Question

What is a creditor's objective in performing an analysis of financial statements?

(a) To decide whether the borrower has the ability to repay interest and principal on borrowed funds.
(b) To determine if the firm would be a good place to obtain employment.
(c) To determine the company's taxes for the current year.
(d) To determine whether an investment is warranted by estimating a company's future earnings stream.

Answer 1

A creditor analyzes financial statements to assess whether a borrower can repay borrowed funds, considering factors like income, past borrowing, cosigners, and collateral. The evaluation helps estimate the risk of lending.

Step-by-step explanation:

The primary objective of a creditor when performing an analysis of financial statements is to decide whether the borrower has the ability to repay interest and principal on borrowed funds. This analysis is crucial as it helps the creditor assess the financial health of the prospective borrower, and determine the risk associated with lending. Factors such as income sources, past borrowing history, collateral, and the ability of the borrower to make a credible promise to pay interest are all considered.

In the financial capital market, a bank or creditor may look into the borrower's financial records or require a cosigner or collateral for securing a loan. Furthermore, understanding a firm's borrowing methods, such as through banks or bonds, also plays a role in this decision-making process.