5.5.3 How and Why Accounts are Used
| In this lesson you will learn: |
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✅ Needs of different users of accounts and ratio analysis ✅ How users of accounts and ratio results might use information to help make decisions, e.g. whether to lend to or invest in the business |
Needs of different users of accounts and ratio analysis
How users of accounts and ratio results might use information to help make decisions
You need to know which stakeholders are interested in financial accounts, what they want to know, and why.
| ⭐⭐⭐Top Tip ⭐⭐⭐ Just like questions about stakeholders, it’s helpful to put yourself in the shoes of each user of financial information. Why do they interested in a business’s accounts? How will they be impacted by the financial performance of a business? How will the results influence their decisions? |
Managers and Leaders have a responsibility to ensure the financial success of a business.
They are interested in the income statement and profitability ratios, so they can see how the performance of the company compares against previous years and against competitors. They also use financial information to make decisions for the business going forward.
For example, if the income statement shows a particular market or product has a higher profit margin, this could be the focus for their marketing strategy in the future.
It’s worth noting managers success (and bonuses) will often be measured against the profitability of the business.
Managers will also be interested in liquidity ratios, so they can analyse the businesses ability to pay its short term debts. If working capital is low they can look at ways of improving cash flow to ensure the business can continue to operate.
Investors will keenly look at the income statement and profitability ratios. If the business is improving it’s profitability it will mean more dividends for shareholders. If profit margins are low investors may decide to move their money elsewhere.
Investors will also look at the statement of financial position, as it shows the total value of a business. If the net worth of the business is increasing year on year, it means the value of the investors shares is likely to increase.
Banks and creditors are more interested in the statement of financial position as they need to make sure a business can pay its debts.
If a business has a high level of debt banks may be unwilling to loan capital as there is a risk the business will not be able to repay.
If a business has low liquidity a supplier may decide not to sell on credit, as they may not receive payment from the business.
Competitors will compare their profitability to companies in the same industry to assess their performance. Toyota may compare its results with Ford, Tesla and other car manufacturers. Finally, the government is interested in financial accounts because of tax. If a business is profitable it will pay more tax so the government will want it’s share.
