Financial analysis

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Financial analysis entails examining the accounts and economic prospects of a firm or project.


[edit] Goals

Financial analysts often assess the firm's:

  • performance, for the management to improve operations,
  • solvency, so a bank or a supplier can safely grant credit,

[edit] Methods

Financial analysts often compare financial ratios (of solvency, profitability, growth...):

  • Across historical time periods for the same firm (the last 5 years for example)
  • In forecasts of the firm's anticipated future performance
  • And among similar firms.

These ratios are calculated by dividing a (group of) account balance(s), taken from the balance sheet and / or the income statement, by another, for example :

Net profit / equity = return on equity
Gross profit / balance sheet total = return on assets
Stock price / earnings per share = P/E-ratio

Comparing financial ratios merely one way of conducting financial analysis. Financial ratios face several theoretical challenges:

  • They say little about the firm's prospects in an absolute sense. Their insights about relative performance require a reference point from other time periods or similar firms.
  • One ratio holds little meaning. As indicators, ratios can be logically interpreted in at least two ways. One can partially overcome this problem by combining several related ratios to paint a more comprehensive picture of the firm's performance.
  • Seasonal factors may prevent year-end values from being representative. A ratio's values may be distorted as account balances change from the beginning to the end of an accounting period. Use average values for such accounts whenever possible.
  • Financial ratios are no more objective than the accounting methods employed. Changes in accounting policies or choices can yield drastically different ratio values.
  • They fail to account for exogenous factors like investor behavior that are not based upon economic fundamentals of the firm or the general economy (fundamental analysis) <ref> </ref>.

[edit] See also

[edit] Ratios

fr:Analyse financière fi:Tilinpäätösanalyysi

[edit] Notes


[edit] External links

  • ProfitCents - This site provides financial analysis tools to convert complex financial data into plain language and understandable analysis.

Financial analysis

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