Question

Explain the term financial analysis and its importance.

Answer 1

Financial analysis involves using financial data to assess a company’s performance and make recommendations about how it can improve going forward.Financial analysis is the process of evaluating businesses, projects, budgets, and other finance-related transactions to determine their performance and suitability. Typically, financial analysis is used to analyze whether an entity is stable, solvent, liquid, or profitable enough to warrant a monetary investment.

Financial analysis is used to evaluate economic trends, set financial policy, build long-term plans for business activity, and identify projects or companies for investment. This is done through the synthesis of financial numbers and data. A financial analyst will thoroughly examine a company's financial statements—the income statement, balance sheet, and cash flow statement. Financial analysis can be conducted in both corporate finance and investment finance settings.

One of the most common ways to analyze financial data is to calculate ratios from the data in the financial statements to compare against those of other companies or against the company's own historical performance.For example, return on assets (ROA) is a common ratio used to determine how efficient a company is at using its assets and as a measure of profitability. This ratio could be calculated for several companies in the same industry and compared to one another as part of a larger analysis.

Importance

If conducted internally, financial analysis can help managers make future business decisions or review historical trends for past successes.If conducted externally, financial analysis can help investors choose the best possible investment opportunities.There are two main types of financial analysis: fundamental analysis and technical analysis.Technical analysis assumes a security's value is already determined by its price, and it focuses instead on trends in value over time.Fundamental analysis uses ratios and financial statement data to determine the intrinsic value of a security.