Investors and lenders rely on financial accounting to obtain critical information about businesses' financial solvency and the risks they face. The most important benefit of financial accounting, and the benefit the Financial Accounting Standards Board (FASB) most emphasizes is access to information.
The average lender or investor does not have ongoing inside access to the day-to-day operations of a company. Instead, they rely on financial accounting to provide accurate and readily comparable information.
Key Takeaways:
- Financial accounting is crucial for investors and lenders to assess the solvency of businesses.
- Financial accounting provides transparency and access to information concerning the operations of a company.
- With standardized accounting practices according to GAAP, investors can compare the financial statements and performance of companies with those of their industry peers.
Understanding the Benefits of Financial Accounting
Financial accounting allows outside actors to observe the profitability and value of a business. An investor can see which companies have consistently performed well, paid dividends, and appear to have positive margins. A lender can review the financial accounts to assess liquidity, cash flow, leverage, and overall solvency.
Consistent Schedule of Final Accounts
The three main external financial statements—the income statement, balance sheet, and cash flow statement—are issued on a routine schedule, typically every quarter. This means investors and lenders have access to information on a consistent and dependable basis not just when the company is doing well or when it looks the most solvent.
Plurality of Uses
Financial accounting information is used in a variety of ways by different market actors. Information is not generally tailored to any one specific group, though investors and lenders are clearly the most important stakeholders for a business. After all, company capital primarily comes from these two sources.
Flexible usage is maintained through a set of standards, or common rules, known as the generally accepted accounting principles (GAAP) in the United States and the international financial reporting standards (IFRS) in the rest of the world.
In the United States, the U.S. Securities and Exchange Commission (SEC) has the authority to set accounting standards under GAAP, which it has further delegated to the FASB. Accountants and corporate managers adopt these standards uniformly. This makes it relatively easy for an investor or lender to compare a company's performance across time and against its competitors.
Financial Accounting, Financial Statements, and Financial Reporting
Financial accounting is one component of a larger business accounting field, which is different from managerial accounting. Financial accounting is performed for the benefit of outside parties. The financial statements are only one portion of financial reporting.
Generally, only three or four issues are considered financial statements. The fourth is sometimes identified as the statement of stockholders' equity. In addition to the financial statements, financial reporting includes the company's annual report to the SEC and its annual report to stockholders. Financial reporting also includes any proxy statements or additional reports created outside of the financial statements' routine framework.
Transparency and the Financial Accounting Standards Board
The FASB was created in 1973 and is recognized by the SEC as the designated accounting standard setter for publicly traded companies. The SEC's stated goal is to encourage transparency and improve the fairness of investment and lending contracts among publicly traded companies. Privately held companies do not have to comply with GAAP and the SEC, but transparency is aided by the training and standard procedures of public accountants and lender expectations.
FAQs
Financial accounting allows outside actors to observe the profitability and value of a business. An investor can see which companies have consistently performed well, paid dividends, and appear to have positive margins.
How does financial accounting help investors? ›
Investors with strong accounting backgrounds use a company's financial reports to identify key risk areas that can point to potential losses in asset values. Also, investors use financial statements to calculate financial ratios that assist in estimating a company's liquidity and default risks.
How does financial statements benefit the lenders? ›
Financial statement analysis is used by a banker to determine a borrower's capability to repay a loan. A banker will typically review a borrower's current financial statements and compare them to previous financial statements to see which areas of the business have changed and by how much.
What is the impact of financial accounting information on investors? ›
Financial statements are important to investors because they can provide information about a company's revenue, expenses, profitability, debt load, and ability to meet its short-term and long-term financial obligations.
Why is accounting important to lenders? ›
Detailed historical and forward-looking accounting data are normally either collected by the lender during their visit with the borrower, or else forwarded to the bank soon after the visit. These accounting data help lenders to assess the need for the loan, its purpose, and the quality of the borrower's organization.
Why do investors need financial information? ›
Financial statements allow investors to see all the income and expenses of a company. This, in turn, helps them determine their ability to generate profits and grow at a sustainable rate. A cash flow statement is a document that shows a company's ability to manage its income and expenses.
Who benefits from financial accounting? ›
Lenders, investors, and tax and regulatory authorities can inspect a business's financial statements regularly, gaining updated information about its profitability, value, solvency, and compliance.
Why do lenders need to see financial statements? ›
A lender can review the financial accounts to assess liquidity, cash flow, leverage, and overall solvency.
Why is financial statement analysis important for investors and lenders? ›
Financial statement analysis is a powerful tool that enables individuals to understand a company's financial health and performance comprehensively. Readers can assess profitability, liquidity, and solvency by examining key ratios, trends, and anomalies and uncovering potential risks.
What uses of financial accounting information are made by investors and creditors? ›
Equity investors use financial information to predict future earnings and cash flows in their efforts to identify securities that will provide high returns. Creditors use financial information to predict whether companies can generate enough cash in the future to cover debt payments.
To obtain credit: Financial statements present the picture of the business to the potential lenders and this information can be used by them to provide additional credit for business expansion or restrict the credit so as to start recovery.
Who are lenders and investors how do they use financial accounting information? ›
Banks or lending institutions may use accounting information to guide decisions such as whether to lend or how much to lend a business. Investors will also use accounting information to guide investment decisions.
What are the benefits of investment accounting? ›
Investment accounting is the management and analysis of accounts actively involved in investments. Working in this profession allows you to make business investment decisions and choose stocks, bonds and debts that are stable and profitable.
How do investors benefit from accounting information? ›
Answer and Explanation: 1) Investors use financial accounting information to make decisions about whether or not to invest in a company. They are looking at the current and future profitability of the company. Their goal as investors is to receive the best return they can on their investment.
Why is financial accounting important to creditors? ›
Lending Decisions
Financial accounting is also a key for creditors, from banks to bondholders. Because financial statements outline all its assets as well as the short- and long-term debt, lenders get a better sense of a company's creditworthiness.
Why is financial accounting important in banking? ›
Accounting impacts all aspects of bank operations and requires recordkeeping systems that generate accurate and reliable information and reports needed to meet the needs of customers, shareholders, supervisory agencies, tax authorities, and courts of law.
Why is financial analysis useful to investors? ›
Financial analysis is a cornerstone of making smarter, more strategic decisions based on the underlying financial data of a company. Whether corporate, investment, or technical analysis, analysts use data to explore trends, understand growth, seek areas of risk, and support decision-making.
Is an accountant useful to investors? ›
Organized accounting and bookkeeping can also help stakeholders and other investors in evaluating the business's financial performance, and ensure your business remains tax compliant. Along with hiring an accountant, small business owners increasingly use online accounting software like FreshBooks.
How do you think accounting standards help investors? ›
Accounting standards ensure the financial statements from multiple companies are comparable. Because all entities follow the same rules, accounting standards make the financial statements credible and allow for more economic decisions based on accurate and consistent information.
What is the importance of financial accounting to stakeholders? ›
Accounting information, one of the most important products offered by accounting, must enable all types of investors, current and potential, to identify, measure and evaluate all the operations and activities of an enterprise in order to determine its efficiency.
