Accounting has many uses. In this lesson, you will learn not only who accounting users are but also what types of accounting information is used. You will also learn the uses of that accounting information.
Which Is Which?
Sam and Sally are cousins. Sam works as a loan officer at a bank. Sally owns her own bakery. Sally decides to ask Sam for a loan to expand her business.
Both Sam and Sally are users of accounting information. One of them is an external user, and one is an internal user. Do you know which is which? You may not yet, but before this lesson is over, you will know not only which one is what type of user, but you will also learn what the uses of accounting information are.
External Users of Accounting Information
External - what does that mean to you? When I think of something that is external, I think of something that is outside. So, if we are talking about external users of a company's accounting information, then I would think of someone outside of the company. Who would be someone outside of a company that is interested in any information that is generated in the accounting process? Believe it or not, there really are several different categories of people that are very interested in this type of information.
- One of the most common categories of an external user is investors. These are the people that use their personal money to buy, or invest, into a company. Since the goal of becoming a shareholder in a business is to make money, investors are keenly interested in financial information.
- A second category of external users are creditors. There are a number of different types of creditors that a business may have. A bank is an example of a creditor. A bank is a potential financer for a business.
- A supplier is another type of creditor. Oftentimes in business, suppliers sell needed supplies to a business on a credit basis. The credit basis means that the supplies are delivered without payment but with a guarantee that they will be paid for in a certain time period.
- A third type of external user of accounting information is the government. They want to know how much money a company made in order to know how much taxes the company should be paying. This is a vital part of our economy, and even though we don't always like it, paying taxes is what keeps our world spinning.
External Uses of Accounting Information
Now that you know what an external user of accounting information is, what exactly is the information that they use? Since an external user is someone with an outside interest in the company, they want to know the bottom line when it comes to company finances.
The main items that interest this type of user are the financial statements. The accounting process involves a number of procedures that are completed in certain steps. This process is called the accounting cycle. One of the ending steps of the accounting cycle is to generate four financial statements.
- The first statement is the income statement. The income statement tells an external user how much money a company made or lost in a given time period.
- The second statement is the statement of retained earnings. This financial statement tells external users how much of the net income shown on the income statement is reinvested in the company.
- The third financial statement that is generated is the balance sheet. The balance sheet tells external users exactly what accounts a company has and the balance in each account.
- The last financial statement is the statement of cash flows. The statement of cash flows tells the external user what brought revenue in and where it was expensed out.
Internal Users of Accounting Information
Internal is the opposite of external. If that's so, then an internal user of accounting information would be someone inside the company. They are the individuals who are directly involved in the company's day-to-day operations. Who would that be, you wonder? Well, let's see.
- Since a company is generally the bread and butter for its owner, company owners are definitely internal users of accounting information. They are concerned not only with profitability of the company but also in the longevity of the company.
- Managers are also internal users of accounting information. They use accounting information to see how well the company is operating under their guidance. They are also looking to see if there are areas that they need to improve upon or areas that need to be cut in general.
Internal Uses of Accounting Information
Though internal and external users are two different groups of people, they do have one thing in common. Both of these types of users rely on the same types of accounting information - the financial statements. Owners use information on the financial statements to see how well the company is performing. They need to know if the company is profitable, or if there are areas that need to be addressed in order to make the company more profitable.
Managers use accounting information for a variety of reasons. First, the financial statements tell them how much there is to allot for labor and for materials. This same bit of information also allows them to forecast how much of a product can be produced. If the company is strictly a sales company, then the financial statements let them see how much inventory can be purchased and how much was sold in the last period. All of this information helps management and owners forecast future supply and demand.
External users of accounting information are those on the outside of a company looking in. Internal users are those that are inside the company. The common thread between the two is that both use the exact same accounting information, but for different reasons. The accounting information that they use are the company financial statements. These are the income statement, statement of retained earnings, balance sheet and statement of cash flows.
- The income statement tells whether the company made a profit or had a loss during the accounting period.
- The statement of retained earnings tells how much of the profit that was made was reinvested in the company.
- The balance sheet lists each account of the company and the balances in each.
- The statement of cash flows tells how revenue came in and flowed out during the given accounting period.
At the very beginning of this lesson, you were introduced to Sam and Sally. You learned that Sam was a loan officer at a bank, and Sally was a business owner seeking a loan for expansion. You were asked what type of user of accounting information Sam and Sally were. Do you know the answer now? Let me help you.
Sam works at a bank; therefore he is a potential investor for Sally's bakery. He does not have a position inside the bakery. That would mean that Sam is an external user of Sally's accounting information. Sally is directly involved in the day-to-day decision making for her business. She needs to know how much money she has made and how much she can spend to continue operations. Sally has a direct interest inside the bakery; therefore, Sally is an internal user of financial information.
In order for Sam to consider giving Sally a loan, she must provide him with the financial statements for the bakery. Sam has to be sure that Sally has made enough money in the past to cover her debts while still being able to operate the bakery. If not, she would not be a good financial risk. Sally uses the financial statements to see how well she is operating her business and to look at areas that she may improve upon. Because Sally realized, by reviewing her financial statements, that she was ready to expand, she went to Sam for a loan. Sam and Sally are wonderful examples of not only the users of accounting information, but also its uses.
At the end of this lesson, you will be able to:
- Differentiate between external and internal users of accounting information
- Describe the different types of accounting information that each use
- Explain how each type of user would use the different types of accounting information