What are the Uses of Financial Analysis?
The financial analysis basically indicates the usage of financial data to assess the performance of a company and recommend how things can be improved in the future. The primary role of a financial analyst is to work in an excel sheet used for analysing historical data and accordingly make projections based on their perception of how the company will perform in the near future.
Four important types of financial analysis in an organization
1) Based on the material used :
(a) External analysis - This analysis is performed by people who are not directly associated with the firm and don’t have right to access the in-house accounting records of the company.
b) Internal analysis - This analysis is conducted by people who have permission to handle the in-house accounting records of a firm.
2) Based on modus operandi :
(a) Horizontal analysis - This refers to the evaluation of finance related data of a firm for many years. The figures in this type of analysis are reflected horizontally across many columns.
(b) Vertical analysis – This indicates the study of the connection of the different items reflecting in the financial statements in an accounting period.
3) Based on entities involved :
(a) Inter-firm analysis – This deals with the assessment of financial data of particular firm with its competitors in the same industry for a similar time frame.
(b) Intra-firm analysis -This analysis includes the assessment of the performance of a firm in for a definite period of time.
4) Based on the objective of analysis or time horizon :
a) Short-term analysis - This calculates the firm’s liquidity position, i.e. the ability of the company to meet its present needs.
(b) Long-term analysis - This involves the study of a firm’s capacity to meet the repayment schedules and interest costs in the long-term. Factors like profitability, solvency and stability are measured with the help of this analysis.
Different Uses of Financial Analysis
The various uses of financial analysis are as follows:
- Analysis of financial statements – Whenever a firm is interested in investing in a small business, the financial analysts then examines its past and present financial statements. The idea here is to determine the probable weaknesses and problem areas if any,to be discussed with the other company owners.
- Ratio analysis – This helps in comparing values within the company against other companies and the industry every year. It includes the liquidity ratio, debt ratio, etc. Business owners and management teams might use ratio analysis in their day-to-day planning to measure where they stand in the industry. If the ratio analysis shows that the company has more debt than other businesses in the same industry, the owner might be encouraged to pay off or reduce some loans.
- To analyse future performance - Financial analysts assist small businesses in their future planning. This planning involves the evaluation of the company's income statement, balance sheet and cash flow statement. This helps in interpreting the trends and identifying the strengths and weaknesses. By following the trends of the general economy the analyst can estimate how well the company will be able to fare in the coming years. Accordingly, they can plan the equipment to be purchased and take other initiatives.
- Making investment decisions – Expert financial analysts are able to make investment decisions and recommend ideas based on sound reasoning. Every company should have dedicated financial analysts who would keep a watch over the strengths and weaknesses of the company and advise the management accordingly. In some cases, they can also hire the services of financial consultants on a periodic basis.
Apart from financial managers, people from other walks of life can use financial analysis for their benefit. A credit manager can use it to examine the basic financial ratios of a prospective customer to decide whether to extend the credit limit. A security analyst uses it to help assess the investment value of securities.
For a banker the tools of financial analysis aids in deciding whether to sanction loans. Similarly, unions use it for evaluating the position of certain employers and students analyze it to determine their career opportunities.