Financial accounting is the process of identifying, measuring and communicating financial information about economic entities to interested parties, both internal and external. Financial information helps users with their decisions on capital allocation in a company. Users of a company’s financial information primarily include both present and prospective investors and creditors. As capital providers, investors and creditors must assess a company’s cash flows and understand its financial position.
Companies assemble financial information in a systematic way based on the generally accepted accounting principles, or GAAP, with the goal of compiling financial statements for use by various interested parties. Financial statements are the primary channel through which financial information is communicated to users outside a company. Basic financial statements include the income statement, the balance sheet, the statement of cash flows and the statement of shareholders’ equity.
Capital Allocation Decision
Capital allocation is the process by which investors and creditors decide how and at what cost their money is allocated among prospective, competing companies. Therefore, the goal of financial accounting is to provide useful financial information that aids them with their investment and credit decisions. The information should be straightforward and easy to understand so users with a reasonable grasp of a company’s business activities can readily study the information.
Cash Flow Assessment
Cash flow assessment about their funded companies is essential to investors and creditors because as capital providers, they are concerned about when and if they will receive dividends, interest payments and future redemption of their investments. The goal of financial accounting is also to provide information that helps investors and creditors assess the amounts, timing and uncertainty of future cash flows of a company, and whether they match with expected cash receipts.
A company’s financial position has implications on the safety and profitability of investors and creditors’ investments. The balance sheet best illustrates a company’s financial position in terms of its economic resources and claims to those resources -- namely liabilities to creditors and obligations to equity investors. The goal of financial accounting is to fully disclose a company’s financial position and the effects of business transactions that influence the strengths and weaknesses of the position.