Financial Analysis and Accounting Basics
Financial analysis involves using financial data to assess a company’s performance
and make recommendations about how it can improve going forward. Financial
Analysts primarily carry out their work in Excel, using a spreadsheet to analyze
historical data and make projections of how they think the company will perform in
the future. This guide will cover the most common types of financial analysis
performed by professionals.
Financial analysis is the process of evaluating businesses, projects, budgets, and
other finance-related transactions to determine their performance and suitability.
Typically, financial analysis is used to analyze whether an entity is
stable, solvent, liquid, or profitable enough to warrant a monetary investment.
KEY TAKEAWAYS
•If conducted internally, financial analysis can help managers make future business
decisions or review historical trends for past successes.
•If conducted externally, financial analysis can help investors choose the best
possible investment opportunities.
•Fundamental analysis and technical analysis are the two main types of financial
analysis.
•Fundamental analysis uses ratios and financial statement data to determine the
intrinsic value of a security.
•Technical analysis assumes a security's value is already determined by its price,
and it focuses instead on trends in value over time.
Understanding Financial Analysis
Financial analysis is used to evaluate economic trends, set financial policy, build
long-term plans for business activity, and identify projects or companies for
investment. This is done through the synthesis of financial numbers and data. A
financial analyst will thoroughly examine a company's financial statements—
the income statement, balance sheet, and cash flow statement. Financial analysis
can be conducted in both corporate finance and investment finance settings.
One of the most common ways to analyze financial data is to calculate ratios
from the data in the financial statements to compare against those of other
companies or against the company's own historical performance.
For example, return on assets (ROA) is a common ratio used to determine how
efficient a company is at using its assets and as a measure of profitability. This
ratio could be calculated for several companies in the same industry and
compared to one another as part of a larger analysis.
Corporate Financial Analysis
In corporate finance, the analysis is conducted internally by the accounting
department and shared with management in order to improve business decision
making. This type of internal analysis may include ratios such as net present
value (NPV) and internal rate of return (IRR) to find projects worth executing.
Many companies extend credit to their customers. As a result, the cash receipt
from sales may be delayed for a period of time. For companies with large
receivable balances, it is useful to track days sales outstanding (DSO), which
helps the company identify the length of time it takes to turn a credit sale into
cash. The average collection period is an important aspect in a company's
overall cash conversion cycle.
QUANTITY SURVEYOR / ESTIMATOR
SAFETY ENGINEER
SURVEY ENGINEER
PLANNING ENGINEER
Types of Financial Analysis
There are two types of financial analysis: fundamental analysis and technical
analysis.
Fundamental Analysis
Fundamental analysis uses ratios gathered from data within the financial
statements, such as a company's earnings per share (EPS), in order to determine the
business's value. Using ratio analysis in addition to a thorough review of economic
and financial situations surrounding the company, the analyst is able to arrive at
an intrinsic value for the security. The end goal is to arrive at a number that an
investor can compare with a security's current price in order to see whether the
security is undervalued or overvalued.
Technical Analysis
Technical analysis uses statistical trends gathered from trading activity, such
as moving averages (MA). Essentially, technical analysis assumes that a security’s
price already reflects all publicly available information and instead focuses on
the statistical analysis of price movements. Technical analysis attempts to
understand the market sentiment behind price trends by looking for patterns and
trends rather than analyzing a security’s fundamental attributes.
Why Is Financial Analysis Useful?
The goal of financial analysis is to analyze whether an entity is stable, solvent, liquid,
or profitable enough to warrant a monetary investment. It is used to evaluate
economic trends, set financial policy, build long-term plans for business activity, and
identify projects or companies for investment.
A key area of corporate financial analysis involves extrapolating a company's past
performance, such as net earnings or profit margin, into an estimate of the
company's future performance. This type of historical trend analysis is beneficial to
identify seasonal trends.
For example, retailers may see a drastic upswing in sales in the few months leading
up to Christmas. This allows the business to forecast budgets and make decisions,
such as necessary minimum inventory levels, based on past trends.
Investment Financial Analysis
In investment finance, an analyst external to the company conducts an analysis for
investment purposes. Analysts can either conduct a top-down or bottom-up
investment approach. A top-down approach first looks
for macroeconomic opportunities, such as high-performing sectors, and then drills
down to find the best companies within that sector. From this point, they further
analyze the stocks of specific companies to choose potentially successful ones as
investments by looking last at a particular company's fundamentals.
A bottom-up approach, on the other hand, looks at a specific company and
conducts similar ratio analysis to the ones used in corporate financial analysis,
looking at past performance and expected future performance as investment
indicators. Bottom-up investing forces investors to consider microeconomic factors
first and foremost. These factors include a company's overall financial health,
analysis of financial statements, the products and services offered, supply and
demand, and other individual indicators of corporate performance over time.
