1.4 Who Uses Financial Accounting Information?

As mentioned earlier, an accounting system is used within a company for routine, but essential, bookkeeping. Accounting information is also used to evaluate the financial status and performance of the company. This analysis is done by interested parties inside and outside the company, as described in this section.

Lenders

Lenders are interested in one thing—being repaid with interest. If you were to approach a bank for a large loan, the bank would ask you for the following types of information so it could evaluate whether you will be able to repay the loan:

• A listing of your assets and liabilities

• Payroll stubs, tax returns, and other evidence of your income

• Details about any monthly payments (car, rent, credit cards, etc.) you are obligated to make, and copies of recent bank statements to document the flow of cash into and out of your account

In essence, the bank would be asking you for a balance sheet, an income statement, and a statement of cash flows. Similarly, banks use companies’ financial statements in making decisions about commercial loans. The financial statements are useful because they help the lender predict the future ability of the borrower to repay the loan.

Investors

Investors want information to help them estimate how much cash they can expect to directly receive from the business in the future if they invest in it now. Financial statements, coupled with a knowledge of business plans, market forecasts, and the character of management, can aid investors in assessing future cash flows, such as dividends to be received.

Obviously, millions of Americans invest in McDonald’s, Microsoft, Exxon Mobil, and General Electric without ever seeing the financial statements of these companies.

Investors can feel justifiably safe in doing this because large companies are followed by armies of financial analysts who would quickly blow the whistle if they found information suggesting that investors in these companies were at serious risk. But how about investing in a smaller company, one that the financial press doesn’t follow, or in a local family business that is just seeking outside investors for the first time? In cases such as these, investing without looking at the financial statements is like jumping off the high diving board without looking first to see if there is any water in the pool.

Management

As mentioned earlier, managers and executives who work inside a company have access to specialized managerial accounting information that is not available to outsiders. For example, the management of McDonald’s Corporation has detailed managerial accounting data on exactly how much it costs to produce each item on the menu. Further, if a local price war over burgers is started by Burger King or Wendy’s in Missouri, for example, McDonald’s managers can request daily sales summaries for each store in the area to measure the impact.

In addition to managerial accounting information, managers of a company can use the general financial accounting information that is also made available to outsiders. Company goals are often stated in terms of financial accounting numbers such as a target of sales growth in excess of 5 percent. In addition, reported net income is frequently used in calculating management bonuses. Finally, managers of a company can analyze its general purpose financial statements (using the techniques outlined in our “Introduction to Financial Statement Analysis”) to pinpoint areas of weakness requiring more detailed managerial accounting information.

Suppliers and Customers

In some settings, suppliers and customers are interested in the long-run staying power of a company. On the supplier side, if Boeing, for example, receives an order from an airline for 30 new 787s over the next 10 years, Boeing wants to know whether the airline will be around in the future to take delivery of (and pay for) the planes. On the customer side, a homeowner who has foundation repair work done wants to know whether the repair company will be around for the next 50 years to honor its 50-year guarantee. Financial statements provide information that suppliers and customers can use to assess the long-run prospects of a company.

Employees

Employees are interested in financial accounting information for a variety of reasons. Financial statement data, as mentioned earlier, are used in determining employee bonuses. In addition, financial accounting information can help an employee evaluate the employer’s ability to fulfill its long-run promises, such as for pensions and retiree health care benefits.

Financial statements are also important in contract negotiations between labor and management, as illustrated by the continuing cycle of negotiations and strikes in major league baseball. Every time the owners and players sit down to negotiate a new contract (the last major negotiation was in the middle of the strike-shortened 1994 season), they spend a significant amount of time arguing about how much money the owners are making. If the teams are profitable, the players can ask for more salary money. If the teams are losing money (as the owners constantly claim), the players’ salary demands must be tempered. In all labor negotiations, the profitability of the employer, as revealed in the financial statements, is a key piece of information at the bargaining table.

Competitors

If you were a manager at PepsiCo, would you be interested in knowing the relative profitability of Coca-Cola operations in the United States, Brazil, Japan, and France? Of course you would, because that information could help you identify strategic opportunities for marketing pushes where potential profits are high or where your competitor is weak. Whenever accounting rules are changed to require companies to publicly disclose more information, companies complain that they are being required to tell their secrets to their competitors. One of the challenges in setting accounting standards is ensuring that companies reveal enough information to be useful to outsiders without also requiring them to harm their competitive position by making confidential data available to competitors.

Government Agencies

Federal and state government agencies make frequent use of financial accounting information. For example, in order to make sure that investors have sufficient information to make informed investment decisions, the Securities and Exchange Commission (SEC) monitors the financial accounting disclosures of companies (both U.S. and foreign) whose stocks trade on U.S. stock exchanges. The International Trade Commission uses financial accounting information to determine whether importation of Ecuadorian roses or Chinese textiles is harming U.S. companies through unfair trade practices. The Justice Department uses financial statement data to evaluate whether companies (such as Microsoft or Google) are earning excess monopolistic profits. State agencies, such as public utility commissions and insurance commissions, use financial statements and other accounting information in setting and/or approving utility and insurance rates.

Politicians

Political debate is frequently neither reasonable nor rational. To make a point, politicians have been known to misuse and distort otherwise innocent financial accounting information. For example, if you were an anti-tobacco congressperson wishing to make the point that tobacco companies are reaping obscene profits at the expense of the health of the American public, you would pick and choose information from the financial statements of the tobacco companies to support your position. And if you were a politician seeking to pin the blame for high health care costs onto the large pharmaceutical companies, you would use the financial statements of those companies to support your claim. Congress used the existence of financial statement fraud in a number of prominent cases (Enron, WorldCom, Tyco) to justify passage of the Sarbanes-Oxley Act of 2002, which greatly increases the government oversight of the accounting and auditing profession.

The Press

Financial statements are a great place for a reporter to find background information to flesh out a story about a company. For example, a story about McDonald’s can be enhanced by the same kind of summary sales data shown in the graph in Figure 1.3. In addition, surprising accounting announcements, such as a large drop in reported profits, are a trigger for an investigative reporter to write about what is going on in a company.

In sum, financial accounting information is organized and distributed to outside parties who are interested in a company’s financial status. The process of summarizing and distributing financial information is illustrated in Figure 1.3.

Questions Exercises