Types of Financial Analysis

Summary

This tutorial covers 12 essential types of financial analysis used to evaluate a company's past performance and predict its future prospects. The analyses include vertical and horizontal comparisons, leverage ratios, growth forecasts, profitability metrics, and liquidity tests. Other key methods include cash flow analysis, return on investment, and company valuation. Additionally, scenario and sensitivity analysis help assess the impact of varying assumptions. Lastly, variance analysis provides insights into budget performance. By applying these methods together, analysts gain a comprehensive understanding of a company's financial health and future potential.

Takeaways

• 😀 Financial analysis assesses a company's performance and helps predict its future performance using historical data.
• 😀 Vertical analysis involves comparing each income statement line item as a percentage of revenue, facilitating industry comparisons.
• 😀 Horizontal analysis compares year-over-year performance using historical data to identify growth trends, often referred to as trend analysis.
• 😀 Leverage ratios measure how much debt or equity a company holds relative to its assets or cash flow, assessing financial risk.
• 😀 Growth rates are used to forecast future company performance based on historical results, with year-over-year growth being a common metric.
• 😀 Regression analysis predicts future outcomes based on historical data, using top-down and bottom-up approaches.
• 😀 Profitability analysis evaluates how much income a business generates relative to its revenue, using metrics like gross profit and net profit margins.
• 😀 Liquidity analysis determines a company’s ability to meet short-term obligations, using ratios like the current ratio and cash ratio.
• 😀 Efficiency analysis examines how well a company uses its assets to generate revenue by analyzing the balance sheet and sales performance.
• 😀 Cash flow analysis helps assess how much cash a company generates, crucial for maintaining operations and making investments.
• 😀 Rates of return, such as internal rate of return (IRR), are vital for investors to assess the potential return on investment (ROI).
• 😀 Valuation analysis determines a company's worth using different methods like the cost approach, market approach, and discounted cash flow (DCF).
• 😀 Scenario and sensitivity analysis explores how changes in operational assumptions affect a company’s value under different future conditions.
• 😀 Variance analysis compares actual performance to budgets or forecasts to understand the causes of overperformance or underperformance, often using a waterfall chart.

Q & A

What is financial analysis?

Financial analysis is the process of assessing a company's financial performance and making projections about its future performance. Analysts use historical data in tools like Excel to generate these forecasts.

What is vertical analysis in financial analysis?

Vertical analysis involves dividing each line item on the income statement by revenue to express it as a percentage. This method allows analysts to compare a company's performance to others in the same industry, often referred to as a common-sized income statement.

How does horizontal analysis differ from vertical analysis?

While vertical analysis focuses on analyzing a company's income statement by comparing individual items as a percentage of revenue, horizontal analysis compares year-over-year performance across multiple years to identify growth trends.

Why are leverage ratios important in financial analysis?

Leverage ratios are important because they measure a company's debt or equity relative to its assets or cash flow. These ratios help analysts understand the financial risk and capital structure of a business.

What are common methods of measuring growth in financial analysis?

Common methods for measuring growth include analyzing year-over-year growth rates and performing regression analysis. These techniques allow analysts to forecast how a company will grow based on historical data.

What is profitability analysis, and how is it measured?

Profitability analysis assesses how much income a business earns relative to its revenue. It is typically measured using metrics such as gross profit margin, EBITDA, EBIT, and net profit margin.

What is the significance of liquidity analysis?

Liquidity analysis is crucial because it helps evaluate a company's ability to meet its short-term obligations. Analysts use ratios like the current ratio, acid-test ratio, and cash ratio to assess liquidity.

What does efficiency analysis examine in a company?

Efficiency analysis examines how well a company utilizes its assets to generate revenue. It focuses on the company's balance sheet and its ability to turn assets into sales effectively.

Why is cash flow analysis essential in financial analysis?

Cash flow analysis is important because it helps determine how much cash a company is generating, providing a clearer picture of its financial health. It complements profitability analysis by showing the actual cash flow in and out of the business.

What is the role of scenario and sensitivity analysis in financial valuation?

Scenario and sensitivity analysis are used to understand how changes in assumptions affect the value of a company. They allow analysts to assess how different future scenarios might impact business performance and company valuation.