Who Uses Accounting Information? (Continued)

External Information

External accounting informationExternal Accounting Information:
Publicly accessible information on a company. This information is standardized so that users can compare current operations to previous years or benchmark performance against competitors. One example of external company information is the annual report. is available publicly to anyone who requests it. Most of the time, this information is on websites, in the news, or in social media. The most comprehensive source of financial information is a company’s annual reportAnnual Report:
A company’s complete telling of its economic reality: the financial statements, financial statement notes, and corresponding narratives.. The annual report is in two parts: narrativesNarratives:
A section in a company’s annual report where management shares their perspective on how the company performed and what their goals are for the next year. Narratives accompany and give context to financial statements. See also: MD&A. and financial statements.

Narratives

In this section, management gets to share their perspective on how the company performed and what their goals are for the next year. Sometimes this section is called the management discussion and analysis, or the MD&A. Narratives (MD&A) give context to the financial statements. This is important because the financial statements have a standard, rigid format with no real capacity for explanation or illustration. Narratives allow management to describe their business modelBusiness Model:
Explains how a company creates value in the marketplace. A business model includes the type of business a company engages in (e.g., retail sales, manufacturing, service) and how it differentiates from its competitors. A company’s business model tends not to change quickly over time. in their own words: to tell a story about how they create value in the market, their strategyStrategy:
Describes how a company intends to operationalize their business model in the short-, medium-, and long-term. Strategy is nimble and adapts quickly to internal (HR, cultural, processual, procedural) and external (supply, demand, market) factors., objectives, and current performance. For example, Sephora describes its business model and strategy as follows:

Business Model:

Our revolutionary beauty-retail concept … is defined by its unique, open-sell environment with an ever-increasing assortment of products from carefully curated brands, featuring indie darlings, emerging favorites, trusted classics, and Sephora’s own, Sephora Collection.

Strategy:

to deliver an unparalleled assortment of prestige products in every category, unbiased service from experts, interactive shopping environment, and innovation.

Business model and strategy are fundamental in accounting because they give us information on how the company evaluates itself and the types of financial information that are of particular interest to them. Look back at Sephora’s business model. How might they evaluate how they’re performing? They might be interested in the number of brands carried in-store, or how many new offerings are introduced each year. Looking at Sephora’s annual report, we may expect to find financial information that is separated by offering: new products, classics, and the Sephora collection. Sephora may also want to benchmark against other beauty stores (that is, their competition) to demonstrate the effectiveness of their revolutionary beauty-retail concept. Business model and strategy are so important for financial information users!

Financial Statements

This section includes the audited financial statements and financial statement notes. Financial statements provide information on what the company owns (cash, buildings, equipment, and patents, for example), what it owes (to suppliers, the bank, or wages to employees), and how it uses its resources to create value.

Financial statement notes give detailed information on items in the financial statements so that readers can get all the information they need without the financial statements themselves getting overly complicated. This is the place to look if you want to become intimately familiar with a company. If you are interested in finance, you will look to the financial statement notes to get an advantage in stock trading. This class focusses on financial statements, and this entire book is about preparing financial statements, so don’t worry if some of these ideas are foreign to you now. We’ll get there!

External Information Users

Now that we know the types of information that are disclosed, and where we might find them, let’s turn back to users of financial information: who are our external users? This question is more difficult to answer comprehensively because there are so many potential external users. These users rely primarily on external financial information, although some like banks, analysts, or large investors may have internal information sources as well. External users include investors such as shareholders, or the bank; customers; suppliers; the government; and public interest groups, the community whose resources a company shares, and society. Let’s consider these in turn.

Investors

may own sharesShares:
Ownership interest in a company. Includes common shares and preferred shares. Share capital, the amount paid for shares, is categorized as Equity and found on the Statement of Financial Position. in a company as a shareholder or may own company debtDebt:
Cash raised on the debt/bond market or from a bank that results in contractual cash flows of interest and principal paid by the company over the term of the debt. as a debtholder, such as a bank that loans a company money. A share is a percentage ownership stake in a company. That means if the company does well, the share is worth more; but if the company goes bankrupt, the share is worthless. If a company’s shares are traded on a public exchange like the Toronto Stock Exchange (TSX), we say that the company is publicly tradedPublic Company:
A corporation whose shares are traded on an exchange like the Toronto Stock Exchange (TSX). Public companies have a large and dispersed shareholder base. These shareholders can buy and sell shares of the company – exchange with other investors – without affecting the company’s accounting. Also called publicly held company.. Companies whose shares are not traded are called private companiesPrivate Company:
A corporation that is not listed on a stock exchange. Private companies are usually closely held, meaning that (1) there are few shareholders, and (2) owners tend to oversee day-to-day operations. Also called a privately held company or private enterprise..

Try looking up the most recent annual report for a publicly traded company like The Second Cup by typing The Second Cup, annual report into your search engine. You should get results. Now try looking up a private company like Booster Juice. There isn’t much financial information available for Booster Juice because it is privately held.

What decisions are investors trying to make? Investors need to decide where to invest their money. Let’s say there are two such possible companies, Company A or Company B. What information do investors need to decide which company to invest in Investors need financial information to determine (1) what the future return on investment will be, for example, how much money do I expect to make from this investment, (2) how risky the investment is, and (3) the timing of cash flows.

To predict how the company will perform in the future, we might look at historical trends: how has the company generated returns in the past, and is the trend likely to continue or how might it change? An investor might look at profit and company structure, including production facilities and intellectual property in place, to predict future returns on investment. Similarly, we can estimate risk by looking at volatility in stock price and profit. Industries like energy, financials, and technology tend to have volatile stock prices, meaning that the price fluctuates intensely and often.

Every investor is in a different position. Consider, for example, an investor who is close to retirement and wants to start withdrawing cash right away. This investor will likely consider a low-risk investment with high dividends. The opposite is true for a young investor saving for retirement who will choose higher risk and lower dividend investments to benefit from higher returns which are only available as risk increases. And the investor doesn’t care about dividends at early career; she’ll just re-invest them because she doesn’t want money until retirement.

I’m excited for you to learn more about investing in your Introduction to Finance class. Investing theories are exciting and there’s much more to learn, but we’ll stop here. Just know that to make profitable investments, you’ll need good accounting skills. Now, what other external users are making decisions from financial information?

Customers

make decisions about what products and services to buy and from whom. Before a customer makes a major purchase, he may consider whether the company will be around to repair the product or take returns. To do this, this customer may look at cash flow to see if the company has enough cash coming in to support current operations. He may also look at profitability: is the company selling enough product at a reasonable price to cover their expenses, such as the cost of product soldCost of Goods Sold (COGS):
The cost of inventory sold during the period indicated on the Income Statement., utility bills, employee salaries, etc.? The customer will most definitely look at the company’s business model and strategy to ensure that the company intends to continue selling and servicing the product in the future.

Financial information is particularly important for corporate customers who buy and resell a product, or use the product in their manufacturing process. For example, if a car dealership can’t buy vehicles maybe because of backorder or supplier bankruptcy, then this dealership may not be able to generate enough cash to pay their rent or their employees, and may be forced to go out of business.

Suppliers

are providers of products. For example, Ford and Toyota supply cars to dealerships. Suppliers need information so they can forecast future sales. That is, suppliers need to know that their customer, for example, a car dealership, will survive and continue purchasing into the future, and estimate how much the customer will be able to purchase. Suppliers have to decide what products to sell, in what quantity, and at what price. And financial information helps suppliers to make these decisions.

Governments

may be federal, like the Canadian government, provincial like Saskatchewan, or municipal such as the City of Regina. Government organizations use financial information for tax purposes. In Canada, companies pay income taxes, and the tax forms start with accounting profit, followed by lots of fun adjustments that you’ll see in your accounting for income tax course!. Companies also withhold and submit sales tax (GST, PST, and HST) to the government which is calculated and reported through a company’s accounting system.

The other decision government makes is whether to offer subsidies. We can think of subsidies as the opposite of taxation. Subsidies are cash paid from the government to companies in targeted industries to keep prices low and competitive for consumers. Examples of industries given subsidies include oil, agriculture, and housing—industries that provide important public goods/services. Government looks at profit figures and other economic factors to determine whether an industry requires bolstering to continue operating at low cost to consumers.

Communities

are places where people work, live, and hopefully get along. Companies are closely tied with communities and need community support to exist. After all, communities share their natural resources such as water, land, and air, time as employees, and infrastructure, like roadways or emergency services, for example, with companies. And it is likely that the community forms a supply chain, particularly in small companies where buyers and purchasers live in the same communities. So, communities are inextricably linked, and members have to get along in order to function. Companies are part of communities, and many companies share how their operations affect the community in their financial reports.

Perhaps you can think of other financial information users. It is fascinating that so many of the processes we take for granted—our work, shopping, taxes, buying a house, operating a community, and society—are all based on an intricate web of accounting. Even the university where your tuition, government grants, community research, the university bookstore, the cafeteria, and restaurants rely on accounting to relate and communicate to internal users like the president’s office and externally to the government or to you!