As a financial leader, your decisions and judgements rely on data analysis and accurate insights to move forward with confidence. Financial data analysis is a pivotal part of your role and the importance of financial statements cannot be overlooked.
In this article, we will share techniques of financial statement analysis and look at the types of financial data analysis that is required for optimal operations.
Financial analysis is the process of using a company’s financial data to assess its performance and gather insights for decision-making. With access to financial analysis, a company is able to evaluate economic trends, develop long-term business plans, set financial policy, and determine where to make good investments.
Financial statement analysis may be performed internally or externally and can be used for internal stakeholders and investors alike.
Financial analysis can be performed in a corporate finance setting, as well as in an investment finance setting.
The process entails having a financial analyst examine the company’s financial statements, including the income statement, cash flow statement, and balance statement.
With this information, the analyst will compare it to financial data of other companies within the same industry or historical data to gauge how the company is performing.
While this can be performed manually through the use of spreadsheets, it can quickly become messy and error-prone. This is one of the main reasons why companies are turning to financial automation solutions to execute analysis in a streamlined, efficient, and accurate manner.
Financial analysis is used to answer very big questions. It can determine whether or not an entity is stable, liquid, solvent, or profitable enough for investors to deem it a favorable investment opportunity.
Financial analysis is also used to:
With access to financial analytics, a company’s stakeholders can also gain a deeper understanding of its creditworthiness, ability to generate wealth, and overall profitability. With this in-depth look at how the business is faring from a financial standpoint, business leaders also can assess if its operations are solid or need improvement.
Corporate financial analysis is performed by an entity’s internal accounting team. The results are then shared with management and stakeholders.
Internal corporate analysis may include calculations and ratios like net present value (NPV) and internal rate of return (IRR) to decide whether or not to move forward with a project or endeavor.
In most instances, corporate financial analysis will involve a historical review, too. For example, the accounting team will evaluate the company’s past performance by looking at its profit margin or net earnings, to name a few key performance indicators. With historical trend analysis, accounting teams can better predict, budget, and forecast.
Since accounting departments already have a lot on their plate, a financial automation solution can perform financial analytics to help accounting teams and leadership better plan for the future. With an automation solution, businesses no longer suffer from data silos or key person dependencies.
Rather than being bogged down performing manual and tedious work, the software streamlines workflows efficiently and accurately. Additionally, business leaders, statekolders, and personnel gain visibility into processes. Plus, advanced analytics can transform raw data into valuable insights to promote smart decision-making.
Investment financial analysis happens externally. It involves an analyst who reviews a company from the top-down or bottom-up to determine if it is a wise investment choice. With a top-down approach, analysts begin with a macroeconomic perspective and choose a strongly performing industry to then find the companies that are at the top of their game.
On the other hand, a bottom-up approach begins when the analyst has a specific company in mind. They’ll then conduct analysis, much like that which occurs in corporate financial analysis, to evaluate the company’s past as an indicator of its future potential performance.
There are two main techniques of financial analysis. They include:
Fundamental analysis is based on the use of ratio and is gathered by collected data within the company’s financial statements. Through the use of the data, the company’s value is extrapolated and the analysts determine the intrinsic value of a security.
The end goal is such that an investor can compare the security’s current price to determine if the price is undervalued or overvalued.
Technical analysis is based on statistical trends. Rather than trying to deduce the security’s price, technical analysis accepts its current price as is and focuses on price movements instead. It aims to understand market sentiments behind the security’s price trends to gain awareness of patterns.
We can create a financial analysis example based off of what’s happened in the real world.
Let’s say that Company A reported its earnings per share (EPS) to be $2.25 in 2021. The year prior, their EPS was $1.75. From fundamental analysis, a financial analyst would determine that the security’s intrinsic value is on the rise. As such, they may increase their forecast and provide a higher projected EPS for the next quarter.
We can get even more granular about financial data analysis by looking at the different types.
In many cases, a financial analysis will begin their work with the income statement. They can either perform vertical or horizontal analysis. Vertical analysis looks up and down at each line item to compare it to the overall revenue as a percentage. Horizontal analysis reviews the income statement in terms of the line items’ year-over-year change.
Balance sheet statement analysis is used to determine the operational efficiency of a business. It’s completed by comparing some items from the income statement to the company’s capital assets listed on the balance sheet.
Cash flow statement analysis helps to understand how cash moves in and out of the business within a certain time period. The three components to consider are cash from operations, cash from financing, and cash from investing. Investors tend to check this out to see if a business is cash flow positive and also, what its funding needs are.
Profitability analysis is one of the most advanced forms of analysis and is conducted by using a pyramid of ratios: return on equity (ROE) ratio, profitability, efficiency and leverage ratios, primary, secondary and tertiary tattoos, and dupont analysis.
As you can see, financial data analysis can become complex, tricky, and time-consuming. The use of financial automation tools ensures that data is accurate, timely, and cleansed before any analysis is performed. Then, depending on the tool, you can leverage it to execute analysis for you and gain insights from automated reports and customisable dashboards.
Without automation tools, finance departments are stuck doing everything manually, with the use of multiple spreadsheets and systems. Not only does it become hard to standardise processes, especially as your scale or operate remotely or with multiple offices, but it also means that when one key person is out of office, processes get stuck.
Automation software resolves these concerns as the tool pulls data from disparate sources, including legacy systems, and runs processes automatically.
They also free up time so that you skilled team members can focus their time on high-level tasks rather than repetitive tasks. Furthermore, with added visibility, everyone can keep track of processes and progress so that nothing slips through the cracks.
With the use of various financial statements and ratios, it can be confusing as to what to look for to determine a company’s financial performance.
Here’s a look at some of the most commonly used financial performance metrics for assessment purposes:
Financial data and financial statements must be up-to-date and accurate in order to make the most out of financial data analysis. With inaccurate data, you run the risk of making decisions based on information that doesn’t adequately represent your company’s financial performance.
That’s why so many companies trust financial automation solutions that can connect to multiple data sources and ensure data is always correct and reliable. Then, financial analysts can execute their duties to uncover trustworthy insights.
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