Uses of Financial Analysis - Financial Management

A financial analysis assists in identifying the major strengths and weaknesses of a business enterprise. It indicates whether a firm has enough cash to meet obligations; a reasonable accounts receivable collection period; an efficient inventory management policy; sufficient plant, property, and equipment; and an adequate capital structure —all of which are necessary if a firm is to achieve the goal of maximizing shareholder wealth. Financial analysis can also be used to assess a firm’s viability as an ongoing enterprise and to determine whether a satisfactory return is being earned for the risks taken.

When performing a financial analysis, an analyst may discover specific problem areas in time for remedial action. For example, an analyst may find that a firm has unused borrowing power that could finance additional income-producing assets. The results of a financial analysis may indicate facts and trends that can aid the financial manager in planning and implementing a course of action consistent with the goal of maximizing shareholder wealth.

Financial analyses are also used by persons other than financial managers. For example, credit managers may examine basic financial ratios of a prospective customer when deciding whether to extend credit. Security analysts use financial analysis to help assess the investment worth of different securities. Bankers use the tools of financial analysis when deciding whether to grant loans. Financial ratios have been used successfully to forecast such financial events as impending bankruptcy. Unions refer to financial ratios when evaluating the bargaining positions of certain employers. Finally, students and other job hunters may perform financial analyses of potential employers to determine career opportunities.

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Financial Management Topics