What Is Financial Analysis?

Cynthia Bassett Hartwig

May 3, 2023

Financial analysis is a process that helps companies assess their financial health and performance. It also allows investors to evaluate whether a company is worth investing in.

Analysts use a variety of methods to conduct financial analysis. Some of these methods include financial statement analysis, financial ratio analysis, and economic forecasting.

Financial Statement Analysis

Financial analysis is a process of analyzing a company’s financial statements to understand the health and performance of the business. It can help companies decide their budgets, investments, and plans.

A key goal of financial analysis is to identify trends and patterns in a company’s finances, which can help business owners see where they are performing well and where they might need improvement. It also helps them formulate new strategies to consider any risks posed by the broader market and gives them an idea of how they compare to their competitors.

There are a few different techniques used to conduct financial analysis. These include horizontal analysis, vertical analysis, ratio analysis, trend analysis, and cost-volume-profit analysis.

Financial Ratio Analysis

Financial ratio analysis is a way to analyze the performance of a business. It can be used by investors to determine the health of a company, as well as by managers to monitor their own business and investment strategies.

The financial ratios used in this analysis are derived from information gathered from different line items on a company’s financial statements. They provide insight into a company’s profitability, liquidity, leverage, and asset usage and help compare its performance to others in the same industry.

Ratios are standardized tools for comparing companies and industries, offering a clearer picture of a company’s strengths and weaknesses than the raw numbers on its financial statements. They can also be used to identify opportunities for improvement by tracking them over time.

Financial Forecasting

Financial forecasting is a vital tool for business planning and financial management. It evaluates the company’s past performance and market trends to predict how it will perform.

It also gauges where to allocate resources, allowing you to position the company for growth. It can be used to create budgets and projections on a quarterly or yearly basis, depending on the numbers being tracked.

There are two main types of forecasting methods – quantitative and qualitative. The quantitative method relies on historical data to predict, while the qualitative approach uses assumptions based on experience and understanding of causal relationships.

Valuation Analysis

Valuation analysis determines the theoretically correct value of a company, investment, or asset. It is used for various purposes, including M&A, strategic planning, capital financing, and investing in securities.

There are several methods and ratios used to perform valuation analysis. These include balance sheet calculations, discounted cash flow, and comparable company analyses.

The most common method is the discount cash flow (DCF) analysis, which estimates a business’s unlevered free cash flow and discounts it back to its present value at its weighted average cost of capital. However, this method can be tricky because it relies on terminal value, which can vary based on assumptions about future growth and discount rates.