10 Steps to A Financial Analysis
As someone who takes an interest in Finance, I know there are certain obligatory topics that we all need to know. Still, almost 2 years into college with a very slow, yet bold, move into the Pre-Business category, perhaps not even a real major, a lot of things I've learned I had to figure out myself. A good amount of time was assigned to feeling inferior compared to my peers on the fast track, who have known and picked their majors from the start of college.
Nevertheless, we learn and we never stop, no matter the odds that stand in our way. Today, I present to you my Very First, Simple Financial Blog, and we are going to learn How to Perform A Financial Analysis.
I, in fact, learned about this valuable knowledge from a number of other sources, so this blog is basically a summary of what I've read elsewhere. Still, I hope it is compacted and precise enough for people who want a briefer read.
The purpose
First off, what is a Financial Analysis?
A financial analysis is the process of examining the financial statements of a company (income statement, balance sheet, and cash flow statement), in order to demonstrate the financial performance of the business over a specified period of time, often on a quarterly or annual basis.
It provides access to the financial health of a company, gives us more insights about the company performance, profitability, liquidity and solvency of the company.
The Benefits of doing a Financial Analysis
- Informed Decision-making
- Performance Evaluation
- Risk Management
- Strategic planning
- Budgeting & Forecasting (allows data-driven forecasting)
- Enhancing Transparency
- Tracks cash flow
- Simplifies Taxation
- Managing Inventory
- Checking stability, revenue growth and optimization
The procedure
- Collect financial data
- Income statements, balance sheets, and cash flow statements. Make sure they are accurate and up-to-date so as to create a reliable foundation.
- Give an overview of the company
- Highlight the potential of the business
- Keep in mind the Rule of Thumb: use plain language when writing the description.
- Things to write about in the overview:
- Background and history
- Business model
- Type of organization/What sector it is in
- Size & scale of the business
- Comparison between the company and other competitors in the industry
- Use the Porter's 5 forces model
- Write Sales Forecast & Other Vital Sections
a) The Sales Forecast
- Comprise of sales data for the past 3 years
- Use financial reporting software or spreadsheets to organize
- First-year data: yearly + monthly basis
- Last two-year data: quarterly basis
b) Other Vital Sections
- Expense Budget
- Cash Flow Statement
- Estimate for net profit
- Estimate for assets & liabilities
- Break-even point (last step)
- Determine the company's valuation
- Analyze the company's data through 3 main ways:
- DCF (Discounted Cash Flow) Analysis
- Book Value Analysis
- Relative Value Method
- Perform Risk Analysis
- Include both current & future risks
- SWOT analysis - microscopic, should be used alongside other techniques
- PESTLE analysis - give more details, and has 2 main benefits:
- Helps understand the marketing environment
- Helps understand other macro factors that affect the company's financials
- Perform Ratio Analysis
- Essential to the financial analysis
- Do key ratios, including:
- Profitability Ratios (Net Profit Margin)
- Liquidity Ratios (Current Ratio)
- Leverage Ratios (Debt-to-Equity Ratio)
- Provides insights to operational efficiency, the financial stability and the company's ability to meet its obligations
- Analyze trends
- Look for patterns in financial data over time
- Analyzing the trends helps dentify:
- Growth opportunities
- Important financial challenges
- Effectiveness of current strategies
- Benchmark against industry standards
- Compare the company's financial performance to the industry benchmarks
- Doing this provides:
- Context for the analysis
- Understand how the company stacks up against competitors and identify areas for improvement or differentiation
- Utilize financial forecasting
- Crucial for strategic planning
- Use historical financial data, combine the current market trends and economic conditions
- Helps with informed predictions about:
- Future revenue
- Expenses
- Cash flow
- Interpret Data & make recommendations
- Interpret the findings from your analysis
- Include summaries of the 3 financial statements (aforementioned)
- Make actionable recommendations:
- Identifying cost-saving opportunities
- Suggesting areas of investment
- Recommending changes to financial strategies
- Summarize your entire report
Techniques
A list of financial management analysis formulas
- Scenario Analysis
- Capital Budgeting
- Risk Assessment
- Cash Flow Analysis
- Break-even Analysis
- Cost-benefit Analysis
- Financial Forecasting
- Leverage Analysis
- Ratio Analysis
- Profitability Ratio Formulas:
- Gross Profit Margin
- Net Profit Margin
- EBITDA Margin
- Profitability Ratio Formulas:
- DCF Analysis
- Book Value Analysis
- Relative Value Method
- SWOT Analysis
- PESTLE Analysis
- Inventory Turnover Ratio
- ITR = total sale/inventory
- Porter's 5 forces Model
Stay tuned for an extended version of this article, where I articulate further the techniques, a tutorial on how to perform a financial analysis on Excel, and more!
Sources:
Elena Linker
Daryl Bush
