As per the LOS A, we are required to:
describe the roles of financial reporting and financial statement analysis.
The most important role of the financial statements is to provide the basis for the financial analysis. The financial statements act as the source of information, the meaningful one, which helps their users in the evaluation of the ‘as-is situation’ of the company and thus helps in taking various important economic decisions.
The examples of some of the important economic decisions that require the analysis of financial statements are:
a. Evaluating an equity investment for inclusion in a portfolio.
b. Evaluating a merger or acquisition candidate.
c. Evaluating a subsidiary or operating division of a parent company.
d. Deciding whether to make a venture capital or other private equity investment.
e. Determining the creditworthiness of a company in order to decide whether to extend a loan to the company and if so, what terms to offer.
f. Extending credit to a customer.
g. Examining compliance with debt covenants or other contractual arrangements.
h. Assigning a debt rating to a company or bond issue.
i. Valuing security for making an investment recommendation to others.
j. Forecasting future net income and cash flow.
The list above is only exemplary, as making an exhaustive list is quite difficult.