Financial analysis (FA) is the process of assessing the performance and suitability of organisations, projects, budgets, and other financial operations. Financial analysis is the use of financial data to assess the performance of an organisation and offers recommendations on how to improve it in the future.
While FA is performed internally, financial analysis can assist fund managers in making future company decisions or reviewing historical trends for prior success.
WHILE (FA) is performed externally, financial analysis can assist investors in selecting the finest potential investment possibilities.
The two basic types of financial analysis are fundamental analysis and technical analysis.
Fundamental analysis determines a security's inherent worth using ratios and financial statement data.
Technical analysis argues that a security's worth is already defined by its price and instead focuses on price changes over time.
DIFFERENT TYPES OF FINANCIAL ANALYSIS
Horizontal Analysis
Horizontal analysis includes analysing many years of financial data to determine a growth rate. This will assist an analyst in determining whether a company is growing or shrinking, as well as identifying significant trends.
Vertical Analysis
This kind of financial analysis entails examining multiple income statement components and dividing them by revenue to express them as a percentage. To maximise the effectiveness of this process, the results should be compared to other companies in the same industry to see how well the company is performing.
Profitability Analysis
Profitability is an aspect of income statement analysis in which an analyst determines how appealing a company's prospects are. Profitability measurements consist of, for example, ROCE, Gross margin, Operating Margin, and Return on Assets.
Profitability Ratios
Return on capital employed = EBIT ÷ Capital employed
Gross margin ratio = Gross profit ÷Net sales
Operating margin ratio = Operating income ÷Net sales
Returns on shareholder funds = Net earnings ÷Total shares outstanding
Return on assets ratio = Net income ÷Total assets
Liquidity Analysis
This is a kind of financial analysis that focuses on the balance sheet, specifically the ability of a corporation to satisfy short-term obligations (those due within a year). Examples of common liquidity analyses for instance: current ratio, acid test or quick ratio and cash ratio.
Liquidity Ratios
Current ratio = Current assets ÷ Current liabilities
Quick or Acid-test ratio = Current assets – Inventories ÷Current liabilities
Cash ratio = Cash and Cash equivalents ÷ Current liabilities
Investment Return Analysis
At the end of the day, investors, lenders, and finance professionals in general are concerned with earning a risk-adjusted rate of return on their money. As a result, determining rates of return on investment (ROI) is essential in the industry. Examples of common rates of return measurements include: ROE(Return on Equity), ROI (Return on Assets) and ROIC(Return on Invested Capital).
Investment Ratios
ROE = Net Income ÷ Shareholders’ Equity
ROA = Net Income ÷ Average Assets
or
ROA = Net Income ÷ End of Period Assets
ROIC= Net Operating profit after tax (i.e. EBIT X (1-Tax rate) ÷ Invested capital
Efficiency Analysis
Efficiency ratios are a critical component of any thorough financial study. These ratios assess how successfully a company manages its assets and how they are used to create revenue and cash flow. Asset turnover ratio, Fixed asset turnover ratio, Cash conversion ratio, and Inventory turnover ratio are examples of common efficiency ratios.
Efficiency Ratios
Asset turnover ratio = sales ÷ total assets
Inventory turnover ratio = Cost of goods sold ÷ Average inventory
Receivables turnover ratio = Net credit sales ÷ Average accounts receivable
Leverage Analyses
One of the most prominent methodologies used by analysts to analyse corporate performance is rates of leverage. A single financial indicator, such as total debt, may not be particularly illuminating on its own, therefore comparing it to a company's total equity can assist provide a more complete picture of the capital structure. Debt to equity, EBITDA to debt and EBITDA to interest (interest coverage) are common examples of a leverage ratio.
Leverage Ratios
Debt to equity or gearing ratio = Total liabilities ÷ Shareholder’s equity
Debt ratio = Total liabilities ÷Total assets
Interest coverage ratio = Operating income ÷Interest expenses