7.2 The need for financial analysis Flashcards
Financial analysis seeks to draw useful relationships between which two financial statements?
1 Profit and loss account (income statement)
2 Balance sheet (statement of financial position)
In what way does the concept of stewardship rely on analysis of the financial statements?
The shareholders entrust the management to run the company (stewardship) and use financial analysis to monitor how well the company is performing.
What is the main purpose of financial analysis?
To assess the financial strength and weakness of a business by assessing its performance and efficiency.
What are the 5 key measures of a business’ financial strength?
1 Profitability
2 Trend of achievements
3 Growth potential of the business
4 Comparative position in relation to similar businesses
5 Overall financial strength and solvency
How can “profitability” be a measure of financial strength?
The main objective of businesses is to earn satisfactory returns - profitability measures whether adequate returns are being made on investments.
How can “trend of achievements” be a measure of financial strength?
Analysis can be done through comparison to previous years’ statements, and can also be used to forecast future performance.
How can “growth potential of the business” be a measure of financial strength?
Analysis predicts how much scope for growth the business has.
How can “comparative position to other similar business” be a measure of financial strength?
Analysis compares levels of sales, expenses etc with others in the market.
How can “overall financial strength and solvency” be a measure of financial strength?
Analysis allows users to determine whether funds for new equipment etc come from internal or external sources and whether an entity can meet its short and long term liabilities.
