The process of examining a company’s various financials in order to assess its financial stability and prospects is referred to as financial analysis. The financial analysis aids business owners in deciding what steps they must take to stay afloat, turn a profit, or keep out of bankruptcy. Additionally, it aids potential investors in making their investment decision. A company’s financial statements, including its income statement and balance sheet, are examined throughout this process.
Types of financial analysis: There are various sorts of financial analysis to take into consideration. The following are seven categories of financial analysis:
- Vertical: The relationship between various components on a financial statement is examined in vertical financial analysis. For illustration, a percentage is used to represent the relationship between two items within one accounting period when one is compared to the other, which is regarded as the base. Even though it only considers one time period, you can use it to compare distinct entities and identify any changes over time.
- Horizontal: The study of how financial statement data vary over time is referred to as horizontal analysis. In other terms, it contrasts two things from separate times. As a result, it can assist in analyzing a company’s finances from one year to the next. Because this type of analysis can be helpful in identifying trends across time, horizontal analysis is also known as dynamic analysis or trend analysis.
- Continuity: Ratios are used in liquidity analysis to assess a company’s ability to cover debt payments and other costs. This kind of study is beneficial because a company will undoubtedly experience financial difficulties in the near future if it is unable to pay off any creditors. For lenders or creditors who wish to learn more about your financial situation before extending you a loan or credit, liquidity analysis is especially useful. A liquidity study uses a variety of ratios, including the cash ratio and current ratio.
- Profitability: The rate of return for a corporation is assessed in profitability analysis. Every organization aspires to be profitable, so it can be quite advantageous for them to assess their cost and income over a specific time period utilizing the profitability analysis. A corporation is deemed profitable if its revenue exceeds its expenses. In this kind of analysis, profitability ratios, including margin and return ratios, are used. These ratios consist of the following: Gross profit margin, operating profit margin, net profit margin, and cash flow margin are examples of margin ratios. Return on Investment (or Assets), Return on Equity, and Cash Return on Assets are all return ratios.
- Sensitivity and the Scenario: This kind of research gauges the worth of an investment using existing possibilities and modifications. For instance, it examines how changes and sensitivities in other variables, such as variable B or C, affect variable A. Analysts can also use scenario and sensitivity analysis to forecast specific outcomes based on various variables. They accomplish this by analyzing the numerous variable effects based on earlier data and then basing their choices on their conclusions.
- Variance: Variance analysis is the practice of examining any discrepancies between a company’s planned spending and actual spending. For instance, if you budgeted $1,000 in sales but only made $250, the variance analysis would show a $750 difference. Once you are aware of this, you can begin to ascertain the reason for the deviation and put methods into place to prevent any future negative variances. Purchase price variance, labor rate variance, fixed overhead spending variance, and material yield variance are only a few examples of the different sorts of variances that are covered by variance analysis.
- Appraisal: The present value of your company is assessed using the financial analysis of valuation. Such an approach can be used in a variety of situations, such as mergers and acquisitions or taxable events. Different valuation ratios exist, such as price/earnings and price/sales. Once you have established your company’s ratios, you may start comparing them to previous ratios, ratios of competitors, or the ratios of your specific industry as a whole.
