Financial Analysis is the test of the financial health of a company. We must have prepared our financial statements such as the statement of financial position, statement of profit or loss and other comprehensive income, and statement of cash flow to mention a few. These financial statements are prepared by the accountant of the organization after these statements have been prepared the next step will now be for the financial reports to be audited to see how reliable it is. Once the financial statements have been audited it is for you to make decisions based on the financial reports, however, in making your decision you need to identify the problem, objective, criteria, alternatives, and financial analysis and then you conclude.
How do you know what you are looking out for in the financial reports? Remember that there is an objective, the objective could be to maximize profits, and create value just to mention a few. As a manager in an organization, how do you measure growth? Growth can be measured through the financial report by dividing cost by income. Financial statements are general purpose statements and as such it must be clear what is the purpose of your analysis. Before you analyze the financial statement, you must understand the business and its environment, the quality of the analysis depends on effective analysis of the business itself and how well you understand the business in terms of product and management.
Different factors that can affect a business are:
Global forces
Distribution
Governance
Tax authorities
Stockholders
Regulators
Types of Financial Analysis Tools
Common Sizing
Comparative Analysis
Ratio Analysis
Benchmarking
Common Size Statements: For instance, if you have two companies A and B. The revenue for A is 100 Million Naira and the revenue for B is 10 Million Naira from the face value company A has the largest revenue also their cost if company A has 80 Million Naira and company B has 5 Million Naira again company A has the higher cost. Since we cannot determine whether company A or company B has the higher profit we would bring everything to the same scale. For instance, on the balance sheet, you will divide all the items by the total assets while on the income statement you will divide all the items by the revenue.
This financial analysis tool cannot be used to analyze the statement of cash flow, it can only be used to analyze the balance sheet and the income statement. This method of bringing everything to the same scale is called an Analytical Review.
Comparative Analysis: This is a financial analysis tool that can be used to compare a minimum of two years’ financial reports that is the current year and the prior year.
Trend Analysis: We can use the trend percentages to construct a graph so we see the trend of an organization over time. We can use the income statement to show a trend analysis.
Financial Ratios/Ratio Analysis: This financial analysis tool can be used by a manager within an organization to compare its strengths and weaknesses. It can also be used to compare industries or a single company and its industry average. There are various types of financial ratios such as:
Liquidity Ratio: This is used to measure the ability of a company to pay off its current obligations.
Efficiency Ratio: This is used to measure the performance of the business.
Profitability Ratio: This is used to measure the operating efficiency of the company. A measure of how much profit activities generate.
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