Introduction to Accounting – Part 1: Basics of Financial

Statements
Prof. R. Narayanaswamy
Users of Accounting Information

Hello!

The accounting system is a rich source of information about the activities of a business organization.
In this class, you will see how the various parties connected with an organization use the information
in the financial statements.

Let’s start with owners—the the intended audience for accounting reports. Owners may be sole
proprietors, partners, individual shareholders, or institutional shareholders. Investors such as these
provide risk capital to a business. They are the most important source of capital fo
for many businesses.
Owners are residual claimants. That means they have to take what is left after paying all other
claimants such as employees, suppliers, lenders, and government. There is no assurance that the
owners will get back their initial investment or receive a fixed return on their investment. If the
business is profitable, they may receive a portion of the profit and their investment will go up in
value. If not, they won’t get anything. Owners use measures such as profit margin, return on
investment,
nt, and return on equity to evaluate the success of a business.

Next, let’s take lenders. Banks and bond holders supply a significant portion of capital and use
accounting information to make decisions. The loan agreement contains the interest rate, the d
dates
for payment of principal and interest, the security for the loan, and other conditions that the
borrower must comply with. While considering a loan application, lenders use accounting
information to assess whether a borrower is creditworthy. They may want to know whether the
borrower can pay the loan and interest, and whether to insist on security. Lenders use measures
such as the current ratio, the debt to equity ratio, debt service cover, and interest cover. These
measures are based on numbers in the financial statements. Loan agreements often contains
stipulations in the form of do’s and don’ts. For example, they impose a ceiling on the borrower’s
overall debt, restrict dividends to the shareholders, and prohibit the borrower from engaging in
high-risk
sk ventures. After sanctioning a loan, lenders use accounting information to monitor the
borrower’s compliance with the do’s and don’ts in the loan agreement.

Employees have a major stake in the success of a business. They would feel more secure about thetheir
future if the business is profitable and growing. They use accounting information to forecast their
financial prospects. Future employees can get a sense of a business from its financial statements.
Past employees hope for their ex-employer’s
ex continued existence, so that they can get pensions and
health care.

Managers not only prepare accounting information, but also use the information. They compare an
enterprise’s sales, profit, cash flow, and other measures with those of its competitors. Managers are
often paid based on profitability, sales growth, and return on investment. So, they are very keen to
understand accounting principles and policies. A number of advisors use the financial statements to
make recommendations to their clients. For example, equity
equity analysts recommend whether investors

©All Rights Reserved. This document has been authored by Prof. R. Narayanaswamy and is permitted for use only within the course
"Introduction to Accounting -Part
Part I: Basics of Financial Statements" delivered in the online course format by IIM Bangalore. No part of this
document, including any logo, data, illustrations, pictures, scripts, may be reproduced, or stored in a retrieval system or transmitted in any
form or by any means – electronic, mechanical,
nical, photocopying, recording or otherwise – without the prior permission of the author.
 Introduction to Accounting – Part 1: Basics of Financial
Statements
Prof. R. Narayanaswamy
Users of Accounting Information

should buy, hold, or sell shares. Credit rating agencies assign rating symbols such as, triple A, double
A, triple B, D, and so on to indicate the relative safety of principal and interest.

Customers and supplierss use accounting information to ensure smooth operations. Customers need
assured supply of products and services. They also need their suppliers to be around for warranty
repairs, spare parts, and product upgrades. Suppliers have to plan their production aand estimate
future investments, and they would like to get paid on time. They use their customers’ sales, profit,
and cash flow trends to predict future demand and cash collections.

Government authorities utilize accounting information to allocate resources,

resources, develop tax policies,
and investigate crime. Notable among them are the ministry of corporate affairs and the ministry of
finance. Regulators in India include the Securities and Exchange Board of India, the Insurance
Regulatory and Development Authority
Authority of India, the Reserve Bank of India, and the Competition
Commission of India. They use accounting information to protect investors, lenders, borrowers, and
consumers, and ensure compliance with laws and regulations.

Political parties, activists, newspapers,

newspapers, and magazines, and television channels have a general
interest in the affairs of business enterprises. They use the information in the financial statements to
put forward their point of view. To sum up, accounting information is useful to owners, lende lenders,
employees, managers, governments, and others. Knowing accounting helps them to understand and
monitor a business organization and improve the quality of their decisions.

©All Rights Reserved. This document has been authored by Prof. R. Narayanaswamy and is permitted for use only within the course
"Introduction to Accounting -Part
Part I: Basics of Financial Statements" delivered in the online course format by IIM Bangalore. No part of this
document, including any logo, data, illustrations, pictures, scripts, may be reproduced, or stored in a retrieval system or transmitted in any
form or by any means – electronic, mechanical,
nical, photocopying, recording or otherwise – without the prior permission of the author.