becomes visible. A buyer or investor will read nothing else first. And an agency with clean financial accounts can answer a client's procurement questions about financial stability in a day rather than a scramble.
For a creative business the statements also carry a lesson that is easy to miss on the studio floor: revenue is not the same as income, and busy is not the same as profitable.
In practice
How financial accounting works in practice
- 01
Transactions are recorded as they happen, in an accounting platform, usually by a bookkeeper: sales invoices, supplier bills, bank payments, payroll, expenses. Each is coded to an account in the chart of accounts, and the bank feed is reconciled so that the books and the bank agree. Revenue is recognized when it is earned, which for a production means when the work is delivered rather than when the deposit arrives, and costs are matched to the period they relate to.
- 02
At month end the books are closed and the statements produced. At year end an accountant reviews or audits them, adjusts for depreciation, accruals and prepayments, and files the accounts and the tax returns. Along the way the same records feed the management reports the owners actually use week to week.
Watch out
What people get wrong about financial accounting
Treating it as a compliance chore to be done once a year. Accounts that are only tidied in the spring are useless for running the business the rest of the time, and the year-end tidy is more expensive than monthly discipline would have been. The second mistake is reading revenue as income. A deposit received in December is not December's profit; a production delivered in January is not January's cost. Timing is the whole art of it.
The third is confusing the financial statements with a management view. They show the business as a whole; they do not show which client or which kind of work made the money.
