Perspectives of Financial Accounting

Financial accounting has a particular perspective. For these professionals, the measure of financial success is based on liquidity in the short-term and on profitability in the long-term. 

Liquidity means that sufficient cash is available for the business and that it is not bound in assets that are difficult to sell, that is, are illiquid. A profitable business is one in which the revenues exceed the costs. The liquidity requirement translates into measures of success based on how quickly the investment

can recoup its costs, as encapsulated in the payback period.

The profitability measure translates to how productive the investment is at generating cash flows or profit. This notion is encapsulated in the return on investment as a measure and decision criterion. These are both accounting measures made with accounting data.

Financial management has a worldview different to that of financial accounting. The aim, and hence the measure of financial success, of financial management is to create and maximize shareholder wealth. Shareholder wealth is not seen as being driven by profitability; rather it is seen as a function of returns of cash to the investor in the medium and long-term. 

The goal of maximizing shareholder value leads to measures for the evaluation of investments and projects that maximize the future cash flows for the allocated capital. These notions are encapsulated in a number of decision criteria such as net present value and internal rate of return, that account for both the cost of the funds required to pursue the opportunity and the time value of money. 

Both of these perspectives are of value. Generally, the perspective that is required by engineers, scientists and managers is one that is closer to financial management than it is to either economics or accounting, and this theme dominates the treatment followed in this text. However, it is essential to understand the accounting view, since the engineers, scientists and managers must be able to communicate effectively with other professions. Since the perspective required of engineers is closer

to financial management, it is instructive to examine the components of value for a shareholder or an investor.