Objectives of Financial analysis

Analysis of financial statements is made to assess the financial position and profitability of a concern. Analysis can be made through accounting ratios, fitting trend line, common size statements, etc. Objectives of Financial analysis - What is Financial Analysis? Meaning, Objectives, and Types. Accounting ratios calculated for a number of years show the trend of the change of position, i.e., whether the trend is upward or downward or static.

The ascertainment of the trend helps us in making estimates for the future. Keeping in view the importance of accounting ratios the accountant should calculate the ratios in the appropriate form, as early as possible, for presentation to management for managerial control.

The main objectives of the analysis of financial statements are :

• to assess the profitability of the concern;
• to examine the operational efficiency of the concern as a whole and of its various parts or departments;
• to measure the short-term and long-term solvency of the concern for the benefit of the debenture holders and trade creditors;
• to undertake a comparative study in regard to one firm with another firm or one department with another department; and
• to assess the financial stability of a business concern.

The different users and decision makers to achieve the following objectives:

Assessment of Past Performance and Current Position:

Past performance is often a good indicator of future performance. Therefore, an investor or creditor is interested in the trend of past sales, expenses, net income, cash flow and return on investment. These trends offer a means for judging management’s past performance and are possible indicators of future performance. Similarly, the analysis of the current position indicates where the business stands today.
For instance, the current position analysis will show the types of assets owned by a business enterprise and the different li­abilities due to the enterprise. It will tell what the cash position is, how much debt the company has in relation to equity and how reasonable the inventories and receivables are.

Prediction of Net Income and Growth Prospects:

The financial statement analysis helps in predicting the earning prospects and growth rates in the earnings which are used by investors while comparing investment alternatives and other users interested in judging the earning potential of business enterprises. Investors also consider the risk or uncertainty associated with the expected return. The decision makers are futuristic and are always concerned with the future. Financial state­ments which contain information on past performances are analyzed and interpreted as a basis for forecasting future rates of return and for assessing risk.

Prediction of Bankruptcy and Failure:

Financial statement analysis is a significant tool in predicting the bankruptcy and failure probability of business enterprises. After being aware of the probable failure, both managers and investors can take preventive measures to avoid/minimize losses. Corporate management can effect changes in operating policy, reorganize financial structure or even go for voluntary liquidation to shorten the length of time losses. In the accounting and finance area, empirical studies conducted have suggested a set of financial ratios which can give the early signal of corporate failure.

Such a prediction model based on financial state­ment analysis is useful to managers, investors, and creditors. Managers may use the ratios prediction model to assess the solvency position of their firms and thus can take appropriate corrective actions. Investors and shareholder can use the model to make the optimum portfolio selection and to bring changes in the investment strategy in accordance with their investment goals. Similarly, creditors can apply the prediction model while evaluating the creditworthiness of business enterprises.

Loan Decision by Financial Institutions and Banks:

Financial statement analysis is used by financial institutions, loaning agencies, banks and others to make the sound loan or credit decision. In this way, they can make the proper allocation of credit among the different borrowers. Financial state­ment analysis helps in determining credit risk, deciding terms and conditions of the loan if sanctioned, interest rate, maturity date etc.