2. Methods of Financial
Analysis
INTRODUCTION
Financial analysis is the process of evaluating the financial health of
a business or organization by analyzing its financial statements,
ratios, and other financial data. The goal of financial analysis is to
assess the financial performance, profitability, solvency, liquidity,
and other key metrics of a company in order to make informed
decisions about investments, lending, and other financial
transactions.
Financial analysis involves a range of techniques, including ratio
analysis, trend analysis, cash flow analysis, and other methods to
examine a company's financial data. Analysts may use financial
statements such as the balance sheet, income statement, and cash
flow statement to evaluate a company's financial position, as well as
external factors such as market trends and economic conditions.
Overall, financial analysis is an essential tool for investors, lenders,
and other stakeholders who need to understand the financial health
and prospects of a company.
3. Methods of Financial
Analysis
NEEDS AND OBJECTIVES
Provide reliable financial information.
Provide other needed information about changes in
economic resources and obligation.
Provide reliable information about changes in net
resources.
Providing financial information that assess in
estimating the earnings of a business.
To disclose other information according to the needs
of the users.
4. Methods of Financial
Analysis
NEEDS AND OBJECTIVES
Helpful in assessing the financial position and
profitability of a concern.
To assess the present and future earning capacity of
the concern.
To assess the operational efficiency of the concern
as a whole and of its various parts or departments.
To assess the short term and long-term solvency of
the concern for the benefit of the debenture holders
and trade creditors.
5. Methods of Financial
Analysis
USERS
Internal users: managers, owners. board of
directors, Employees
External users: Creditors, Government, Suppliers of
long-term debt, investors, public, share holders.
6. Methods of Financial
Analysis
TYPES OF FINANCIAL ANALYSIS
i. Based on material used,
ii. Based on modes of operation,
iii. Based on Entities involved.
iv. Based on time horizon.
7. Methods of Financial
Analysis
ON THE BASIS OF MATERIAL USED
According to this analysis can be of two types:
External analysis: It is done by outsiders who don't
have access to the detailed internal accounting
records of the firm.
These include investors, potential investors,
creditor, potential creditors, government agencies
& the general public. They entirely depend on
published financial statements. Serves only a
limited purpose.
8. Methods of Financial
Analysis
ON THE BASIS OF MATERIAL USED
Internal Analysis:
This is done by persons who have access to the
internal accounting records of a business firm.
It can be performed by employees of the organization
as well as government agencies which have statutory
powers vested in them.
9. Methods of Financial
Analysis
ON THE BASIS OF MODES OF OPERATION
According to the method of operation followed, it is
also be of two types;
Horizontal analysis: It refers to comparison of
financial data of a company for several years. Also
called Dynamic Analysis. The figures of the various
years are compared with base year. The figures for
this analysis are presented horizontally over a
number of columns. It makes it possible to focus
attention on items that have changed significantly.
10. Methods of Financial
Analysis
Vertical Analysis: It refers to the study of
relationship of the various items in the financial
statements of one accounting period. Also called
Static Analysis.
As it takes only the current years data it is not
considered.
It can be made use along with horizontal
analysis.
11. Methods of Financial
Analysis
ON THE BASIS OF ENTITIES INVOLVED
Based on entities, it is again divided into 2 types;
a. Cross Sectional or Inter-firm analysis: It involves
comparison of financial data of a firm with other
firms (competitors) or industry averages for the
same time period.
b. Time Series or Intra-firm analysis: Time series
analysis involves the study of performance of the
same firm over a period.
12. Methods of Financial
Analysis
ON THE BASIS OF TIME HORIZON
Based on time horizon, financial analysis ca can be classified
under 2 heads:
Short Term Analysis: It measures the liquidity of the firm i.e., the
short-term paying capacity of a firm or the firm's ability to meet
its current obligations.
Long Term analysis: It involves firms' ability to meet the interest
costs and repayment schedules of its long-term obligations. The
solvency, stability and profitability are measured under this
analysis.
13. Methods of Financial
Analysis
LIMITATIONS
Mislead the user.
Not useful for Planning.
It does not provide qualitative aspects.
Comparison is not always possible.
Wrong judgement.
Subject to fraud.