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Objectives of Financial Statement Analysis

Motivation of the financial analysis users

In order to efficiently manage its finance every company needs to develop a systematic approach to the analysis of its financial statements. The motivation for applying the financial statement analysis to the annual report of a company is different for each group of users. Creditors are normally interested in estimating the creditworthiness of borrowers, investors want to measure the revenue their potential investments can bring, and managers are willing to have the most precise information on the financial position and performance of their companies. Users of the financial statement analysis can be grouped into two groups, which would respectively include parties, directly and indirectly interested in firm's performance.

First group includes:

  • existing and potential owners of an enterprise;
  • creditors and investors, using the financial statement analysis result to estimate the risks of providing credits to an enterprise and measure the efficiency of invested funds;
  • buyers and suppliers, estimating the reliability of their working relationships with a firm;
  • taxing authorities estimating the risk of a firm's bankruptcy;
  • company's management, since the financial condition indicators measure the efficiency of their work.

Second group includes:

  • audit firms;
  • financial consultants, developing investing recommendations for their clients based on the results of the financial statement analysis;
  • lawyers, needing the analytical information to estimate the execution of contracts' terms and conditions;
  • press and information agencies, using the results of the financial statement analysis for the preparation of reviews, estimation of the development trends and performance analysis of different companies and industries.

Despite the apparent difference in motivation, all the above-mentioned users have common objectives in the financial statement analysis.

Financial statement analysis objectives

1. Reviewing the company’s performance over past periods. Building the trend lines, calculating ratios and indicators with the use of the company’s past financial report is a key to making conclusions on its possible future performance. For creditors and investors reviewing the profitability, activity and liquidity ratios from previous periods can be a base for consideration of their further cooperation with a firm, while for the company managers it may be a reason for some serious economic decisions.

2. Assessing the current financial position. Analyzing company’s current balance sheet and income statement is the most effective way to estimate the condition of a company here and now. Reviewing firm’s assets and liabilities, checking the profitability margins for the current period is necessary for all the users in terms of operative and long-term decision-making.

3. Forecasting the profitability trends. As the main goal of every business is the generation of revenue for its owners and investors, planning the company’s cash flows and using analytical methods of forecasting the profitability is highly important for every user of financial analysis. Profitability forecast is a strong base for investors’ consideration of the alternative ways of using their funds.

4. Forecasting financial failure. One of the most important assumptions that can be made during the analysis of the company’s financial report is measuring a chance of its possible bankruptcy. This factor is vital to a business, and thus, should be under a tight control of company’s management, while for investors and creditors financial distress forecasts work as a warning sign.

Conclusion

Analyzing the financial report of the company is a mandatory activity for each party, currently or potentially involved in its activity. Company’s statements indicate facts and trends, which should cause awareness of the business’ management, as well as of its creditors and investors.

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