Business Studies – 5.5.3 Users of accounts | e-Consult
5.5.3 Users of accounts (1 questions)
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A bank assessing the risk of lending to a manufacturing company would scrutinize several key pieces of information from its financial statements. Here are four examples:
- Profitability (Net Profit): The bank would examine the company's net profit over the past few years. A consistent and healthy net profit indicates the company is generating sufficient revenue to cover its costs and repay the loan. Fluctuating or negative profits would raise concerns about the company's ability to repay.
- Liquidity (Current Ratio): The bank would calculate the current ratio (current assets / current liabilities). A current ratio greater than 1 suggests the company has enough liquid assets to cover its short-term debts. A low current ratio indicates potential difficulties in meeting immediate obligations, increasing the risk of default.
- Solvency (Debt-to-Equity Ratio): The bank would calculate the debt-to-equity ratio (total debt / total equity). A high debt-to-equity ratio indicates the company relies heavily on borrowed funds, making it more vulnerable to economic downturns and interest rate changes. A lower ratio suggests a more financially stable company.
- Cash Flow from Operations: The bank would analyze the cash flow from operations section of the statement of financial position. Positive and consistent cash flow from operations demonstrates the company's ability to generate cash from its core business activities. This is a crucial indicator of its ability to repay the loan, as it shows the company has sufficient cash to meet its financial obligations.