Question

1. Explain with examples how these three users (investor, manager and creditor) analyze financial statements and how they use it. If you were one of the three users, what statement(s) entry or entries, and ratios would you observe more critically and what would you be looking for in your analysis?

Answer 1

Answer: Financial statements- These are the reflection of a company's financial and liquidity position. These include:

• Income statement
• Balance sheet
• Cash flow statement

Users of Financial statements- Are as following:

Investors- These are the people who invest their hard earned money in the company, they buy shares of the company. They are also called Shareholder. They use financial statements for investing decision.

Managers- They are internal people of the company who want financial statement for forecasting and decision making.

Creditors- They are the people who give loan to company, they can be banks or bondholders. They analyse company's financial statement to know the financial health and the current obligations.

I were a Creditor who is supposed to lend loan to company, I would see the following ratios:

Debt-equity ratio- It is the relationship between total liabilities and total shareholder's equity in the company, Lower the ratio is good. Ideal ratio is below .50.

Debt to Total assets ratio- This is the relationship between total liabilities and total assets of the company, it analyzes that total assets are enough to pay debt of the company.

Interest coverage ratio- This is calculated by dividing Earning before interest and Tax (EBIT) by interest expense. This ratio tells whether company is able to pay its interest expense on loan or not.