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Interpreting the numbers: Business Financial Analysis

What is financial analysis?

Financial analysis is the assessment of fiscal transactions such as projects and budgets. The aim is to confirm whether an organisation is in a position to make a monetary investment, and if that project is likely to be profitable. This involves using financial data to assess a company’s current performance and make recommendations about how it can improve going forward.

Key data and management information used for financial analysis include:

  1. Income statements
  2. Balance sheets
  3. Cash flow statements

Types of financial analysis

There are two main methods of financial analysis: fundamental analysis and technical analysis.

It is wise to use both fundamental analysis and technical analysis to provide a well-rounded market strategy for your business.

Fundamental financial analysis

Fundamental analysis aims to determine an organisation’s value through ratios gathered from data within financial statements, for example earnings per share (EPS).

By using ratio analysis in addition to a thorough analysis of current economic and fiscal trends, as well microeconomic factors like the company’s management, analysts derive an intrinsic value for the security, so investors can see whether a company is undervalued or overvalued. Through this data, it is easier to identify the right companies for long-term investment.

An example is return on assets (ROA), which can determine how efficient an organisation is at utilising its assets to their optimal potential. This could be calculated for several industry competitors to find the best candidate to invest in.

Technical financial analysis

By contrast, technical analysis uses past statistical trends such as stock volume and price as well as moving averages, gathered from trading activity. It assumes a security’s price accurately represents all public data information, and that stock prices are more likely to repeat past trends rather than move unexpectedly.

Technical analysis attempts to understand the market sentiment behind price trends by looking for patterns and trends rather than analysing a security’s fundamental attributes. It assumes we can better understand investment opportunities if we use these past trends.

How is financial analysis used?

Financial analysis is crucial in order to allow companies to assess economic situations, make fiscal policy decisions and develop their long-term plans for surviving and thriving. As a financial analyst, you should thoroughly assess the organisation’s financial statements, whether in corporate finance or investment finance settings.

What do financial analysts do and what is the value?

Financial analysis is critical to any commercial operations – without it, you cannot judge the current health and future capacity of your company.

This information is critical both for shareholders and investors in choosing their stocks, and company managers to measure and improve performance to keep up with their industry competitors.

In short, it shows the strengths and weaknesses of a company, and where you need to improve to maintain your competitiveness.

Corporate financial analysis for data-driven decisions

Internal financial analysts carry out corporate financial analysis, including ratios like net present value (NPV) and internal rate of return (IRR) to enable senior leaders to make the best-informed decisions for a company’s future, including the right projects to execute.

Modelling future company performance

A vital aspect of corporate financial analysis is using your business’ past financial performance to help estimate your future performance.

This is particularly useful to help make the most of  / be prepared for seasonal trends with higher or lower demand for your product, and thus forecast budgets and decide how much stock to make available. For example, retailers usually see significant increases in sales leading up to Christmas.

Analysing current cash flow

If you extend credit to customers, cas from sales may not be received immediately – in this case, it can be useful to track days sales outstanding (DSO), in order to identify thow long between a credit sale and it generating cash. This is vital to ensuring you maintain a sustainable cash conversion cycle as part of your overall cash flow.

Investment financial analysis for company growth

If you are looking to invest in other companies to grow your organisation, you would use your financial analysts to assess the potential, via either a top-down or bottom-up investment approach.

Top-down analyses cover all macroeconomic factors, such as which sectors have the highest growth potential, and then assesses the stocks of specific companies in the sector to find the best candidate. Finally, the provisional choice is fundamentally and specifically examined before a decision is made.

A bottom-up approach is the other way round, looking at a strong specific candidate company for investment and performing corporate financial ratio analysis to confirm this potential.

Financial analysts performing bottom-up analysis primarily consider microeconomic factors, such as an organisation’s overall fiscal health, financial statements, and supply and demand for the products and services it offers.

Overall, financial analysts perform quantitative and qualitative analysis of your organisation’s financial activities, as well as economic and business trends, to try and map out the most successful financial future.

Read more about what an FP&A team does.

5 key elements of a finance analysis

  1. Financial analysis helps managers make the best future business decisions
  2. External financial analysis enables people and companies to discover
    optimal investment opportunities
  3. There are two main types of financial analysis
  4. Fundamental analysis determines the intrinsic value of a security
  5. Technical analysis focuses on trends in value over time.

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