What is financial analysis?
Financial analysis is an evaluation process to determine the results and adequacy of enterprises, projects, budgets and other financial transactions. Typically, financial analysis is used to analyze whether an enterprise is stable, solvent, liquid, or profitable enough to provide investment.
Key points in financial analysis.
When done internally, financial analysis can help managers make future business decisions or review historical trends for past successes.
If conducted externally, financial analysis can help investors choose the best investment opportunities.
There are two main types of financial analysis:
- Fundamental analysis.
- Technical analysis.
Fundamental analysis uses ratios and financial statement data to determine the intrinsic value of a ratio. Technical analysis assumes that the value of a value is already determined by price and focuses on value trends over time.
Financial analysis
Financial analysis is used to assess economic trends, set financial policies, make long-term business plans, and identify projects or companies for investment. This is done through the synthesis of financial numbers and data. A financial analyst will thoroughly examine a company's financial statements - profit and loss statements, cash flow statement. Financial analysis can be performed in both corporate finance and investment finance.
One of the most common ways to analyze financial information is to calculate ratios from the data in the financial statements to give a comparison of the historical performance of other companies or firms.
For example, return on assets (ROA) is a measure of how efficiently a company uses its assets and is defined as a measure of profitability. This ratio can be calculated for several companies in the same industry and can be compared with each other as part of a larger analysis.
How financial analysis is used
Corporate Financial Analysis
In corporate finance, the analysis is conducted by the accounting department and shared with management to improve business decision-making. This type of internal analysis can include ratios such as net present value (NPV) and internal revenue ratio (IRR) to find projects that are worth performing. Many companies provide loans to customers. As a result, cash received from the sale may be deferred for a period of time. For companies with large receivables, it is useful to track the Date of Sale (DSO), which helps determine the time to cash in on sales. The average accumulation period is an important aspect of the company's overall cash conversion period. The main area of corporate financial analysis involves extrapolating a company's past performance as a measure of net profit or profit margin to assess the company's future performance. This type of historical trend analysis is useful for identifying seasonal trends. For example, retailers may experience a sharp increase in sales in the months leading up to New Year's Eve. This allows businesses to forecast budgets and make decisions based on past trends, such as the required minimum inventory level.
Investment Financial Analysis
An outside analyst in investment finance conducts analysis for investment purposes. Analysts can take a top-down or bottom-up investment approach. The top-down approach first looks for macroeconomic opportunities as high-yield sectors and then drags downwards to find the best companies in the sector. In this regard, they look further at the fundamentals of a particular company and further analyze the shares of private companies in order to select potentially successful ones as investments. On the other hand, a bottom-up approach looks at a particular company and analyzes similar ratios to those used in corporate financial analysis by looking at past financial performance and expected future performance. Bottom-up investment forces investors to consider microeconomic factors first and foremost. These factors include the company's overall financial health, analysis of financial statements, products and services offered, supply and demand, and other individual indicators of corporate performance over time.
Types of financial analysis
There are two types of financial analysis:
- Fundamental analysis.
- Technical analysis.
Fundamental analysis
Fundamental analysis uses information from financial statements, such as a company's earnings per share (EPS), to determine the value of an enterprise. By using a ratio analysis with a thorough review of the economic and financial conditions surrounding the company, the analyst can obtain an intrinsic value for security.
Technical analysis
Technical analysis uses statistical trends collected from trading activities, such as moving averages (ME). In fact, technical analysis probably reflects the price of a price known to the general public and instead focuses on statistical analysis of price movements. Instead of analyzing security criteria, technical analysis seeks to understand the market sentiment behind price trends by looking for trends and tendencies.
