Financial analysis is the examination and screening of financial knowledge to reach business decisions.
This analysis typically involves an examination of both historical and projected profitability, cash flows, and risk. It may result in the reallocation of resources to or from a business or a specific internal operation.
This type of analysis applies particularly well to the following cases:-
Investment decisions by the external investor. In this case, a financial analyst or investor reviews the financial statements and accompanying disclosures of a company to see if it is profitable to invest in or lend money to the entity.
This typically involves ratio analysis to see if the organization is sufficiently liquid and generates a sufficient amount of cash flow.
It may also involve combining the information in the financial statements for multiple periods to derive trend lines that can be used to predict financial results in the future.
Investment decisions by an internal investor. In this situation, an internal analyst reviews the projected cash flows and other information related to a prospective investment (mostly for a long term asset).
The intent is to see if the expected cash outflows from the project will generate a sufficient return on investment (ROI)
This examination can also examine whether to rent, lease, or purchase an asset.
The key source of information for financial analysis is the financial statements of a business. The financial analyst uses these documents to derive ratios, create trend lines, and conduct comparisons against similar information for comparable firms.
The outcome of financial analysis may be any of several decisions such as:-
• Whether to invest in a business and at what price per share.
• Whether to lend money to a business or no.
• Whether to invest internally in a fixed asset or in working capital and how to finance it.
Financial analysis is one of the key tools needed by the managers of a business to examine how their organization is performing. For these causes, they are always questioning the financial analyst about the profitability, cash flows, and other financial aspects of their business.
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