Question

Financial Statement Analysis, specifically Ratio Analysis is often performed by managers, investors, and creditors. What is the primary goal of each of these groups when evaluating ratios?

Answer 1

Goal of Financial analysis for creditors: Creditors are the group of persons who lend the money for running the business. Creditors check the liquidity and solvency among others before advancing the credit to a company. Creditors look for current ratio to determine if the company has the ability to repay the loan in the next year. Creditors use debt-equity ratio to understand the use of debt and its repaying ability.

Therefore, basically creditors use financial ratios to study the debt repayment capacity through liquidity and other related ratios.

Goal of Financial analysis for investors: Investors study financial ratios to determine if the investment will generate dividends in a profitable way. Price to earnings ratio is used by investors to analyse the earnings from each unit of investment made. Price to earnings to growth (PEG) ratio is used by firms to determine the earnings as well as growth of the firm. Asset turnover ratio is used by investors to determine how assets are being used and what value assets will generate those are owned by investors. Similarly investors use Return on equity, Return on capital employed etc. to study the returns from the company.

Profitability ratios help the investors in determining the profits that company is generating. These ratios help in deciding whether company is generating enough profits from the investment.

Solvency and liquidity ratios help in arriving at a judgement on the longevity of the firm and its ability in meeting its other financial obligations.

Therefore, basic goal of financial analysis for investors is to determine profitability from the investments that they make.

Goal of Financial analysis for managers: Financial ratios help a manager in determining profitability, liquidity, operational efficiency and other related aspects. Liquidity helps in identifying and estimating the risks. Estimation of risks helps the managers in early management. Profitability helps the managers in estimating the growth of the firm. These ratios also help the managers in comparison of the firm’s performance which the managers will utilize for deciding future course of action.

Therefore, basic goal of financial analysis for managers is to determine understand the financial implications arising out of day to day business and deciding a future course of action.

Answer 2

Financial statements analysis , specifically Ratio Analysis is performed by different parties inside the organisation for the different purpose. Each party i.e investors, creditors and managers are interested in determination of financial position of business organisation through analysing and investigating into the ratio analysis for different reasons which form their respective interests.

The primary goal of each party while evaluating the ratios are explained below:

1) Creditors :

Creditors are the people who borrow money to the business organisation for smooth flow of its operations. The creditors borrow money to business organisation for ensuring that their routine operations are carried without any discrepancy and they are able to purchase resources that are critical to their production.

There are to work types of creditors. Long term creditors and short term creditors. The long term creditors are this interested in the Solvency ratio of the business organisation so as to ensure that business in Long term will be able to return it's principal amount aling with the regular payment of interests. Long term creditors are thus interested in knowing the long term financial position of business through analysing and evaluating its Solvency ratio to investigate the capacity of business to replace its borrowed amount on time.

The short term creditors are interested in knowing about the liquidity position of the firm in order to ensure that the business organisation has the capacity to pay its amount on maturity date. Therefore they evaluate the liquidity ratio of the business for assuring that business is in a good liquidity position before advancing the funds.

 

2) Investors : Investors are the people who invest in the business organisation with the expectations of getting good returns on their investments. The investors are interested in knowing about the profits earned by the organisation to assess the capacity of business to provide acceptable returns in future. Investors are usually interested in evaluating the Profitability Ratios which reflects on the ability of business organisation to earn profits over a period of time. Investors are interested in profits rather than revenues because revenues do not translate into high dividends or interests, therefore they look to investigate through ratios, what profitability prospectus the business holds to get assured of getting profitable returns also.

 

3) Managers:.

Managers are the people who work for organisation inorder to ensures its well being and stability. They are primarily interested in assessing the efficiency and profitability of business organisation. Therefore inorder to investigate what benefits their decisions reap, they evaluate the turnover ratios of business organisation. These ratios include, the stock turnover ratio, debtor and creditor turnover ratios and Profitability ratios because these ratios are directly influenced and are a result of their decisions.