Financial analysis is an essential tool used by investors and analysts to evaluate the financial health of a company. It involves analyzing the company's financial statements, such as the balance sheet, income statement, and cash flow statement, to determine its performance and suitability for investment. There are several types of financial analysis used in accounting, including vertical analysis, horizontal analysis, ratio analysis, sensitivity analysis, and fundamental analysis. Each type of analysis has its own place and importance in financial analysis; however, this article will focus on vertical analysis (the most commonly used), horizontal analysis, ratio analysis and sensitivity analysis.
Vertical analysis is a type of financial statement analysis that shows each item on a statement as a percentage of a base figure. For example, in an income statement, you can analyze each item and divide it by gross sales to see the percentage of each item as gross sales. Similarly, on the balance sheet, you can show each item as a percentage of total assets or total liabilities. Vertical analysis is useful for comparing different items on the same financial statement over time. Horizontal analysis is another type of financial statement analysis that interprets the change in financial statements over two or more accounting periods based on historical data.
This type of analysis is useful for comparing different items on the same financial statement between different periods. For example, you can compare the net income of a company from one year to the next to see if it has increased or decreased. Ratio analysis is a type of financial statement analysis that uses ratios collected from financial statement data to determine the value of a company. By using ratio analysis, in addition to a thorough review of the economic and financial situation surrounding the company, the analyst can arrive at an intrinsic value for security. The ultimate goal is to arrive at a number that the investor can compare with the current price of a security to see if the security is undervalued or overvalued. Sensitivity analysis is a type of financial statement analysis that looks at how changes in certain variables will affect a company's performance.
This type of analysis is useful for predicting how changes in certain variables will affect a company's future performance. For example, you can use sensitivity analysis to predict how changes in interest rates will affect a company's profits. Fundamental analysis is another type of financial statement analysis that uses ratios collected from financial statement data to determine the value of a company. The ultimate goal is to arrive at a number that the investor can compare with the current price of a security to see if the security is undervalued or overvalued. In general, financial analysis is used to analyze whether an entity is stable, solvent, liquid, or profitable enough to justify a monetary investment. Financial analysts use these types of analyses to assess economic trends, establish financial policies, create long-term plans for business activity, and identify projects or companies for investment. Variance analysis can be performed using standard cost.
The standard cost is an estimated cost determined by the company for the production of goods and services or for carrying out an operation under normal circumstances. Variance analysis helps entities avoid any gaps in their process and take corrective measures to avoid them. A key area of corporate financial analysis is extrapolating a company's past performance, such as net profits or profit margin, to an estimate of its future performance. To verify the viability of their decisions, analysts must perform profitability analyses to check their rate of return over given periods. Financial analysts use these types of analyses to assess economic trends, establish financial policies, create long-term plans for business activity, and identify projects or companies for investment. By using these types of analyses together with thorough reviews of economic and financial situations surrounding companies, analysts can arrive at accurate assessments of their intrinsic values and make informed decisions about investments.
