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Who Uses Financial Analysis and for What Purpose?
What is Meant by Financial Analysis?
Financial analysis is a method of finding the strengths and competencies of a firm by establishing relationships between the items on the balance sheet and the profit and loss account. It is very essential for firms to succeed by focusing on needful financial points and revitalizing their financial strength. Financial analysis can be done by any stakeholder of the company and they differ in terms of content which is used by the stakeholder according to his/her own needs.
Who Uses Financial Analysis?
Financial analysis can be used by different groups of people for a variety of reasons. The reasons may vary from judging the short-term profitability of the company to the long-term health of the firm.
The main users of the financial analysis are the following −
Trade Creditors
Trade creditors want the firm to which they offer loans to meet their needs within a very short span of time. Their idea is to generate profit in shorter durations, so they look into the liquidity position of the company.
In opposition to long-term debtors, trade creditors are only interested in the short-term financial position of the company because once they get their investment back, they have no role to play in the firm’s operations.
Long Term Debtors
In contrast to trade creditors who look for short-term liquidity, the long-term debtors are interested in the long-term solvency or survival of the firm. These debtors often invest for the long term, and their idea is to earn a respectable amount of profit from the firm’s operations.
Debtors analyze the firm’s profitability over time and the firm’s ability to pay back the interest and principal amounts. The debtors look into the capital structure analysis which consists of the relationship between various elements of funds.
Although long-term debtors look at the historical performances of the company, they are more interested in the Pro-forma statements to resolve the long-term profitability and solvency of the firm.
Investors
Investors invest their money in the shares of the company in order to get long-term premiums. Their focus areas are earnings and risks of the company. As they resolve to get more returns from the shares, they want the price of shares to go up in the capital markets. Therefore, investors are the users of financial analysis who look for increased profits whereas also considering the risks associated with the earnings made from the shares.
Management
Management of a firm is interested in all details of the company’s activities and so, they look for details in all financial aspects of the business. They look at and analyze various details of profit and loss accounts and the balance sheet to arrive at different financial matrices that help them see the current and future financial health of their company.
What is the Purpose of Financial Analysis?
Financial analysis is looked at for different reasons by different groups of individuals. Whereas investors and lenders look at it to understand the financial health of the company, the management looks at it to increase the efficiency of the firm in terms of the use of finances.
The broader purpose of financial analysis is to measure the profitability of the projects a firm is engaged with so that it can return the money it has borrowed.
Many individuals use financial analysis to gauge the risks associated with the projects a firm is engaged in. Although more risk always brings more profitability, financial analysts usually grade the shares of companies depending on various aspects. The idea is to offer a correct view of the future financials of the company although no one can claim that its analysis would be 100% correct.
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