Describe briefly the uses and limitations of financial statement analysis

Uses of financial statement analysis

From the financial statements, users want to comprehend key facts about the business's performance and disposition and thereafter make decisions about the business based on facts from the statements. 

For large organizations, the financial statements are complex and often include an extensive set of notes explaining financial policies and management analysis. Typically, the notes give an explanation to each and every item in the balance sheet cash flow and income statement in further detail. 

Financial statements are used in a number of ways: 

• Make decisions about the future of the business, whether to continue or stop it.
• Decide whether to lease some equipment in the goods production.
• Perform financial analysis, a key component in investment decision making in the case of prospective investors.
• Examine the financial strength of a person or company so as to arrive at a decision as to whether to lend to the company or person.
• The government uses the financial statements to ascertain the accuracy of taxes paid by the organization.
• Those who may want to extend credit to the business will use these statements to ascertain the credit worthiness of the company.
• Financial statements are used by employees of the business to make collective bargaining agreements.

Limitations of financial statement analysis

In spite of financial statement analysis being a highly useful tool, it also features some limitations, including comparability of financial data and the need to look beyond ratios. Although comparisons between two companies can provide valuable clues about a company’s financial health, alas, the differences between companies’ accounting methods make it, sometimes, difficult to compare the data of the two.

Besides, many a times, sufficient data are on hand in the form of foot notes to the financial statements so as to restate data to a comparable basis. Or else, the analyst should remember the lack of data comparability before reaching any clear-cut conclusion. However, even with this limitation, comparisons between the key ratios of two companies along with industry averages often propose avenues for further investigation.