The size of a business is dependent on the potential of the idea and not on the pockets of the entrepreneur. Look at the example of Facebook, Mark Zuckerberg has created a company worth billions even though he had nothing in his pocket. However, as companies grow bigger, the ownership and management are separated. This leads to problems in managing the business. Here is how Financial Accounting helps solve this need:
Principal-Agent Problem: Financial accounting helps solve the principal agent problem. This means that through a company’s statements of accounts, shareholders can look at the movement of money in and out of the firm. The movement of money provides a good deal of insight about the firm. The owners can look at the actual production done, the actual costs involved and see if the numbers match.
Performance to Stakeholders: Financial accounting for public companies needs to be in the public domain. This means that anyone can access the data regarding the performance of a public company. This helps many different stakeholders make decisions about the firm. For instance, employees can study to find out whether the firm is solvent and suppliers can decide if they want to give credit or not.
Tax Purposes: Lastly, the declared financial accounts of a company are used by the government for taxation purposes. It is now allowed for the companies to have different sets of books based for tax purposes and reporting to investors.
Financial accounting, therefore, is just the arrangement of financial data in a format that is easy to read for the investors. This will help them understand the business and exert control over it.
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