Question

What external entities use financial ratios and why do they use them?

Answer 1

Financial ratios are calculated and used to measure the performance of the company. The external users which use financial ratios are bankers, investors, suppliers, customers and tax authorities. Each of the users use the financial ratios for their own benefit. Bankers use the financial ratios to understand whether the company would be able to make payment of its loan that is whether the company is solvent and liquid.

The investors would use the financial ratios so as to verify whether the company is able to use its fund efficiently and provide higher returns on its investment.

Suppliers may use the financial ratios so as to understand the liquidity of the company and whether the company has defaulted in making payment to suppliers and in general how many days it takes the company to make payment to suppliers.

Tax authorities may want to monitor the performance of the company and also understand the business activity and whether company is showing all its revenue and therefore it may use the financial ratios.

The financial ratios helps the users to compare the company with that of the peer company so that it helps in better analyzing the company.