The financial statements companies issue provide information about the company’s performance and financial position. Their role is to provide useful information to stakeholders such as lenders, investors, and regulators. When making financial decisions internally, managers have access to far more information than is available on their financial reports, and thus may not need to rely on the reports.
For external stakeholders, financial statement analysis plays a major role in their economic decisions related to the company. Analysts examine the past and current performance of companies to form expectations about their future performance and to identify risks to this performance. They use this information for a variety of purposes, including:
- whether to invest in the company’s equity or debt securities
- evaluating merger or acquisition candidates
- evaluating a company’s subsidiaries
- evaluating compliance with debt covenants
- assigning ratings to the company’s securities
- forecasting future profitability and cash flow
- assigning a value to the security
The factors analysts consider include the company’s:
- Profitability, the ability to earn more by providing goods or services than it costs to provide them
- Cash flow, the difference between cash income and cash outlays
- Liquidity, the ability to meet short-term obligations
- Solvency, the ability to meet long-term obligations
- Financial position, or the resources owned by a company (its assets) relative to the claims against those resources (liabilities and owner’s equity)