Information Needs of Different Users
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People from different sectors like shareholders, creditors, regulators and tax authorities need financial statement analysis as their needs are different. The purpose of their financial statement analysis is also different. Investors want to know the earning power of their investment, creditors want to know the credibility of the firm while the regulatory authorities and tax authorities want to know the profitability of the firm to make rules and to levy taxes respectively. All these users are broadly categorized into (i) users with a direct financial interest, and (ii) users with indirect financial interest.
Users with a Direct Financial Interest
The most important group that needs financial statement analysis is the one with a direct financial interest in the business. It needs financial analysis to measure and collect information about how a business has performed. The most important users with a direct financial interest are investors and creditors.
Information Needs of investors
Investors are the capital providers to the organization in return for the risks and rewards of the ownership. Equity investors are the major fund providers in any organization. Equity shareholders safeguard both preference shareholders and creditors. Equity shareholders are entitled to receive any rewards only after meeting the claims for debt interest and preference dividend. Thus equity investors are the major risk takers. When company prospers, they gain a lot more than preference shareholders and creditors and they are the main losers when the company collapses. Thus, the information needs of investors, particularly equity shareholders, is more comprehensive than other users of financial data.
Investors always need to know where their money is, as also the current status and value of their account. Thus, they want to know the information relating to operations, profitability, financial condition, and capital structure. For this, they require fundamental analysis information relating to firm, industry and economy. Financial statements play a key role in preparing fundamental analysis. Investors also want to know the information relating to their securities and their trading in the market. Technical analysis relating to examining trends in security prices, security trading volume is useful to the investors for getting information relating to securities.
Information Needs of Creditors
Creditors are the lenders of funds to the organizations. Funds may be lent in many forms and for different types of purposes. Trade creditors supply goods on credit and extend very short-term credit. The credit period ranges from 30 to 60 days. Usually they do not receive interest for extension of credit. But occasionally they allow credit on early payments. Organization may receive other short-term and long-term loans for different purposes and collect credit from various sources. Banks often provide short-term loans. Financial institutions provide long-terms loans or companies collect long-term funds in the form of convertible debts, public notes or bonds etc. from the public. Short-term creditors or long-term creditors always analyze the profitability of the organization for extending their term or relationship. The rate of interest they charge also depends on the profitability. If the enterprise is earning constant or increasing profits, then the creditors will still be limited to their fixed rate of interest. If the firm incurs losses, the creditors' principal may be placed in jeopardy. Thus, this uneven risk-reward ratio has a major effect from the creditors' point of view and the manner in which they analyze for the possibility of extension of credit.
Creditors always are concerned about the specific security provision of their loan such as the fair market value of assets pledged; repayment of principal and interest. They always look to the existence of resources and projections of future flows of funds and the reliability and stability of such flows. Thus, creditors are more conservative in their outlook and rely on financial statement analysis. The techniques of financial statement analysis creditors use is primarily concerned with the term, the security and the purpose of the loan.
In case of short-term loans, creditors are mainly concerned with the current financial position, the liquidity of the assets and the rate of turnover. In case of long-term loans, creditors require the valuation of bonds, projection of cash flows and fund flows, and the evaluation of the long-term earning power of the organization and the ability of the firm to meet the fixed charges on the long-term commitments. Profitability information is also required by the creditors because the interest payments and loan repayments depends on the profitability. Creditors generally look at the asset values to ensure the assumption of going concern.
MANAGERS AND EMPLOYEES
Managers and employees of the enterprise have vested interest in the continued and profitable operations of the firm. Most incentive plans and bonus plans for employees are based on the profitability of the enterprise.
When structuring agreements, planning mergers and acquisitions, between different other entities, most terms and agreements are based on the financial statements. Managers also utilize the financial statement information in many of their financing, investment or operating decisions. Structural Ratios such as debt-equity ratio, or interest coverage ratio are important in deciding how much long-term debt has to be raised. For the employees the profitability ratios are important in monitoring the viability of their pension plans, the incentive plans, etc.
CUSTOMERS
Customers' relationship with the firm extends over many years. These relationships take the form of legal obligation often associated with guarantees, warranties, deferred benefits, consumer services, consumer redressal, etc.
They have vested interest in monitoring the financial viability of firms with which they have long-term relationship. Especially when a takeover is expected, or when there is possible bankruptcy their interest increase over the firm's performance. Financial statements are one source of information that customers look for to make inferences about the viability of the firm. For example, in the case of a Banking company, especially with the signs of bankruptcy can be seen from the financial statements, customers withdrawal of their deposits etc.
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