Types of Financial Analysis
Financial analysis is the process of assessing a company’s performance, and making recommendations about how it’s going to perform in the future. Financial Analysts carry out their work in Excel and use historical data to then generate projections about the future.
Let’s look at the most common types of financial analysis, and the ones that we’re going to discuss in this tutorial. These 12 types are extremely important, and we’re going to outline what each of them are and how they’re useful.
an analyst will take each line item on the income statement and divide it into revenue to see it as a percentage. This enables the analysts to compare the company to other companies in the same industry, which is why it’s also called a common size income statement.
So this is a very good first step in comparing companies.
Another type of analysis is horizontal with horizontal investing moving up and down the income statement, we move across the income statement comparing year over year performance is typically done with three to five years of historical data. And the numbers are divided into each other to express them as a growth rate either up or down year over year. This is commonly referred to as trend analysis.
Leverage ratios are very important to analyze for a company.
It tells the analyst how much debt or equity a business has relative to its assets, or to some type of cash flow generation.
Growth Rate Analysis
Growth rates are another important type of financial analysis based on historical results. An analyst can forecast how it expects a company to grow in the future. Analyzing historical growth rates and projecting future ones are a big part of any financial analyst’s job.
Common examples were being year over year growth rates regression analysis bottom up and top down approaches to forecasting.
Profitability analysis looks at how much income a business earns relative to its revenue. You can look at gross profit EBITDA, EBIT, and net profit margins to see, how much earning a company can generate.
Liquidity analysis is also very important. liquidity analysis looks at the short term ability of a company to meet its obligations.
You can look at the current ratio, perform an asset test the cash ratio and net working capital to understand how easily a company can meet its obligations that are due in less than a year.
Cash Flow Analysis
Cash flow analysis, there is an expression that cash is king. And this is very true in finance thus, cash flow analysis needs to be performed. In addition to profitability analysis, looking at the cash flow statement will give a clear picture of how much cash accompanies generating.
Rates of Return Analysis
When they make an investment they want to get a return on it or an ROI. There are many types of ways to measure return.
Valuation analysis is when an analyst attempts to value a company based on cash flow or other metrics. Let’s look at the main methods of valuing a business or an asset. There is the cost approach The market approach and the discounted cash flow approach or intrinsic value. In CF eyes courses we focus mostly on the market approach and the intrinsic value approach. These are the most common methods used by industry practitioners.
Scenario and Sensitivity Analysis
Scenario and sensitivity analysis can be layered on top of valuation work, and it looks to understand how sensitive the value of a company is relative to changes in operating assumptions. Scenarios can be used to understand how a business might perform in different future states of the world.
Variance analysis looks to assess how a company performed relative to its budget or to a forecast. It seeks to understand using root cause analysis. What was the lead or the cause of over an underperformance a waterfall chart as shown on the right here can help summarize the impact of various assumptions in the world, results that the company achieved.
At the end of the day, all 12 methods of financial analysis are very important and should all be done together in conjunction with each other so that you can have a full picture of a business’s performance and how you expect it to perform in the future
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