Objectives of financial statements analysis
Category: Financial Control Management
The process of Financial Statement Analysis consists of the application of analytical tools and techniques to financial statements and data in order to derive from them measurements and relationships that are significant and useful for decision making. Thus financial statement analysis first and foremost serves the essential function of converting data into useful information, which is always in scarce supply.
The process of financial analysis can be described in various ways, depending on the objectives to be attained. Thus, financial analysis can be used as:
A preliminary screening tool in the selection of investments or merger candidates;
A forecasting tool of future financial conditions and results;
A process of diagnosis of managerial, operating, or other problem areas;
A tool in the evaluation of management.
There are a number of possible approaches in respect of tools and techniques of financial analysis. One way, popularly employed in the financial practice is to describe the analysis of specific financial statements, such as Balance Sheet, without a concurrent emphasis of objectives to be attained. In order to develop a sound and meaningful analysis of financial statements, one must emphasis on the major objectives of the most important categories of users of financial data, namely:
• Credit grantor (banks, suppliers);
• Equity investors;
• Management;
• Acquisition and merger analysts;
• Auditors;
• Other interested groups (Governmental regulatory bodies, Labour unions, lawyers).
Through the financial analysis, the Suppliers are looking to (1) obtaining a profit on the goods supplied occurring from the normal transactions (2) secure the repayment of the provided loans.
The banks are concerned primarily with (1) repayment of the principal and interest, (2) security provisions of the loan (the fair market value of assets pledged), (3) determination of the true profitability of the borrower’s business (primary source of interest repayments).
The common objectives of credit grantors are (1) ongoing nature of the business, (2) existence of resources and the projections of future flows of funds, (3) reliability and stability of such funds, (4) how low earnings will shrink during recessionary periods, (5) borrower’s demonstrated ability to control the flow of cash and to maintain a sound financial condition under a variety of economic and operating circumstances.
Managements primary objective in utilizing the tools of analysis is (1) to exercise control over the business, (2) to assure the profitability and stability of business, (3) to view the enterprise in the way important outsiders, such as creditors and investors, view it, (4) to obtain stable revenues in form of salaries for quite a long time span, (5) to monitor and keep up with the ever-changing condition of the enterprise.
An important first step in any decision-making process is to identify the most significant, pertinent, and critical questions that have a bearing on the decision. Financial analysis reduces reliance on pure hunches, guesses, and intuition, and this reduces and narrows the inevitable areas of uncertainty that attend all decision-making processes. Financial statement analysis does not lessen the need for judgment but rather establishes a sound and systematic basis for its rational application and does not provide answers to all questions. However, any kind of financial issues can, to a significant extent, be answered by such analysis.