Laws and Customs of Finance Analysis

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 companys 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 companys 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.

Infographics Chart showing Financial Analysis Procedure



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 industrys 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 companys 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 companys 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 companys current liabilities. The company is considered to be profiting if the ratio is higher than 1.

Solvency Ratios

These ratios measure a companys 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 companys cash in-flow with the payments that are made towards interests.

Ø Debt-to-equity ratio

This ratio shows companys 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 companys 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 companys 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 companys 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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