5 Uses of Financial Analysis

Financial analysis is the assessment of viability, stability and long-term profitability of a business or a project. The reports are prepared using ratios and other techniques obtained from financial statements and other significant reports.

Financial analysis indicates the financial health, performance and prospects of a business. With the help of historical data and projections, financial analysts prepare indicators that highlight essential financial apex.

Stated are 5 main uses of financial analysis-

  1. Analysis of current position- Financial analysis helps determine the current financial position of a company. A strong financial stance means better savings, investments and prospects for a business. It does not only reflect the potential of a business at present but also builds a strong ground for the future.
  2. Analysis of financial statements- Financial statement is mainly assessed to make good investment decisions. Businesses who want to invest in other businesses analyze financial statements to ascertain SWOT and make decisions accordingly.
  3. Analysis of prospects- By evaluating a company’s income statement, balance sheet, cash flow statement, etc., financial analysts assist businesses in planning their future. Market and economic trends often help in estimating the future potential.
  4. Ratio analysis- Ratio analysis is an indicator of performance for a business in comparison to other businesses. It is an industry-hold indicator. Companies arrive at a ratio by calculating liquidity ratio, debt ratio, turnover ratio, etc. It helps business owners to align their investment, expenditure and savings strategies.
  5. Making investment decisions- Financial consultants evaluate the investment plans and strategies of a business periodically and recommend options that may prove to be more viable in the long run. By appraising the strengths and weaknesses of a given prospect, analysts arrive at ratios that must be considered.

Most common ratio metrics for analysis-

  1. Balance sheet: This includes asset turnover, quick ratio, receivables turnover, days to sales, debt to assets, and equity debt.
  2. Income statement: This includes gross profit margin, operating profit margin, net profit margin, tax ratio efficiency, and interest coverage.
  3. Cash flow: This includes cash and earnings before interest, taxes, depreciation, and amortization (EBITDA). These metrics may be shown on a per-share basis.
  4. Comprehensive: This includes return on assets (ROA) and returns on equity (ROE), along with DuPont analysis.

Financial analysis should establish a proper basis for comparison to determine if a business’s performance is aligned with appropriate industry benchmarks. For instance, a 10% growth for a business may sound good but if market competitors are growing at a 25% rate, the owner must re-evaluate and make liquidity changes, to begin with.

With changing times and the introduction of technology, financial analysis is more technology-driven with minimal human intervention. Companies like Moneyfront offer robo-financial advisors who calculate and offer a complete company analysis at a reasonable fee structure which otherwise, was a costly affair.

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