In today’s capitalist world, financial analysis is at the heart of every money-related decision. The reason for this is simple; no one wants to waste money on the wrong thing in the face of other potentialities. Furthermore, financial analysis can be internal or external.
Financial analysis’s scope is broad, comprising; data analysis, cost review, financial statements, interpreting financials, etc. But, summarily, financial analysis involves everything needed to make better business and money decisions. Therefore, let’s take a closer look at what financial analysis is.
WHAT IS FINANCIAL ANALYSIS?
Financial analysis involves the evaluation of businesses, budgets, projects, and other activities featuring financials, to determine feasibility, suitability, and performance. Upon adequate and accurate financial analysis, stakeholders can determine whether the venture promises stability, solvency, liquidity, or profitability needed to drive investment.
The financial analysis examines economic trends and develops long-term business strategies or sets up financial policies. The process of financial analysis calls for a synthesis of data and financial numbers.
Thanks to the incredible insight that comes with the process, financial analysis is done in corporate and investment finance environs. Also, business plans have section(s) dedicated to financial analysis, predicting expenses, and growth potentials.
TYPES OF FINANCIAL ANALYSIS
It’s no news that data and trend analysis is key to business decisions of the 21st century. Interestingly, financial analysis plays a similar role. The financial analysis required by institutions per time, however, comes in varying forms. Here are the types of financial analysis:
Horizontal Analysis
Horizontal financial analysis involves the examination of a financial result in comparison with another from consecutive reporting periods. The horizontal financial analysis aims to identify any decline or spike in the results.
Vertical Analysis
The vertical analysis involves a proportional analysis of expenses on a company’s income statement, which is subsequently measured against the net sales. You can also use vertical analysis for a balance sheet.
Short Term Analysis
Short-term analysis analyses running capital while also calculating turnover rates for inventory, account payable, and receivable.
Multi-Company Comparison
The multi-company comparison calculates and compares two organizations’ financial ratios. The companies, in this case, should be in the same industry.
Industry Comparison
Industry comparison is similar to multi-company comparison. However, the industry comparison process evaluates specific business’ results against the industry’s average.
Valuation Analysis
Valuation analysis leverages several methods to arrive at an array of potential valuations for specific businesses.
THE KEY COMPONENTS OF FINANCIAL ANALYSIS
For financial analysis to be up to standard, the financial statements must be accurate. The financial statements provide insights needed to understand a business’ financial standing. To have an accurate financial statement, the following components are critical:
Income Statement
The income statement functions primarily in depicting the net income or loss of a business. If expenses are more than revenue, that’s a net loss and vice versa.
The net income measure calculates operating profit margin, gross profit margin, and net profit margin. Therefore, a company’s income statement is not expected to change drastically year on year.
Balance Sheet
Evaluating the balance gives insight into how a company’s capital is used. The balance also helps you understand the reason behind a company’s move to borrow capital.
Ratios like the ‘return on assets percentage’ and ‘working capital ratio’ are calculated based on the balance sheet and income statement.
Cash Flow Statement
The cash flow statement can be used to measure a business’ solvency. The cash flow statement also gives insight into how a company’s liabilities will be liquidated. The cash flow ratio is calculated by the division of the operations ‘total cash flow’ by current liabilities.
CONCLUSION
Financial analysis is vital to a business’ decision-making. Hence, it’s pertinent to ensure due diligence on every component presented for the evaluation.
