The financial account records transactions associated with changes of ownership of a country's foreign assets and liabilities. The financial account is divided into four main sub-accounts: direct investment, portfolio investment, other investment and reserve assets, each showing inflows of money (credits) and outflows of money from a country (debits).
(i) Direct investment is productive investment. It is investment in plant, equipment, machinery or factories, i.e. investment that will help with the process of wealth creation.
(ii) Portfolio investment, on the other hand, is investment in paper assets like shares and government bonds. The only purpose of portfolio investment is financial gain, so they do not involve foreigners' participation in the management of the domestic firms. There may be both inflows and outflows of portfolio investment.
(iii) Other financial flows - this heading can cover a range of short-term monetary flows like bank deposits from overseas residents, loans into a country from abroad and so on.
(iv) Flows to, and from, reserves - all countries hold reserves of foreign currency and this section measures any changes in these reserves. If the government influences the exchange rate, e.g. wants to appreciate the rate, then they may sell some of their foreign currency reserves and buy their own currency instead.
A deficit or surplus on the current account is offset with an equal and opposite surplus or deficit on the capital and financial account. In practice, however, as data for the current account and financial account come from different data sources, a balancing item called net errors and omissions is included in the balance of payments account. This ensures that there will be an exact balance in the overall balance of payments.