Understanding the Importance of External Users of Accounting Information
As businesses operate, they need to communicate their financial status to different categories of stakeholders. The accounting information serves as a means of providing stakeholders with an insight into the company’s performance, financial position, and cash flows. While individuals within the organization may find the accounting information valuable in making decisions, the external users of accounting information need the information to make their decisions.
Who are the External Users of Accounting Information?
External users of accounting information are individuals or organizations outside of the company. They have a significant interest in the financial status of the company because their decisions are impacted by the financial performance. Here are different types of external users of accounting information:
Investors
Investors are perhaps the most critical external users of accounting information. They need accounting information to decide whether to buy, hold, or sell shares of the company. Financial statements, annual reports or management discussion and analysis (MD&A) of financial results are some of the documents that investors need to inform their decision-making.
Creditors and Lenders
Creditors and lenders also rely on accounting information to determine the creditworthiness of a business before lending. They need to make sure the company has sufficient liquidity to honor repayment terms. Accounting information helps them determine the potential risk of default and also helps them track the company’s performance after funding it.
Government and Regulatory Agencies
Government and regulatory agencies use accounting information to monitor a company’s compliance with legal and regulatory requirements. They also use it to collect taxes, set tax policies, and formulate laws to promote economic growth.
Customers and Suppliers
Customers need financial information to assess the solvency of the company, especially when making long-term purchases or investments. On the other hand, suppliers need accounting information to evaluate the credibility of the company before engaging in business.
Why is External Users’ Understanding of Accounting Information Relevant?
External users of accounting information use it to make informed decisions on matters that impact the company. For instance, investors use accounting information to decide whether to buy, sell or hold shares of the company. They also make investing decisions based on the company’s financial performance as presented in the accounting information.
Creditors use accounting information to evaluate the ability of the company to repay loans. The information helps them understand the company’s liquidity, debt, and liquidity ratios.
Government agencies use accounting information to provide guidance on regulatory requirements for companies. They use the information to collect taxes and formulate policies that can help businesses grow.
Customers and suppliers use accounting information to evaluate the company’s operational and sustainability performance. They need to see whether the company is profitable and can meet its financial obligations.
Conclusion
External users of accounting information rely on financial statements, management discussion and analysis (MD&A) of financial results, and annual reports to make decisions. These external users include investors, creditors, government and regulatory agencies, customers, and suppliers. All of them need to understand the importance of accounting information and the impact it has on their decision-making. The relevance of accounting information to external users is essential since it enables them to make informed decisions that impact the company.
