Financial analysis is an essential practice in the corporate world used by businesses to evaluate the current and fluctuating economic trends. It helps to build long-term financial strategies and set final policies for business activities. It also assists companies in identifying which parties and projects are worth investing in. The specialists perform financial analysis by using business data and statistics to evaluate the business’s performance.
Understanding Financial Analysis
Financial analysis helps evaluate a company’s data to analyze several factors and present a financial report. Most of the time, businesses get carried away in spending their capital resources. Hence, a financial statement helps them keep a check by providing a clear picture of expected versus real progress. Financial analysis is beneficial for small and large businesses alike. It helps them make decisions that accelerate the business growth and helps in attaining the business objectives more efficiently. However, the key is to hire a professional financial analyst rather than performing it on your own.
If you want to devise an effective financial statement, it is essential to be mindful of the three main factors:
- The economic trends of the industry in which your company operates
- The structure and type of the financial statement
- The strategies/characteristics of your company that sets it apart from the competitors
Are you a financial analyst or a business owner looking to improve financial health? Or a business owner seeking better investment opportunities for your company? Make sure the analysis process follows the following steps for effective results.
1 – Identify the Industry’s Economic Trends
The first step towards financial analysis is determining a chain analysis of the respective market. Without evaluating the activities involved in the planning, producing, and distributing a business’s products and services, it is impossible to assess its financial standing. One reason is that identifying the industrial trends helps financial analysts determine whether your company is getting the products and services from reliable sources.
To further develop your skills and learn the ropes, you may consider enrolling yourself in a diploma or a short course. It is best to enroll in a Master of Accountancy to learn from the experts and use data to compare the current financial records of your business and create a sound comparative study.
2 – Identify Company Strategies
In the next step, financial analysts assess the nature of the products and services offered by your company. It includes evaluating the individuality of your products or services, the level of profit margins. It also provides an assessment of control of costs and brand loyalty amongst the clientele. In addition, it is crucial to consider factors like geography and industrial diversification and supply chain integration.
3 – Evaluate the Quality of the Company’s Financial Statement
Once you identify the economic trends and the firm’s current strategies, the next step is to review the company’s financial statements. However, it is vital to stick to the relevant accounting standards for the evaluation in this step. Financial specialists consider various stages such as valuation, recognition, and classification to examine the balance sheet accounts properly. In addition, assessing the quality of earnings and the cash flow statements helps create strategies that would benefit in the long run. It does so by aiding the financial analysts in developing a better understanding of the impacts of your business’s liquidity in terms of investments, operations, and other economic activities.
4 – Analyze the Current Risks and Profitability
While it might sound like an unnecessary step, this technique adds value to the overall evaluation of your company’s financial statements. Professionals use analysis tools such as asset management, debt coverage, management, financial statement ratios in liquidity, and market risk valuation. To analyze the firm’s profitability, the experts consider factors like the company’s perception in the eyes of its equity stakeholders. The analyst must critically evaluate the financial statement ratios by comparing the current ratios to previous reports and records. Another way is to use the market average ratios for comparative analysis.
5 – Value the Company
Financial Analysts use several approaches such as discounted cash flow like the discounted cash flow methodology to determine the valuation of a business. In this step, experts evaluate the cash flows in projected dividends through techniques like the discounted cash flow methodology. These cash flows are usually detailed, for instance, the free cash flows on an enterprise basis or equity holders. Other valuation techniques include relative valuation and economic value-added.
A financial analyst examines a company’s diverse data, such as its income statements, cash flow statements, and balance sheets. It proves to be beneficial in devising a verdict on the financial status of the company. The data derived through financial analysis helps make strategic decisions that could increase business growth opportunities.
However, the financial analyst experts need to be show diligence. The reason is that economic analysis has become subject to criticism in the current times due to the recurrent irregularities during the procedure.