Chapter 14, Problem 1Q

(a) Jose Ramirez believes that the analysis of financial statements is directed at two characteristics of a company: liquidity and profitability. Is Jose correct? Explain.

(b) Are short-term creditors, long-term creditors, and stockholders interested primarily in the same characteristics of a company? Explain.

To determine

Financial Analysis: Analysis of financial statements of the firm helps to frame policies and plans. The financial analysis determines the financial situation of the firm. It can be used for comparison.

To explain: Whether Mr. J correctly analyzes the financial statements based on liquidity and profitability.

Explanation of Solution

No, Mr. J is not correctly analyzed the financial statements based on liquidity and profitability because the financial statements must be analyzed based on liquidity, profitability, and solvency.

Liquidity refers to the ability to pay short-term liabilities. Profitability refers to the earning capacity of the firm. Solvency determines the ability to pay long-term liabilities of the firm.

Conclusion

So, Mr. J was incorrect in the analysis of the financial statements based on liquidity and profitability only.

To determine

Financial Analysis: Analysis of financial statements of the firm helps to frame policies and plans. The financial analysis determines the financial situation of the firm. It can be used for comparison.

To explain: The interest of short-term creditors, long-term creditors, and stockholders in the company.

Explanation of Solution

Short-term creditors: Short-term creditors are interested in liquidity ratio as they want to know whether their funds are safe or not.

Short-term creditors are the current liability of the company and must be paid within a short period of time. So, they are interested in the company’s short-run performance of the company.

Long-term creditors: Long-term creditors are interested in solvency ratio as they want to know whether their funds are safe or not in long run.

Long-term creditors are the non-current liability of the company and paid after a long period of time. So, they are interested in the company’s long-run performance of the company.

Stockholders: Stockholders are interested in all the three characteristics that are liquidity, profitability, and solvency to know the overall performance of the company.

Stockholders have significant influence over the company’s activities and operations; therefore, they are interested in the overall performance of the company.

Conclusion

No, the short-term creditors, the long-term creditors, and the stockholders do not have same primary interest in characteristics of the company.