Finance is game of numbers, it’s a powerful game of numbers and understanding the potential of these numbers gives root cause to the success of an organization.
Obtaining well-defined and explicit information from the financial facts and figures is always remained most demanding in the financial industry, from that a view of financial analysis and its elements we learn through this conversation.
“It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.” – Warren Buffett
This blog covers
1. What is financial analysis?
2. Role of tools and techniques
3. Why is it important?
4. Key elements of financial analysis.
So, let's make our knowledge more interesting.
What is Financial Analysis?
“Financial analysis”, the process of accumulating, envisioning, controlling, deciphering, and anticipating financial data and following the aim to evaluate the financial accomplishment of a particular department inside a company or of a company itself. It helps in making more reliable decision making.
Financial analysis is adopted for examining economical patters, fixing financial policy, making long-term plans for various business activities, and analyzing projects or groups for investment. This can be perfected with the fusion of financial numbers and data.
The financial statements that include the income statement, balance sheet and cash flow statement of an organization are analyzed to obtain actionable interferences, also financial analysis can be conducted in both modes of corporate finance and investment finance frameworks.
If you want to learn more about these terms, follow our previous blog “An Introduction to Financial Analysis”
However, in order to evaluate and analyze the financial data, one of the most general methods is “measure the ratio or degree from the data available in financial statements and compare it with those of alternatives companies”, “even it can be compared with own past performance of the company.”
Consider the example of Return On Assets (ROA), it is a well-known degree/asset that is used to determine how capable an organization is while implementing its assets and also in the context of a ratio of profitability.
This ratio can be measured, within the same industry, for multiple companies and can be correlated to each other as a portion of the massive analysis.
(Also check: What is Inflation? Demand-pull and Cost-push)
Role of Tools and Techniques
There are multiple finance analytics tools available that comprise numerous features for delivering accurate and undiscovered substantial information.
It eliminates most of the intricacies of the data. Also, it assists in controlling the cash flows inclusive of revenue and expenditures across the organizations.
With the combined data of CRM, ERP, etc, and other systems, they give a consolidated aspect of all the data touching the entire organization. This helps in evading uncertainties and clutching better opportunities.
Apart from that, most of the latest financial analytics tools create the individual reports for example reports as per department and stakeholders and a financial dashboard that is simple to understand.
(Must check: What is FinTech? Examples and Applications)
Questions (or Example) Financial Analysis can Answer
From the past few years, companies have uncovered the value that finance can produce many perspectives on business. Most of the business leaders are leveraging finance to get actionable insights.
Through the linking of organic financial and operational data with external data like social media, demographics, and big data, finance analysis enables us to address decisive business queries with unparalleled ease, speed, and accuracy.
According to the report; below are the lists of questions that can be answered using finance analysis;
What is the uncertainty exposure with some particular customers, and how the relationship with customers is going to influence working capital?
How to streamline and intensify various business processes in order to make them extra dynamic?
Does a company is investing in the appropriate opportunities based on capital-value or revenue?
Is each product and service across sale modes are profitable for customers?
What would be possible future events that might affect stock prices?
(Most related: COVID-19 Impacts on Financial Markets)
Why is it important?
In the present time when each business has become digitalized, it entails up-to-date information for the process of decision-making.
It delivers in-depth information about the financial position of an organization and augments profitability, business value, and cash flow.
It assists to revamp the eventual purposes of a business that also fix the decision making approaches.
“The best financial models are simple enough for anyone to understand, yet dynamic enough to handle complex situations.” – Tim Vipond
Broad demand for prudent financial planning and forecasting is essential for each organization.
“Cash is King” is a familiar mantra, understand what? Financial analysis majorly focuses on estimating and operating on the substantial equities of the business, for example, cash and physical pieces of equipment.
For triumphant financial analysis, the assorted necessity of conventional financial department and augmentation in technologies are crucial factors.
(Recommended blog: Introduction to Technical Analysis)
Key elements of Financial Analysis
Key elements(components) of the Financial Analysis
Accounted as the core origin of cash, Revenues is crucial for long-term achievement;
Revenue growth: No former revenue can be added while calculating revenue growth as it leads to distorting the analysis.
Revenue concentration: It is assured that no single client can make more than 10% of total revenue, as a customer is generating high revenues now, but what if he stops purchasing, one can encounter financial difficulty.
Revenue per employee: It calculates the productivity of the business, the higher the value, the better it is.
(Refereing blog: Largest Stock Exchanges in the World)
Profit is the return investment that a business derives from the invested amount on the business. Multiple factors such as price, market trends, assets, obligations, costs, etc, can affect the profit of the business. It can be measured on the basis of;
Gross profit margin: It enables us to handle revenues or the cost of goods that are sold out without suffering the capability to pay off for continuous expenses.
Operating profit margin: It incorporates no interest or taxes, although it measures the strength of generating profits for a company despite how an individual manages finance services.
Net profit margin: Pure value that is left for reinvestment into the business, also the redistributed amount to be divided amid owners.
In order to determine how adequately the company’s resources are utilized, operational efficiency is implemented and its scarcity leads to shorter profits and more delicate growth.
(Related blog: What is Credit Rating?)
Capital Efficiency and Solvency
The core aspect of interest of capitalists and bestowers, basically;
Return on equity: It is used to depicts the return that is generated by lenders, coming out from the business.
Debt to equity: In generalized terms, it symbolizes how much leverage is practiced to work that can’t be more than what is justifiable to business.
The term Liquidity signifies the availability of a sufficient amount of cash and other assets to satisfy cash expenses like debts, bills.
Every business demands for a sufficient amount of liquidity to meet its expenses. Therefore, a low level of Liquidity implies the company needs extra capital and its performance is underprivileged. Liquidity can be measured by;
Current ratio: It calculates the worth amount to be paid for short-term debts from the available cash. If the value of the current ratio is less than the one, then the company needs extra amount due to inadequate liquidity, however, the current ratio’s value above two is considered as beneficial.
Interest covered: The measurement to pay interest expenditure from the available cash, and the value of 1.5 leads to meet bestowers. (Source)
While coming so far with the discussion, it can be concluded that Financial analysis is an extremely worthy tool for each organization either on small and large-scale. It should be adopted to maintain and regulate its progress. It lets the organization acclimate the trends that transform its operations.
(Most important: Fundamental Analysis Guide)
Financial analysis will yield highly reliable and convenient financial reports of an organization that is the major asset for calculating its achievement form the aspect of investors, analysts, and capitalists.
"Financial peace isn't the acquisition of stuff. It's learning to live on less than you make, so you can give money back and have money to invest. You can't win until you do this." - Dave Ramsey
In fact, if the financial analysis is handled internally, it could assist in executing substantial business decisions, also inspect past trends for consistent profits. And if it is handled externally, it leads the venture capitalists for selecting the exceptional-achievable investment opportunities.