Financial Accounting · Analysis of financial statements

Purpose and Users of Financial Statement Analysis

Updated 11 October 2026 · Fact-checked

Financial statement analysis turns raw figures into information for decisions. You compare ratios and trends across years, against other entities or against benchmarks. Users such as investors, lenders and managers each ask different questions. Ratios have limits: historical data, differing accounting policies, and no explanation of why figures changed.

Understand Purpose and Users of Financial Statement Analysis

Financial statements list figures. On their own, a profit of $500,000 tells you little. Is that good? It depends on sales, capital invested and last year's profit. Analysis gives figures context so a reader can judge performance, position and risk.

The usual tool is ratio analysis. A ratio links two figures, for example profit to sales. Ratios let you compare entities of different sizes, or the same entity over time. Analysis can also use trend analysis (changes across years) and common-size statements (each item as a percentage of a base figure).

Different users want different answers. Investors want return and risk, and the ability to pay dividends. Lenders want to know that interest and capital will be repaid, so they look at liquidity and gearing. Suppliers want to be paid on time. Employees care about job security and pay. Customers care about continuity of supply. Governments and tax authorities care about profit and tax. Management uses analysis to monitor performance, though it can get more detailed internal information.

Ratios have limits. Statements show historical data, so they may not predict the future. Entities may use different accounting policies (for example depreciation methods or inventory valuation), which makes comparison unreliable. Year-end figures may be unrepresentative, for example because of seasonal trade or window dressing. Inflation distorts comparisons across years. Ratios ignore non-financial matters such as staff quality or market conditions. They also show what changed, not why. Entities of different sizes or industries may not be comparable.

Key formulas to remember

Ratio: Ratio = Figure A ÷ Figure B (or expressed as a percentage); A ratio is only useful when compared with something: prior years, competitors, industry averages or targets.
Percentage change (trend): Change % = (Current year − Prior year) ÷ Prior year × 100; Use the prior year as the base. Do not divide by the current year.
Common-size percentage: Item % = Item ÷ Base figure × 100; Base is usually revenue for the statement of profit or loss and total assets for the statement of financial position.
Three comparison bases: Over time | Against other entities or industry | Against budget or target; Name the basis you use when you comment.

How to solve Purpose and Users of Financial Statement Analysis questions

Use this method for any question on the purpose, users or limitations of analysis.

1Read the scenario and identify who the user is (investor, lender, supplier, employee, manager) and what decision they face.
2Link the user to the information need: return and risk, repayment ability, payment ability, job security or performance control.
3Choose the analysis that fits that need, for example gearing and interest cover for a lender, or profitability for an investor.
4State the basis of comparison: prior years, similar entities or a target.
5For a limitations question, match each limitation to a clue in the scenario (different policies, old data, year-end timing, inflation).
6Check the question wording: 'purpose', 'user' and 'limitation' need different answers. Select exactly the number of options asked.
7Answer with the specific reason, not a vague phrase like 'ratios are not accurate'.

Quickest way: User, need, tool, limit

When to use it: Use for multiple choice and multiple response questions where you have about two minutes.

Underline the user named in the question.
Recall their one main question: lender = 'can I be repaid?', investor = 'what return and risk?', supplier = 'will I be paid?'.
Eliminate options that suit a different user.
For limitation questions, pick options about history, policies, timing or comparability; reject claims that ratios are 'always' reliable or 'predict' the future.
Re-read the number of answers required before you submit.

Common mistakes in Purpose and Users of Financial Statement Analysis

Saying ratios predict future performance.
Students treat trends as forecasts.
Fix: Remember statements are historical. Ratios may help judge the future but do not guarantee it.
Giving every user the same needs.
Students memorise a list of users without linking needs.
Fix: Tie each user to a decision: lenders to repayment, investors to return, suppliers to payment.
Comparing two entities without checking policies.
Ratios look precise, so differences seem real.
Fix: Check for different depreciation, inventory or revaluation policies before concluding one is better.
Ignoring the year-end timing effect.
Students forget the statement of financial position is a snapshot.
Fix: Note that seasonal trade or window dressing can make year-end balances unrepresentative.
Treating management as an external user with only published statements.
Students overlook that managers can access internal data.
Fix: Say management can obtain detailed internal reports and so uses analysis to supplement them.
Listing a limitation without explaining its effect.
Students rush and write one-word answers.
Fix: Add the consequence, for example: 'different depreciation methods make profit margins not comparable'.

Worked examples

Example 1

A bank is considering a loan to Kestrel Co. Which TWO items of analysis are most relevant to the bank? A. Gearing ratio B. Dividend growth for shareholders C. Interest cover D. Staff turnover rate

Show the solution

The user is a lender. Its main question is whether interest and capital will be repaid.
Gearing shows how heavily the entity relies on debt, which indicates risk to the lender.
Interest cover shows how easily profit covers finance costs.
Dividend growth is mainly an investor interest, and staff turnover is not a financial statement ratio.

Answer: A and C

Example 2

Alpha Co has a gross margin of 40% and Beta Co has 30%. Alpha depreciates equipment over 10 years and Beta over 4 years. Both operate in the same industry. Explain why concluding Alpha is more profitable may be unreliable.

Show the solution

Identify the limitation: the entities use different accounting policies.
Depreciation is usually charged in cost of sales or expenses depending on entity classification, so a longer life gives a lower annual charge.
Where depreciation is included in cost of sales, a longer useful life raises gross margin, so part of the 10-point gap may come from the policy, not real efficiency.
Therefore adjust to a common basis or compare with caution, and consider other measures.

Answer: The margins may not be comparable because Alpha's longer depreciation life lowers its costs and raises profit, so the gap may partly reflect policy rather than better performance.

Exam tips

Objective questions often name a user. Decide the user's decision first, then pick the answer.
For multiple response items, select exactly the number stated, and avoid options using absolute words like 'always' or 'guarantees'.
In limitation questions, tie the limitation to the clue given in the scenario.
Percentage change calculations use the prior year as the base. Check this before entering a number.
When asked for the purpose of ratio analysis, think 'comparison to support decisions', not just 'calculating ratios'.

Practice questions from Analysis of financial statements

Purpose and Users of Financial Statement Analysis in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Purpose and Users of Financial Statement Analysis: frequently asked questions

What is the purpose of ratio analysis?

It turns financial statement figures into comparable measures of profitability, liquidity, efficiency and risk. Users compare them over time, with other entities or with targets. This supports decisions such as investing, lending or controlling the business.

What are the main limitations of ratio analysis?

Data is historical and may not reflect the future. Different accounting policies reduce comparability, and year-end figures can be unrepresentative. Inflation and non-financial factors are ignored, and ratios show what changed but not why.

Who uses financial statements?

Investors, lenders, suppliers, employees, customers, governments and management all use them. Each group has a different need, such as return, repayment, payment, job security or tax. Link each user to their decision in exam answers.

How do I approach interpretation questions in the exam?

Identify the user and decision, choose relevant ratios, and compare with a basis such as prior year or industry. Then explain the cause and effect, and mention limits where relevant. In objective tests, eliminate options that suit another user.