View source for Financial analysis

{{Short description|Assessment of the viability, stability, and profitability of a business}}
{{Distinguish|Economics{{!}}Economic analysis}}

{{Accounting}}

'''Financial analysis''' (also known as '''financial statement analysis''', '''accounting analysis''', or '''analysis of finance''') refers to an assessment of the viability, stability, and profitability of a [[business]], sub-business, [[Project#Corporate_finance |project]] or investment. 

It is performed by professionals who prepare reports using [[ratio]]s and other techniques, that make use of information taken from [[financial statements]] and other reports. These reports are usually presented to top management as one of their bases in making business decisions.  
Financial analysis may determine if a business will:

*Continue or discontinue its main operation or part of its business;
*Make or purchase certain materials in the [[Manufacturing|manufacture]] of its product;
*Acquire or rent/lease certain machineries and equipment in the production of its goods;
*Issue  [[share capital|shares]] or negotiate for a bank [[loan]] to increase its [[working capital]];
*Make decisions regarding investing or lending capital;
*Make other decisions that allow management to make an informed selection on various alternatives in the conduct of its business.

== Firm-level analysis==
Financial analysts often assess the following elements of a firm:

# '''Profitability''' - its ability to earn income and sustain growth in both the short- and long-term. A company's degree of profitability is usually based on the [[income statement]], which reports on the company's results of operations;
# '''Solvency''' - its ability to pay its obligation to [[creditor]]s and other third parties in the long-term; 
# '''Liquidity''' - its ability to maintain positive [[cash flow]], while satisfying immediate obligations;
# '''Stability''' - the firm's ability to remain in business in the long run, without having to sustain significant losses in the conduct of its business. Assessing a company's stability requires the use of both the income statement and the balance sheet, as well as other financial and non-financial indicators.

Both 2 and 3 are based on the company's [[balance sheet]], which indicates the financial condition of a business as of a given point in time.

== Techniques==
Financial analysts often compare [[financial ratios]] (of [[solvency]], [[Profit (accounting)|profitability]], growth, etc.):

* '''Past Performance''' - Across historical time periods for the same firm (the last 5 years for example),
* '''Future Performance''' - Using historical figures and certain mathematical and statistical techniques, including present and future values, This [[Extrapolation|extrapolation method]] is the main source of errors in financial analysis as past statistics can be poor predictors of future prospects.
* '''Comparative Performance''' - Comparison between similar firms
<!-- 
These ratios are calculated by dividing a (group of) account balance(s), taken from the [[balance sheet]] and/or the [[income statement]], by another, for example :

:''[[Net income]] / equity = [[return on equity]] (ROE)

:''[[Net income]] / total assets = [[return on assets]] (ROA)

:''Stock price / earnings per share = [[P/E ratio]]
 -->
Comparing financial ratios is merely one way of conducting financial analysis. 
Financial analysts can also use percentage analysis which involves reducing a series of figures as a percentage of some base amount.<ref>Kieso, D. E., Weygandt, J. J., & Warfield, T. D. (2007). ''Intermediate Accounting'' (12th ed.). Hoboken, NJ: John Wiley & Sons, p. 1320 {{ISBN|0-471-74955-9}}</ref>  For example, a group of items can be expressed as a percentage of net income. When proportionate changes in the same figure over a given time period expressed as a percentage is known as horizontal analysis.<ref>Kieso, et al., 2007, p. 1320</ref>

Vertical or common-size analysis reduces all items on a statement to a "common size" as a percentage of some base value which assists in comparability with other companies of different sizes.<ref>Kieso, et al., 2007, p. 1320</ref> As a result, all Income Statement items are divided by Sales, and all Balance Sheet items are divided by Total Assets.<ref>Ehrhardt, M., Brigham, E. (2008). ''Corporate Finance: A Focused Approach'' (3rd ed.). p. 131 {{ISBN|978-0-324-65568-1}}</ref>

Another method is comparative analysis. This provides a better way to determine trends. Comparative analysis presents the same information for two or more time periods and is presented side-by-side to allow for easy analysis.<ref>Kieso, et al., 2007, p. 1319</ref>

==Theoretical challenges==
[[Financial ratios]] face several theoretical challenges:

* They say little about the firm's prospects in an absolute sense.  Their insights about relative performance require a reference point from other time periods or similar firms.
* One ratio holds little meaning.  As indicators, ratios can be logically interpreted in at least two ways.{{Why|reason="Not mentioned in source and seems to be referring to two specific (well-known?) ways of interpreting ratios|date=August 2019}} One can partially overcome this problem by combining several related ratios to paint a more comprehensive picture of the firm's performance.
* Seasonal factors may prevent year-end values from being representative. A ratio's values may be distorted as account balances change from the beginning to the end of an accounting period. Use average values for such accounts whenever possible.
* Financial ratios are no more objective than the accounting methods employed. Changes in accounting [[Policy|policies]] or choices can yield drastically different ratio values.<ref>[http://www.netmba.com/finance/financial/ratios/ Financial Ratios<!-- Bot generated title -->]</ref>

== See also ==
*[[Business valuation]]
*[[Economic base analysis]]
*[[Financial accounting]]
*[[Financial forecast]] & [[Cash flow forecast]]
*{{slink|Financial modeling #Accounting}}
*{{slink|Financial risk management#Corporate finance}}
*[[Financial statement]]
*[[FP&A]]
*[[Going concern]] (Fundamental basis of financial statements)
*[[Managerial risk accounting]]

==Notes==
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==External links==
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* [http://www.sfaf.com/ SFAF – the French Society of Financial Analysts]
* [http://www.aciia.org/ ACIIA – Association of Certified International Investment Analysts]
* [https://web.archive.org/web/20090317063049/http://www.effas.com/ EFFAS – European Federation of Financial Analysts Societies]

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[[Category:Valuation (finance)]]

[[ja:証券アナリスト]]