Lesson Objectives:- Differences between internal and external users of financial accounting
- Specific uses of financial data
- Questions that internal and external users ask to interpret economic information
- Examples of uses of accounting information
It wouldn't make sense to record financial transactions if no one had a use for the data. Luckily, there are many users that have a business use for the company's financial position. Accounting involves communicating important economic information about a company to the end users. Who are those end users?
The easiest way to look at the individual end users is by breaking them down into two categories: internal and external users.
We discussed in the Introduction to Accounting lesson that financial accounting is primarily used by external parties. Internal users lean more toward the use of managerial accounting but financial accounting still plays a vital role in the success of the company.
Let's dig into the individual users in each company both internally and externally.
External users are individuals that exist outside of the company. Creditors, analysts and investors are the most common types of external users that use financial statements in order to make decisions.
Creditors need to look at the financial statements of a business in order to evaluate the risk level of extending credit to your business, also known as the credit worthiness. The financial statements will reflect the levels of debt and income which are vital to determine whether the company has the ability to pay their debts.
Analysts make independent evaluations of the company's position. The financial information is analyzed in order to examine the performance and advise whether the stocks buy, sell or hold position.
Investors need to be able to decide if it is a profitable investment.
Looking at the year-to year comparisons of financial statements often gives investors a picture of the company's growth and profitability. They will also reflect whether the income will be distributed through dividends or in the form of share appreciation.
In contrast to external users, any individual that uses financial accounting within the company is considered an internal user. The first type of person that comes to mind is the employees as they make up the mass majority of the company.
Employees consist of the accounting department, collections, sales and any users that have access to financial information. One example of a use of financial information is to look at the profit and loss statement in order to identify whether there may be cash flow issues for the upcoming quarter. Another example would be that the collections department is responsible for collecting unpaid debt amounts.
Managers evaluate the performance of the business by looking at the financial statements. One thing that managers use this information for is to evaluate the capital structure; how the company is distributed among assets, debt and stock shares. Managers also look at areas of opportunity within the financial statements such as reducing expenses or increasing cash reserves.
At the top of the management structure is the chief financial officer (CFO). The CFO owns the overall responsibility of managing economic decisions and making improvements to the company's bottom line. The CFO must help the company identify cost savings and drive insights for profitability.
Plant supervisors differ from managers in the sense that they have more control over wages of the employees. Generally, they use financial data to manage operational items such as labor costs and overhead expenses.
External users can be asking a wide range of questions when looking at data from the financial statements. Some of these questions from external users include:
Is the company seeing income or loss each year?
How profitable is the company in comparison with their competitors?
Will the company pay their loan payment?
What interest rate should I charge?
Now, internal users have completely different motives for examining transactions and statements. They want to know things such as:
Does the company have enough cash to pay their bills?
What is the manufacturing cost for each individual unit?
Can we allocate money for employee pay raises?
Which product that we sell is the most profitable?
The answers to each of these questions lies within the data summarized on financial statements.
The primary difference between internal and external users is that the internal users work within the company while external users exist outside of the company.
Internal users want to be able to drive positive change for the company. External users have their own interests in the data such as considering a loan application or deciding to invest.
Internal users are more likely to use managerial accounting which is a separate type of accounting. External users rely on the financial accounting data that is provided in the financial statements, while internal users are often responsible for recording and interpreting the transactions.
While both types of users differ in their purpose for examining financial information, they are essentially using the same information records on the statements including the balance sheet, retained earnings, income and cash flow statements. We will be diving into the specific uses of each statement in one of the next lessons.