Financial analysis

Financial analysis refers to an assessment of the viability, stability and profitability of a business, sub-business or project.

It is performed by professionals who prepare reports using ratios that make use of information taken from financial statements and other reports. These reports are usually presented to top management as one of their bases in making business decisions. Based on these reports, management may:

*Continue or discontinue its main operation or part of its business;

*Make or purchase certain materials in the manufacture of its product;

*Acquire or rent/lease certain machineries and equipments in the production of its goods;

*Issue stocks or negotiate for a bank loan to increase its working capital.

*Make decisions regarding investing or lending capital
*other decisions that allow management to make an informed selection on various alternatives in the conduct of its business.

Goals

Financial analysts often assess the firm's:

1. Profitability- its ability to earn income and sustain growth in both short-term and long-term. A company's degree of profitability is usually based on the income statement, which reports on the company's results of operations;

2. Solvency- its ability to pay its obligation to creditors and other third parties in the long-term;
3. Liquidity- its ability to maintain positive cash flow, while satisfying immediate obligations;

"Both 2 and 3 are based on the company's balance sheet, which indicates the financial condition of a business as of a given point in time."

4. Stability- the firm's ability to remain in business in the long run, without having to sustain significant losses in the conduct of its business. Assessing a company's stability requires the use of both the income statement and the balance sheet, as well as other financial and non-financial indicators.

Methods

Financial analysts often compare financial ratios (of solvency, profitability, growth...):

* Past Performance: Across historical time periods for the same firm (the last 5 years for example),

* Future Performance: Using historical figures and certain mathematical and statistical techniques, including present and future values, This extrapolation method is the main source of errors in financial analysis as past statistics can be poor predictors of future prospects.

* Comparative Performance: Comparison between similar firms.

These ratios are calculated by dividing a (group of) account balance(s), taken from the balance sheet and / or the income statement, by another, for example :

:"Net profit / equity = return on equity

:"Gross profit / balance sheet total = return on assets

:"Stock price / earnings per share = P/E-ratio

Comparing financial ratios are merely one way of conducting financial analysis. Financial ratios face several theoretical challenges:
* They say little about the firm's prospects in an absolute sense. Their insights about relative performance require a reference point from other time periods or similar firms.
* One ratio holds little meaning. As indicators, ratios can be logically interpreted in at least two ways. One can partially overcome this problem by combining several related ratios to paint a more comprehensive picture of the firm's performance.
* Seasonal factors may prevent year-end values from being representative. A ratio's values may be distorted as account balances change from the beginning to the end of an accounting period. Use average values for such accounts whenever possible.
* Financial ratios are no more objective than the accounting methods employed. Changes in accounting policies or choices can yield drastically different ratio values.
* They fail to account for exogenous factors like investor behavior that are not based upon economic fundamentals of the firm or the general economy (fundamental analysis) [ [http://www.netmba.com/finance/financial/ratios/ Financial Ratios ] ] .

See also

*Business valuation
*Fair value
*Fundamental analysis
*Optimism bias
*Reference class forecasting
*Return on capital
*Stock valuation
*Financial planning
*FRICTO analysis

Ratios

*PE ratio
*PEG ratio

Notes

External links

* [http://www.sfaf.com] SFAF - the French Society of Financial Analysts
* [http://www.aciia.org] ACIIA - Association of Certified International Investment Analysts
* [http://www.effas.com] EFFAS - European Federation of Financial Analysts Societies


Wikimedia Foundation. 2010.

Look at other dictionaries:

  • financial analysis — Analysis of a company s financial statement, often by financial analysts. Bloomberg Financial Dictionary * * * financial analysis financial analysis ➔ analysis * * * financial analysis UK US noun [U] FINANCE ► the study of financial information… …   Financial and business terms

  • Financial Analysis — The process of evaluating businesses, projects, budgets and other finance related entities to determine their suitability for investment. Typically, financial analysis is used to analyze whether an entity is stable, solvent, liquid, or profitable …   Investment dictionary

  • Financial Analysis Auditing Compliance Tracking System — ( FACTS) The National Futures Association s computerized system of maintaining financial records of its member firms and monitoring their financial conditions. Chicago Board of Trade glossary …   Financial and business terms

  • Misleading financial analysis — Financial analysis of an organization is misleading when it is used to misrepresent the organization, its situation or its prospects. This type of deceit is sometimes used to obtain money by misdirecting people to invest in a stock market bubble …   Wikipedia

  • Dynamic financial analysis — Key Uses Business mix Reinsurance Asset Allocation Profitability Solvency Sensitivity Dependency Elements …   Wikipedia

  • International Review of Financial Analysis — The International Review of Financial Analysis (IRFA) is an academic journal in the field of finance. It has a focus on international research.External links* http://www.sciencedirect.com/science/journal/10575219 *… …   Wikipedia

  • Z-Score Financial Analysis Tool — The Z score formula for predicting bankruptcy was developed in 1968 by Edward I. Altman, a financial economist and professor at the Leonard N. Stern School of Business at New York University. The Z score is a multivariate formula that measures… …   Wikipedia

  • Financial modeling — is the task of building an abstract representation (a model) of a financial decision making situation.[1] This is a mathematical model designed to represent (a simplified version of) the performance of a financial asset or a portfolio, of a… …   Wikipedia

  • analysis — a‧nal‧y‧sis [əˈnælss] noun analyses PLURALFORM [ siːz] [countable, uncountable] 1. a careful examination of something in order to understand it better: • The researchers carried out a detailed analysis of recent trends in share prices. •… …   Financial and business terms

  • Financial intelligence — (FININT) is the gathering of information about the financial affairs of entities of interest, to understand their nature and capabilities, and predict their intentions. Generally the term applies in the context of law enforcement and related… …   Wikipedia


Share the article and excerpts

Direct link
Do a right-click on the link above
and select “Copy Link”

We are using cookies for the best presentation of our site. Continuing to use this site, you agree with this.