Financial Analysis: Meaning, Importance & Functions

Financial analysis plays a crucial role in the success of businesses by providing insights into a company’s financial health. Financial statement analysis is a key component of financial analysis that enables businesses to evaluate their financial performance, identify areas for improvement, and make informed decisions. This write-up explores the importance of financial analysis for businesses, including how it helps with shares investment and holding, plans, decisions, and management, providing credit, and assessing a company’s financial health. The methods of financial statement analysis, including ratio analysis, trend analysis, and comparative analysis, are also discussed in this write-up. Overall, financial analysis is a critical tool for businesses to make informed decisions, allocate resources efficiently, and achieve their financial goals.

What is Financial Analysis?

Financial analysis is a process of evaluating the financial performance of a company. It involves analysing financial statements, ratios, and other financial data to gain insights into the company’s financial health. Importance of financial statement analysis is seen in making informed decisions in businesses by identifying strengths, weaknesses, opportunities, and threats in their financial performance. Let’s understand why financial analysis is important for any business/organization.

Importance of Financial Statement Analysis

The importance of financial statement analysis is a critical tool for businesses to evaluate their financial health. Knowing the importance of financial statement analysis that help get information on a company’s financial performance, including its profitability, liquidity, solvency, and efficiency. Financial analysis enables businesses to identify trends, evaluate performance, and make informed decisions. Take a deep dive into the basics of financial markets to know more. 

1. The Shares Investment and Holding

   Financial analysis for business is essential for investors who want to invest in shares or hold them. By analysing a company’s financial statements and performance, investors can make informed investment decisions. Investors use financial statement analysis to assess a company’s profitability, growth potential, and financial stability. This analysis enables investors to identify companies that are likely to generate good returns on investment and avoid companies that are risky.

2. Plans, Decisions, and Management

   Financial analysis for business is crucial for businesses when making plans, decisions, and managing their finances. By analysing financial data, businesses can identify potential risks and opportunities. This financial analysis enables businesses to make informed decisions, develop strategies, and allocate resources more efficiently. Financial statement analysis also helps businesses identify areas where they can reduce costs and increase profitability. Read about financial management functions in detail.

3. Providing Credit

   Importance of financial statement analysis for business is seen in providing credit to businesses. By conducting a company’s financial analysis, lenders can evaluate the company’s creditworthiness and assess the risk involved in lending. This analysis enables lenders to make informed decisions about whether to grant credit, how much credit to grant, and what terms and conditions to apply.

4. Financial Analysis Helps in Assessing a Company’s Financial Health

   Businesses can leverage the importance of financial statement analysis to assess their financial health. By analysing financial data, businesses can identify areas where they need to improve and develop strategies to achieve their financial goals. Financial analysis for business also helps monitor their financial performance and identify potential risks and opportunities. Tools of financial statement analysis enables businesses to make informed decisions about investments, cost-cutting measures, and other strategies to improve financial performance.

Objectives of Financial Analysis

The importance of financial statement analysis is to comprehend and analyse the data in financial statements in order to evaluate the firm’s profitability and financial stability and to predict its future possibilities. These are the top four objectives of financial analysis:

• Knowing the company’s existing situation 
• Reducing likelihood of fraud
• Decision making 
• Removing any discrepancies.

Methods of Financial Statement Analysis

There are several methods of financial statement analysis, including ratio analysis, trend analysis, and comparative analysis. 

• Ratio Analysis:

  Ratio analysis involves analysing financial ratios to gain insights into a company’s financial performance. 

• Trend Analysis:

  Trend analysis involves analysing financial data over time to identify trends and patterns.

• Comparative analysis:

  This method of financial analysis involves comparing a company’s financial performance to that of its competitors or industry benchmarks. 

• Adjustment of errors:

  This process of financial analysis helps in adjustment of measurement errors and removes any redundancy from the input data. 

• Balance Sheet:

  This financial analysis process involves segmenting the balance sheet into operations and financial assets. 

These methods enable businesses to gain insights into their financial performance and make informed decisions based on the data

Types of Financial Analysis

Fundamental analysis and technical analysis are the two types of financial analysis.

• Fundamental Analysis

  To ascertain a company’s value, fundamental analysis analyses ratios derived from information found in the financial statements, such as its profits per share (EPS). The analyst can determine the intrinsic value of the security by using ratio analysis along with a comprehensive investigation of the economic and financial circumstances around the company.

• Technical Analysis

  Moving averages and other statistical trends gleaned from trade activity are used in technical analysis (MA). Technical part of financial analysis is based on the statistical examination of price movements since it essentially believes that the price of a security already represents all information that is generally available. Read about types of financial statement analysis in detail here.

Importance of Financial Analysis in Determining Value of Business

There are several key financial metrics that analysts use to determine the value of a business, including revenue growth, profitability, cash flow, and return on investment. These metrics enable analysts to evaluate a company’s financial performance and assess its ability to generate future profits. Tools of financial statement analysis also enables businesses to compare their financial performance to that of their competitors and industry benchmarks. This analysis provides valuable insights into the company’s position in the market and its competitive advantage.

Ultimately, importance of financial analysis can be observed in businesses looking to determine their value and make informed decisions about investments, mergers and acquisitions, and other strategic initiatives. By conducting financial analysis, businesses can identify areas for improvement, develop strategies to improve their financial performance, and increase their overall value. 

What is a Financial Analyst

Banks, insurance companies, and other financial institutions employ financial analysts. Financial analysts advise companies and people on how to spend money to make a profit. Financial analysis in business helps evaluate the performance of bonds, equities, and other financial products in order to help them succeed.

Skills Required for Financial Analyst

Database and Excel proficiency are skills needed for a financial analyst. These tools aid in data comparison, analysis, and the creation of beneficial visual presentations for clients. Excel formulas, pivot tables, and other graph kinds can all be utilised to analyse the data. Hero Vired, in partnership with edX*, offers a program in Financial Analysis from Columbia University, one of the world’s leading universities. This program is designed to master the theoretical and real-world concepts spanning the world of finance. Check the future scope of financial management to know in 2023.

Challenges in in Conducting Financial Analysis

Tools of financial statement analysis provides valuable insights into a company’s financial health, there are several challenges that businesses may face when conducting financial analysis for business. Some of these challenges in financial analysis include:

• Data quality issues:

  : Financial analysis requires accurate and reliable financial data. However, businesses may face challenges in ensuring that their financial data is accurate and up-to-date.

• Limited access to data:

  Some businesses may face challenges in accessing financial data, particularly if they are a small business or have limited resources.

• Lack of expertise:

  Financial analysis requires specialized knowledge and expertise. Some businesses may not have the necessary skills or resources to conduct financial analysis effectively.

• Time constraints:

  Conducting financial analysis can be time-consuming, particularly if businesses have to analyse large amounts of financial data.

Addressing these challenges requires businesses to invest in financial expertise, data management, and technology to ensure that they can conduct financial analysis effectively.