Accounting in a Business Context

One of the main uses of financial accounting information is for funding purpose. Capital from shareholders and loans and credit from creditors require reporting of financial accounting information to solicit funds (Atrill &amp. McLaney, 2003. Berry &amp. Jarvis, 1997). Since the owners or shareholders provide the funds for the organization to run, they are interested in the returns earned on their investments. Financial ratios such as return on shareholders’ funds can be calculated to assess the returns earned on their investments. They use the information on the past performance obtained from the financial statements comprising the profit and loss statement, balance sheet, and cash flow statement together with the present economic market conditions to predict the future returns. Also, since the shareholders elect the board of directors, they would want to regularly evaluate the management’s performance. Profitability ratios, indications of earning capacity and ability to make profits, can be used by the shareholders to evaluate the management’s performance. Examples of profitability ratios are the gross profit ratio, the net profit ratio, and the return on total assets. Loan creditors, such as bankers are interested in the financial stability and liquidity of the organization, as assessed by the liquidity ratios, solvency ratios, and capital structure ratios, such as the fixed assets to long-term liabilities ratio and the capital gearing ratio. Loan creditors would also like to know whether the organization is able to pay interest on time and to repay the principal of the loan. They can use financial ratios such as the coverage of fixed interest charges to assess the organization’s ability in this regard. They are also interested in the amount of security existing for their debt, other liabilities the organization has and security offered for them. The balance sheet offers this information. Trade creditors let the organization obtain goods or services with postponed payment. They are interested in the ability of the organization to pay its debts as they fall due, as revealed by liquidity ratios, such as the current ratio and the acid test ratio/liquidity ratio/quick ratio. Both shareholders and creditors use financial accounting information to assess the timing and uncertainty of prospective cash receipts. The prospects of cash receipts depend on the organization’s ability to generate enough cash to meet its obligations when due and its other cash operating needs. The cash flow statement, when used in conjunction with the rest of the financial statements, provides information that enables users to evaluate the changes in net assets of an enterprise, its financial structure (including its liquidity and solvency) and its ability to affect the amounts and timing of cash flows in order to adapt to changing circumstances.
Another use of financial accounting information is to solicit investments from potential investors (Atrill &amp. McLaney, 2003, Berry &amp. Jarvis, 1997). Potential investors require information on various matters, including solvency, financial strength, earning capability, and the ability of the management in order to decide whether or not to invest in the organization. The financial statements and the various financial ratios derived from the financial statements as mentioned in the above paragraph can be used by potential investors to make this decision.