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Financial Account Definition, With Components and Assets

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Table of Contents

What Is a Financial Account?

Understanding Financial Accounts

Capital vs. Current Account

Transaction Recording

Risks and Benefits

FAQs

The Bottom Line

Economics

Macroeconomics

Financial Account Definition, With Components and Assets

Will Kenton

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Will Kenton is an expert on the economy and investing laws and regulations. He previously held senior editorial roles at Investopedia and Kapitall Wire and holds a MA in Economics from The New School for Social Research and Doctor of Philosophy in English literature from NYU.

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Updated September 08, 2023

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When a Rise in the Financial Account Is Bad

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Financial Account Subaccounts

How It's Part of the Balance of Payments

Balance of Payments

Photo: SDI Productions / Getty Images

The financial account is part of a country's balance of payments. The other two parts are the capital account and the current account. The capital account measures financial transactions that don't affect income, production, or savings. Examples include international transfers of drilling rights, trademarks, and copyrights. The current account measures international trade of goods and services plus net income and transfer payments.

The financial account is a measurement of increases or decreases in international ownership of assets. The owners can be individuals, businesses, the government, or its central bank. The assets include direct investments, securities like stocks and bonds, and commodities such as gold and hard currency.

The financial account reports on the change in total international assets held. You can find out if the number of assets held increased or decreased. It does not tell you how much in total assets is currently being held.

Key Takeaways

The financial account reports foreign ownership of domestic assets and domestic ownership of foreign assets.If it increases, that means foreign money is flowing into the country.If it decreases, the country's money is flowing into foreign markets.The financial account is part of the balance of payments. The other two parts are the capital account and the current account.

The Two Subaccounts of the Financial Account

The financial account has two main subaccounts. The first is domestic ownership of foreign assets. It measures money flowing out of the country to purchase foreign assets. If this increases, it subtracts from the financial account.

The second subaccount is foreign ownership of domestic assets. It measures money flowing into the country to pay for the asset. If this increases, it adds to a country's financial account.

The financial account components are similar in each subaccount. The only difference is whether the asset is owned by someone in the country or a foreigner.

Domestic Ownership of Foreign Assets

This subaccount is further divided into three types of ownership: private, government, and central bank reserves. No matter which entity owns the foreign asset, increases subtract from the financial account.

Private owners can be either individuals or businesses. Their assets include:

Deposits at foreign banks, such as a Yankee CD

Loans to foreigners

Securities of foreign-owned companies

Direct investments made in foreign countries

Commodities, such as gold, held in other countries

Government owners can be at the federal, state, or local level. Most foreign assets are owned by the federal government. Its assets can include all of the above, but most are gold and foreign currencies held in reserve. This component also includes the government's reserve position in the International Monetary Fund.

The nation's central bank can own all of the above except for the reserve position in the IMF. Also, it owns currency swaps with other central banks.

Foreign Ownership of Domestic Assets

This subaccount is further divided into two types of ownership: private and foreign official assets. When foreigners increase their ownership of a country's assets, it adds to the financial account.

These domestic assets include:

Deposits owned by foreigners held at the country's banks

Loans made by foreign banks to domestic banks

Foreign private purchases of a country's government bonds, such as U.S. Treasury notes

Corporate securities, such as stocks and bonds, owned by foreigners

Foreign direct investment, such as reinvested earnings, equities, and debt

Other debts owed to foreigners

Hard assets, such as gold and other commodities

The country's currency

Foreign official assets include:

Assets mentioned above that are held by foreign governments or foreign central banksNet shipments of the country's currency to foreign governments or foreign central banks

The financial accounts measure the change in international ownership of assets. This should not be confused with the income, such as interest and dividends, that is paid out on the assets owned. That is measured by the current account.

The Financial Account Is Part of the Balance of Payments

The financial account is a large component of the balance of payments. It adds to the balance of payments when it's positive, or when foreign money is flowing into the country to purchase assets. It subtracts from the balance of payments when domestic money is flowing out of the country to purchase foreign assets.

Note

If the financial account runs a large enough surplus, it can help offset a trade deficit. That's not a good thing.

If the financial account offsets the trade deficit, it means the country is selling off its assets to pay for purchases of foreign goods and services. That's like selling off your land to pay for groceries. You would be better off investing in that land by farming it to grow your food. It’s not sustainable to sell off all your assets for something consumable.

Balance of Payments

Current AccountCurrent Account DeficitU.S. Current Account DeficitTrade BalanceImports and ExportsU.S. Imports and Exports SummaryU.S. ImportsU.S. Imports by Year for Top 5 CountriesU.S. ExportsTrade DeficitU.S. Trade DeficitU.S. Trade Deficit by CountryU.S. Trade Deficit With ChinaCapital AccountFinancial Account

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Sources

The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy.

Bureau of Economic Analysis. "A Guide to the U.S. International Transactions Accounts and the U.S. International Investment Position Accounts,"

Federal Reserve Bank of New York. "Balance of Payments,"

Capital Account, How It's Measured, with Examples

Current Account and Its Four Components

Balance of Payments: Its Components and Deficit vs. Surplus

Current Account Deficit, Its Components and Causes

U.S. Imports and Exports: Components and Statistics

Balance of Trade: Favorable Versus Unfavorable

What Is the Current U.S. Account Deficit?

What Is a Central Bank Freeze?

US Trade Deficit by Country, With Current Statistics and Issues

Impact of Trade Deficits and Surpluses on Investors

Trump's NAFTA Changes

U.S. Imports, Including Top Categories, Challenges, and Opportunities

What is Owner's Equity?

Trade Deficits, Their Causes, and Effects

Dollar Decline vs. Dollar Collapse

Foreign Exchange Reserves and How They Work

The Balance

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Financial Accounting Meaning, Principles, and Why It Matters

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Table of Contents

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Table of Contents

What Is Financial Accounting?

How It Works

Financial Statements

Accrual Method vs. Cash Method

Principles

Why It Matters

Users of Financial Accounting

Financial vs. Managerial Accounting

Professional Designations

Financial Accounting FAQs

The Bottom Line

Corporate Finance

Accounting

Financial Accounting Meaning, Principles, and Why It Matters

Will Kenton

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Updated December 20, 2023

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What Is Financial Accounting?

Financial accounting is a specific branch of accounting involving a process of recording, summarizing, and reporting the myriad of transactions resulting from business operations over a period of time. These transactions are summarized in the preparation of financial statements—including the balance sheet, income statement, and cash flow statement—that record a company’s operating performance over a specified period.

Work opportunities for a financial accountant can be found in both the public and private sectors. A financial accountant’s duties may differ from those of a general accountant, who works for themself rather than directly for a company or an organization.

Key Takeaways

Financial accounting is the framework that dictates the rules, processes, and standards for financial recordkeeping.Nonprofits, corporations, and small businesses use financial accountants to prepare their books and records and generate their financial reports.Financial reporting occurs through the use of financial statements, such as the balance sheet, income statement, statement of cash flow, and statement of changes in shareholder equity.Financial accounting differs from managerial accounting, as financial reporting is for reporting to external parties, while managerial accounting is for internal strategic planning.Financial accounting may be performed under the accrual method (recording expenses for items that have not yet been paid) or the cash method (only cash transactions are recorded).

Investopedia / Laura Porter

How Financial Accounting Works

Financial accounting utilizes a series of established principles. Which accounting principles are used depends on the regulatory and reporting requirements of the business.

U.S. public companies are required to perform financial accounting in accordance with generally accepted accounting principles (GAAP). Their purpose is to provide consistent information to investors, creditors, regulators, and tax authorities.

The statements used in financial accounting cover the five main classifications of financial data, which are:

Revenues – Included here is income from sales of products and services, plus other sources, including dividends and interest.Expenses – These are the costs of producing goods and services, from research and development to marketing to payroll.Assets – These consist of owned property, both tangible (buildings, computers) and intangible (patents, trademarks).Liabilities – These are all outstanding debts, such as loans or rent.Equity – If you paid off the company’s debts and liquidated its assets, you would get its equity, which is what a company is worth.

Revenues and expenses are accounted for and reported on the income statement, resulting in the determination of net income at the bottom of the statement. Assets, liabilities, and equity accounts are reported on the balance sheet, which utilizes financial accounting to report ownership of the company’s future economic benefits.

International public companies also frequently report financial statements in accordance with International Financial Reporting Standards (IFRS).

Financial Statements

Balance Sheet

A balance sheet reports a company’s financial position as of a specific date. It lists the company’s assets, liabilities, and equity, and the financial statement rolls over from one period to the next. Financial accounting guidance dictates how a company records cash, values assets, and reports debt.

A balance sheet is used by management, lenders, and investors to assess the liquidity and solvency of a company. Through financial ratio analysis, financial accounting allows these parties to compare one balance sheet account with another. For example, the current ratio compares the amount of current assets with current liabilities to determine how likely a company is going to be able to meet short-term debt obligations.

Income Statement

An income statement, also known as a “profit and loss statement,” reports a company’s operating activity during a specific period of time. Usually issued on a monthly, a quarterly, or an annual basis, the income statement lists revenue, expenses, and net income of a company for a given period. Financial accounting guidance dictates how a company recognizes revenue, records expenses, and classifies types of expenses.

An income statement can be useful to management, but managerial accounting gives a company better insight into production and pricing strategies compared with financial accounting. Financial accounting rules regarding an income statement are more useful for investors seeking to gauge a company’s profitability and external parties looking to assess the risk or consistency of operations.

Cash Flow Statement

A cash flow statement reports how a company used cash during a specific period. It is broken into three sections:

Operations – These are the costs of a company’s core business activities.Financing – This is money the company receives from taking loans or issuing shares, as well as money paid in interest on loans and dividends to investors.Investments – This is money that comes from buying and selling the company’s investments, such as securities or fixed assets.

Financial accounting guidance dictates when transactions are to be recorded, though there is often little to no flexibility in the amount of cash to be reported per transaction.

A cash flow statement is used by managed to better understand how cash is being spent and received. It extracts only items that impact cash, allowing for the clearest possible picture of how money is being used, which can be somewhat cloudy if the business is using accrual accounting.

Shareholders' Equity Statement

A shareholders' equity statement reports how a company’s equity changes from one period to another, as opposed to a balance sheet, which is a snapshot of equity at a single point in time. It shows how the residual value of a company increases or decreases and why it changed. It gives details about the following components of equity:

Share Capital – Money raised by selling stock in the companyNet Income – Any profit after expenses and deductionsDividends – The part of profit that is paid to shareholdersRetained Earnings – Whatever is left after paying dividends

Nonprofit entities and government agencies use similar financial statements; however, their financial statements are more specific to their entity types and will vary from the statements listed above.

Accrual Method vs. Cash Method

There are two primary types of financial accounting: the accrual method and the cash method. The main difference between them is the timing in which transactions are recorded.

Accrual Method

The accrual method of financial accounting records transactions independently of cash usage. Revenue is recorded when it is earned (when a bill is sent), not when it actually arrives (when the bill is paid). Expenses are recorded upon receiving an invoice, not when paying it. Accrual accounting recognizes the impact of a transaction over a period of time.

For example, imagine a company receives a $1,000 payment for a consulting job to be completed next month. Under accrual accounting, the company is not allowed to recognize the $1,000 as revenue, as it has technically not yet performed the work and earned the income. The transaction is recorded as a debit to cash and a credit to unearned revenue, a liability account. When the company earns the revenue next month, it clears the unearned revenue credit and records actual revenue, erasing the debt to cash.

Another example of the accrual method of accounting are expenses that have not yet been paid. Imagine a company received an invoice for $5,000 for July utility usage. Even though the company won’t pay the bill until August, accrual accounting calls for the company to record the transaction in July, debiting utility expense. The company records a credit to accounts payable. When the invoice is paid, the credit is cleared.

Cash Method

The cash method of financial accounting is an easier, less strict method of preparing financial statements: Transactions are recorded only when cash is involved. Revenue and expenses are only recorded when the transaction has been completed via the facilitation of money.

In the example above, the consulting firm would have recorded $1,000 of consulting revenue when it received the payment. Even though it won’t actually perform the work until the next month, the cash method calls for revenue to be recognized when cash is received. When the company does the work in the following month, no journal entry is recorded, because the transaction will have been recorded in full the prior month.

In the other example, the utility expense would have been recorded in August (the period when the invoice was paid). Even though the charges relate to services incurred in July, the cash method of financial accounting requires expenses to be recorded when they are paid, not when they occur.

Financial Accounting

Accrual Method

Records transactions when benefit is received or liability is incurred

A more accurate method of accounting that depicts more-realistic business operations

Required for larger, public companies as part of external reporting

Cash Method

Records transactions when cash is received or distributed

An easier method of accounting that simplifies a company down to what has already actually occurred

Primarily used by smaller, private companies with low to no reporting requirements

Principles of Financial Accounting

Financial accounting is dictated by five general, overarching principles that guide companies in how to prepare their financial statements. They are the basis of all financial accounting technical guidance. These five principles relate to the accrual method of accounting.

Revenue Recognition Principle – This states that revenue should be recognized when it has been earned. It dictates how much revenue should be recorded, the timing of when that revenue is reported, and circumstances in which revenue should not be reflected within a set of financial statements.

Cost Principle – This states the basis for which costs are recorded. It dictates how much expenses should be recorded for (i.e. at transaction cost) in addition to properly recognizing expenses over time for appropriate situations (i.e. a depreciable asset is expensed over its useful life).

Matching Principle – This states that revenue and expenses should be recorded in the same period in which both are incurred. It strives to prevent a company from recording revenue in one year with the associated cost of generating that revenue in a different year. The principle dictates the timing in which transactions are recorded.

Full Disclosure Principle – This states that the financial statements should be prepared using financial accounting guidance that includes footnotes, schedules, or commentary that transparently report the financial position of a company. It dictates the amount of information provided within financial statements.

Objectivity Principle – This states that while financial accounting has aspects of estimations and professional judgement, a set of financial statements should be prepared objectively. It dictates when technical accounting should be used as opposed to personal opinion.

Importance of Financial Accounting

Companies engage in financial accounting for a number of important reasons.

Creating a standard set of rules – By delineating a standard set of rules for preparing financial statements, financial accounting creates consistency across reporting periods and different companies.

Decreasing risk – Financial accounting does this by increasing accountability. Lenders, regulatory bodies, tax authorities, and other external parties rely on financial information; financial accounting ensures that reports are prepared using acceptable methods that hold companies accountable for their performance.

Providing insight to management – Though other methods such as managerial accounting may provide better insights, financial accounting can drive strategic concepts if a company analyzes its financial results and makes reactionary investment decisions.

Promoting trust in financial reporting – Independent governing bodies oversee the rules of financial accounting, making the basis of reporting independent of management and a highly reliable source of accurate information

Encouraging transparency – By setting rules and requirements, financial accounting forces companies to disclose certain information on how operations are going, and what risks the company is facing, painting an accurate picture of financial performance regardless of how well or poorly the company is doing.

Careers in financial accounting can include preparing financial statements, analyzing financial statements, auditing financial statements, and supporting the technology/systems that produce financial statements.

Users of Financial Accounting/Financial Statements

The entire purpose of financial accounting is to prepare financial statements, which are used by a variety of groups and often required as part of agreements with the preparing company. In addition to management using financial accounting to gain information on operations, the following groups use financial accounting reporting.

Investors – Before putting their money into a company, investors often seek reports prepared using financial accounting to understand how the company has been doing and set expectations about the company’s future.

Auditors – Companies may be required to present their financial position to auditors, who analyze the financial statements and ensure that proper financial accounting guidance has been used and the reports are free from material misstatements.

Regulatory Agencies – Public companies are required to submit financial statements to governing bodies such as the Securities and Exchange Commission. These financial statements must be prepared in accordance with financial accounting rules, and companies face fines or exchange delisting if they do not comply with reporting requirements.

Suppliers – Vendors or suppliers may ask for financial statements as part of their credit application process. Suppliers may require a credit history or evidence of profitability, such as a Piotroski Score, before issuing or increasing credit to a requested amount.

Banks – Lenders and other similar financial institutions will almost always require financial statements as part of the business loan process. Lenders will need to see verifiable proof via financial accounting that a company is in good operational health prior to issuing a loan. The statements may also be used for determining the cost, covenants, or interest rate of the loan.

Financial Accounting vs. Managerial Accounting

The key difference between financial and managerial accounting is that financial accounting provides information to external parties, while managerial accounting helps managers within the organization make decisions. Managerial accounting assesses financial performance and hopes to drive smarter decision-making through internal reports that analyze operations. It is not an allowable basis for financial statements.

Managerial accounting uses operational information in specific ways to glean information. For example, it may use cost accounting to track the variable costs, fixed costs, and overhead costs along a manufacturing process. Then, using this cost information, a company may decide to switch to a lower quality, less expensive type of raw materials.

Professional Designations for Financial Accounting

Members of financial accounting can carry several different professional designations.

Certified Public Accountant (CPA) – The most common accounting designation demonstrating an ability to perform financial accounting within the United States is the CPA license.

Chartered Accountant (CA) – Outside of the United States, holders of the CA license demonstrate the ability as well.

Certified Management Accountant (CMA) – The CMA designation is more demonstrative of an ability to perform internal management functions than financial accounting. However, this license does test on financial analysis.

Certified Internal Auditor (CIA) – Holding a CIA designation demonstrates creditability in maintaining the control environment within a company by overseeing processes and procedures related to financial accounting.

Certified Information Systems Auditor (CISA) – The CISA exam tests proficiency on maintaining the systems of an entity and may directly or indirectly influence the outcome of the financial accounting process.

What Is an Example of Financial Accounting?

A public company’s income statement is an example of financial accounting. The company must follow specific guidance on what transactions to record. In addition, the format of the report is stipulated by governing bodies. The end result is a financial report that communicates the amount of revenue recognized in a given period.

What Is the Main Purpose of Financial Accounting?

Financial accounting is intended to provide financial information on a company’s operating performance. Though management can analyze reports generated using financial accounting, they often find it more useful to use managerial accounting, an internally geared method of calculating financial results that is not allowable for external reports. Financial accounting is the widely accepted method of preparing financial results for external use.

Who Uses Financial Accounting?

Public companies are required to perform financial accounting as part of the preparation of their financial statement reporting. Small or private companies may also use financial accounting, but they often operate with different reporting requirements. Financial statements generated through financial accounting are used by many parties outside of a company, including lenders, government agencies, auditors, insurance agencies, and investors.

The Bottom Line

Financial accounting is the framework that sets the rules on how financial statements are prepared. The U.S. follows different accounting rules than most other countries. These guidelines dictate how a company translates its operations into a series of widely accepted and standardized financial reports. Financial accounting plays a critical part in keeping companies responsible for their performance and transparent regarding their operations.

Article Sources

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Financial Accounting Standards Board. "About the FASB."

University of Nevada, Reno. "What Is Financial Accounting and Why Is It Important?"

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Part Of

Guide to Accounting

Accounting Explained With Brief History and Modern Job Requirements

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4 of 51

Equity Definition: What it is, How It Works and How to Calculate It

5 of 51

Revenue Definition, Formula, Calculation, and Examples

6 of 51

Expense: Definition, Types, and How Expenses Are Recorded

7 of 51

Current Assets vs. Noncurrent Assets: What's the Difference?

8 of 51

What Is Accounting Theory in Financial Reporting?

9 of 51

Accounting Principles Explained: How They Work, GAAP, IFRS

10 of 51

Accounting Standard Definition: How It Works

11 of 51

Accounting Convention: Definition, Methods, and Applications

12 of 51

What Are Accounting Policies and How Are They Used? With Examples

13 of 51

How Are Principles-Based and Rules-Based Accounting Different?

14 of 51

What Are Accounting Methods? Definition, Types, and Example

15 of 51

What Is Accrual Accounting, and How Does It Work?

16 of 51

Cash Accounting Definition, Example & Limitations

17 of 51

Accrual Accounting vs. Cash Basis Accounting: What's the Difference?

18 of 51

Financial Accounting Standards Board (FASB): Definition and How It Works

19 of 51

Generally Accepted Accounting Principles (GAAP): Definition, Standards and Rules

20 of 51

What Are International Financial Reporting Standards (IFRS)?

21 of 51

IFRS vs. GAAP: What's the Difference?

22 of 51

How Does US Accounting Differ From International Accounting?

23 of 51

Cash Flow Statement: What It Is and Examples

24 of 51

Breaking Down The Balance Sheet

25 of 51

Income Statement: How to Read and Use It

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What Does an Accountant Do?

27 of 51

Financial Accounting Meaning, Principles, and Why It Matters

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How Does Financial Accounting Help Decision-Making?

29 of 51

Corporate Finance Definition and Activities

30 of 51

How Financial Accounting Differs From Managerial Accounting

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Cost Accounting: Definition and Types With Examples

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Certified Public Accountant: What the CPA Credential Means

33 of 51

What Is a Chartered Accountant (CA) and What Do They Do?

34 of 51

Accountant vs. Financial Planner: What's the Difference?

35 of 51

Auditor: What It Is, 4 Types, and Qualifications

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Audit: What It Means in Finance and Accounting, and 3 Main Types

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Tax Accounting: Definition, Types, vs. Financial Accounting

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Forensic Accounting: What It Is, How It's Used

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Chart of Accounts (COA) Definition, How It Works, and Example

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What Is a Journal in Accounting, Investing, and Trading?

41 of 51

Double Entry: What It Means in Accounting and How It's Used

42 of 51

Debit: Definition and Relationship to Credit

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Credit: What It Is and How It Works

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Closing Entry

45 of 51

What Is an Invoice? It's Parts and Why They Are Important

46 of 51

6 Components of an Accounting Information System (AIS)

47 of 51

Inventory Accounting: Definition, How It Works, Advantages

48 of 51

Last In, First Out (LIFO): The Inventory Cost Method Explained

49 of 51

The FIFO Method: First In, First Out

50 of 51

Average Cost Method: Definition and Formula with Example

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Related Terms

What Are Accruals? How Accrual Accounting Works, With Examples

Accruals are revenues earned or expenses incurred that impact a company's net income, although cash has not yet exchanged hands.

Financial Statements: List of Types and How to Read Them

Financial statements are written records that convey the business activities and the financial performance of a company.

Consolidated Financial Statements: Requirements and Examples

Consolidated financial statements show aggregated financial results for multiple entities or subsidiaries associated with a single parent company.

Accounting Explained With Brief History and Modern Job Requirements

Accounting is the process of recording, summarizing, and reporting financial transactions to oversight agencies, regulators, and the IRS.

Generally Accepted Accounting Principles (GAAP): Definition, Standards and Rules

GAAP is a set of generally accepted accounting principles widely used in the U.S. for financial reporting by corporations and government entities.

Balance Sheet: Explanation, Components, and Examples

A balance sheet is a financial statement that reports a company's assets, liabilities and shareholder equity at a specific point in time.

What Are Accruals? How Accrual Accounting Works, With Examples

Accrual Accounting vs. Cash Basis Accounting: What's the Difference?

Financial Statements: List of Types and How to Read Them

Consolidated Financial Statements: Requirements and Examples

Accounting Explained With Brief History and Modern Job Requirements

Accounting for Small Businesses: A Comprehensive Guide to Financial Management

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Home › Resources › Economics › Financial Account

Financial Account

A measure of the changes in the number of foreign assets held by residents of a country Over 1.8 million professionals use CFI to learn accounting, financial analysis, modeling and more. Start with a free account to explore 20+ always-free courses and hundreds of finance templates and cheat sheets.

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What is the Financial Account?

The financial account measures the changes in the number of foreign assets held by residents of a country. Residents include individuals/families, businesses, and the government. A country’s financial account is one of the three components of its balance of payments.

The balance of payments, as the name suggests, is simply the way a country accounts for its financial welfare, including all income coming into the country, as well as looking at its trade with foreign countries and the success or failures of foreign and domestically-held assets.

Exploring the Financial Account

Assets measured within the financial account include everything from direct investments to commodities (such as precious metals, like gold, or foreign currency) and securities (such as bonds or stocks).

The financial account works in combination with the current account – which acts as a metric for international trade – and the capital account – which is a metric for all financial transactions that don’t actively have an impact on production, savings, or income – with all three completing the system of balance of payments for a country.

The financial account does not reveal the total number of assets held by a country. However, it does act as a record of the changes in the amount or value of assets being held by a country’s residents. It simply shows whether the number of assets held increases or decreases in total value.

The Two Subaccounts of the Financial Account

There are two subaccounts or sections within the financial account:

1. Foreign ownership of domestic assets

The foreign ownership subaccount is broken into two parts: private assets and foreign official assets. When residents of a foreign country own assets in the domestic country, the financial account records a decrease.

Domestic assets that may be owned by foreigners include loans made from foreign to domestic banks, deposits made by foreigners to domestic banks, corporate securities (i.e., stocks/bonds), and foreign debt. Foreign official assets can be any of the assets already mentioned; however, they must be held by a foreign government or central bank.

2. Domestic ownership of foreign assets

The domestic ownership subaccount specifies three types of ownership. Private owners are individuals or businesses and can have assets that include foreign loans, deposits at banks in other countries, or direct investments made into other countries. Government owners are either at the local, state, or federal level, though the federal government is the primary type of government asset owner.

Finally, the central bank of a country can own foreign assets, which include all of the assets mentioned above, except for a reserve position in the International Monetary Fund (IMF), an asset that is uniquely held by government owners.

Despite the fact that the financial account does not give a solid number of total foreign assets held, it is important in the way it functions both to reveal increases or decreases in the number of assets held by a country, and in its role as one of the three metrics used in the balance of payments system.

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Current and Financial Account Balance - Economics Help

ent and Financial Account Balance - Economics Help Skip to content

0 Menu HomeShopEconomics A – ZBlogContact 0 0 Menu HomeShopEconomics A – ZBlogContact 0 Current and Financial Account Balance 2 March 20226 October 2020 by Tejvan PettingerReaders Question I am confused by the statement that is written in my O level text book (Economics Author: Dan Moynihan; Brian Titley). It says that if the current account is in surplus the financial account will be in deficit. Is this true?Yes, it is trueFirstly, the current account on balance of payments measures trade in goods, services, investment incomes and current transfersThe financial account measures capital flows / short term and long term. For example, long-term investment in building a factory or financial flows such as buying bonds or depositing money in bank accounts.Current Account = (Financial + Capital Account)Note: The (Financial + Capital Account) used to be just called the capital account.

Why does the Current Account and Financial account balance?Basically, if we import goods and services, we need an inflow of capital (financial flows) to be able to pay for them.If you take a simplistic model.Suppose, we import £1m of clothes from China. We need to buy £1m of Chinese Yuan. To get this foreign currency, we need an inflow of foreign currency in the financial account.For example, if the Chinese deposited £1m of Chinese Yuan in British Banks, the foreign currency comes into the UK, and this is how we can afford the goods. This bank deposit would be counted as a short-term capital flow and included in financial account as a credit item. This balances the debit on our trade in goods.What would happen if we couldn’t attract capital flows?Suppose the UK had a current account deficit because the UK was importing goods from China, but, China wasn’t sending capital flows to the UK. This would mean more money is flowing out of the UK than coming in.This would mean the supply of pounds is greater than the demand and the Pound would fall in value. This would make our exports cheaper and imports more expensive. If exports are cheaper, the demand will increase. Conversely more expensive imports would reduce their quantity. Therefore depreciation would improve the current account deficit until it was in equilibrium.Since the Credit Crunch, the UK has found it harder to attract capital flows. Because we have a current account deficit, we have seen the Pound fall in value. So a large current account deficit often causes a depreciation, especially, if the country struggles to attract a balancing item on the financial/capital account. Categories economicsAdvantages and disadvantages of monopoliesFacts about Global Poverty 2 thoughts on “Current and Financial Account Balance” rajeev 12 October 2009 at 11:23 am how depreciation in the value of pound which is going to make export cheaper and inport expensive, will evetually reduce current account deficit. adonia 26 April 2018 at 6:00 am Depreciation in the value of pound means that the currency value of the pound is now relatively cheaper.Domestic goods (exports) are now cheaper to foreign consumers and so they may increase demand, hence increasing quantity of export sold.Since the domestic currency has depreciated against the foreign currency, the domestic country will find the import more expensive, hence may decrease demand for imports.With increase in export, along with a decrease in import – this improves the current account (by definition, current account = inflow – outflow).Comments are closed.

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