why financial accounting is important
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Why financial accounting is important

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Answer: Capital shares of thousands of corporations trade each day on markets around the world, such as the New York Stock Exchange or NASDAQ National Association of Securities Dealers Automated Quotation Service An electronic market that allows for the trading of equity securities in approximately 4, companies, providing instantaneous price quotations to efficiently match buyers and sellers allowing ownership in companies to change hands.

One party is looking to sell shares whereas another is seeking shares to buy. Stock markets match up these buyers and sellers so that a mutually agreed-upon price can be negotiated. This bargaining process allows the ownership interest of all these companies to change hands with relative ease.

When investors believe a company is financially healthy and its future is bright, they expect prosperity and growth. Everyone attempts to anticipate such movements in order to buy the stock at a low price and sell it later at a higher one. Conversely, if predictions are not optimistic, then the share price is likely to drop and owners face the possibility of incurring losses in the value of their investments.

Many factors affect the movement of stock prices such as the perceived quality of the management, historical trends in profitability, the viability of the industry in which it operates, and the health of the economy as a whole. Financial accounting information plays an invaluable role in this market process as millions of investors attempt each day to assess the financial condition and prospects of corporate organizations.

Ignorance can lead to poor decisions and much less lucrative outcomes. In the United States, such investment gains—if successfully generated—are especially appealing to individuals if the shares are held for over twelve months before being sold. For income tax purposes, the difference between the buy and sale prices for such investments is referred to as a long-term capital gain or loss Occurs when certain investments are held for more than twelve months before being sold; a favorable tax treatment can result when gains are earned.

Under certain circumstances, significant tax reductions are allowed in connection with long-term capital gains. This same tax benefit is not available to corporate taxpayers, only individuals. Congress created this tax incentive to encourage investment so that businesses could more easily obtain money for growth purposes.

Question : Investors acquire ownership shares of selected corporations hoping that the stock values will rise over time. This investment strategy is especially tempting because net long-term capital gains are taxed at a relatively low rate. Is the possibility for appreciation of stock prices the only reason that investors choose to acquire capital shares?

Answer: Many corporations—although certainly not all—also pay cash dividends Distributions made by a corporation to its shareholders as a reward when income has been earned; shareholders often receive favorable tax treatment when cash dividends are collected.

A dividend is a reward for being an owner of a business that is prospering. It is not a required payment; it is a sharing of profits with the stockholders. The receipt of cash dividends is additionally appealing to stockholders because, in most cases, they are taxed at the same reduced rates as are applied to net long-term capital gains. The board of directors determines whether to pay dividends. Some boards prefer to leave money within the business to stimulate future growth and additional profits.

For example, Yahoo! Not surprisingly, a variety of investing strategies abound. Some investors acquire ownership shares almost exclusively in hopes of benefiting from the potential for significant appreciation of stock prices. Another large segment of the investing public is more interested in the possibility of dividend payments.

Unless an owner has the chance to influence or control operations, only these two possible benefits can accrue: appreciation in the value of the stock price and cash dividends. Question: An investor can put money into a savings account at a bank and earn a small but relatively risk free profit. How is the annual return computed when the capital stock of a corporation is acquired? Answer: Capital stock investments are certainly not risk free.

Profits can be high, but losses are also always a possibility. The shares of Company B have not performed as well. Clearly, investors want to have all the information they need in hopes of maximizing their potential profits each year. A careful analysis of the available data might have helped this investor choose Company A rather than Company B.

Incorporation allows an organization to be viewed as a separate entity apart from its ownership. As a corporation, shares of capital stock can be issued that give the holder an ownership right. If the organization is financially healthy and prospering, these shares can increase in value—possibly by a significant amount. In addition, a profitable organization may well share its good fortune with the ownership through the distribution of cash dividends. In most large organizations, few owners want to be involved in the operational decision making.

Instead, these stockholders elect a board of directors to oversee the company and direct the work of management. Question: Investors are interested sometimes almost obsessively interested in the financial information that is produced by a company based on the rules and principles of financial accounting.

They want to use this information to make wise investing decisions. What do investors actually hope to learn about a company from this financial information? Answer: The information reported by financial accounting is similar to a giant, complex portrait painted of the organization. There are probably hundreds, if not thousands, of aspects that can be examined, analyzed, and evaluated in assessing the financial health and future prospects of the model.

Theories abound as to which pieces of information are best to use when studying a business. One investor might prefer to focus on a particular portion of the data almost exclusively such as profitability while another may believe that entirely different information is most significant such as the sources and uses of cash during the period.

Ultimately, in connection with the buying and selling of capital stock, all investors are trying to arrive at the same two insights. Despite the complexity of the information, these two goals are rather simplistic. If an investor owns capital shares of a company and feels that the current accounting information signals either a rise in stock prices or strong dividend payments, holding the investment or even buying more shares is probably warranted. Conversely, if careful analysis indicates a possible drop in stock price or a reduction in dividend payments, sale of the stock is likely to be the appropriate action.

Interestingly, by the nature of the market, any exchange of ownership shares means that the buyer has studied available information and believes the future to be relatively optimistic for the business in question. In contrast, the seller has looked at similar data and arrived at a pessimistic outlook. Question : Are there reasons to analyze the financial accounting information produced by a particular business other than to help investors predict stock prices and cash dividend payments?

For example, as discussed previously, a loan might be requested from a bank or one company could be considering the sale of its merchandise to another on credit. Such obligations eventually require payment. Therefore, a sizeable portion of the parties that study the financial information reported by an organization is probably most interested in the likelihood that money will be available to pay its debts.

Future stock prices and cash dividend distributions are much less significant speculations for a creditor. The same financial data utilized by investors buying or selling stock will also be of benefit to current and potential creditors. Cash flows also influence stock prices and dividend payments and would, thus, be information useful for potential investors in the capital stock of a company as well as its creditors.

Therefore, millions of individuals use reported financial information to assess various business organizations in order to make three predictions:. The first two relate to investors in the capital stock of the company; the last is of more significance to a creditor. What is meant by financial information? Answer: The financial information reported by and about an organization consists of data that can be measured in monetary terms.

In both cases, relevant information is communicated to decision makers as a monetary balance. However, if a company has eight thousand employees, that number might be interesting but it is not financial information. The figure is not a dollar amount; it is not stated in the form that is useful for decision-making purposes.

Instead, the company reports that it currently owns shirts for sale inventory A current asset bought or manufactured for the purpose of selling in order to generate revenue. Question: The value of reported data seems somewhat restricted if it only includes dollar amounts. Is financial information limited solely to figures that can be stated in monetary terms? Answer: Although financial accounting starts by reporting balances as monetary amounts, the communication process does not stop there.

Verbal explanations as well as additional numerical data are also provided to clarify or expand the information where necessary. This is financial information to be reported based on the rules of financial accounting. However, the organization must also communicate other nonfinancial information such as the cause of the lawsuit and the likelihood that the loss will actually occur. Thus, accounting actually communicates to decision makers in two distinct steps:.

Throughout the world, investors buy and sell the capital stock of thousands of businesses. Others choose to loan money to these same organizations. Such decisions are based on assessing potential risks and rewards. Financial accounting provides information to these interested parties to help them evaluate the possibility of stock value appreciation, cash dividend distributions, and the ability to generate cash to meet obligations as they come due.

This information is financial in nature, meaning that it is stated in monetary terms. However, such numerical information alone is too limited. Thus, financial accounting provides financial information as well as clarifying verbal explanations to assist users in evaluating the financial health and potential of a particular organization.

Kevin G. Burns is a partner in his own registered investment advisory firm, LLBH Private Wealth Management, an organization that specializes in asset management, concentrated stock strategies, and wealth transfer. Burns began his career on Wall Street in at Paine Webber. He has been kind enough to agree to be interviewed about his opinions and experiences in using accounting information.

Question : You majored in accounting in college but you never worked in the accounting field. Instead, you became an investment advisor. If you never planned to become an accountant, why did you major in that subject? Kevin Burns : In my view, accounting is the backbone of any business major in college. Being able to translate the information that a company provides, prepare a budget, understand the concept of revenues and expenses, and the like has been enormously helpful in my investment management business.

Anyone majoring in any aspect of business needs that knowledge. I also liked being able to know I had the right answers on the tests that my accounting professors gave me when all the numbers added up properly. KB : I think it is very important to diversify investments. In my world, that includes stocks as well as other types of investments. Of course, there is a place for investments in real estate, commodities, and the like.

My personal preference is to invest only in very liquid assets; those—such as stocks—that can be turned into cash quickly. I like to know, even if I am investing for the long term, that I can sell my investments five minutes after I buy them should I change my mind. I simply prefer liquid investments. Real estate is not very liquid. Gold, of course, is liquid. If my clients earned a total return of 10 or 12 percent on their money over forty years, they would fire me. What were the five points that you encountered in this chapter that seemed most important to you?

A lot of information is provided here. What stood out as truly significant? After you make your choices, go to the following link and watch a short video clip where one of the authors will make an analysis of the top five points presented here in Chapter 1 "Why Is Financial Accounting Important? You can learn the rationale for these picks and see whether you agree or disagree with the selections.

Ramon Sanchez is a loan officer at Washington Bank. He must decide whether or not to loan money to Medlock Corporation. Which of the following would Ramon most likely consider when making this decision? Which of the following is not a reason an investor would purchase stock in a corporation? Which of the following would not be considered an example of a decision made using financial accounting information? Which of the following is most likely to have a say in the policy decision of a large corporation?

Leon Williams is an investor in Springfield Corporation. Explain how each of the following might use the information provided by the financial accounting of Nguyen Company. Mark each of the following with an F to indicate if it is financial information or an N to indicate if it is nonfinancial information.

The chapter introduced several forms of business, including a corporation, sole proprietorship, and partnership. Other forms of business exist as well. Do research to compare and contrast the following business forms:. Examine the following areas for each form of business: ease of organization and maintenance of form, number of people involved, government involvement, liability to owners, ease of exit, taxation, day-to-day management, and funding sources.

Corporations usually provide a good amount of financial information on their Web sites. Go the U. Here you can learn about the profession of accounting. Help Creative Commons. Creative Commons supports free culture from music to education.

Their licenses helped make this book available to you. Help a Public School. Previous Chapter. Table of Contents. Next Chapter. Explain the importance of learning to understand financial accounting. List decisions that an individual might make about an organization. Differentiate between financial accounting and managerial accounting.

Provide reasons for individuals to be interested in the financial accounting information supplied by their employers. Key Takeaway Financial accounting encompasses the rules and procedures to convey financial information about an organization. Discuss the necessity and purpose of a board of directors.

List the potential benefits gained from acquiring capital stock. Figure 1. Key Takeaway Incorporation allows an organization to be viewed as a separate entity apart from its ownership. List the predictions that creditors and potential creditors want to make. Distinguish financial accounting information from other types of data about a business organization. Explain how financial accounting information is enhanced and clarified by verbal explanations.

Key Takeaway Throughout the world, investors buy and sell the capital stock of thousands of businesses. What Was Truly Important? How does financial accounting differ from managerial accounting? List the potential users of the information provided by financial accounting. What is a corporation? How does a business become a corporation?

Why would a business want to become a corporation? What is the board of directors of a corporation? Why do individuals or entities choose to invest in the capital stock of corporations? How does an investor differ from a creditor? If you are considering a career in finance, it is important to understand the role that financial accounting plays in business.

In this article, we discuss what financial accounting is and why financial accounting is important. Financial accounting is the process of organizing and communicating a business's financial information. All of the financial information within a company is collected and calculated in a document called a financial statement or report.

Accountants typically produce this document at the end of each quarter, business period or year, depending on the company. Financial accountants keep track of this data and present their reports to the company's manager or executive. Financial accounting sorts this information into three main statements. An income statement describes the company's profits and losses throughout that period. A balance sheet provides information about the overall financial status of the company. Finally, a cash flow statement describes how much money the company has earned and spent during that period.

Financial accounting makes a company's financial standing available for people on many different levels. Any company, but especially larger companies, have many different transactions, gains, losses and other monetary changes throughout a business period. Financial accounting puts all of this information into one location and makes it easier to understand.

Financial accounting also includes performing essential calculations from this information. The main functions of financial accounting involve:. Recording and summarizing a company's transactions and financial activity. Creating official financial reports at the end of each quarter.

Communicating the financial status of the company to relevant parties. Informing a company's decision-making processes. Read more: What Is Financial Accounting? Definition and Examples. Financial accounting has many functions within a business and is essential for decision-making purposes. Without financial accounting, businesses would not be able to keep track of their finances and this would affect their ability to operate. Here are some of the main ways financial accounting benefits a company:.

The first role that financial accounting serves is to communicate information externally. Financial accounting allows companies to convey their financial status to outside parties, which is essential for conducting business deals. Companies need financial accounting in order to qualify for loans and coordinate with suppliers.

These external organizations want to know that a company is in good standing before doing business with them. Financial accounting allows companies to show these organizations a record of their finances that determines their capital and their reliability to make payments. Another way companies use financial accounting is for internal communication.

Internal communication relates to a company's employees and finance team. It is important for the members of a company to understand how well the business is doing for many reasons. First, knowing a company's financial status can help employees feel stable in their jobs.

Knowing that the company is doing well means that there should not be any layoffs or downsizing. This kind of transparency also allows employees to feel more involved in the company's success. Knowing how well the company is doing can motivate employees to continue working hard.

A company's financial report can show which areas it is performing well in and which it is struggling with.

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Financial accounting is a specific branch of accounting concerned with recording, summarizing, and reporting a company's business transactions through financial statements. Let's see what is the importance of financial accounting for the success of any company? Importance of Financial Accounting. Financial accounting plays a key role in the success of any business. It allows companies to record and track all their financial statements and understand the company's health and it helps internal and external stakeholders make better business decisions.

Let's introduce you to financial accounting and its objective, then we will discuss the benefits and importance of financial accounting for a business. Financial accounting is a set of processes that include recording, summarizing, and reporting a company's financial transactions that result from business operations during a specific period of time.

Financial accounting is concerned with applying a system to monitor the financial activities and position of a business, person, or other entity. All financial accounting processes are summarized by relying on the preparation of financial statements. Financial statements are formal records of the business activities and the financial performance of a company.

There are 4 main financial statements, including: 1 cash flow statements, 2 balance sheet statements, 3 income statements, and 4 statements of shareholders' equity. These statements help to clarify the operating performance of the firm during a specific period of time.

There are several categories of individuals or organizations who benefit from financial accounting information, and this depends on the diversity of the parties associated with the company, whether by relying on direct or indirect contact. Businesses use financial documents to present revenues, expenses, assets, liabilities and equity and drive growth opportunities and success. Financial accounting seeks to achieve many goals in all types of companies, but its main objective is to contribute to the provision of accounting and financial information to its beneficiaries, whether inside or outside the company.

Financial accounting depends on the financial statements, as they are the main and reliable source of information about business activities and the financial performance of a company and the financial statements seek to achieve a set of goals, including:. Financial accounting is one of the most important branches of accounting in general.

It provides a lot of information that is very important to the work environment and helps companies to record and track all their financial data and understand the company's health and take decisions accordingly. The importance of financial accounting can be summarized according to the following points:. Recording financial transactions: The main function of financial accounting is to write and record financial transactions, and this function is called bookkeeping in accounting language.

Small business owners rely on financial accounting in order to record all business activities that occur within their companies in the accounting ledger. Financial accounting depends on the use of double entries in recording all financial transactions. Therefore, every accounting process has two sides, one of which is a creditor and the other is a debitor. Financial accounting is important for business owners because it provides them with systematic insights that help to provide a description of their work and take necessary decisions.

Comparing and analyzing financial data: Comparison and analysis are two means that help owners of commercial companies to benefit from financial accounting information in order to analyze and study competitors and investment opportunities. Financial accounting is governed by the general principles of accounting.

Therefore, a similarity appears in the method of preparing financial data and information for various companies, and this accounting helps to calculate the financial ratios based on the company's own data, and then compare it with competing companies or standard ratios. Communicating information to internal parties: The purpose of financial accounting is to take care of internal users and constitute the financial department and all individuals whose tasks depend on the distribution of profits according to shares.

It is possible for company owners to use this financial information in order to identify the weaknesses and strengths of employees, and this information also contributes to supporting the productivity of employees by providing rewards to them. Communicating information to external parties: Financial accounting helps the owners of commercial companies to communicate accounting information to external parties, and this includes both individuals and other firms that deal financially with these companies but they do not form part of their businesses, and they are also called external users of financial data and information.

Accounting is one of the basic solutions for keeping records in a systematic way. Financial information is collected from different sources and then organized, analyzed, validated and Communicated to enable informed economic decision making which will help in obtaining long term results. The making use of statistical tools, companies around the globe can able to plan their economic pursuits to grow their business. Frauds can only be discovered and prevented through proper accounting records.

This accounting information system is the only way out to keep track of all fraudulent occurrences ina very appropriate, effective and efficient way. As the business grows, there arises the importance of establishing accountability and the manner. These can be structured by the shareholders as well as top management.

Company financial managers need to assure compliance of such policies with the help of accurate financial reports as and when required to verify. Audit reports provide a complete and details of its findings to small as well as large business. In the future if there are any changes happen to the business, the same will have to be updates for a complete understanding of the financial information whenever it is required to be inspected.

Auditing regularly and consistently of financial statements is a rewarding part of any business for Investors, Creditors and Lenders. It helps in stabilizing and improving the credit rating of a business. Auditing can benefit from pursuing audited financial statements for the tax authorities, financial institutions, and company management with an independent financial auditing, tax officials can depend on the accuracy of the financial information provided for thetax computation.

So in todays any business accounting and auditing play a very vital role to keep the financial aspects of business in an orderly way. Hope this article will help you to know more and understand the reasons why accounting and auditing is so important to run a good business. To know further you can log on to our website. Sign In. Skip to content. This involves a methodology of tracking— Business assets Liabilities Income The main purpose of an accounting information system AIS is — Collection Storing Collating financial and accounting data Creating informational reports The above details help managers and other accounting professionals to make proper business decisions.

Normally, the accountant deals with third parties, such as — Vendors Customers Financial Institutions Accountants can help in determining areas for growth by providing informaion on things such as — Cash flow plans Inventory Management Pricing Business Financing Also provides advice on property and equipment leasing and purchase, which helps in case, is audited by the Internal Revenue Service.

Productivity improvement in operations. Ensuring integrity and financial reliability. Establishing compliance with statutory regulations and laws. Put in place procedures for monitoring. They can also give advice and recommend for possible risk avoidance measures and of savings cost through — Preparing Reports Analysis Reports Financial Statements The five characteristics of an auditor which are important in this profession are — Should have a required experience.

Professional certifications apart from main academic qualifications are a must for an auditor Should have good ability to make and apply independent decisions Should have the ability to understand different business needs of requirement Should be independent and confidential. Should have good effective Communication Skills Auditors evaluate financial transactions, help and work to ensure that companies move forward successfully to achieve huge growth in their respective business in the long run.

Accounting help in proper planning for Financial Stability In order to aid financial decisions, proper planning is a requirement for an entity. This actual planning helps us to understand the inter connected aspects of financialinformation such as — Cash Flow Planning Sales Planning Procurement Planning Inventory management Development Planning Establishing various targets including Profit goals etc.

All these are dependent on the quality of financial information and accounting data. Accounting aids helps future Financial Estimates and Budgets The accounting details aid a company to prepare budgets and also forecast for future periods.

Accounting helps in keeping records in order Accounting is one of the basic solutions for keeping records in a systematic way. Accounting helps in discovery and prevention of Fraud Frauds can only be discovered and prevented through proper accounting records. Auditing helps in assigning complete report Audit reports provide a complete and details of its findings to small as well as large business.

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