What is Financial Analysis?
Financial Analysis can be understood as the process of complex business evaluation to assess and find out about the viability and profitability of an enterprise. Financial analysis can also be applied to a specific project or business segment to determine if it’ll be a profitable opportunity to pursue based on various financial parameters. A business can also be judged on its liquidity and solvency aspects using various financial analysis techniques by the analysts.
Financial analysis is often used by businesses to build financial policies for the firm, predict economic trends, identify profitable investment avenues, frame long-term business plans based on calculated trends. One of the mainstream ways to do financial analysis is using u ratios that are calculated using the financial statements and are compared with the historical ratios of the firm to evaluate the performance.
Different Types Of Financial Analysis
In the traditional sense, financial analysis can be categorised under two categories - Fundamental financial analysis and Technical financial analysis. If we go deeper into the categories it has multiple dimensions, for an example, (based on modus operandi) it can be categorised under Horizontal analysis and Vertical analysis. Based on entities involved it can be categorised as Inter-firm analysis and Intra-firm analysis, based on time horizon we can classify it under Short-term analysis and Long-term analysis. There are other such bases on which we can divide and categorise the types of financial analysis. Let’s delve deeper into the broader category that includes Fundamental analysis and Technical analysis.
The concept of fundamental analysis is built on the grounds of finding the intrinsic value of the business or the stocks. It is carried out to find whether the stocks that are trading currently in the market reflect the true value of the business or not. At the end of the fundamental analysis, analysts rate the stocks as undervalued or overvalued. It is rated as undervalued when the intrinsic value is more than the price of the stock in the market, meaning that it’ll be beneficial to buy it. Overvalued means the exact opposite, it means that the stocks are overly priced in the market and the actual value is lower.
Fundamental analysis is carried out by calculating various ratios for the business from the data obtained using the financial statements. Ratio analysis takes a holistic approach and calculates metrics like earning per share, debt to equity ratio, liquidity ratio, etc. In addition to this, the process of fundamental analysis also includes doing a thorough financial and economic review of the organisation to arrive at a meaningful conclusion that factors in all aspects of financial viability.
Technical analysis is a method of financial analysis that is used to evaluate the Securities being traded. This approach has a different take to analyze the financial viability of the firm. It relies on statistics generated from the market to do the analysis, like using the charts and patterns of trading to conclude the performance. The technical analysis is about making predictions about the movement of the market prices of the security by taking the historical price movements into account. The market price is the sole determinant here instead of the internal performance data of the firm. It does not evaluate the intrinsic value of the firm. The major assumption here is that the price trends are likely to repeat themselves. The major emphasis here is to find out the right time to buy or sell a security based on past and current price movements.
Broadly speaking, there are two types of financial analysis techniques - Technical analysis and Fundamental analysis. One is focused on finding the intrinsic value and the second is focused on predicting future trends.