Question

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

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

Answer 1

A creditor's objective in analyzing financial statements is to assess if the borrower can repay debts. They look at the company's financial stability and consider how the firm raises and intends to pay back its financial capital. So the correct answer is option 2.

Step-by-step explanation:

A creditor's main objective in performing an analysis of financial statements is to decide whether the borrower has the ability to repay interest and principal on borrowed funds. Creditors analyze financial statements to assess the financial stability and creditworthiness of a business.

When a firm consistently earns significant revenues or profits, it can credibly promise to pay the interest on debts and is thus more likely to secure borrowing through banks or the issuance of bonds. Firms need to raise financial capital to fund their long-term investment projects and have several methods to do so, such as attracting early-stage investors, reinvesting profits, borrowing through banks or bonds, and selling stock.

This decision also influences how firms will pay for the capital acquired. A creditor uses the financial statements to see past the imperfect information and make an informed lending decision while considering potential risks involved.