Financial Accounting · Importance and purpose of analysis of financial statements

Purpose of Analysing Financial Statements for ACCA

Updated 11 October 2026 · Fact-checked

Analysing financial statements means turning reported figures into insight about performance, financial position and cash flows. Users such as investors, lenders, managers and employees do it to make decisions. To answer exam questions, name the user, state their need, then link it to the right measure.

Understand Purpose of Analysing Financial Statements

Financial statements report figures. On their own, a profit of $500,000 or receivables of $200,000 say little. You cannot tell whether they are good or bad. Analysis gives the figures meaning by comparing them and finding patterns.

Analysis looks at three areas. Performance asks how profitable the business is and whether profit is growing. Financial position asks what the business owns and owes, and how it is financed. Cash flows ask whether the business generates enough cash to pay its debts and fund its growth. Profit is not cash, so you need both views.

Different users want different answers. Investors want return and risk, and whether to buy, hold or sell. Lenders want to know whether interest and capital will be repaid. Suppliers want to know whether they will be paid on time. Employees want job security and pay prospects. Customers want the business to stay in operation. Managers want to judge their own results and plan. Governments and tax authorities want tax and statistics. The public may want to know about the entity's effect on the community.

Analysis works through comparison. You compare with prior years to see trends, with other businesses or industry averages, and with budgets or targets. Ratios are the main tool, but you can also use trend and percentage comparisons.

Analysis has limits. It uses historic figures. Accounting policies can differ between businesses. Year-end figures may not represent the whole year. Analysis shows what has happened and raises questions. It does not give the answers by itself.

Key formulas to remember

Three areas of analysis: Performance + Financial position + Cash flows; Say which area the user cares about before choosing any measure.
Bases of comparison: Prior years, other entities or industry averages, budgets or targets; A single figure means little unless compared with something.
Answer structure: User → Need → Measure → Conclusion; A reliable pattern for any 'why analyse' question.

How to solve Purpose of Analysing Financial Statements questions

Use this method for any question on why financial statements are analysed or who needs the analysis.

1Read the question and identify the user or users named, and the decision they face.
2State what that user needs to know: return, risk, repayment ability, security or control.
3Match the need to an area: performance, financial position or cash flows.
4Name the information or measure that helps, such as profit trend, liquidity or gearing.
5Say what comparison would make it meaningful: prior year, competitor or target.
6Add a brief limitation if the question asks for an evaluation.
7Check that your answer is tied to the user in the question and not generic.

Quickest way: User-need-measure shortcut

When to use it: Use it in objective test questions that ask which user needs which information, or why analysis is carried out.

Underline the user in the question.
Ask whether the user is looking forward (investing, lending) or protecting an existing interest.
Choose the option that matches that user's decision, not the most general one.
Reject options that suit a different user, such as tax authority needs for a lender question.
For multiple response, select exactly the stated number and check each against the user.

Common mistakes in Purpose of Analysing Financial Statements

Listing users without explaining what they need.
Students memorise lists of users and stop there.
Fix: Always add one phrase on the decision each user makes, such as lenders deciding whether to lend.
Treating profit as the only thing analysed.
Profit is the most familiar figure.
Fix: Cover performance, financial position and cash flows. A profitable business can still run out of cash.
Giving a figure without comparison.
Students calculate a result and treat it as the conclusion.
Fix: State what you compare it with: last year, a competitor or a target.
Assuming all users need the same information.
Students think of one 'typical reader'.
Fix: Tailor your answer. Investors focus on return and risk, lenders on repayment, employees on security.
Presenting analysis as proof of what will happen.
Numbers look precise and certain.
Fix: Remember that statements are historic. Analysis points to questions and likely trends only.

Worked examples

Example 1

A bank is considering a loan to a company. Explain why the bank would analyse the company's financial statements and what it would look for.

Show the solution

User: the bank, a lender deciding whether to lend.
Need: confidence that interest and capital will be repaid on time.
Areas: financial position (existing debt and assets) and cash flows (cash generated to pay interest).
Measures: gearing, interest cover, liquidity and operating cash flow.
Comparison: trend over several years and against similar companies.
Limitation: figures are historic and do not guarantee future repayment.

Answer: The bank analyses the statements to judge repayment ability. It looks at existing borrowing, cash generation, liquidity and profit available to cover interest, compared over time and with similar businesses.

Example 2

Which ONE of the following is the main reason an employee would analyse the financial statements of their employer? A) To decide whether to buy more shares B) To assess the security of their job and pay prospects C) To calculate the tax payable by the entity D) To decide whether to extend credit terms

Show the solution

User: an employee.
Main need: continued employment, pay and benefits, so stability and profitability.
A suits an investor.
C suits a tax authority or the entity itself.
D suits a supplier.
B matches the employee's need.

Answer: B

Exam tips

Always name the user from the question and write about that user, not users in general.
In objective tests, match each option to a user. Wrong options usually describe a different user's need.
In written style answers, use the pattern user, need, measure, comparison. It earns marks quickly.
Mention cash flows as well as profit. Examiners often test the difference.
Do not overclaim. Say analysis supports decisions, it does not make them.

Practice questions from Importance and purpose of analysis of financial statements

Purpose of Analysing Financial Statements in other exams

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

Purpose of Analysing Financial Statements: frequently asked questions

Why do we analyse financial statements?

Figures alone have little meaning. Analysis compares them over time, with other entities and with targets. This helps users judge performance, financial position and cash flows and make decisions.

Who uses the analysis of financial statements?

Investors, lenders, suppliers, employees, customers, managers, governments and the public. Each has a different decision to make. Investors look at return and risk, while lenders look at repayment ability.

How do I explain the importance of financial statement analysis in the exam?

Name the user, state their decision, say which area (performance, position or cash flows) matters, and add a comparison. Keep it linked to the scenario given.

Is profit enough to judge a business?

No. A business can report profit and still lack cash to pay its debts. You need to look at the financial position and cash flows as well.