BASICS OF

FINANCIAL
ANALYSIS
FAR
FINANCIAL ANALYSIS
Financial analysis is the process of evaluating businesses, projects, budgets,
and other finance-related transactions to determine their performance and
suitability. Typically, financial analysis is used to analyze whether an entity is
stable, solvent, liquid, or profitable enough to warrant a monetary investment.
KEY TAKEAWAYS
If conducted internally, financial analysis can help fund managers make future business
decisions or review historical trends for past successes.

If conducted externally, financial analysis can help investors choose the best possible
investment opportunities.

Fundamental analysis and technical analysis are the two main types of financial analysis.

Fundamental analysis uses ratios and financial statement data to determine the intrinsic
value of a security.

Technical analysis assumes a security's value is already determined by its price, and it
focuses instead on trends in value over time.
Understanding Financial Analysis
Financial analysis is used to evaluate economic trends, set financial policy, build
long-term plans for business activity, and identify projects or companies for
investment. This is done through the synthesis of financial numbers and data. A
financial analyst will thoroughly examine a company's financial statements—the
income statement, balance sheet, and cash flow statement. Financial analysis can
be conducted in both corporate finance and investment finance settings.

One of the most common ways to analyze financial data is to calculate ratios from
the data in the financial statements to compare against those of other companies
or against the company's own historical performance.
For example, return on assets (ROA) is a common ratio used to determine how
efficient a company is at using its assets and as a measure of profitability. This
ratio could be calculated for several companies in the same industry and
compared to one another as part of a larger analysis.
Corporate Financial Analysis
In corporate finance, the analysis is conducted internally by the accounting department and shared with management
in order to improve business decision making. This type of internal analysis may include ratios such as net present
value (NPV) and internal rate of return (IRR) to find projects worth executing.

Many companies extend credit to their customers. As a result, the cash receipt from sales may be delayed for a
period of time. For companies with large receivable balances, it is useful to track days sales outstanding (DSO), which
helps the company identify the length of time it takes to turn a credit sale into cash. The average collection period is
an important aspect of a company's overall cash conversion cycle.

A key area of corporate financial analysis involves extrapolating a company's past performance, such as net earnings
or profit margin, into an estimate of the company's future performance. This type of historical trend analysis is
beneficial to identify seasonal trends.

For example, retailers may see a drastic upswing in sales in the few months leading up to Christmas. This allows the
business to forecast budgets and make decisions, such as necessary minimum inventory levels, based on past trends.
Investment Financial Analysis
In investment finance, an analyst external to the company conducts an analysis for investment purposes.
Analysts can either conduct a top-down or bottom-up investment approach. A top-down approach first
looks for macroeconomic opportunities, such as high-performing sectors, and then drills down to find the
best companies within that sector. From this point, they further analyze the stocks of specific companies to
choose potentially successful ones as investments by looking last at a particular company's fundamentals.

A bottom-up approach, on the other hand, looks at a specific company and conducts a similar ratio
analysis to the ones used in corporate financial analysis, looking at past performance and expected future
performance as investment indicators. Bottom-up investing forces investors to consider microeconomic
factors first and foremost. These factors include a company's overall financial health, analysis of financial
statements, the products and services offered, supply and demand, and other individual indicators of
corporate performance over time.
Types of Financial Analysis
There are two types of financial analysis: fundamental analysis and technical
analysis.
Fundamental Analysis
Fundamental analysis uses ratios gathered from data within the financial
statements, such as a company's earnings per share (EPS), in order to
determine the business's value. Using ratio analysis in addition to a thorough
review of economic and financial situations surrounding the company, the
analyst is able to arrive at an intrinsic value for the security. The end goal is to
arrive at a number that an investor can compare with a security's current
price in order to see whether the security is undervalued or overvalued.
Technical Analysis
Technical analysis uses statistical trends gathered from trading activity, such
as moving averages (MA). Essentially, technical analysis assumes that a
security’s price already reflects all publicly available information and instead
focuses on the statistical analysis of price movements. Technical analysis
attempts to understand the market sentiment behind price trends by looking
for patterns and trends rather than analyzing a security’s fundamental
attributes.
Horizontal vs. Vertical Analysis
When reviewing a company's financial statements, two common types of financial analysis are horizontal
analysis and vertical analysis. Both use the same set of data, though each analytical approach is different.

Horizontal analysis entails selecting several years of comparable financial data. One year is selected as the
baseline, often the oldest. Then, each account for each subsequent year is compared to this baseline,
creating a percentage that easily identifies which accounts are growing (hopefully revenue) and which
accounts are shrinking (hopefully expenses).

Vertical analysis entails choosing a specific line item benchmark, then seeing how every other component
on a financial statement compares to that benchmark. Most often, net sales is used as the benchmark. A
company would then compare cost of goods sold, gross profit, operating profit, or net income as a
percentage to this benchmark. Companies can then track how the percent changes over time.
Why Is Financial Analysis Useful?
The goal of financial analysis is to analyze whether an entity is stable, solvent,
liquid, or profitable enough to warrant a monetary investment. It is used to
evaluate economic trends, set financial policy, build long-term plans for
business activity, and identify projects or companies for investment.
How Is Financial Analysis Done?
Financial analysis can be conducted in both corporate finance and investment
finance settings. A financial analyst will thoroughly examine a company's financial
statements—the income statement, balance sheet, and cash flow statement.

One of the most common ways to analyze financial data is to calculate ratios from
the data in the financial statements to compare against those of other companies or
against the company's own historical performance. A key area of corporate financial
analysis involves extrapolating a company's past performance, such as net earnings
or profit margin, into an estimate of the company's future performance.
What Techniques Are Used in Conducting Financial Analysis?
Analysts can use vertical analysis to compare each component of a financial statement as a
percentage of a baseline (such as each component as a percentage of total sales).
Alternatively, analysts can perform horizontal analysis by comparing one baseline year's
financial results to other years.

Many financial analysis techniques involve analyzing growth rates including regression
analysis, year-over-year growth, top-down analysis such as market share percentage, or
bottom-up analysis such as revenue driver analysis.

Last, financial analysis often entails use of financial metrics and ratios. These techniques
include quotients relating to the liquidity, solvency, profitability, or efficiency (turnover of
resources) of a company.
What Is Fundamental Analysis?
Fundamental analysis uses ratios gathered from data within the financial
statements, such as a company's earnings per share (EPS), in order to
determine the business's value. Using ratio analysis in addition to a thorough
review of economic and financial situations surrounding the company, the
analyst is able to arrive at an intrinsic value for the security. The end goal is to
arrive at a number that an investor can compare with a security's current
price in order to see whether the security is undervalued or overvalued.
What Is Technical Analysis?
Technical analysis uses statistical trends gathered from market activity, such
as moving averages (MA). Essentially, technical analysis assumes that a
security’s price already reflects all publicly available information and instead
focuses on the statistical analysis of price movements. Technical analysis
attempts to understand the market sentiment behind price trends by looking
for patterns and trends rather than analyzing a security’s fundamental
attributes.
The Bottom Line
Financial analysis is a cornerstone of making smarter, more strategic decisions
based on the underlying financial data of a company. Whether corporate,
investment, or technical analysis, analysts use data to explore trends,
understand growth, seek areas of risk, and support decision-making. Financial
analysis may include investigating financial statement changes, calculating
financial ratios, or exploring operating variances.