Financial statement analysis can clearly be defined as a process that help in understanding the profitability as well as risk of a company by taking into consideration the reported financial information. The paper discusses the importance of financial statement analysis and its uses. The limitation of financial statement analysis as well as the consequences of improper analysis of financial statement will finally be discussed.
Feroz, Kim & Raab (2014) argues that financial statement analysis is a very important process to both the company and the prospect investor who wish to invest. First, the financial statement analysis provides information to the investors wishing to invest in a company as well as to the shareholders who need the data analyzed so as to make decisions of whether to continue investing or to stop. Therefore, financial statement analysis is used by investors and shareholder to make decision on whether to invest in a company.
Secondly, financial statement analysis helps the company to acquire information that help the management to make decisions and formulate policies for future betterment of the firm. Therefore, the information from the financial statement analysis is used to evaluate the overall performance of the company as well as its effectiveness in its bid to achieve its future objectives. Thirdly, creditors who provide loans to the company uses the financial statement analysis to make decisions on whether to extend their loan to the firm. It also helps the creditor to make decisions on whether to demand higher or lower interest rates on their loans. In addition, financial statement analysis usually provides important data that helps creditor to achieve their purpose. Finally, financial statement analysis, it is used by regulatory authorities for instance the IASB to control the accounting functioning of the company. It is important because it ensures that the firm follows the required accounting standards and policies set the companies regulatory authorities.
According to Shctyne (2012) it’s clear that beside many importance and uses of financial statement analysis, it has limitations that can cause negative consequences to both the company as well as the shareholder. The financial statement is expected to provide accurate financial information which sometime may be inaccurate. The inaccuracy limitation usually has a consequence of misleading the users, hence leading them to making wrong decisions. Secondly, financial statements are usually prepared by making use of the past financial information, the data derived may be ineffective for the company’s corporate planning. The financial statement analysis is only concerned about the quantitative aspect of the company’s financial affairs. Therefore, this analysis fails to provide qualitative data, for instance information about the customer’s satisfaction as well as management’s skill. Such a limitation can cause improper decision making that can be dangerous to the future expectation of the shareholder and the company itself.
In conclusion, if financial statement analysis is carried out without adequate knowledge, it may lead to the wrong judgment about the company. Similarly, the attitude of the analyst may sometimes be biased, hence lead to poor conclusions and judgments. Therefore, analysis of financial statement of the company should be carried out properly so as to avoid possible future drawbacks to the company and shareholder caused by poor decision making. The paper has addressed on the importance, uses, limitations as well as the consequences of improper financial statement analyses.
- Feroz, E., Kim, S., & Raab, R. (2014). Financial Statement Analysis: A Data Envelopment Analysis Approach. The Journal of the Operational Research Society, 54(1), 48-58
- Shctyne, C. (2012). Financial Analysts Journal, 68(6), 106-107. Retrieved from http://www.jstor.org/stable/41714298