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