Significance of Analysis of Financial Statements

Significance of analysis of financial statements : Financial analysis is the process of evaluating business, projects, budgets and other finance related transactions to determine their performance and suitability. It is generally used to analyze whether an entity is stable, solvent, liquid or profitable enough to warrant a monetary investment. Financial analysis is not restricted to any specific individual. It can be undertaken by management of the company or by external parties like owners, bankers, lenders, investors, economists, government, analysts and others.

Financial analysis is imperative for different users –

  • Finance Manager : Analysis of financial statements helps the finance manager in assessing and analyzing the operational efficiency and managerial effectiveness of the company along with the current position of financial analysis and the types of assets owned by a business enterprise and the liabilities which are due to the enterprise. It helps in providing the information about the cash position company is holding and how much debt the company has in relation to equity.
  • Top Management : Financial analysis is of utmost use to the top management of the company. It helps them in understanding the outcome of their decisions and what changes need to be made in the future to increase profitability. They can assess whether the resources of the firm are efficiently used, the progress of the company’s operations and govern the system of internal control. They can also investigate the future prospects of the enterprise.

  • Trade Payables : Trade payables conduct analysis of financial statements to ascertain the capability of the company to fulfil its short term and long term obligations. They focus on determining the credit worthiness of the enterprise and the liquidity position to meet any of the short term debts.
  • Lenders : Long term suppliers of funds are concerned with the firm’s long term solvency and survival. They analyze the firm’s financial statements to ascertain the profitability over a period of time of the company, assess financial statements which contain information on past performances and interpret it as a basis for forecasting future rates of return with risk for determining a company’s ability to generate cash, to pay interest and repay the principal amount.
  • Investors : To ensure safety and security of the amount invested by the investors in the company, they are interested in the company’s earnings and future profitability. Financial statement analysis helps them to predict failure and bankruptcy of the enterprise. Investors can take preventive measures in case of probable failure and avoid/minimize losses.
  • Labour Unions – Labour unions are interested in analysing the financial statements in order to assess whether they can demand a wage increase depending on the profitability of the business.
  • Others – Other than the above mentioned users of financial statements, there are quite a few others. The researches and economists study the financial reports of a company to analyse the current business, market and economic conditions.

Thus, financial analysis has different significance to each user of a financial statement depending on the purpose of analyst. The analysis can be beneficial in assessing the profitability, liquidity, solvency, efficiency and effectiveness of the company.

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