Types of Financial Analysis
Financial analysis means the analysis of the financial statement to reach up to the productive conclusion, which will help the investors and other stakeholders to maintain their relationship with the company. Financial statements, which are complex cobweb of transactions and disclosures, a variety of financial analysis are needed to be done to ensure the safe working of the company. Experts and analyst will do a post-mortem of the financial statement and will try to interpret the situation of the company. In this article, we are going to discuss the different types of financial analysis including their advantages and disadvantages
Top 10 Most Important Types of financial analysis are listed below –
- #1 – Horizontal Analysis
- #2 – Vertical Analysis
- #3 – Trend Analysis
- #4 – Liquidity Analysis
- #5 – Solvency Analysis
- #6 – Profitability Analysis
- #7 – Scenario & Sensitivity Analysis
- #8 – Variance Analysis
- #9 – Valuation Analysis
- #10 – FP&A Analysis
Top Types of Financial Analysis
#1 – Horizontal Analysis
The horizontal analysis measures the line items of financial statements with the base year. That means, it compares the figures for a given period with the other period.
- Pros – It helps to analyze the growth of the company from year on year or quarter on quarter with the increase in operations of the company.
- Cons – The company operates in the industrial cycle and if the industry is downgrading in spite of company is performing better, due to specified factors that affect the industry; trend analysis will show negative growth in the company.
#2 – Vertical Analysis
The vertical analysis measures the line item of the income statement or balance sheet by taking any line item of financial statement as a base and will disclose the same in percentage form.
For example, in Income Statement, to disclose all the line items in percentage form by taking base as Net sales. Likewise, in the Balance sheet on the asset side, to disclose all the line items in the percentage form of total assets.
- Pros – The vertical analysis helps in comparing the entities of different size, as it presents the financial statements in absolute form.
- Cons – It represents the data of a single period only, so miss comparison across different time phase
To learn more on Vertical Financial Analysis, you can refer to the following articles –
- Income Statement Vertical Analysis
- Formula of Vertical Analysis
- Income Statement Common Size
- Balance Sheet Common Size
#3 – Trend Analysis
Trend analysis means identifying patterns from multiple time period and plotting those in a graphical format such that actionable information could be derived.
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#4 – Liquidity Analysis
The short-term analysis focus on routine expenses. It analyses the short-term capability of the company with respect to day-to-day payments of trade creditors, short-term borrowings, statutory payments, salaries etc. Its main intent is to verify the appropriate liquidity being maintained thoroughly for the given period and all the liabilities are being met without any default.
The short-term analysis is carried out using the technique of ratio analysis, which uses various ratios like liquidity ratio, current ratio, quick ratio, etc
#5 – Solvency Analysis
The long-term analysis is also termed as Solvency analysis. Focus under this analysis is to ensure the proper solvency of the company in the near future and to check whether the company is able to pay all the long-term liabilities and obligations. It gives stakeholders confidence about the survival of the entity with proper financial health.
Solvency ratios like Debt to Equity ratio, Equity Ratio, Debt ratio etc give a correct picture of the financial solvency and burden on the firm in the form of external debts.
#6 – Profitability Analysis
Profitability financial analysis helps us understand how the company generates
The investment decision is one of the most important decisions to be taken by all the businessperson. The main aim of all the investment decisions is to ensure the maximum profit out of the investment made in the project. In order to verify the viability of the decision, they carry out profitability analysis, which will check the rate of return in a given period, This will help the investor in obtaining assurance of safekeeping of funds.
Following tools are used to analyze the same –
- Profit Margin Calculation
- Operating Profit Margin Calculation
- EBIT Margin Calculation
- EBIDTA Margin Calculation
- Earnings Before Taxes Calculation
#7 – Scenario & Sensitivity Analysis
In business, day in and day out various changes keep on coming. In addition, based on the economic outlook, various kinds of changes in tax structures, banking rates, duties, etc. Each of this determinants highly affects the financials, hence it is utmost important that treasury department does such sensitivity analysis with respect to each factor and try to analyze the effect of the same with the company financials.
You can use the following to do sensitivity analysis –
- Sensitivity Analysis
- Data Table using Excel
- Two-Variable Data Table using Excel
- One Variable Data Table using Excel
#8 – Variance Analysis
Business runs on estimates and budgets, after the completion of transactions, it is utmost important to check the variance in between budget and estimates with the actuals one. Such variance analysis will help in checking any loopholes in the process and hence it will help an entity to take corrective actions for avoidance of the same in the future. Variance analysis can be carried out by standard costing technique, comparing budgeted, standard and actual costs.
#9 – Valuation
Valuation analysis means deriving the company’s fair valuation. You may use one of the following valuation financial analysis tools –
- Dividend Discount Model
- DCF Formula
- Relative Valuation Multiples
- Transaction Multiples
- SOTP Valuation
#10 – FP&A Analysis
Every company will be having its own financial planning and analysis (FP&A) department whose main work is to analyze the internal organization’s various data points and to construct the Management Information System (MIS), which will be reported to top management. Such MIS circulated by FP&A department is of the highest importance for the company as there will be, both published as well as unpublished information. Such analysis helps top management to adopt strategies, which will be preventive in nature and can help in avoiding any major setback.
Conclusion
Financial analysis is nowadays considered as the main ingredient in business activity, without this, to run business will turn out to be futile. Hence for every organization, to do financial analysis is not only necessary but to handle the same diligently and all the findings of the analysis should get duly implemented.
Recommended Articles
This has been a guide to Types of Financial Analysis. Here we discuss the top 10 types of financial analysis along with its advantages and disadvantages. You can learn more about financial analysis from the following articles –
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