Financial analysis is one of the core functions that a company must perform to ensure the stability of its business. Having said that, financial analysis occurs by examining the flow of company finances. The accounting of company finances is a prerequisite to producing financial data needed for analysis. Therefore, accountants are at the core of this task as well, and with the “new normal” environment created by COVID-19, all the more that their role becomes essential in the conduct of financial analysis.
See our previous article on How Accountants Fit in the New Normal
After accountants produce the financial data, what then does top management do with the information? Can they easily decipher and translate the information from the accountants and use those for decision making? Learn more about the different methods of conducting financial analysis.
Introduction to financial analysis
All top management and company governance executives have a background in the language of business, which is accounting. However, accountants produce data that are sometimes too broad or all-encompassing to be immediately useful. Most managers prefer dealing with “sifted” data that are ready for decision making. These are figures that immediately make sense without having to read through numerous spreadsheets and pages of financial statements.
Financial analysis is the process of evaluating the business as a whole, projects to be done and accomplished, budgets and their constraints, and other finance-related intricacies to gauge the company’s performance and appropriateness.
The process itself uses financial ratios, financial statements, values of securities, etc., to ascertain whether the company is doing well enough in the present. Financial analysts and other users of financial data primarily use Excel and other spreadsheets to analyze historical data and make projections, to carry out the different types of financial analysis.
Purpose of financial analysis
Usually, financial analysis is used to analyze whether an entity is stable, solvent, liquid, or profitable enough to be a worthwhile investment, if conducted externally. If conducted internally, financial analysis can aid managers in decision-making for the present, past, and future endeavors of the company. These endeavors are not necessarily financial in nature because the results of financial analysis can affect all aspects of the business and its operations.
Types of financial analysis
Vertical analysis
One might look at the revenues and expenses of the company when checking the various components of an income statement. You can use these data to benchmark your company against others in the same industry (especially competitors), and gauge how the company is doing. Hence, this analysis allows for competing companies of different sizes to make comparisons involving ratios and not monetary values.
Horizontal analysis
The horizontal financial analysis aims at examining several years’ worth of financial data and determining the company’s growth rate. This analysis not only identifies the growth (or decline) rate, but also any trends that might come up year after year.
Fundamental financial analysis
This type of analysis makes use of financial ratios and financial statement data to determine the intrinsic value. It usually applies to securities; to know whether or not they can be good investments.
Financial ratios are lifted from financial statements (income statement, balance sheet, and cash flows) to assess and gain financial information about the company. These figures are used to perform quantitative analysis and give light to a company’s:
- Liquidity (Current ration, Acid test ratio, cash ratio, net working capital)
- Leverage (Debt/Equity, Debt/EBITDA, EBIT/Interest, Dupont Analysis)
- Growth (Year-over-year, Regression analysis, Bottom-up analysis, top-down analysis)
- Margins
- Profitability (Gross margin, EBITDA margin, EBIT margin, Net profit margin)
- Rates of return (Return on Equity, Return on Assets, Return on Invested Capital, Dividend Yield, Capital Gain, Accounting Rate of Return, Internal Rate of return)
- Valuation (Cost to build/replace, comparable company analysis, precedent transactions, discounted cash flow analysis, scenario & sensitivity analysis)
- Efficiency
Technical financial analysis
This type of financial analysis pegs the value of a security, depending on its price. It focuses on the trends involving the securities’ value over time. Technical analysis uses statistical trends gathered from trading activity.
Financial analysis – turning basic information into financial data
Financial analysis can evaluate a company’s overall performance when the persons-in charge and decision-makers utilize it correctly. Thus, the top management can make recommendations on how to improve the company moving forward. If a company opts not to employ a trained financial analyst and does not undergo the process of financial analysis, accounting data at hand would still be useful despite only using it at face value. Knowing how much money you have and how much you’ve spent is still useful data. But can you imagine if you can turn this basic information into data such as:
- How heavy a company relies on debt rather than capital in bringing in additional money; do we need to pay more stockholders their dividends or do we pay more for interest expense? (Debt/Equity Ratio)
- What percentage of your revenue is kept as gross profit? (Gross Margin)
- Get a sense of how much cash is generated for every dollar of revenue earned (EBITDA Margin)
- Are you capable of meeting short-term obligations due within one year? (Current Ratio)
- Are your current assets able to cover your current liabilities? (Acid-test ratio)
- Are your cash and cash equivalents enough to pay off your current borrowings? (Cash ratio)
Conclusion
Competent individuals can turn financial data into more useful information to analyze the performance and standing of a company. Accountants, business owners, or professional analysts who are capable of recommending the best-case scenario for your company may conduct the financial analysis.
Contact us
S.J. Grand can give you advice on your company’s needs. Our accountants and analysts who are well-versed in China’s economy are capable of performing financial analysis. Furthermore, we utilize state-of-the-art technology, Kwikdroid, that assists in automating several functions for data gathering and creating a financial dashboard for easy monitoring. Contact us to get you started with examining your current financial standing.
If you want to know more about our latest Cloud-based company solution, go to our Kwikdroid page to check the prices and packages we offer, no matter the size or type of company.
