How do investors and lenders benefit from financial accounting?

Investors and lenders rely on financial accounting to obtain critical information about the financial health and risks of businesses. The most important benefit of financial accounting, and the benefit the Financial Accounting Standards Board, or FASB, most emphasizes, is the access to information. The average lender or investor does not have ongoing inside access to the day-to-day operations of a company. Instead, it relies on financial accounting to provide accurate and readily comparable information.

Financial accounting allows outside actors to observe the profitability and value of a business. An investor can see which companies have consistently performed well, paid dividends and appear to have positive margins. A lender can review the financial accounts to assess liquidity, cash flow, leverage and overall solvency.

The three main external financial statements – the income statement, balance sheet and cash flow statement – are issued on a routine schedule. This means investors and lenders have access to information on a consistent and dependable basis; external statements are not just issued when the company is doing well or when it looks the most solvent.

Financial accounting information is used in a variety of ways by different market actors. Information is not generally tailored to any one specific group, although investors and lenders are clearly the most important to a business. After all, company capital primarily comes from these two sources.

Flexible usage is maintained through a set of standards, or common rules, known as the generally accepted accounting principles, or GAAP or U.S. GAAP, in the United States and the International Financial Reporting Standards, or IFRS, in the rest of the world. In the U.S., GAAP is created by the FASB and issued through official statements. Accountants and corporate managers adopt these standards uniformly. This makes it relatively easy for an investor or lender to compare a company's performance across time and against its competitors.

Financial accounting is one component of a larger field of business accounting, which is different from managerial accounting. Financial accounting is performed for the benefit of outside parties. The financial statements are only one portion of financial reporting. Generally, only three or four issues are considered financial statements. The fourth is sometimes identified as the statement of stockholders' equity. Financial reporting, in addition to the financial statements, includes the company's annual report to the Securities and Exchange Committee, or SEC, and its annual report to stockholders. It also includes any proxy statements or additional reports created outside of the routine framework of the financial statements.

The FASB was developed and legitimized by the SEC. The stated goal of the SEC is to encourage transparency and improve the fairness of investment and lending contracts among publicly traded companies. Privately held companies do not have to comply with GAAP and the SEC, but transparency has followed through the training and standard procedures of public accountants and lender expectations.