Types of Financial Analysis

Types of Financial Analysis

Types of financial analysis is analyzing and interpreting data by various types according to their suitability and the most common types of Financial Analysis are vertical analysis, horizontal analysis, leverage analysis, growth rates, profitability analysis, liquidity analysis, efficiency analysis, cash flow, rates of return, valuation analysis, scenario and sensitivity analysis, and variance 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, and there are various types that experts and analysts use to do a post-mortem of financial statements.

List of Top 10 Types of Financial Analysis

• #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

Further, we will discuss the above-described ratios with a detailed explanation.

#1 – Horizontal Analysis

The horizontal analysis measures the financial statements line of items 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 the 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 sizes, 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 periods and plotting those in a graphical format such that actionable information could be derived.

#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. The 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 the safekeeping of funds.

The 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, different kinds of changes in tax structures, banking rates, duties, etc. Each of these determinants highly affects the financials; hence it is of utmost importance that the 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 of utmost importance 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 have 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 the 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 a 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 article 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 –

• Financial Ratios Types
• Financial Ratios Overview
• Importance of Ratio Analysis
• Advantages of Ratio Analysis