Accounting is the systematic collection and recording of financial information concerning companies. This financial information is used by users of financial statements which are internal and external. Internal users are management at different levels, and external, which are shareholders, investors, customers, suppliers, banks, and tax authorities.
This collection and recording of financial information is compiled into financial statements which are made public. Those financial statements are comprised of the following: the balance sheet, income statement, statement of cash flows, change in owners’ equity, notes to the financial statements.
Accounting then helps management make decisions as well as external users and objectively decide on their business decisions. Once the financial statements are published, internal and external users must be able to analyze them, and to do so, they must have sufficient know how as to how the financial statements were prepared, the principles and practices used.
Then we come to the financial statement analysis. The purpose is to evaluate the financial condition of the company based on certain financial ratios, such as liquidity, profitability, capital structure (percent of stock, debt, etc...) and accounting figures, like sales, profit margin, assets, liabilities and owners’ equity.
From a management perspective, since they are the internal users and have knowledge of how the financial statements were prepared, they can point out the strengths or weaknesses of the company thus improve the financial position of the company. On the contrary, external users, like investors, can use the financial statements to predict possibly the possibility of the firm to improve future earnings, distribute dividends, so as to improve their capital gains.
Another part of external users who use financial statements are banks, suppliers and other creditors (who loaned on credit) of the business so as to determine, if the business will be in a position to fulfill its obligations when they come due.
Accounting is also used via the financial statements, to ascertain whether a company is in the verge of bankruptcy, to ascertain whether the company has a good or bad credit rating based on the accounting figures and financial ratios.
Accounting provides important financial ratios and accounting variables, besides the business aspect to the users of the financial statements. The asset turnover ratio, for example, indicates how quickly a company can convert its inventory (especially for businesses that use a lot of inventory) to sales. Also the more quickly the company turns over its inventory, the less charges it incurs for storage. If inventory, an asset on the balance sheet of the company, is turned into cash, another asset, then the company has liquidity.
