What Is a Financial Account?
In macroeconomics, a financial account is a component of a country's balance of payments that covers claims on or liabilities tononresidents, specifically concerning financial assets. Financial account components include direct investment, portfolio investment, and reserve assets broken down by sector.
When recorded in a country's balance of payments, nonresidents' claims madeon residents' financial assets areliabilities, while claims made against nonresidents by residents areassets.
Key Takeaways
- A financial account is a component of a country’s balance of payments that covers claims on or liabilities tononresidents concerning financial assets.
- Financial account components include direct investment, portfolio investment, and reserve assets broken down by sector.
- The financial account involves financial assetssuch as gold, currency, derivatives, special drawing rights, equities, and bonds.
Understanding Financial Accounts
The financial account isa tracking mechanism for shifts in international asset ownership, and it is composedof two subaccounts.
- The first subaccountincludesdomestic ownership of foreign assets, such as foreign bank deposits and securities in foreign companies.
- The second subaccountincludesforeign ownership of domestic assets, such as the purchase of government bonds by foreign entities or loans provided to domestic banks by foreign institutions.
To compare how the financial account can increase or decrease, let's analyze the following scenarios for the financial account of the United States:
- If there's an increase in U.S.-owned foreign assets abroad, it's a financial outflow and decreases the financial account of the U.S., as shown by a negative value.
- Conversely, if there's a decrease in U.S.-owned foreign assets abroad, it's considered a financial inflow and increases the financial account; shown as a positive value.
- If there's an increase in foreign-owned assets in the U.S., it's a financial inflow and increases the financial account of the U.S., showing a positive value.
- Conversely, if there's a decrease in foreign-owned assets in the U.S., it's a financial outflow and decreases the financial account of the U.S., showing a negative value.
Capital Account vs. Current Account
The financial account differs from the capital account in that the capital account recordstransfers of capital assets. Transactions in the capital account have no impact on a country’s production levels, rate of savings,or overall income.
The current account reflects the country’s current trade balance, combined with net income and direct payments, and measures the importand exportof goods and services. When combined with the financial and capital accounts, the three accounts form acountry’s balance of payments.
Transaction Recording
The financial account involves financial assetssuch as gold, currency, derivatives, special drawing rights, equities, and bonds. During a complex transaction containing capital assets and financial claims, a country may record part of a transaction in its capital account and the other part in its current account.
In addition, because entries in the financial account are net entries that offset credits with debits, they may not appear in a country’s balance of payments, even if transactions occur between residents and nonresidents.
Risks and Benefits of Increased Access
Easing access to a country’s capital is considered part of a broader movement toward economic liberalization, and a more liberalized financial account opensa country up to capital markets.
However, reducing restrictions onthe financial account has risks. The more a country’s economy is integrated with other economies worldwide, the greaterthe likelihood that economic troubles abroad will affect the domestic situation. This potential outcome is weighed against the potential benefits: lower funding costs, access to global capital markets, and increased efficiency.
What Makes Up the Balance of a Financial Account?
The balance of a financial account is the sum of net direct investments, net portfolio investments, asset funding, and errors/omissions.
What Is a Current Account and Financial Account?
The current account records imports and exports; the movement of goods in and out of a country, measuring the transfers between U.S. residents and foreign residents. A financial account measures the change in a country's ownership of international assets.
Does the Financial Account Always Balance?
The current account is offset by the capital account and the financial account, meaning the sum of these accounts, which is the balance of payments, will balance to zero.
The Bottom Line
Financial accounts are a part of a nation's balance of payments that covers nonresident claims and liabilities, which comprises assets such as gold, equities, bonds, derivatives, and special drawing rights. The purpose of a financial account is to track the changes in international asset ownership.
FAQs
The financial account measures the capital assets that enter or leave a country during a certain time period. The assets can be physical capital, commodities, investments, and securities, and they may be owned by governments, businesses, or individuals.
What is financial account and its components? ›
Financial account components include direct investment, portfolio investment, and reserve assets broken down by sector. The financial account involves financial assets such as gold, currency, derivatives, special drawing rights, equities, and bonds.
What are the components of financial assets? ›
Cash, stocks, bonds, mutual funds, and bank deposits are all are examples of financial assets. Unlike land, property, commodities, or other tangible physical assets, financial assets do not necessarily have inherent physical worth or even a physical form.
What is a financial account? ›
8.1 The financial account records transactions that involve financial assets and liabilities and that take place between residents and nonresidents. The finan- cial account indicates the functional categories, sectors, instruments, and maturities used for net international financing transactions.
What are the assets in the financial account? ›
Financial assets can include stocks, corporate and government bonds, and other types of securities. Unlike fixed assets, they tend to be liquid, and they are valued according to their current price on the relevant market.
What are three 3 components of financial system? ›
The three components of the financial system include financial institutions, financial services, and financial markets. What is financial system? The financial system is a set of markets and financial institutions that enable funds to flow from lenders to borrowers.
What are the 5 financial accounts? ›
So join us as we share the five different types of accounts that you need to know about as a small business owner. Key Takeaways: The 5 primary account categories are assets, liabilities, equity, expenses, and income (revenue)
What are examples of financial assets? ›
Deposits, stocks, bonds, notes, currencies, and other instruments that possess value and give rise to claims, liabilities, or equity investment. Financial assets include bank loans, direct investments, and official private holdings of debt and equity securities and other instruments.
What are the two components of assets? ›
Assets can be grouped into two major classes: tangible assets and intangible assets. Tangible assets contain various subclasses, including current assets and fixed assets. Current assets include cash, inventory, accounts receivable, while fixed assets include land, buildings and equipment.
What are the three basic types of financial assets? ›
Money, stocks and bonds are the main types of financial assets. Each is something you can own, and each has some amount of financial value.
There are two types of financial accounting; cash accounting and accrual accounting. Cash accounting means transactions are recorded when cash is received. The drawback with this form of accounting is that it doesn't reveal whether revenue or expenses were generated before the cash was received.
What are the three main financial accounts? ›
The income statement, balance sheet, and statement of cash flows are required financial statements.
What is the difference between accounting and financial account? ›
The difference between finance and accounting is that accounting focuses on the day-to-day flow of money in and out of a company or institution, whereas finance is a broader term for the management of assets and liabilities and the planning of future growth.
What are the components of a financial account? ›
This includes:
- 1.Net balance of foreign direct investment flows (FDI)
- 2.Net balance of portfolio investment flows (e.g. inflows/outflows of debt and equity)
- Balance of banking flows (e.g. hot money flowing in/out of a country's commercial banks)
- Changes to the value of reserves of gold and foreign currency.
In addition to loans, other types of financial assets include stock, bonds, and bank deposits. As the financial asset is a claim on another party's future income, it will always be an asset for one side and a liability for the other.
How to define assets? ›
An asset is anything that has current or future economic value to a business. Essentially, for businesses, assets include everything controlled and owned by the company that's currently valuable or could provide monetary benefit in the future. Examples include patents, machinery, and investments.
What are the 4 financial accounts? ›
Understanding the 4 types of financial statements
- Balance sheet: Assets, liabilities, and equity.
- Income statement: Revenues, expenses, and resulting net income or loss.
- Cash flow statement: The inflow and outflow of cash and cash equivalents.
- Statement of owner's equity: Changes in the ownership interest of a business.
Financial statements can be divided into four categories: balance sheets, income statements, cash flow statements, and equity statements.
What are the main items on the financial account? ›
The three main types of financial statements are the balance sheet, the income statement, and the cash flow statement. These three statements together show the assets and liabilities of a business, revenues, and costs, as well as its cash flows from operating, investing, and financing activities.
What are the main component accounts of the current account and financial account? ›
The four major components of a current account are goods, services, income, and current transfers.
