How Does Financial Accounting Help Decision-Making?

How Does Financial Accounting Help Decision-Making?
Tally Solutions | Updated on: October 20, 2023

What is financial accounting?

Financial accounting consists of recording financial transactions and reporting them using financial statements. Financial statements such as income statements, cash flow statements, and balance sheets contain distinct transaction summaries that provide insights into different aspects of the business. Financial statements reveal a different side to a business’s operating performance which is why it is beneficial to generate them regularly. They are used by people outside the business and see how valuable the business is. The FASB or Financial Accounting Standards Board develops principles and standards in the U.S.

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How does financial accounting help in decision-making?

Financial accounting is vital for every business, including start-ups, micro-businesses, and small businesses. It has various benefits, including analyzing cash flow, preparing tax returns, minimizing errors and problems, and forecasting. But the major benefit of financial accounting is decision making.

The following are some key decision areas that proper financial accounting helps with.

Decisions pertaining to standards: In the US, most companies must ensure they are following the GAAP or the Generally Accepted Accounting Principles that have been developed by the FASB. This applies to publicly traded businesses too. GAAP refers to standards and best practices that must be followed when the financial statements are being generated. Financial decision making comes in use when creditors need to evaluate a business’s credit worthiness and liquidity rate. It helps investors understand the financial health of businesses and highlights how resources are allocated in the business. This helps in making decisions related to standards and best practices.

Investment decisions: Investors use financial statements for financial decision making because they can thoroughly understand the stock value of the business. They use various financial statements to determine the value of the business and set price targets. As the financial statements reveal information about the previous and present stock-related information, they can make better predictions about where the stock value is headed. This way they know if they should continue to invest in the business or not. As financial statements are regularly generated by a business and a strict format is followed, it makes it easy for investors to compare and contrast thereby allowing for easy decision-making.

Investors do not want to undertake big risks as they risk losing everything they invest in your business. Investors will thoroughly go through the financial statements provided by your business and then analyze them to see if the benefits outweigh the risks or vice versa. They will look at whether you are earning a consistent income or if you have been incurring steady losses in the past few months. Investors do not take financial decisions lightly because they enable them to make current decisions and predict what may be the case in the future concerning your business.

Lending decisions: Financial decision making with regards to lending is made efficient with financial accounting. Creditors can make key decisions based on financial statements as these show the debt of the business and assets. Both long-term and short-term debts are outlined in the financial statements which show creditors how creditworthy your business is and they can base their decisions to lend to your business or not. Creditors can use several accounting ratios to better understand a business’s credit. This includes the debt-to-equity ratio and times interest earned ratio.

The debt-to-equity ratio measures how much debt your business has compared to the investment and retained earnings over time. The formula for this ratio is total liabilities divided by shareholder’s equity. The times interest earned ratio or TIE ratio is also known as the interest coverage ratio. It measures the ability of your business to repay debts with the current earnings. It is calculated by dividing EBIT (earnings before interest and taxes) by interest expense. These two ratios reveal how risky it is for a lender to provide a loan to your business.

Corporate governance decisions: Businesses can derive value from generating financial statements and ensure proper financial decision making based on them. Financial accounting will ensure you are complying with all the rules, principles, and policies set out by the governing body. As a business, you must be transparent and provide proof of your business including whether you are incurring profits or losses. All business financial information must be accurate and up-to-date. This helps businesses ensure they operate most efficiently and enable their employees to be productive.

Financial accounting has to be accurate so businesses can make budgets based on them. For example, if you have skewed and incorrect information about your business financials, you will either underestimate or overestimate your budget. This can cause problems down the line for your business. This is why proper financial accounting is the key to business success. It drives efficiency, productivity, stability, and growth for all sizes of businesses. It also helps to evaluate, compare, and analyze information.

TallyPrime for accurate reports and insights

MSMEs need an accounting software solution they can trust to generate financial statements such as the income statement, balance sheet, and cash flow statement, among others. Put simply, accurate financial accounting will lead to accurate decision-making. TallyPrime is tailor-made for MSMEs as it can generate all the major financial statements whenever your business requires it including a ratio analysis report. It has the best accounting features suitable for a growing business. Its automated features save hours of manual labor and improve the productivity of your employees for a better work environment.

TallyPrime’s reporting prowess doesn’t end there because it can generate over 400 reports in total letting you in on the most specific answers and insights. TallyPrime has major features built-in, including inventory management, payroll management, credit management, invoicing, cost control analysis, and much more. Its superior data security features mean you don’t have to worry about your data being accessed by unauthorized individuals while giving you the freedom to access it as you wish. Expert advice and help are just a click away, and you get a software package that is a complete accounting tool. If you want proper financial accounting, choose TallyPrime.

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