Financial analysis is the valuation of business corporations, projects, budgets, and estimates from a financial perspective by analyzing the data from financial statements. It is referred to as the examination of business from different perspectives so as to completely acquire the knowledge of the financial situation and determine various ways to boost the crucial areas of the business. A financial analysis identifies the corporation from numerous perspectives from its profitability and stability to its solvency and liquidity. The three main sources of data for financial analysis are a company’s balance sheet, income statement, and cash flow statement.
What are the different types of Financial Analysis
- Horizontal analysis
The horizontal analysis involves the comparison of the financial results of a business for various reporting periods. The aim is to distinguish any increase or declines in the data that could be used in order to conduct a detailed evaluation of financial results.
- Vertical analysis
This is a comparative analysis of different expenses incurred by the business on the income statement. It is measured as a percentage of net sales. The same analysis can be used for the balance sheet.
- Short term analysis
This is a comparative analysis of the several expenses on the income statement that is calculated as a percentage of net sales.
- Multi-company comparison
This involves the calculation and contrast of the key financial ratios of two corporations which belongs to the same industry. The objective is to determine the comparative financial strengths and weaknesses of the two businesses, on the basis of their financial statements.
- Industry comparison
Industry comparison is the comparison between the results of a particular business and the consequences of the whole industry. The aim of industry comparison is to identify if there are any unusual results in comparison to the average method of doing business.
How to prepare Financial Analysis Report
There are many aspects that the individual has to take into consideration before drafting a financial report analysis. A financial report is a documents that must be prepared which will be further used for various purposes discussed earlier in this article. Financial Reporting is a document that mentions the financial results and related information to management and stakeholders.
Components of Financial Reporting
- The financial statements which includes Balance Sheet, Profit & loss account, Cash flow statement and Statement of changes in stock holder’s equity
- The notes to financial statements
- Quarterly & Annual reports
- Management Discussion and Analysis
Advantages of Financial Reporting
- Better understanding of risks and opportunities
- Highlights the connection between financial and non-financial performance
- Affects long term business strategies of the management, policies and business plans
- Helps in the simplification of business processes, leads to reduced costs and improves efficiency
- Benchmarking and evaluates sustainability performance with regards to laws, standards, codes, performance standards, and voluntary initiatives
- Better comparison of performance internally in the business and between organizations
Process of Financial Analysis
For a proper financial analysis, companies are required to follow certain steps that are a necessity.
The first step in the financial analysis process is to determine the objective of conducting the same. For example, whether the analysis is taking place for the granting of loans and advances or making an investment in the entity being audited for the financial analysis.
The financial data is analyzed based on the purpose of analysis. The data is analyzed and construed to suit the needs of the objective. Drawing a conclusion from interpreted data is the objective of the process.
The financial analysis should not only include the financial statements but inclusion of the notes given with reference to the statements and auditor’s report. The report certifies that the statements were audited by following standard accounting procedures. The notes brief about the accounting policies of the company and how they were taken into consideration while preparation of the statements.
Benefits of Financial analysis
The most significant benefit of financial evaluation of a business is that it attracts several investors that would want to invest in the business. It gives them a better understanding about the financial position of the firm.
Corporations cannot neglect the benefits of a regular financial examination of their businesses. Let us look into some of its other important benefits –
- It helps the business thrive and fulfill business goals
- It provides a better knowledge about the financial strengths, weakness
- Comparison becomes easier and businesses financial position of different years can be compared with the help of the analysis
- Liquidity as well as profitability of the business can be evaluated
- Business efficiency can be identified
- Helps the investors to make better investment decisions
Elements of Financial Analysis
Certain features that make up the financial analysis will be discussed in this section
Revenues are probably your business’s main source of cash. The quantity, quality and timing of revenues can determine long-term success.
Profit is the income remaining after total costs are deducted from total revenue. it is the positive gain as it indicates the basis on which tax is calculated and dividend is paid.
- Operational Efficiency
Operational efficiency measures how well you’re using the company’s resources. A lack of operational efficiency leads to smaller profits and weaker growth.
- Capital Solvency and Liquidity
Both liquidity and solvency allows businesses to continue operating. Assets are the things businesses own, and the liabilities are what businesses owe on those assets. This is important because every business has issues with cash flow.
- Capital Efficiency
Capital efficiency is the ratio between dollar expenses incurred by a company and dollars that are spent to make a product or service.
How to prepare an effective Financial Statement Analysis
- Identify the industry economic characteristics
- Identify company strategies
- Assess the quality of the firm’s financial statements
- Analyze current profitability and risk
- Prepare forecasted financial statements
Financial analysis is highly beneficial for the companies which are why they must be taken into consideration right from the start of the business. Considering various factors, companies must prepare an analysis report that shows how financially strong it is which would attract investors as well as shareholders.