All publicly traded companies and large private entities prepare financial statements periodically. The purpose of creating financial statements is to capture a company’s financial position for a given period. This allows users of financial information to analyze and compare the health of one company to another. Financial statements provide assessment of a company’s profitability, liquidity and operational efficiency. As a result, there are a number of reasons why managers analyze financial statements.
The greater the number of transactions a company makes, the harder it is for the company to gauge its performance at any given moment. Financial statement preparation forces a company to close the books and record the company’s actual financial position on a regular basis. Thus financial statements can be as valuable internally as they are externally. Managers use these booked figures to monitor measurements like debt leverage, costs, sales, assets and liabilities. Financial statements help managers assess achievement of financial goals.
Strategy and Benchmarking
Managers analyze competitors' financial statements and compare them to internal finances. This is useful in developing tactical options and strategies. Benchmarking financial performance relative to the market competition allows leaders to identify areas of competence or weakness. It also aids in investment, financing and operational decision-making.
Companies engaged in mergers and acquisitions analyze financial statements to help determine a prospective investment’s value. For example, book value is calculated using information in financial statements. Also useful in valuation are historical cash flows and profit, which can then be used to estimate for future years. Companies also invest in stock to earn interest on unused cash. Financial statements can be used to help identify undervalued companies.
Credit Risk Management
Lenders providing loan or trade credit will perform due diligence on the creditworthiness of their customers. This usually entails a review and analysis of financial statements. Banks and financial institutions evaluate financial statements to approve loans. These loans may include ratio covenants based on annual statements as a condition to the loan agreement. Large companies have credit departments that utilize financial statement analysis to manage the risk associated with unsecured lending.