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Unit 11: Introduction to Financial Reporting Framework

11.2 Contribution of Financial Statements in Meeting the Needs of Notes
Users

The accounting system generates accounting information in the form of financial reports. There
are two major categories of these reports: External and Internal.
Individuals and organisations that have an economic interest in the business but are not a part
of the management use external financial reports, included in the company’s annual report.
Information is provided to these external users in the form of general-purpose financial
statements. Special reports are sometimes required by the government agencies, which the
company has to provide. Internal users, which include managers and executives working for the
company, have access to specialised management accounting information that is not available
to outsiders.
11.2.1 External Users of Accounting Information

External users have limited access to an organisation’s valuable information. The success of
their decisions depends upon the use of external reports that are reliable, relevant and comparable.
Typically, governmental and regulatory agencies have the power to get reports in specific
forms. The rest of the external users rely on general-purpose financial statements like Balance
Sheet, Income Statement and Cash Flow Statement. The term general purpose refers to the broad
range of purposes for which external users rely on these statements.
Each external user has special information needs depending on the kind of decisions he has to
take. These decisions involve getting answers to key questions, which are often available in
accounting reports. Let us now discuss several external users and the questions that confront
them.

Investors

Ravi owns a music cassettes store at Dehradun. He got an excellent job with a music company in
Delhi so he moved here. He hired Raman to manage his store, who sends Ravi a cheque every
month representing the profits from the business. How can Ravi know whether Raman is doing
a good job of managing his store? Are the amount of profits is all that he can reasonably expect?
Should he consider selling his business and invest his money elsewhere to earn more profit?
As investors, the current owners of a firm are obviously interested in knowing how the business
is doing. If Ravi considers selling his business, he needs to know how much the business is
worth. The buyer will also be interested in a fair valuation of the firm’s assets.
Investors in a company are the shareholders (owners) of the company and in many cases they are
not a part of management. They are exposed to the greatest return and risk from the company. Risk
is high because there is no promise of either repayment of their investment or a return on their
investment. Therefore, they want information that helps them estimate how much returns they
can expect in the future if they invest in a business now. Financial statements coupled with knowledge
of business plans, market forecast and the character of management helps investors in assessing
these future cash flows. External reports aim to help answer shareholder questions such as:

What is the income for current and previous years?
Are assets adequate to meet future business plans? If the company requires raising more
funds to meet its requirements, what are the sources that the company is planning to tap?

Is the company competitive enough in its industry and how does it stand compared to
other companies in the same industry?

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