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Financial analysis (also referred to as financial statement analysis or accounting analysis or Analysis of finance) refers to an assessment of the viability, stability, and profitability of a
business Business is the activity of making one's living or making money by producing or buying and selling products (such as goods and services). Simply put, it is "any activity or enterprise entered into for profit." Having a business name A trad ...

business
, sub-business or
project A project (or program) is any undertaking, carried out individually or collaboratively and possibly involving research or design, that is carefully plan A plan is typically any diagram or list of steps with details of timing and resources, us ...

project
. It is performed by professionals who prepare reports using
ratio In mathematics, a ratio indicates how many times one number contains another. For example, if there are eight oranges and six lemons in a bowl of fruit, then the ratio of oranges to lemons is eight to six (that is, 8∶6, which is equivalent to ...

ratio
s and other techniques, that make use of information taken from
financial statements Financial statements (or financial reports) are formal records of the financial activities and position of a business, person, or other entity. Relevant financial information is presented in a structured manner and in a form which is easy to un ...
and other reports. These reports are usually presented to top management as one of their bases in making business decisions. Financial analysis may determine if a business will: *Continue or discontinue its main operation or part of its business; *Make or purchase certain materials in the
manufacture Manufacturing is the production of goods In economics Economics () is the social science that studies how people interact with value; in particular, the Production (economics), production, distribution (economics), distribution, and Co ...
of its product; *Acquire or rent/lease certain machineries and equipment in the production of its goods; *Issue
shares In financial markets A financial market is a market in which people trade financial securities and derivatives at low transaction costs. Some of the securities include stocks and bonds, raw materials and precious metals, which are known ...
or negotiate for a bank
loan In finance Finance is the study of financial institutions, financial markets and how they operate within the financial system. It is concerned with the creation and management of money and investments. Savers and investors have money avai ...
to increase its
working capital Working capital (abbreviated WC) is a financial metric which represents available to a business, organization, or other entity, including governmental entities. Along with fixed assets such as plant and equipment, working capital is considered a ...
; *Make decisions regarding investing or lending capital; *Make other decisions that allow management to make an informed selection on various alternatives in the conduct of its business.


Firm level analysis

Financial analysts often assess the following elements of a firm: # Profitability - its ability to earn income and sustain growth in both the short- and long-term. A company's degree of profitability is usually based on the
income statement An income statement or profit and loss accountProfessional English in Use - Finance, Cambridge University Press, p. 10 (also referred to as a ''profit and loss statement'' (P&L), ''statement of profit or loss'', ''revenue statement'', ''statemen ...
, which reports on the company's results of operations; # Solvency - its ability to pay its obligation to
creditor A creditor or lender is a party 300px, '' Hip, Hip, Hurrah!'' (1888) by Peder Severin Krøyer, a painting portraying an artists' party in 19th century Denmark A party is a gathering of people who have been invited by a host A host is ...

creditor
s and other third parties in the long-term; # Liquidity - its ability to maintain positive
cash flow A cash flow is a real or virtual movement of money Image:National-Debt-Gillray.jpeg, In a 1786 James Gillray caricature, the plentiful money bags handed to King George III are contrasted with the beggar whose legs and arms were amputated, in ...
, while satisfying immediate obligations; # 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. Both 2 and 3 are based on the company's
balance sheet In financial accounting Financial accounting is the field of accounting Accounting or Accountancy is the measurement, processing, and communication of financial and non financial information about economic entity, economic entities such a ...

balance sheet
, which indicates the financial condition of a business as of a given point in time.


Techniques

Financial analysts often compare
financial ratios A financial ratio or accounting ratio is a relative magnitude of two selected numerical values taken from an enterprise's financial statements. Often used in accounting, there are many standard ratios used to try to evaluate the overall financial ...
(of
solvency Solvency, in finance Finance is the study of financial institutions, financial markets and how they operate within the financial system. It is concerned with the creation and management of money and investments. Savers and investors have money ...
,
profitability An economic profit is the difference between the revenue a has received from its outputs and the s of its inputs. Unlike an , an economic profit takes into account both a 's and costs, whereas an accounting profit only relates to the explici ...
, growth, etc.): * 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 In mathematics, extrapolation is a type of estimation, beyond the original observation range, of the value of a variable on the basis of its relationship with another variable. It is similar to interpolation, which produces estimates between known ...

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 Comparing financial ratios is merely one way of conducting financial analysis. Financial analysts can also use percentage analysis which involves reducing a series of figures as a percentage of some base amount. For example, a group of items can be expressed as a percentage of net income. When proportionate changes in the same figure over a given time period expressed as a percentage is known as horizontal analysis. Vertical or common-size analysis reduces all items on a statement to a "common size" as a percentage of some base value which assists in comparability with other companies of different sizes. As a result, all Income Statement items are divided by Sales, and all Balance Sheet items are divided by Total Assets. Another method is comparative analysis. This provides a better way to determine trends. Comparative analysis presents the same information for two or more time periods and is presented side-by-side to allow for easy analysis.


Theoretical challenges

Financial ratios A financial ratio or accounting ratio is a relative magnitude of two selected numerical values taken from an enterprise's financial statements. Often used in accounting, there are many standard ratios used to try to evaluate the overall financial ...
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 Policy is a deliberate system of guideline A guideline is a statement by which to determine a course of action. A guideline aims to streamline particular processes according to a set routine or sound practice. Guidelines may be issued by an ...

policies
or choices can yield drastically different ratio values.Financial Ratios
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See also

*
Business valuation Business valuation is a process and a set of procedures used to estimate the economic value In economics Economics () is the social science that studies how people interact with value; in particular, the Production (economics), product ...

Business valuation
*
Economic base analysisEconomic base analysis is a theory that posits that activities in an area divide into two categories: basic and nonbasic. Basic industries are those exporting from the region and bringing wealth from outside, while nonbasic (or service) industries su ...
*
Financial accounting Financial accounting is the field of accounting Accounting or Accountancy is the measurement, processing, and communication of financial and non financial information about economic entity, economic entities such as businesses and corporat ...
* Fundamental basis of financial statements (going concern) *
Financial forecast A financial forecast is an estimate of future financial outcomes for a company A company, abbreviated as co., is a Legal personality, legal entity representing an association of people, whether Natural person, natural, Legal personality, legal o ...
* Financial statements analysis and model


Notes


External links


SFAF - the French Society of Financial Analysts

ACIIA - Association of Certified International Investment Analysts

EFFAS - European Federation of Financial Analysts Societies
{{DEFAULTSORT:Financial Analysis Valuation (finance) ja:証券アナリスト