Types of financial analysis
/Financial analysis involves the review of an organization's financial information in order to arrive at business decisions. This analysis can take several forms, with each one intended for a different use. The types of financial analysis are as follows.
Horizontal Analysis
Horizontal analysis involves the side-by-side comparison of the financial results of an organization for a number of consecutive reporting periods. The intent is to discern any spikes or declines in the data that could be used as the basis for a more detailed examination of financial results.
Vertical Analysis
Vertical analysis is a proportional analysis of the various expenses on the income statement, measured as a percentage of net sales. The same analysis can be used for the balance sheet. These proportions should be consistent over time; if not, one can investigate further into the reasons for a percentage change.
Related AccountingTools Courses
Liquidity Analysis
Liquidity analysis is a detailed review of working capital, involving the calculation of turnover rates for accounts receivable, inventory, and accounts payable. Any differences from the long-term average turnover rate are worth investigating further, since working capital is a key user of cash. It can also be useful to see if any strategic or tactical changes in a business have had a specific impact on liquidity levels; this can be a particular concern when an organization does not have ready access to additional cash.
Leverage Analysis
Leverage analysis involves a review of the proportions of debt and equity that a business uses to fund its operations. A key part of the analysis is determining the stability of a firm’s cash flows, to see if it can reliably generate enough cash to pay off its debt obligations as they mature. Businesses in unstable industries should generally avoid excessive debt levels, while those in monopoly situations probably have sufficient cash flows to support very high debt levels. This analysis typically includes a review of the debt to equity ratio, as well as the interest coverage ratio.
Profitability Analysis
Profitability analysis is an analysis of the profits generated by a business. It can be broken down into profits by product, product line, geographic region, subsidiary, individual store, and so forth. For a smaller business with few products, a profitability analysis is probably only conducted for the business as a whole. The outcome of this analysis may be decisions to alter price points, adjust product configurations to alter costs, strip away overhead costs, and so forth.
Multi-Company Comparison
A multi-company comparison involves the calculation and comparison of the key financial ratios of two organizations, usually within the same industry. The intent is to determine the comparative financial strengths and weaknesses of the two firms, based on their financial statements. This is particularly useful for an acquirer, to evaluate which businesses in an industry are most worthy of an acquisition attempt.
Industry Comparison
An industry comparison is similar to the multi-company comparison, except that the comparison is between the results of a specific business and the average results of an entire industry. The intent is to see if there are any unusual results in comparison to the average method of doing business. If there are positive differences, it could be due to the unique strategic positioning of the business.
Valuation Analysis
A valuation analysis involves the use of several methods to derive a range of possible valuations for a business. Examples of these methods are discounted cash flows valuation, a comparison to the prices at which comparable companies have sold, a compilation of the valuations of the subsidiaries of a business, and a compilation of its individual asset values.