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 security-issuing institutions. Financial accounting helps creditors assess the solvency, liquidity and creditworthiness of businesses. Financial accounting (and its cousin, managerial accounting) helps organizations make business decisions about how to allocate scarce resources.
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.
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.
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 performance and develop short- and long-term strategies.