1. FINANCIAL ANALYSIS: WHAT IS IT?
Financial analysis can be defined as a process that evaluates businesses, budgets, projects, and entities for analysis purpose. This evaluation is done with the purpose of determining the suitability for investment by a business. Usually, the main purpose of financial analysis is to analyze the stability, solvency, liquidity, and profitability of a business. The process of financial analysis is carried out by professionals who work by preparing reports with the help of ratios containing information from financial statements and other similar reports.
Goals and Objectives
The main objectives of financial analysis include:
One of the most important goals of financial analysis is to assess the ability of a business to pay back its debts (Short term and Long term) to its creditors. The liquidity of a business entity is reflected in its balance sheet. * Profitability
Another goal of financial analysis aims at assessing the profitability of a firm. Here, profitability refers to a firm’s ability to earn income and sustain its growth in both long-term and short-term. Statement of comprehensive income is used to determine the profitability of a company. Income statement provides other information as well like details of sources of income and expenses. * Liquidity
In addition to the aforesaid goals and objectives, a financial analysis reports about the firm’s ability to sustain positive cash flow in addition to satisfying current debts. Just like the solvency of a firm, the liquidity of a business firm is also indicted by its balance sheet. * Stability
Stability implies the ability of a business firm to maintain its existence in the long run. However, this stability should not include significant losses during the conduct of this business. The process of assessing the stability of a firm through financial analysis involves the use of the balance sheet as well as the income statement. Besides, other non-financial and financial indicators also play a vital role in the process. It is noteworthy that while preparing the financial analysis for a company, the analysts focus on the balance sheet, the cash flow statement, and the income statement. Besides, one important area involved in financial analysis is the extrapolating firm’s past performance into its future performance.
a. MEASUREMENT OF LIQUIDITY AND PROFITABILITY OF THE FIRM
2. ANALYSIS AND INTERPRETATION OF ACCOUNTS
Financial Analysis is concerned with the evaluation of the worth, progress and prospects of a business, and as one aspect of these, the detection of weaknesses. A satisfactory analysis and interpretation is best carried out by assessing the results over at least three years. Trends in the business are significant. Whether such figures as sales and net profit are rising or not may be more significant than the actual sales figures and profit figures under review. Analysis of the revenue accounts of an enterprise will give the best indication as to future prospects. If a business is operating profitably, weaknesses in the financial structure (as revealed in the Balance Sheet) may be overcome. However, a satisfactory financial structure can deteriorate quickly if losses are being incurred.
A comprehensive analysis and interpretation of accounts would include the following:
| Study the Gross Profit
| Examine Expenses
| Consider Net Profit
| Use Accounting Ratios
1. STUDY THE GROSS PROFIT
The amount of Gross Profit is the most important single factor in any business, as it must be large enough to cover the expenses and produce a profit. Fluctuations in Gross Profit could be caused by:
| Mark-ups being taken which are too low
| Incorrect mark-ups being taken
| Excessive mark-downs caused by inefficient buying
| Failure to charge credit sales or get credits for returns
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