NAME: Rajaramalingeshwaran M
REG NO: EA2452001012017
Subject: Financial Accounting
Week: Week 4
Type: LAQ
Question: Explain how Financial Statement Analysis contributes to informed decision-making by various
stakeholders. Provide examples to illustrate its significance.
Answer: Financial Statement Analysis is a vital tool for stakeholders to assess the financial health,
performance, and future potential of a company. It helps in making informed decisions by analyzing the core
components of financial statements: the income statement, balance sheet, and cash flow statement. Here’s
how it contributes to various stakeholders:
1. Investors
Purpose: Investors use financial statement analysis to assess a company's profitability, growth potential, and
risk before making investment decisions.
Example: A potential investor might analyze the company's net income growth over time and return on
equity (ROE) to determine if it's worth buying shares. If the ROE is consistently high, it signals efficient
use of capital and may attract investments.
2. Creditors and Lenders
Purpose: Creditors assess the company's ability to repay its debts. Financial ratios like the debt-to-equity
ratio and interest coverage ratio are crucial in evaluating credit risk.
Example: A bank might examine a company's current ratio to see if it has enough short-term assets to
cover its liabilities. A current ratio of less than 1 may indicate liquidity issues, leading to higher interest
rates or refusal of loans.
3. Management
Purpose: Management uses financial analysis to evaluate company performance, set future goals, and make
operational decisions. They often focus on profitability, efficiency, and cost management.
Example: Management could assess the company's gross profit margin to identify inefficiencies in
production or supply chain processes. If the margin is decreasing, they might decide to renegotiate
supplier contracts or implement cost-saving measures.
4. Employees
Purpose: Employees, particularly those in higher management, may use financial analysis to gauge the
company's stability and their job security. Profitability metrics may also inform decisions related to bonuses or
raises.
Example: Analyzing the company’s revenue growth and operating margin could give employees insight
into whether the business is expanding or if there might be potential layoffs in case of shrinking margins.
5. Regulators and Tax Authorities
Purpose: Regulators ensure compliance with financial reporting standards, and tax authorities use financial
statements to calculate taxes owed.
Example: A tax authority might scrutinize the income statement for tax compliance, while a regulator like
the SEC might ensure that companies follow appropriate accounting practices under GAAP or IFRS.
6. Suppliers
Purpose: Suppliers analyze financial statements to assess the creditworthiness of a company and its ability to
meet payment terms.
Example: A supplier could evaluate the company's cash flow statement to ensure it has sufficient
operating cash flow to pay for goods and services on time.
7. Shareholders
Purpose: Shareholders use financial analysis to understand the company’s dividend-paying capacity,
profitability trends, and overall financial health.
Example: Shareholders might look at the company’s earnings per share (EPS) and dividend payout
ratio to determine if they are receiving a good return on their investment or if reinvestment would be more
beneficial.
8. Customers
Purpose: For large clients, knowing that their supplier or partner is financially stable is important for long-term
relationships.
Example: A large corporation might analyze a supplier's liquidity and solvency ratios to ensure that they
won’t face supply chain disruptions due to financial instability.
