How does financial accounting help decision making?

There are three main areas where financial accounting helps decision-making.

  • It provides investors a baseline of analysis for – and comparison between – the financial health of securities-issuing corporations.
  • It helps creditors assess the solvency, liquidity and creditworthiness of businesses.
  • Along with its cousin, managerial accounting, it helps businesses make decisions about how to allocate scarce resources.

Investing Decisions

Fundamental analysis depends heavily on a company's balance sheet, its statement of cash flows and its income statement. All of the financial statements for publicly traded companies are created and reported according to the financial accounting standards set forth by the Financial Accounting Standard Board (FASB).

Without the information provided by financial accounting, investors would have less understanding about the history and current financial health of stock and bond issuers. The requirements set forth by the FASB create consistency in the timing and style of financial accounts, which means that investors are less likely to be subject to accounting information that has been filtered based on a firm's current condition.

Lending Decisions

A number of common accounting ratios that creditors rely on, such as the debt-to-equity (D/E) ratio and times interest earned ratio, are derived from the financial statements. Even for privately owned businesses that do not necessarily follow the requirements of the FASB, no lending institution assumes the liability of a large business loan without critical information provided by financial accounting techniques.

Corporate Governance

Reliable accounting serves a practical function for the firms themselves. Beyond the regulatory and compliance hurdles that financial accounting helps clear, financial accounting also helps managers create budgets, understand public perception, track efficiency, analyze product performance and develop short- and long-term strategies.