Financial Analysis Laws and Conventions
Every company’s projects, goals, budgets, funding,
liabilities, strengths and other such financial aspects need to be examined
periodically as an important key to a company’s retrospective features and
future betterment and assessment of potential of business and productivity. Everything needs performance in a very legal way keeping relevant laws and rules in mind. This course of examination would be termed as Financial Analysis in the corporate and banking language.
Financial Analysis is an important feature for companies as it enables the figuring out of the potentials of the company’s performance. It enables regulating authorities and governments to ensure that companies are adhering to the set standards. It helps in maintenance of financial stability and health of the company’s life.
An analysis of instruments
for investment can be done by external company organs as well as the internal
parties.
Analyses are the insurance and performance of the firm. It gives a skeleton of the company's accounts and financial figures giving experts of the company ideas and suggests strategies for the betterment of the company and its progress and increased profitability.
This aids in predicting and figuring out future earnings and thus accordingly adjust current expenses, funding and helps in the calculating the taxation for the firm as well.
It makes the
current financial stand clear and explicit and thus helps have an idea of the
requirements for the firm in future.
Why is financial analysis important?
When a financial analysis is conducted in a running business, the managers will get to know how the business is performing, whether it is bringing in expected profits or if it needs further improvements to earn profit.
The direction in which a business should be taken can be decided through
these analysis reports. Every major company, business or a project has its own financial analyst to constantly
study their finances at every step and direct them accordingly.
Analysts normally go through the numbers involved in any business or project. They usually aim to achieve specific goals through each financial analysis.
Often it is conducted to understand the economic trend of a
certain business. Or it could be undertaken to decide on long term goals or
financial plans for a firm. It can also be helpful setting a financial policy
for a company.
Another aspect of a financial analysis is the historical figures and data. Analysts make use of the past financial statuses and cash flow of the given entity to study the present scenario better and thus generate plans for future. Such plans could seriously determine the health of any company.
The information procured through the analysis is used in making
critical decision that will determine the future of any entity.
Sometimes, financial analysis is conducted before mergers or acquisitions to decide whether or not it will be profitable to buy the company off. It can also help in figuring out the amount to be invested per share.
Basically, financial
analysis is an assessment conducted before taking any major business decisions.
What are the elements of financial analysis?
There are five key elements to any financial analysis. These
elements are of primary concern in analyzing the financial statuses of
organizations. They are as follows:
1. Revenue
For any business of seriousness, revenue acts as the prime
source of money. In long term plans, the quality, quantity and timing of
revenues can play major roles. While considering this, there are several facets
that come under the umbrella term 'revenue
'. They include:
·
Revenue
growth
·
Revenue
concentration
·
Revenue
per employee
Revenue per employee is a ratio which measures the
productivity of any business. For the ideal growth of a business, it is
desirable that no single customer should hold more than 10% of the total
revenue of the firm.
2. Profits
Profit can be sub-divided into three
categories:
Ø Gross profit margin
A good gross profit means your company is strong enough to suffer
comparative degree of losses or downfalls in the form of revenues or expenses.
Ø Operating profit margin
The higher the operating profit margins of the company are,
the better will be your company financially. It shows your company's ability to
make a profit regardless of how the operations are financed.
Ø Net profit margin
This is the excess of profit that is available to be given away as
dividends or investors or to owners. It can also be utilized for any
reinvestments within the firm.
3. Operational Efficiency
This refers to the efficiency with which the managers are
making use of the resources available before them. A lack of operational
efficiency will mean that the company is having low growth rates with little profits.
4. Capital Efficiency and Solvency
Capital efficiency and solvency are the factors that might
interest potential lenders, banks or investors of your company. The factors
affecting the efficiency and solvency are:
·
Return
on equity which is the returns that any investor is receiving from the business.
·
Debt
to equity which is a track of the leverages you are using to run the business.
5. Liquidity
A detailed study of your company’s liquidity explains your ability to bring out the necessary cash to cover everyday expenses. If the liquidity of a firm falls low, there is no amount of revenue or growth that can compensate the loss.
The two factors to be considered while analyzing the
liquidity of a firm are:
·
Current
ratio
·
Interest
coverage
Financial Statements Analysis / Types of Financial Analysis
Horizontal analysis
In this method of analyzing Company’s financial records such as balance sheet, cash inflow etc. will be studied and compared for a period of consecutive time span also called as the reporting periods.
The observed data
is depicted in a horizontal manner for their corresponding year for a range of
years and this figure is then compared with the year with which the study began
also called as the Base Year.
Vertical Analysis
It’s the analysis of data for a particular period but
pertaining to various aspects of the financial statement of the organization.
It's also called as the Static
Analysis as its focal point centers on the data of only one year.
This method analyses the structural relationship between
various factors of a financial statement. Here each item is represented by
means of percentage or proportionate ratio of the base figure selected from the
same statement.
The size statements and proportional ratios are considered as
important tools in analysis. This method helps in understanding the expenses
over an income statement put up in percentile of the net sales.
Dynamic Analysis
The depiction of data can be also in the graphical mode. Since the study records the data over a period it called as the Dynamic Analysis.
This kind of analysis helps to understand the trends and patterns of
different kinds taken up in the working of the company and its effect and
efficiency and if required then what modifications to be made to counter the
downsides of the currently deployed systems.
Internal Analysis
Serves the purpose of vigilance over the finances and operations as well as resultant performances of the company and it’s taken up by the internal organs such as the management itself.
This analysis is more
efficient and authentic as it’s executed by the internal members of the
company.
Cross Sectional Analysis
It comprises of the analysis of different companies from the same industry as in the competitor entities of the company subject to analysis for an immediate time frame.
It is also called as the inter firm analysis.
External Analysis
General public and credit agencies, investors, potential
investors, creditors, potential creditors, and the government agencies conduct
this method of analysis though it serves only limited purpose as they don’t
have any source to amass the internal data and hidden accounts of the company.
Hence the external analysis result is more or less derived
from the data observations from the published financial statements. Nonetheless
the government in the near past has directed companies to put up more detailed
information subject to external analysis.
Time Series Analysis
It comprises of analyzing the outputs of the same company for
a vast time frame for understanding the success of implemented strategies and
so on.
Financial analysis ratios
Analysts have developed a number of ratios to make their job easier in making comparisons between various financial entities of companies, organizations and projects.
These are broadly classified as Activity ratios, Liquidity ratios, Solvency ratios and Profitability ratios.
Each of these ratios has sub
divisions in them which facilitate a thorough analysis of every factor
regarding a business for a total and sweeping investigation of the finances.
Activity Ratio
The Activity ratios are in fact turnover ratios. They point to the efficiency with which
assets are used inside a company. This gives the investors an idea of the
proceedings and expenses within a company. They are:
1. Inventory turnover
This shows the efficiency with which inventories are sold off in a business. If the inventory turnover is higher than the industry an average, it means the business is on a path of growth.
On
the other hand, a too high inventory turnover may be indicative of the
inefficiency of the business to meet with its increasing demands.
2. Payables turnover
This is a measure that shows how fast
the company is paying off the bills it owes to third parties. With a payables
turnover higher than the industry’s average, then it means the company
is well off to make its own payments.
3. Receivables turnover
Receivables turnover is defined as a
measure of how quickly and efficiently a company collects on its outstanding
bills.
4. Asset turnover
Asset turnover is a measure of the
company’s efficiency in converting its assets
into revenue.
Liquidity Ratio
The liquidity ratios are the most widely used of ratios in a financial analysis, second only to profitability ratios. They measure a company’s ability to meet its shirt term obligations. Hence these are the ratios that creditors usually look for.
There
are three sub-divisions to liquidity ratios. They are:
·
Current
ratio
A current ratio compares the current
assets in possession of a company with the current liabilities with it. This
finds out whether or not the business can pay off its debts through
liquefaction of its assets in case of an emergency.
·
Quick ratio
This ratio compares the cash,
short-term marketable securities and accounts receivable to current
liabilities.
·
Cash ratio
The cash ratio is the ratio between
the cash and easy liquefied assets in a company to the company’s current liabilities. The company is
considered to be profiting if the ratio is higher than 1.
Solvency Ratios
These ratios measure a company’s ability to meet its long term liabilities. The
ratios counted as solvency ratios are as follows:
Ø Interest coverage ratios
This is also known as times interest
earned. This compares a company’s cash in-flow with the payments that are made towards
interests.
Ø Debt-to-equity ratio
This ratio shows company’s debt capital versus its equity
capital.
Ø Debt-to-assets ratio
The debt-to-assets ratios, as its
name suggests, is measure of the percentage of assets that are financially
supported by debts.
Ø Debt-to-capital ratio
Similar to the debt to assets ratio,
the debt-to-capital ratio measures the percentage of a company’s capital that is financed by debts.
Profitability Ratios
The profitability ratios of a company examine its ability to
earn profitable returns. It is always advisable for a firm to compare its
margin ratios with those of its competitors and the industry averages. The
various types of profitability ratios are:
Ø Gross profit margin
A simple ratio between the gross incomes
of a company to the net revenue it pays. It is said that the gross profit
margin is a reflection of the company’s pricing decisions and product
costs.
Ø Operating profit margin
This ratio shows the difference
between the operation income and the net revenue. The operation income of a
company can found when yours subtract the operational expenses from the gross
income of the company.
Ø Net profit margin
The comparison between gross profit and operating profit margin.
What are Financial analysis tools?
Three major documents are used in creating a financial analysis report. These
are tools anyone or any analyst would need to conduct a financial analysis:
Cash flow statement
A cash flow statement is a lot similar to an income state that in that both these statements record the performance of a company over a given period of time.
It gives the exact statement of the income generated by
the company during the given period. It gives a clearer picture of the
company’s ability to manage its expenses.
Income statement
Unlike a balance sheet, an income statement gives information about the financial performance of any company over a specific period of time. It stresses more upon the company’s future viability that it’s present financial stability.
The most important factors considered while creating an income statement are revenues earned, expenses met with and the overall profit or loss incurred.
The revenues further include royalties, interests, and those
of sales.
Balance sheet
A balance sheet is an extensive documentation of all the assets available for trading within a business, especially the financial and the physical resources. It is, however, a mere state that of the assets and does not include information about how efficiently these assets are being used by the managements.
Assets and liabilities form the major content of balance sheets, in general. Thus, a balance sheet
shows the current financial state of a company only.
After going through this content we will be able to:
·
Understand
Financial Analysis Meaning
·
Thoroughly
understand Financial Analysis and Control
·
Understand
Financial Analysis Ratios
·
Make
better use of Financial Analysis
Tools
·
Make
Financial Analysis of a Company
·
Determine
best use of Money
·
Able
to select optimum Financial Analysis Course
·
Able
to make appropriate presentation or financial analysis ppt help
·
Find
help as regards Financial Analysis Project Management
The above list is not so far-reaching. There shall be several
benefits after thorough study of this article and on other pages.
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