The purpose of financial accounting for a business, and the internal and external users of accounting information and the decisions each group makes from it.

What this dot point is asking

The SQA wants you to explain why a business keeps financial accounting records and to identify the users of accounting information, splitting them into internal and external users and stating the decision each group makes from the figures.

The purpose of financial accounting

Every business, even a one-person sole trader, handles money: it sells goods, pays expenses, buys assets and may borrow. Financial accounting is the system that records those transactions in an organised way and summarises them into financial statements at the end of a period, usually a year.

The records exist to answer three questions that matter to the people who deal with the business:

• How much profit (or loss) was made? The income statement compares income with expenses for the period.
• What is the business worth, and what does it owe? The statement of financial position lists the assets, liabilities and the owner's capital at a point in time.
• Can the business be trusted and controlled? Up-to-date records let the owner spot problems early, control costs, and meet legal duties such as declaring the correct tax and VAT.

Users of accounting information

The SQA expects you to know the main stakeholders who use a business's accounting information and to match each one to a reason. They divide neatly into two groups.

Internal users

These people work inside the business and see the detailed figures.

• The owner. Wants to know the profit earned on their investment, whether the business is growing, and what it is worth.
• Managers. Use the figures to plan, set targets, control spending and make day-to-day decisions. In a small sole trader the owner and manager are often the same person.

External users

These people are outside the business and usually see only the published statements.

• Lenders (banks). Decide whether to grant a loan or overdraft, and whether the business can repay it.
• Suppliers (trade creditors). Decide whether to sell goods on credit and how much credit to allow.
• HM Revenue and Customs. Checks that the correct income tax and VAT have been declared and paid.
• Employees. Judge whether their jobs are secure and whether the business can afford fair pay.
• Customers. Want assurance that the business will keep trading so it can honour orders and guarantees.
• Prospective owners or investors. Decide whether the business is worth buying or investing in.

Internal and external information differ

External users see the formal year-end statements, which follow accepted accounting practice so they can be compared between businesses and years. Internal users also see detailed management information - budgets, costings and break-even figures - that is never published. The same underlying records feed both, which is why accurate book-keeping matters to everyone who relies on the business.

Examples in context

When a sole trader applies for a business loan, the bank asks for the latest income statement and statement of financial position because it is an external user making a lending decision. When the same owner sits down to decide whether to drop a slow-selling product line, they are acting as an internal user, using the detailed figures to control the business. The records are the same; the use and the user differ, and recognising that distinction is exactly what this dot point tests.

Try this

Q1. State two internal users of a business's accounting information. [2 marks]

• Cue. The owner; the managers.

Q2. Give one reason a supplier needs a customer's accounting information. [2 marks]

• Cue. To decide whether to sell goods on credit and how much credit to allow.

Q3. Explain one difference between financial accounting and management accounting. [2 marks]

• Cue. Financial accounting reports the past for external users; management accounting plans ahead for internal users.