Reviewed by Oct 05, 2020| Updated on
Financial analysis is the method of reviewing companies, programs, expenditures, and other activities relevant to finance to assess their performance and appropriateness. Financial analysis is usually used to determine whether an enterprise is sufficiently stable, solvent, liquid, or competitive to warrant a monetary investment.
Financial analysis is used to assess economic trends, set monetary policies, build long-term business activity plans, and identify investment projects or companies. This is achieved using the financial numbers and data synthesis. A financial analyst must scrutinise the financial statements of a company—the statement of income, the balance sheet, and the statement of cash flow.
One of the most common methods of evaluating financial data is to derive ratios from the data in the financial statements to be compared with those of other firms or against the past output of the company itself.
Return on assets (ROA), for example, is a standard ratio used to determine how efficient a business is in using its assets and as a measure of profitability. For several companies in the same industry, this ratio could be calculated and compared with each other as part of the more significant analysis.
For corporate finance, the accounting department performs the research internally and shares it with management to enhance company decision-making. This form of internal analysis can involve ratios, such as Net Present Value (NPV) and Internal Return Rate (IRR), to identify projects worth carrying out.
Several companies are extending credit to their customers. As a consequence, the cash refund from sales could be postponed for some time. This is helpful for businesses with large receivable balances to track unpaid days of sales (DSO), which helps the company determine the amount of time it takes to convert a credit transaction into cash.