Users Of Financial Reporting Information Essay

Financial Statement Analysis is a method of reviewing and analyzing a company’s accounting reports (financial statements) in order to gauge its past, present or projected future performance. This process of reviewing the financial statements allows for better economic decision making.

Globally, publicly listed companies are required by law to file their financial statements with the relevant authorities. For example, publicly listed firms in America are required to submit their financial statements to the Securities and Exchange Commission (SEC). Firms are also obligated to provide their financial statements in the annual report that they share with their stakeholders. As financial statements are prepared in order to meet requirements, the second step in the process is to analyze them effectively so that future profitability and cash flows can be forecasted.

Therefore, the main purpose of financial statement analysis is to utilize information about the past performance of the company in order to predict how it will fare in the future. Another important purpose of the analysis of financial statements is to identify potential problem areas and troubleshoot those.

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Here, we will look at 1) the users of financial statement analysis, 2) the methods of financial statement analysis, 3) key accounting reports (the balance sheet, income statement, and statement of cash flows) and how they are analyzed, 4) other financial statement information, and 5) problems with financial statement analysis.


There are different users of financial statement analysis. These can be classified into internal and external users. Internal users refer to the management of the company who analyzes financial statements in order to make decisions related to the operations of the company. On the other hand, external users do not necessarily belong to the company but still hold some sort of financial interest. These include owners, investors, creditors, government, employees, customers, and the general public. These users are elaborated on below:

1. Management

The managers of the company use their financial statement analysis to make intelligent decisions about their performance. For instance, they may gauge cost per distribution channel, or how much cash they have left, from their accounting reports and make decisions from these analysis results.

2. Owners

Small business owners need financial information from their operations to determine whether the business is profitable. It helps in making decisions like whether to continue operating the business, whether to improve business strategies or whether to give up on the business altogether.

3. Investors

People who have purchased stock or shares in a company need financial information to analyze the way the company is performing. They use financial statement analysis to determine what to do with their investments in the company. So depending on how the company is doing, they will either hold onto their stock, sell it or buy more.

4. Creditors

Creditors are interested in knowing if a company will be able to honor its payments as they become due. They use cash flow analysis of the company’s accounting records to measure the company’s liquidity, or its ability to make short-term payments.

5. Government

Governing and regulating bodies of the state look at financial statement analysis to determine how the economy is performing in general so they can plan their financial and industrial policies. Tax authorities also analyze a company’s statements to calculate the tax burden that the company has to pay.

6. Employees

Employees need to know if their employment is secure and if there is a possibility of a pay raise. They want to be abreast of their company’s profitability and stability. Employees may also be interested in knowing the company’s financial position to see whether there may be plans for expansion and hence, career prospects for them.

7. Customers

Customers need to know about the ability of the company to service its clients into the future. The need to know about the company’s stability of operations is heightened if the customer (i.e. a distributor or procurer of specialized products) is dependent wholly on the company for its supplies.

8. General Public

Anyone in the general public, like students, analysts and researchers, may be interested in using a company’s financial statement analysis. They may wish to evaluate the effects of the firm on the environment, or the economy or even the local community. For instance, if the company is running corporate social responsibility programs for improving the community, the public may want to be aware of the future operations of the company.


There are two main methods of analyzing financial statements: horizontal or trend analysis, and vertical analysis. These are explained below along with the advantages and disadvantages of each method.

Horizontal Analysis

Horizontal analysis is the comparison of financial information of a company with historical financial information of the same company over a number of reporting periods. It could also be based on the ratios derived from the financial information over the same time span. The main purpose is to see if the numbers are high or low in comparison to past records, which may be used to investigate any causes for concern. For example, certain expenditures that are high currently, but were well under budget in previous years may cause the management to investigate the cause for the rise in costs; it may be due to switching suppliers or using better quality raw material.

This method of analysis is simply grouping together all information, sorting them by time period: weeks, months or years. The numbers in each period can also be shown as a percentage of the numbers expressed in the baseline (earliest/starting) year. The amount given to the baseline year is usually 100%. This analysis is also called dynamic analysis or trend analysis.

Advantages and Disadvantages of Horizontal Analysis

When the analysis is conducted for all financial statements at the same time, the complete impact of operational activities can be seen on the company’s financial condition during the period under review. This is a clear advantage of using horizontal analysis as the company can review its performance in comparison to the previous periods and gauge how it’s doing based on past results.

A disadvantage of horizontal analysis is that the aggregated information expressed in the financial statements may have changed over time and therefore will cause variances to creep up when account balances are compared across periods.

Horizontal analysis can also be used to misrepresent results. It can be manipulated to show comparisons across periods which would make the results appear stellar for the company. For instance, if the profits for this month are only compared with those of last month, they may appear outstanding but that may not be the case if compared with the same month the previous year. Using consistent comparison periods can address this problem.

Vertical Analysis

Vertical analysis is conducted on financial statements for a single time period only. Each item in the statement is shown as a base figure of another item in the statement, for a given time period, usually for year. Typically, this analysis means that every item on an income and loss statement is expressed as a percentage of gross sales, while every item on a balance sheet is expressed as a percentage of total assets held by the firm.

Vertical analysis is also called static analysis because it is carried out for a single time period.

Advantages and Disadvantages of Vertical Analysis

Vertical analysis only requires financial statements for a single reporting period. It is useful for inter-firm or inter-departmental comparisons of performance as one can see relative proportions of account balances, no matter the size of the business or department.

Because basic vertical analysis is constricted by using a single time period, it has the disadvantage of losing out on comparison across different time periods to gauge performance. This can be addressed by using it in conjunction with timeline analysis, which shows what changes have occurred in the financial accounts over time, such as a comparative analysis over a three-year period. For instance, if the cost of sales comes out to be only 30 percent of sales each year in the past, but this year the percentage comes out to be 45 percent, it would be a cause for concern.


The main types of financial statements are the balance sheet, the income statement and the statement of cash flows. These accounting reports are analyzed in order to aid economic decision-making of a firm and also to predict profitability and cash flows.

I. The Balance Sheet

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The balance sheet shows the current financial position of the firm, at a given single point in time. It is also called the statement of financial position. The structure of the balance sheet is laid out such that on one side assets of the firm are listed, while on the other side liabilities and shareholders’ equity is shown. The two sides of the balance sheet must balance as follows:

Assets = Liabilities + Shareholders’ Equity

The main items on the balance sheet are explained below:

Current Assets

Current assets held by the firm refer to cash and cash equivalents. These cash equivalents are assets that can be easily converted into cash within one year. Current assets include marketable securities, inventory and accounts receivable.

Long-term Assets

Long-term assets are also called non-current assets and include fixed assets like plant, equipment and machinery, and property, etc.

A firm records depreciation of its fixed, long-term assets every year. It is not an actual expense of cash paid, but is only a reduction in the book value of the asset. The book value is calculated by subtracting the accumulated depreciation of prior years from the price of the assets.

Total Assets = Current Assets + Book Value of Long-Term Assets

Current Liabilities

Current liabilities of the firm are obligations that are due in less than one year. These include accounts payable, deferred expenses and also notes payable.

Long-term Liabilities

Long-term liabilities of the firm are financial payments or obligations due after one year. These include loans that the firm has to repay in more than a year, and also capital leases which the firm has to pay for in exchange for using a fixed asset.

Shareholders’ Equity

Shareholders’ equity is also known as the book value of equity or net worth of the firm. It is the difference between total assets owned by a firm and total liabilities outstanding. It is different from the market value of equity (stock market capitalization) which is calculated as follows: number of shares outstanding multiplied by the current share price.

Balance Sheet Analysis

The balance sheet is analyzed to obtain some key ratios that help explain the health of the firm at a given point in time. These metrics are as follows:

Debt-Equity Ratio = Total Debt / Total Equity

The debt-equity ratio is also called a leverage ratio. It is calculated to assess the leverage, or gearing, of a firm to show how much it relies on debt to finance its activities. This ratio has pertinent implications for the financial health of the firm and the risk and return of its shares.

Market-to-Book Ratio = Market Value of Equity / Book Value of Equity

The market-to-book ratio is used to reflect any changes in a firm’s characteristics. The variations in this ratio also show any value added by the management and its growth prospects.

Enterprise Value = Market Value of Equity + Debt – Cash

The enterprise value of a firm shows the underlying value of the business. It reflects the true value of the firm’s assets, not including any cash or cash equivalents, while unencumbered by the debt the firm carries.

II. The Income Statement

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The purpose of an income statement is to report the revenues and expenditures of a firm over a specific period of time. It was previously also called a profit and loss account. The general structure of the income statement with major components is as follows:

Sales revenue

– Cost of goods sold (COGS)

= Gross profit

– Selling, general and administrative costs (SG&A)

– Research and development (R&D)

= Earnings before interest, taxes, depreciation and amortization (EBITDA)

– Depreciation and amortization

= Earnings before interest and taxes (EBIT)

– Interest expense

= Earnings before taxes (EBT)

– Taxes

= Net income

The net income on the income statement, if positive, shows that the company has made a profit. If the net income is negative, it means the company incurred a loss.

Earnings per share can be derived from knowing the total number of shares outstanding of the company:

Earnings per Share = Net Income / Shares Outstanding

Income statement Analysis

Some useful metrics based on the information provided in the income statement and the balance sheet are as follows:

Profitability Ratios:

1. Net profit margin: This ratio calculates the amount of profit that the company has earned after taxes and all expenses have been deducted from net sales.

Net profit Margin =Net Income / Net Sales

2. Return on Equity: This ratio is used to calculate company profit as a percentage of total equity.

Return on Equity = Net Income / Book Value of Equity

Valuation Ratios:

Price to earnings ratios (P/E ratio)

The P/E ratio is used to evaluate whether the value of a stock is proportional to the level of earnings it can generate for its stockholders. It assesses whether the stock is overvalued or undervalued.

(P/E) Ratio = Market Capitalization / Net Income = Share Price / Earnings per Share

III. The Statement of Cash Flows

The statement of cash flows shows explicitly the sources of the firm’s cash and where the cash is utilized. It is essentially a statement whereby the net income is adjusted for non-cash expenses and any changes to the net working capital. It also reflects changes in cash coming from, or being used by, investing and financing activities of the firm. The structure and main components of the cash flow statement are as follows:

Cash from operating activities = Net income + Depreciation ± Changes in net working capital

Cash from financing activities = New debt + New shares – Dividends – Shares repurchased

Cash from investment activities = Capital expenditure – Proceeds from sales of long-term assets

All three of the above determine the bottom line: changes in cash flows.

Cash Flows Statement Analysis

In order to measure how much cash is available to the company for investments without outside financing or money diverting from operations, it is useful to conduct a simple cash flow statement analysis. The free cash flow, as the name suggests, allows a company to be able to pay dividends, repay its debts, buy back its stock and also make new investments to facilitate future growth. The excess cash produced by the company, free cash flow, is calculated as follows:

Net Income

+ Amortization/Depreciation

– Changes in Working Capital

– Capital Expenditures

= Free Cash Flow

Some analysts also study the cash flow from operating activities to see if the company is earning “quality” income. In order for the company to be doing extremely well, the cash from operating activities must be consistently greater than the net income earned by the company.


Apart from the key financial statements, complete financial reporting statements also include the following:

Business and Operating Review

The business and operating review is also called “management discussion and analysis”. It serves as a preface to all the complete reporting statements in which the management talks about recent events, discloses essential information regarding expansion and future plans, and discusses significant developments in the business industry.

The business and operating review is a good place for the company to share any good news with the general public. They have room to elaborate on plans that would help enhance the company’s image and address any unpleasant events that may have occurred, to show the customers that they truly care about talking openly to their customers.

Statement of Change in Shareholders’ Equity

The statement of change in shareholders’ equity is also known as equity analysis. It provides information about all the changes in the company’s equity value over a certain time period. It reconciles the opening balances of the equity accounts with the closing balances. There are two types of changes expressed in the statement of change in shareholders’ equity:

  1. Changes arising from any transactions conducted with shareholders of the company. For example, issuing new shares, paying dividends, purchasing treasury stock, and issuing bonus shares, etc.
  2. Changes that are a result of alterations in the comprehensive income of the company. These changes might include revaluation of fixed assets, net income for the period and fair value of for-sale investments, etc.

Notes to the Financial Statements

Notes to the financial statements are basically additional information provided in a company’s financial statements. These notes provide details and information that are left out of the main reporting documents. They are important for the sake of clarity on many points as they outline the accounting methodology used for recording certain transactions. The notes to the financial statements are essentially footnotes because if included in the main statements, they would obscure the important information, as they are generally quite elaborate and detailed.

The following notes are usually used to impart important disclosures for explaining the numbers on the financial statements:

  1. Notes that show the basis for presentation
  2. Notes that advise on significant accounting policies
  3. Notes about valuing inventory
  4. Notes about depreciating assets
  5. Notes about intangible assets
  6. Notes that disclose subsequent events
  7. Notes about employee benefits
  8. Notes that reveal contingency plans


Financial statement analysis is a brilliant tool to gauge the past performance of a company and predict future performance, but there are several issues that one should be aware of before using the financial statement analysis results blindly, as these issues can interfere with how the results are interpreted. Some of the issues are:

Comparability between Companies

This is a big issue for analysts because they can seemingly compare financial statement analyses between different companies on the basis of ratios used, but in reality it may not paint an accurate picture. The financial ratios of two different companies may be compared to see how they match up against each other, but each company may aggregate all their information different from each other in order to draw up their accounting statements. This may lead to incorrect conclusions drawn about a company in relation to other companies in the industry.

Comparability between Periods

The change in accounts where financial information is stored may skew the results of the financial statement analysis, from one period to the next. For example, if a company records an expense in one period as cost of goods sold, while in another period, it is recorded as a selling and distribution expense, the analysis between those two periods would not be comparable.

Operational Information

Analysts do not take into account operational information of a company, as only financial information is analyzed and reviewed. There may be several indicators in operational information of the company which may be predictors of future performance, for example, the number of backlogged orders, any changes in licenses or warranty claims submitted to the company or even changes in the culture and work environment. Therefore, analysis of financial information may only relay half the story.

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The Potential Users Of Financial Accounting Information Accounting Essay

The users are an of import constituent in accounting systems, and play a cardinal function in utility of fiscal accounting information. Financial accounting is a term normally applied to external coverage by supplying information about the fiscal place of a concern to a broad scope of users in doing economic determinations ( Weetman, 2011 ) . The intent of this paper is to reexamine the relationships between the possible users and existent users of fiscal accounting information and the relevance grounds to current pattern. A assortment of different statements have been put frontward about this issue.

The paper has been divided into five parts. It first gives a brief overview of who the possible users of fiscal accounting information are. Second, it deals with the existent users of the information. It so goes on to how utile of fiscal accounting information is and looks at how strong is the grounds that they use information in the ways predicted. Finally, the ground why the possible users may non be existent users of fiscal accounting information is carried out.

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The possible users of fiscal accounting information

Fiscal accounting purposes to let users to understand the economic activity of the company ( Stolowy, et al. , 2010 ) . For a limited liability company fiscal statements would incorporate balance sheet, net income and loss history, statement of recognized additions and losingss and hard currency flow statement ( Weetman, 2011 ) . Without users, fiscal accounting information will lost its function. Harmonizing to FASB ( 2010 ) , the aim of fiscal coverage is to supply utile fiscal information for bing and possible users to do economic determinations. There are several users who are interested in fiscal accounting information. Atrill and Mclaney ( 2008 ) stated that the intent of fiscal information to be used and the individual fiscal information to be given must be clear. By definition and different demands from each other, it could specify as internal users such as directors and external users which include proprietors, loaners, authorities, employees, rivals, clients, community, and providers ( IASC, 1989 ) . General purpose fiscal statements expected accounting information which would be of involvement to a broad scope of user groups ( FASB, 2010 ) , see appendix 1. Therefore, everyone could be the possible users of fiscal accounting information every bit long as there is a demand for the information.

Actual users of the fiscal accounting information

From the internal direction position, it has been argued that the chief users of accounting information about an organisation could be those who manage the company every twenty-four hours, such as directors ( Weetman, 2011 ) . A Statement of Basic Accounting Theory ( ASOBAT ) did non declare any peculiar user group such as investors to be primary users. Alternatively, it has been asserted that utile information was required for both internal and external intent. Classified users of accounting information into two wide groups: external users which include present and possible investors, creditors, employees, stock exchanges, governmental units and clients on contrast with internal direction. However, Harmonizing to FASB ( 2010 ) , the primary users of fiscal accounting information refer to bing and possible investors, loaners, and other creditors. They need entities describing information provided indirectly. As existent users are contained in the possible users, see appendix 2, if they have same involvements in the fiscal accounting information, the existent users might include directors, loaners, providers, clients, rivals, employees, authorities and community ( Britton and Waterston, 2006 ) . Similar decision has been argued by Atrill and McLaney ( 2008 ) , Perks ( 2007 ) and Weetman ( 2011 ) .

The utility of fiscal accounting information

Most of users treat the fiscal statements as the chief beginning of fiscal information. Harmonizing to IASB ( 1989 ) , it assumes that if fiscal statements run into the demands of investors, it will besides run into the demands of most other users ( Weetman, 2011 ) . The utility of accounting information is under premiss of its high qualitative features. There are four chief qualitative features which are described as relevancy, dependability, comparison and comprehensibility. However, merely if the information really makes a alteration in users ‘ determinations could specify it as relevancy Framework ( 1989 ) . Besides accounting information should be material and the benefits of supplying the information should outweigh the costs ( Atrill and Mclaney, 2008 ) .

The intent of fiscal statements is non meant to run into all the users ‘ demands ( FASB, 2010 ) . It is possible to fix the fiscal statements for general intent which will hold some involvements for all users. For case, as investors provide hazard capital to the company, the proviso of fiscal statements meets both investors and other users who are interested in gauging hazards ( Stolowy, et al. , 2010 ) . These fiscal studies are valuable for users who have no bargaining power and no important economic influence in organisations ( Elliott and Elliott, 2009 ) . It has been asserted that general purpose fiscal statements tend to concentrate on the primary users which included the proprietors, long-run loaners and creditors. The involvements of primary users might overlap with the involvements of other user groups. Therefore, this could fulfill most users ‘ demands for fiscal accounting information ( Weetman, 2011 ) . The fiscal statements, which dainty proprietors, loaners and creditors as primary users, could supply utile fiscal accounting information for the being of users.

usage information in the ways predicted

The fiscal accounting information could assist users to do determinations and cut down uncertainness over the fiscal place and public presentation of the concern. For illustration, to assist handiness of financess to pay proprietors a return, to refund loans, to honor employees ( Atrill and Mclaney, 2008 ) . It has been claimed that accounting information can non run into all of the demands of each of the assorted user groups ( FASB, 2010 ) . Atrill and Mclaney ( 2008 ) stated that Different groups of users have different value and demands. However, user groups desire to cognize more accounting information as possible. Conflict between user groups is likely happen during concern processing. For case, directors they have close engagement with the concern, they have entree to a broad scope of information and most might be confidential in company ( Weetman, 2011 ) . They know more internal information about the current and future state of affairs of the company than outside investors. This could be defined as information dissymmetry ( Scott, 2009 ) . Investor might do incorrect determination based on inaccurate information provided by directors, so they want to cognize more information besides the fiscal statements.

It is further contended that there are several user groups they want to run into specific demands straight from the concern, such as authoritiess, HM Revenue and Customs, and directors and managers. Lenders are normally given much more information than is included in published fiscal statements, including prognosis information, monthly dislocations and hard currency budgets ( Perks, 2007 ) . To hold everything to be included in a company ‘s fiscal statements is unrealistic ( Perks, 2007 ) . Fiscal accounting information is presented as the signifier of extremely summarized fiscal statements.

The chief job with the fiscal information demands of the user groups are that most want to cognize predict the hereafter. Stockholders, creditors, loaners and employees all want to cognize what the company ‘s future chances are. But most of information in fiscal statements has already happened ( Stice and Stice, 2006 ) . Many users concerned how valuable the past information was and the dependability of concern hereafter prognosis. Therefore, it is non possible for a company to print precisely the information that everyone wants. The information is designed on the behalf of focal point on stockholders and creditors ( Perks, 2007 )

There is no similar replacement for the information provided by the fiscal statements. Therefore, if users can non garner the needed information signifier the fiscal statements. It is frequently unavailable to them. Other beginnings of information refering the fiscal wellness of a concern are usually much less utile. As a consequence, the grounds is non strong plenty for the user groups to utilize information in the manner predicated and it is usually really hard to measure the impact of accounting on decision-making ( Atrill and Mclaney, 2008 )

possible users may non be existent users of fiscal information

As Young ( 2006 ) claimed some of the existent users were multiple, conflicting, inconsistent, and uneducated. These users are undependable and limited cognition about fiscal accounting information and its procedure. FASB ( 2010 ) have conducted a new construct of the fiscal statement user-a rational economic decision-maker. It means that the determinations of involvement are rational, if statements can be connected to the prognosis of future hard currency flows, it could be said rational determination shapers need it. Users can be seen more as conjectural readers of fiscal statements than as existent users, because they need peculiar types of information ( Young, 2006 ) . Furthermore, the conflicting demands of users and limited information provided in studies might do possible users can non happen information utile to them ( Atrill and McLaney, 2008 ) . Therefore, the possible users might non be the existent users of fiscal accounting information, a part of possible users could be.


In decision, the current paper has reviewed the users of fiscal accounting information. The inquiry posed at the beginning of this paper was to analyze the grounds why the possible users may non be existent users of fiscal accounting information and relevance grounds to pattern. It has been seen that different users have different demands, even fiscal statements concentrate on primary users to supply utile information. However, it could non accomplish the expected degree and can non run into all users ‘ demands. It may hence be concluded from the above treatment that the existent users are a part of possible users. Potential users might non be existent users of fiscal accounting information.

Appendix 1

The relationship between possible users and existent users:

Potential users

Actual users

Primary users

Appendix 2 Users and their information demands ( FASB,2010 )

Investors. The suppliers of hazard capital and their advisors are concerned with the hazard inherent in, and return provided by, their investings. They need information to assist them find whether they should purchase, keep or sell. Stockholders are besides interested in information which enables them to measure the ability of the entity to pay dividends.

Employees. Employees and their representative groups are interested in information about the stableness and profitableness of their employers.

They are besides interested in information which enables them to measure the ability of the entity to supply wage, retirement benefits and employment chances.

Lenders. Lenders are interested in information that enables them to find whether their loans, and the involvement attaching to them, will be paid when due.

Suppliers and other trade creditors. Suppliers and other creditors are interested in information that enables them to find whether sums owing to them will be paid when due. Trade creditors are likely to be interested in an entity over a shorter period than loaners unless they are dependent upon the continuance of the entity as a major client.

Customers. Customers have an involvement in information about the continuation of an entity, particularly when they have a long-run engagement with, or are dependent on, the entity.

Governments and their bureaus. Governments and their bureaus are interested in the allotment of resources and, hence, the activities of entities. They besides require information in order to modulate the activities of entities, determine revenue enhancement policies and as the footing for national income and similar statistics.

Public. Entities affect members of the populace in a assortment of ways.

For illustration, entities may do a significant part to the local economic system in many ways including the figure of people they employ and their backing of local providers. Fiscal statements may help the populace by supplying information about the tendencies and recent developments in the prosperity of the entity and the scope of its activities.

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