What is Financial Accounting?
Accounting in general deals with identifying business activities, like sales to customers, recording these activities, like journalizing, and communicating these activities with people outside the organization with financial statements.
Financial accounting, however, is a subsection of the general field of accounting that focuses on gathering and compiling data in order to present it to external users in a usable form. So what does that mean? Basically, financial accounting’s main purpose is to provide useful, financial information to people or groups outside of companies often called external users.
Who Uses Financial Accounting?
Unlike company management or internal users, external users of financial information are not directly involved in running the business or organization. They are outsiders to the business and only have limited information about companies’ operations, financial position, and well being. In other words, external users need financial information about companies in order to support their financial decisions.
The ultimate goal of financial accounting is to compile business transactions and other input documents like invoices and sales receipts in the form of general purpose financial statements that can be understood by external users.
The key concept here is that external users must be able to understand and use this financial information when they are making decisions about the company. If the information can’t be used, it is worthless. That is why the FASB has created a series of accounting principles and concepts to make sure financial statements are comparable and understandable.
Different Types of Financial Statement Users
There are many different types of external users who want or need financial information for different purposes. All of these external users have something in common. They are interested in doing business with a company but only have limited access to the company’s financial information. Financial accounting aims as providing financial information that is reliable, relevant, and comparable to these external users.
Here is a list of the most common external users of financial information and how they use it.
Shareholders and other investors are usually the first group of external users that comes to mind. Investors in general want to assess the value of a company in order to decide whether it is worth buying, selling, or holding their stock. Investors read financial statements to help predict future performance and company worth.
Lenders or Creditors
Lenders or creditors also use financial statements to base the decisions on because they want to know if a company is creditworthy enough to pay off its current loans or borrow additional funds. Creditors study financial statements in order to analyze the liquidity and sustainability of a company.
It might sound unlikely, but many customers study financial statements before making major purchases. For instance, large companies like GM will study financial statements of their potential suppliers in order to make sure they are fiscally sound. A company, like GM, benefits from long-term relationships with its suppliers. It wants to make sure of potential suppliers’ longevity before it goes into business with them.
Suppliers also use the financial statements of customers to judge whether they are creditworthy enough to extend credit. For example, if a customer orders 100,000 units from a supplier, the supplier wants to know whether the customer will be able to pay for these units before the supplies incurs the expense of producing them.
Regulators like the SEC, PCAOB, and IRS use company financial statements to make sure the companies are following applicable laws. The SEC and PCAOB monitor publicly traded companies to reduce fraudulent business activities; whereas, the IRS is mainly focused on tax collection and compliance.
Labor unions use financial information to judge whether employee wage rates and benefit packages are fair. They also use this information to assess future job prospects and bargain for higher wages and better benefits.
Brokers and Analysts
Brokers and analysts are often potential investors that use financial information about companies to chart performance trends and growth rates. These external users create reports that influence current investors opinions and actions.
Finally, the last main external user is the press. Although the press doesn’t use financial information for its decision bases, it does report on the financial information of companies. Networks like Yahoo Finance and MSN Money are multi-million dollar businesses that simply report financial information about other companies.
As you can see, the list of external users is almost endless. Financial accounting aims to provide all of these groups with information that can be useful for them in their individual decision making processes.