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Financial analysis is the process of using a company’s financial data to assess its performance. Then, the financial data is used to make recommendations on improvements that can be made moving forward. Finally, an analyst uses spreadsheets to consider historical data to make projections of how the company will likely perform in the future. 

Financial analysis involves evaluating all finance-related transactions, including projects and budgets. By looking at these transactions, the analyst can determine the suitability and performance of the company’s finances. In most cases, financial analysis determines if a business entity is stable, liquid, solvent, or profitable enough to attract investors.

There are two types of financial analysis. One type of financial analysis is fundamental analysis. The second type is technical analysis. Fundamental analysis uses ratios derived from data found on the business’s financial statements. Technical analysis uses statical trends that are derived from activities like moving averages.

There are numerous financial analysis techniques used to summarize financial data, evaluate a company’s performance, and assess its financial position. These techniques include ratio analysis and common-size financial statements. There are several types of ratios used as techniques to analyze a company’s financial standing. The end result of financial analysis helps to provide input that helps forecast future earnings and cash flow of the business.

What is Financial Analysis?

Financial analysis is a process. It evaluates a business’s financial standing based on a variety of financial information. The process evaluates the business, its budgets, projects, and other financial transactions. The purpose of conducting financial analysis is to determine whether the business entity is stable, liquid, solvent, or simply profitable enough for investors to invest funds into. An analysis of a business’s finances can be done internally or externally. 

An internal financial analysis is useful for helping managers make future business decisions. They get a good picture of historical trends and past successes, which can influence the ongoing decision-making processes. An external analysis helps investors decide where their best investment opportunities exist.

Where is Financial Analysis Used?

A financial analysis has numerous uses and benefits for a business. A formal analysis is often used when a firm is considering investing in a business. Investment decisions are based on sound reasoning.  The analysts examine past and present financial statements. Investors will look for possible weak or problem areas and then discuss them with business owners. Another use for financial analysis is to help a business with future planning. Financial trends can help a business discover its own strengths and weaknesses. The trends help an analysis estimate how the company is likely to do in the coming years. 

What is the Process of Financial Analysis?

A financial analysis can be conducted in various settings. An internal analysis can be completed in a corporate setting or from an investment perspective. The financial analyst examines the company’s financial statements, including the balance sheet, cash flow statement, and income statement. In most instances, analyst calculates ratios derived from financial data in financial statements. The ratios are compared against ratios for other companies. They may also be compared against the historical performance of the company. One important area of corporate financial analysis extrapolates the best performance of the company, such as profit margin or net earnings, and estimates the future performance of the company. 

What are the Components of Financial Analysis?

There are many reports that can be used to gauge the performance of a business. But three components are the most important when it comes to conducting a financial analysis. The three components include the company’s income statement, its balance sheet, and its cash flow statements. These three components of a financial analysis together provide an accurate picture of how the business is performing. When used properly, these three components can help provide an accurate forecast of where the business is headed financially.

What are the Different Types of Financial Analysis?

A financial analysis examines the financial data of a business or company and then interprets it to determine its suitability. There are numerous types of financial analysis that may be used internally or externally. Internally, financial analysis helps improve the decision-making process and helps the company adjust its budgets accordingly. Externally, different types of financial analysis help determine if a company is a worthwhile investment. Investors get a glimpse at the past performance of a company, which helps them predict its future performance. The most common types of financial analysis include horizontal analysis, vertical analysis, growth rates, leverage analysis, profitability analysis, scenario, and sensitivity analysis, rates of return, variance analysis, liquidity analysis, and efficiency analysis.

1. Fundamental Analysis

Fundamental analysis uses a company’s financial data to create ratios. These comparisons help determine an accurate portrayal of the company’s business value. Ratio analysis, along with a deep review of financial and economic situations surrounding the business, helps an analyst deliver a number that can be used by an investor. Investors then compare the company’s data with current economic circumstances to determine if the security is over or under-valued. 

A fundamental analysis, for example, evaluates stocks to measure a company’s intrinsic value. The process involves studying everything from the state of the overall economy and industry conditions to the management and financial strength of an individual company. Fundamental analysts scrutinize everything from earnings to assets, expenses, and liabilities to make their determination. An investor, for example, may perform a fundamental analysis of a bond’s value. They will look at economic factors such as bond issuers, stock market trends, and interest rate movements.

2. Technical Analysis

Technical analysis is a whole different way to look at a company’s financial standing. A technical analyst looks for opportunities by examining statistical trends, like the stock market’s volume and price. The technical analysis does not try to assign an intrinsic value to the company like the fundamental analysis. Instead, a technical analyst uses stock charts to help them identify trends and patterns that suggest what the company’s stock is likely to do in the future. 

The technical analysis considers that market prices and sentiment are reflected in the fundamental information. An example of a technical analysis looks at specific patterns in the financial markets, including investor trading behaviors, to determine how they may repeat over time. A technical analyst helps account for these and other factors as well as predict future movements of prices. 

What are the Techniques of Financial Analysis?

Listed below are the techniques of financial analysis. 

  • Comparative Statements: A comparative statement looks at two or more periods to compare various items from the Balance Sheets and Profit and Loss Accounts. There are two comparative statements prepared for each of the documents. Generally, a comparative statement can be prepared from any financial statement, including a comparative statement of working capital, balance sheet, cost of production statement, profit and loss account, etc.
  • Common Size Statements: Common-size statements are prepared using a vertical presentation of a company’s financial information. This technique only considers the percentage and not the dollar value of the financial statements. Total liabilities or sales and total assets are considered 100%. The balance items are then compared to total liabilities and assets in terms of a percentage. A common size statement demonstrates the relationship between each component and the whole. Separate common-size statements are prepared for the profit and loss account and the balance sheet.
  • Average Analysis: An average analysis technique compares ratios to industry averages. Trends are represented on graphs to demonstrate the significance of their curves. This pictorial technique makes analysis and comparison more comprehensive.
  • Trend Analysis: A trend analysis creates ratios for different items in various periods. The ratios are then compared. Analyzing ratios over years provides a general idea of whether the business financials are trending up or down. This technique is also called the Pyramid Method.
  • Fund Flow Analysis: A fund flow analysis provides details of the sources and applications of business funds during a specific period. It will indicate where the funds came from and how they were distributed and used during the review period. It also highlights any changes in the company’s structure.
  • Statement of Working Capital Changes: The statement of changes in a company’s working capital reflects the extent of increases and decreases in working capital. Net working capital is calculated by subtracting the total current liabilities from the total current assets. It does not give any details or reasons for why working capital has changed.
  • Ratio Analysis: The ratio technique finds the relationship between the balance sheet or the profit and loss account and individual items or item groups. The ratio analysis is useful for the internal workings of a business but can also be useful to external parties as well. Ratio analysis will highlight capital gearing, profitability, solvency, and liquidity.
  • Cash Flow Analysis: The cash flow technique analyzes the movement of cash and the bank balances. For example, it looks at how cash moves instead of considering working capital. The two types of cash flows analyzed include notional cash flow and actual cash flow.
  • Cost-Volume-Profit Analysis: The cost-volume-profit analysis discloses the main relationship between cost, sales, and profit. The cost is represented by two categories fixed cost and variable cost. There is a continuing relationship between variable costs and sales. Cost analysis helps management with profit planning. 

Using a variety of financial analysis techniques and various means of analyzing data offers a business many benefits. Financial information found in a variety of business documents provides data for use in these different techniques. Ratios, graphs, and spreadsheets can be useful for demonstrating changes in a variety of ways for both internal and external use.

Who Performs Financial Analysis?

Financial analysis is performed by a financial analyst who studies the financial data of a company and then provides advice. An analyst helps guide business investments and financial strategies. Their duties include writing financial reports, predicting the return on investments, and collecting industry research to help inform decision-making. They gather data to help understand the trends that may affect a specific product type and look at specific geographical regions and industries to help clients make important financial investments.

The responsibilities of a financial analyst include analyzing financial data and using it to forecast, prepare reports, and make projections. They recommend portfolio investments and collections. An analyst evaluates financial data, both current and previous. A financial analyst studies both economic and business trends and examine financial statements to determine the value of a company. 

Why is Financial Analysis Essential for Investors?

Investors look at financial statements for the information they need pertaining to a company’s revenue, debt load, profitability, expenses, and how they meet both short and long-term obligations. They also benefit from obtaining a solid financial analysis of a company. An analysis of the company’s finances gives them a good look at how the company is performing in its sector. Then, investors can choose specific companies to invest in. This process gives them the assurance that the company will be profitable over the long haul, so they can protect their investment. 

How does Financial Analysis Benefit a Business?

The insight gained from examining financial statements can be invaluable. They can help a business improve its cash flow, value, and profitability. A ratio analysis taken from key financial statements can be compared to industry standards, past results, goals, and projections. Ratio analysis helps a business find profitability. Projections made from data taken from a financial analysis can earn higher profits because the company can better understand its profit margins, overhead, and other expenses. It can also help a business focus more on accounts receivable. Management may want to improve cash flow and create credit and collection policies to help collect from customers quicker on average. Financial analysis can also help a business manage inventory more effectively and efficiently.

How are Financial Statements Evaluated by Investors?

A company’s financial statements provide investors with a snapshot of the entity’s financial health. Investors can gain insight into the company’s performance, cash flow, operations, and overall financial condition. Shareholders and investors use financial statements so that they can make informed decisions about their investments. They are especially helpful when they are voting on corporate matters. Shareholders and investors use a variety of financial documents and statements to make equity evaluations. They will analyze the company’s stocks using different measures. Some metrics investors will look at will be liquidity ratios, efficiency ratios, price ratios, and profitability ratios.

What is Financial Statement Analysis?

The process of analyzing the financial statements of a company for the purpose of making decisions is financial statement analysis. External investors and stakeholders conduct and use a financial statement analysis to help them understand more about the overall financial health of a business. They also use it to evaluate the business value and the financial performance of the business. Internally, financial statement analysis is used to monitor and manage finances.

Is Business Financial Analysis Useful?

Yes. A business financial analysis is useful in many ways. It helps optimize workflows in order to strengthen the company’s performance. An analysis can help reduce debts, strengthen credit ratings, and improve cash flows. But they also help a business make strategically valuable decisions.