Financial analysis is an important aspect of business activities that includes research of historical data in order to get information on the current and future financial outlook of a company. It determines a company’s financial health and stability.
Financial statement analysis provides needful information about a company’s performance and financial position. It also indicates changes in its financial position to users in order for them to make economic decisions.
It shows the financial position of a company based on its financial statements. The data contained in those statements are used to detect the respective company’s imbalances and instabilities.
The analysis based on financial statements gives the opportunity to understand a company’s operational performance.
Comparative Financial Analysis
Comparative financial analysis is used to compare the past financial data of companies in order to detect their weaknesses and strengths. In other words, comparative financial analysis is the process of analysis of financial data of different companies. It converts raw information from financial statements into useful financial information for planning and making decisions.
Purpose of Financial Analysis
Financial analysis is used to evaluate companies’ financial information. Financial analysis helps make investment decisions or recommendations to companies based on their financial statements.
Financial analysts learn how to read balance sheets and cash flow statements in order to reveal all such information. The objective is to research any problem areas that may exist, in order to prevent or solve them.
Importance of Financial Analysis
Financial analysis plays a significant role in any company’s activities.
A proper analysis gives a comprehensive understanding of how a company operates. It is needful not only for a company to increase profitability, but also for stockholders, governments and regulatory authorities to determine the legality of its accounting procedures. For instance, governments use financial analysis to evaluate the appropriate taxation for the respective company, while managers use it for correct investment, financing and operating decisions in order to prevent mistakes due to such decisions.
Financial analysis is an integral part of financial management, and is one of its most important components. Understanding financial data is essential for any business manager in order to make critical decisions. It is also an important part of the process of business plan development, which is the first step in the opening of any business.
Basic Accounting Financial Statements
The major financial accounting statements aim to determine the financial position and performance of a business. There are three basic financial statements, which are balance sheet, income statement and cash flow statement. When taken together, they provide an overall picture of the financial health of the respective business. Financial statements are based on information concerning past transactions. This can be useful for comparing past transactions because, as it provides necessary keys to future performance.
The balance sheet is also known as the statement of financial position. This means that the aim of a balance sheet is to show the accumulated wealth of a business at a particular point in time.
This statement presents the respective company’s assets, liabilities and shareholders’ equity.
Assets are resources held by businesses that ensure probable future benefits. Items that are often considered as assets in the balance sheet include property, plant and equipment, patents and trademarks, trade receivables, fixtures and fittings, and investments.
The balance sheet shows few useful information, but provides useful insights about the financing activities of a business.
The income statement is one of the three primary financial statements used to evaluate a company’s performance and financial position. The income statement is also named as the loss and profit statement.
The statement of balance sheet is not enough for the users of financial statements to have information at one moment in time. The income statement reports how much profit or loss a business has generated over a period. In other words, the purpose of the income statement is to show a company’s profitability over a certain period of time. The statement of income summarizes a company’s revenues and expenses.
Cash Flow Statement
The statement of cash flow is one of the main financial statements. This statement indicates the cash generated and used by a company during a reporting period. It helps users assess a company’s ability to generate cash.
The aim is to evaluate company’s financial position and performance using financial statements and ratio analysis.
Liquidity ratios are used to analyze a company’s ability to meet its short-term financial liabilities. Those ratios represent the cash levels of a company, and its ability to turn other assets into cash to pay liabilities and current obligations.
The liquidity ratios measure not only how much cash a company has, because the importance of liquidity means how easy that will be for the company to convert assets into cash. The main liquidity ratios that are widely used in financial analysis will be considered below.
The purpose of any business is to create wealth for its owners. Profitability ratios express a company’s overall efficiency and performance. They focus on the company’s return on investment in assets. To evaluate the profitability of a company, the main profitability ratios described below can be used.
Activity ratios are financial analysis tools used to measure how well a company manages various activities, and how effectively it uses its assets. The use of activity ratios is needed to indicate how efficiently the management of inventory is performed. This category of ratios shows a company’s ability to convert various assets into cash or sales. A company’s ability to convert its assets faster means that its business is run more efficiently.
Activity ratios are useful tools when comparing to other companies’ activity ratios, which allows knowing whether those ratios are better or worse.
Solvency ratios indicate a company’s ability to perform its long-term debt obligations.
The solvency ratios vary from industry to industry, and different norms have been developed for different.
Capital market ratios are used to a measure a company’s investors’ interest in funding the company’s activities, as they in fact show the level of profits a company is able to generate per share of its equity, and the amounts payable from such earnings to its shareholders in the form of dividends.