أخر الاخبار

What is financial analysis?

Horizontal What is meant by financial analysis?

As one of the processes that are used in evaluating a business, projects, budgets, and other financial transactions with the aim of determining the quality of their performance, and if the financial analysis is internal, it helps managers to make future business decisions, while if the financial analysis is external, it helps investors to choose the best investment opportunities available.

 The financial analysis of companies is also defined as conducting the internal financial analysis through the accounting department, which works to share its results with the management in order to improve the process of making business decisions. Examples of this analysis are: calculating the net present value, calculating the internal rate of return.

As for the financial analysis of investment, it means that an analyst from outside the company performs the financial analysis process with the aim of investing, where the analyst analyzes the shares of specific companies and chooses the company that can achieve success as an investment.

While the financial analysis of governments is meant as a liquidity and monetary management process, as the majority of governments have long-term debts, they seek to calculate the extent of their ability to bear these debts in order to maintain the government's financial health.

Based on the foregoing, the financial analysis can be defined according to the entity, the objective, and the nature of the business for which the financial analysis is calculated, but the importance of the financial analysis for all parties is to verify the quality of the business and its proper functioning.
What is financial analysis?
What is financial analysis?

What are the types of financial analysis?

Financial analysis is based on the use of existing financial data in companies in order to evaluate the performance of these companies in addition to providing many recommendations in order to help improve them in the future, where historical financial data is analyzed in order to obtain these expectations and benefit from the uses of financial analysis according to many types Financial analysis, and the following are the most commonly used types of financial analysis:

vertical financial analysis

This type of financial analysis works on studying the components of the income statement and its goal is to divide them based on revenues, and it is called the income statement with the common size because the results must be compared with other companies, especially those in the same sector, as the goal of comparing companies It is to know how well the company is performing. Examples of vertical financial analysis for it are the following:
  • Vertical financial analysis of the income statement.
  • Vertical financial analysis of net sales.
  • Vertical financial analysis of the balance sheet.

Horizontal Financial Analysis

Horizontal financial analysis is used to compare financial statements for several years with each other in order to determine the growth rate, and horizontal financial analysis aims to determine the important trends of the company in addition to determining the growth or decline of companies. Examples of using horizontal financial analysis are:
  • Compare historical data such as ratios or items.
  • Analyze important metrics such as profit margins, return on equity, and inventory turnover in order to identify emerging problems as well as to identify strengths.
  • Find out why your EPS is rising, whether it's because the cost of goods sold has fallen or sales have been growing strongly.
  • Discover the cash flow to debt ratio and interest coverage ratio by calculating coverage ratios.

Leverage Analysis

This type of financial analysis is one of the most widely used types for evaluating the performance of companies, as it is possible to compare total debt to equity in order to obtain a comprehensive picture of capital. Examples of using leverage analysis are:
  • Calculate the debt/equity ratio.
  • Calculation of EBIT/interest (interest coverage).
  • Debt/earnings before interest, taxes, depreciation, and amortization (EBITDA) calculation.

growth analysis

Growth analysis, which is one of the types of financial analysis, aims to analyze historical growth rates in addition to calculating expectations of future growth rates. Examples of using growth analysis are the following:
  • Regression analysis.
  • Bottom-up analysis (which starts with the individual drivers until it reaches the revenue in the business).
  • Top-down analysis (an analysis that starts with market size and ends with market share).

profitability analysis

Profitability analysis is one of the types of financial analysis that is based on the analysis of the income statement. The analyst evaluates the importance of the economies associated with the company. Examples of using profitability analysis are the following:
  • Calculate the gross profit margin.
  • Calculate net profit margin.
  • Calculate the EBITDA margin.

Liquidity Analysis

Liquidity analysis, which is one of the types of financial analysis, focuses on the balance sheet. Liquidity analysis aims to determine the company's ability to pay obligations, especially short-term obligations, that is, those that are due within less than a year. Examples of liquidity analysis are the following:
  • Calculate the current ratio.
  • Calculate the cash ratio.
  • Calculation of net working capital.

efficiency analysis

Efficiency measures how well the company manages the assets it owns and how they are used in order to generate revenue and cash flows. Therefore, efficiency analysis is one of the types of financial analysis that makes it a powerful analysis. Examples of using efficiency analysis are the following:
  • Calculate the asset turnover ratio.
  • Calculate the fixed asset turnover ratio.
  • Calculate the cash transfer ratio.
  • Calculate the inventory turnover ratio.

cash flow analysis

Cash is the basis of business, as corporate business is based on determining the extent to which companies are able to generate cash flow. Therefore, financial auditors work to analyze cash flow in corporate activities, especially the main ones, such as: operational activities, investment activities, financing activities, and here are some examples of the use of Cash Flow Analysis:
  • Operating cash flow (OCF) calculation.
  • Free cash flow (FCF) calculation.
  • Free cash flow to equity (FCFE) calculation.

rate of return analysis

Evaluating the rate of return on investment (ROI) is one of the most important matters for investors, lenders and financial professionals. The rate of return analysis contributes to determining the risks surrounding the funds that can be obtained. Examples of the rate of return analysis are the following:
  • Calculate return on equity (ROE).
  • Return on assets (ROA) calculation.
  • Calculation of return on invested capital (ROIC).
  • Calculate the accounting rate of return (ARR).
  • Calculate the internal rate of return (IRR).

Evaluation

Evaluation analysis is one of the main types of financial analysis, as business evaluation can be done in many ways and methods. Therefore, analysts use a set of methods that help reach a reasonable evaluation. Examples of evaluation are the following:
  • Calculation of the cost approach.
  • Calculation of relative value (market approach).
  • Comparative company analysis account.
  • Calculate the intrinsic value.
  • Discounted cash flow analysis.

Scenario and sensitivity analysis

Scenario and sensitivity analysis is used as a means used to measure risks, as companies are working on building a model for evaluating companies by trying to predict the future, so the use of the scenario and sensitivity analysis method contributes to determining the shape that the company’s future will become, whether for better or worse, and here are some Examples of scenario usage and sensitivity analysis:
  • Calculating the effect of interest rates on bond prices varies with different interest rates.
  • Calculate the effect of net working capital on the profit margin, as the analysis will include all variables such as cost of goods sold and managers' wages.
  • Prediction that the increase in customer traffic will lead to an increase in the company's total sales revenue.

Variance analysis

Variance analysis is used as a type of financial analysis in order to compare actual results with the budget or expectations, and variance analysis is an important matter in the internal planning and budgeting process of companies. Examples of using variance analysis are the following:
  • Calculation of the purchase price variance: The difference between the actual price paid for materials used in the production process minus the standard cost multiplied by the number of units used.
  • Labor rate variance: The actual price paid for direct labor used in the production process minus its standard cost multiplied by the number of units used.
  • Calculate the fixed overhead variance: The total amount by which fixed overhead costs exceed the total standard cost for the reporting period.
  • Calculating the selling price difference: It is the actual selling price minus the standard selling price multiplied by the number of units sold.
Based on the foregoing, the types of financial analysis are multiple and you can use what businesses need from them, where you can choose the appropriate ones to meet your business needs and verify their proper functioning.

What is the purpose of financial analysis?

Financial analysis is a process of examining financial information to reach business-related decisions, as many financial matters are calculated, such as examining profitability, cash flows, risks, and others [8], and understanding and diagnosing the information in the financial statements in order to know the amount of profitability, determine the extent of the financial health of the company and predict future expectations. The primary objective of financial analysis, and other objectives for which financial analysis is used are the following:
  • Make a comparison between companies.
  • Measuring the company's ability to achieve profitability.
  • Assistance in making business decisions.
  • Calculating forecasts related to the company's future business.
  • Evaluate the progress of the company's business during a specified period of time.
  • Assessment of the short- and long-term solvency position of companies.
  • Measuring the extent of the ability to achieve operational efficiency and administrative effectiveness.
  • Knowing the reasons that led to a change in the profitability and financial position of the company.

What are the steps of financial analysis?

The process of conducting business financial analysis is one of the things that help improve companies’ business and predict their future business, where the steps of financial analysis can be completed using many elements, such as balance sheet, cash flow analysis, profit, and loss analysis, break-even point analysis, and by following accepted accounting principles In general, financial analysis can be performed, and the following will explain the steps of the financial analysis:
  • Knowing the economic characteristics of the business: This is the first step in conducting the financial analysis of the business and it is done through the analysis of the business value chain; It is a series of activities that create, manufacture, and distribute products or services, and these characteristics can be known using different techniques such as Porter's Five Forces.
  • Determining company strategies: There are many strategies that companies can follow. To determine the strategy, it is necessary to know the nature of the products or services provided by companies through several means, such as the level of profit margins, brand loyalty.
  • Assessing the Quality of the Company's Financial Statements: The quality of the financial statements is assessed by examining balance sheet accounts that reflect the company's economic position.
  • Analysis of profitability and current risks: Profitability is analyzed by calculating the ratios of financial statements such as ratios of liquidity, profitability, asset management, and risk assessment.
  • Preparing expected financial statements: It is necessary to set expectations about the future and the extent of the impact of these expectations on cash flows and financing.
  • Company valuation: Many valuation methods can be used, such as: discounting cash flows, calculating relative valuation, or calculating economic value added.
Therefore, it is necessary to follow the steps of financial analysis in order to assess the financial situation of companies and the quality of their work. This is usually the task of the financial analysis department in companies, or you can take a financial analysis course that will help you in carrying out the financial analysis process.

What are the main disadvantages of financial analysis?

The financial analyst works on using the financial statements and following the steps of the financial analysis to access information related to the company’s business and how to make the right decisions in it, and to verify how the business is performing and other objectives that show the importance of financial analysis, but this does not exclude the existence of financial analysis problems that the analyst is exposed to when conducting For financial analysis, the most prominent disadvantages of financial analysis are the following:
  • There are limits to the analysis of financial statements, as the analysis is based on the available financial data only. Financial analysis is a powerful mechanism for determining the financial strengths and weaknesses of a company.
  • But the analysis is based on the information available in that financial analysis is based on monetary information only while non-monetary factors are ignored.
  • Changes in price levels are not taken into account. The adoption of the going concern principle does not give accurate data.
  • Any change in the accounting procedures by the company makes the financial analysis inappropriate for the company's business.
  • Analysis is a method used by the analyst who interprets results according to his own conclusions.

Therefore, there are many financial analysis problems that the analyst can face, most notably the lack of specific ratios that are comprehensive with all the important information, in addition to the fact that the analysis depends on the analyst’s ability to interpret the results, which leads to differences in the interpretation of the results.

Example of financial analysis

One company reported earnings per share during the first quarter of the year by $2.15, while earnings per share for the second quarter of the same year were reported to have amounted to $2.32, so the analyst who uses fundamental analysis will have this result for him as evidence of Increasing the value of the stock and thus the profitability of the company.

Accordingly, the types of financial analysis that can be used can lead to different results and interpretations, as these analyzes depend on the analyst's ability to interpret the results.
Comments
No comments
Post a Comment



    Reading Mode :
    Font Size
    +
    16
    -
    lines height
    +
    2
    -