9-193-029
REV: SEPTEMBER 13, 2004

WILLIAM BRUNS

Introduction to Financial Ratios and Financial
Statement Analysis
There is almost always a reason why someone picks up an organization’s financial statements and begins to analyze them. Lenders or creditors may be interested in determining whether they will be repaid money they have lent or may lend to the organization. Investors may be interested in comparing a potential investment in one organization with that of another. Employees may want to compare the current performance or financial status of their employer with earlier periods.
Regulatory agencies often need to assess organizational or industry financial health and performance.
Financial analysis is always based on a set of questions, and the specific questions requiring answers depend on who the financial statement user is and the reasons for his or her analysis.
Financial analyses based on accounting information consistently involve comparisons. Amounts or ratios may be compared with industry norms, the same measurement in a prior period, the same measurement in a competitor’s organization, or with planned and budgeted amounts previously established. Figuring out which comparisons will best answer the questions motivating the analysis is one of the necessary steps in making the best use of accounting information.
Financial ratios can help describe the financial condition of an organization, the efficiency of its activities, its comparable profitability, and the perception of investors as expressed by their behavior in financial markets. Ratios often permit an analyst or decision maker to piece together a story about where an organization has come from, its current condition, and its possible future. In most cases, the story is incomplete, and important questions may remain unanswered.
Even though the analyst or decision maker is