The Role of Accounting Information in Business Decision-Making

Analysing the Role of Accounting Information in Business Decision-Making

 As boring or esoteric as it may sound, one cannot overlook the role of accounting information in business decision-making. Quality and accurate financial information is a key decision-making element and plays an instrumental role in helping businesses keep track of their financial transactions.

All companies should adhere to the accounting principles or common set of practices, like the generally accepted accounting principles (GAAP) issued by the Financial Accounting Standards Board (FASB) that all US-based public companies must follow to compile their financial statement and make business-related decisions. Before we dig into the role of accounting information in business decision-making, let’s quickly understand what accounting is.

What is accounting?

Accounting is the process that involves recording, summarising and reporting all the economic transactions and business operations for a specific time. The role of accounting information in business is crucial for decision-making as it creates an overview of the overall development and gives direction to increasing the efficiency of business activities.

Understanding the role of accounting information in business decision making

The role of accounting information in business isn’t confined to decision-making but also to helping management plan and make decisions to increase the company's profit margin. Managers, analysts, stakeholders, investors, lenders, and others use accounting statements to understand the business's current position and determine what can be done to make the company more profitable.

The business scene is constantly evolving, so business officials need to stay updated with the current changes and obstacles in business operations to plan the necessary course of action to achieve the business goals. Accounting helps the management evaluate different scenarios and minute details related to the business to predict the future and make decisions in the firm's best interest.

As mentioned earlier, accounting is governed by a series of accounting principles and best practices. Public companies in the US follow the GAAP, while companies outside the American borders are bound by other principles and norms subjected to that region and country. Financial accounting has three major roles in business decision-making regardless of the principles.

• It acts as the analysis baseline and compares the financial health of companies issuing securities.
• It helps businesses to decide on ways to allocate scarce resources.
• It helps creditors assess a business’s solvency, liquidity and creditworthiness.

 Let’s elaborate!

Making Investing Decisions

Financial analysis heavily banks on accounting data recorded from income statements, balance sheets, and cash flow statements, among other financial statements. Investors and financial analysts use these data to determine the valuation of a business and its creditworthiness which helps them to set price targets to check if the stock’s price is fair or not. Without financial accounting, investors won’t have any information related to the company's financial health and stock and bond issuers. Without consistency in the style of financial accounting and the timing, investors are less likely to have a clear knowledge of past, present, and prospective financial health.

Determining Lending Decisions

A business’s financial accounting is a key determiner of its creditworthiness. Creditors, from banks to bondholders, rely upon financial statements and accounting ratios such as the time's interest earned ratio and the debt-to-equity (D/E) ratio to evaluate a company’s short and long-term debt and current financial position. No lender will approve a large business loan, even for private companies, without analysing the crucial accounting information generated using different accounting techniques.

Basically, a lender reviews the financial reports to determine any risk involved in lending money to a business. Once the lending institution determines the risk factor, it outlines how much to lend and at what rate of interest.

Usefulness in Business Governance   

Accounting serves as a reliable tool for outside investors and internal business activities. One of the primary benefits of accounting is to abide by the legal and regulatory guidelines outlined for public companies. The most obvious obligation for any company is, to be honest and transparent with their financial policies and maintain accurate and updated data.

Besides the regulatory and compliance challenges, accounting helps to optimise business operations and highlight the areas with growth opportunities. Furthermore, managers can prepare budgets, track the efficiency of policies, evaluate product performance, understand public views, and develop short- and long-term strategies, among other business decisions using accounting reports.

Additional benefits of accounting information for a business

• Accounting is a principal element for a business's growth and development. The elaborate statistical information gathered through accounting allows a business to make decisions about different activities and get a transparent picture of how to make a business profitable.
• Accounting helps management officials to identify the most and least used resources. They can decide on the allocation and optimum use of resources to minimise wastage and increase profits by reducing costs.
• Compliance requirements are one of the priorities of a business, as failing to comply with the standard rules and regulations can invite penalties. Accounting helps to ensure a company meets its compliance requirements and is safe from penalties.
• Auditing and budget preparation are critical business functions heavily dependent on financial accounting. It assists with auditing and helps a business to plan and make effective decisions for the future to protect the firm from risks and uncertainties.  

The Bottom Line

Accounting is an effective way for a business to keep track of its operations and get an honest picture of its financial standing. With accurate financial accounting data gathered through various statements, such as cash flow statements and balance sheets, potential and existing lenders and investors can evaluate a firm’s financial health and decide whether to invest or lend money to the business.