Financial Analysis is important to a business for a number of reasons. The nature of analysis is different and it is undertaken depending on the need of the analysts. This article speaks about the users of Financial Analysis.
Financial analysis is the process of identifying the financial strengths and weaknesses of the firm by properly establishing relationships between the items of the balance sheet and the profit and loss account. Financial analysis also refers to as financial statement analysis or accounting analysis or Analysis of Finance which is used to asses viability, stability and profitability of a business, sub-business or project.
There are different reasons why financial statement analysis is important. And the nature of analysis differs depending on the requirement and the purpose of an analyst. Financial analysis is undertaken by a management of a business firm or parties outside the firm, such as, owners, investors, creditors and others.
The ability to understand financial data is essential for any business manager. A business manager needs to take a broad view to critically analyze a business. It is also important to consider how business decisions have their impact on the organization.
Financial analysis thus enables business managers to make the right decisions while it aids them greatly to analyze the financial problems that a company faces.
Financial analysis is a quantifying method for determining the past, current and the future performance of a company. As regards the ratio analysis, it’s a powerful tool of financial analysis. The ratios are used to measure the efficiency with which a company turns business activities into profitability. They are not only used to measure the return earned on a company’s capital, but also to determine profits and the expense margin. Ratios are categorized according to the financial aspect of the business. Accordingly, there are five categories of financial ratios. They are: liquidity (solvency), leverage (debt), asset efficiency (turnover), profitability and market ratios. And each ratio is used to measure different financial aspect of the business firm. Financial analysis is useful for business owners and managers in decision making process while it is very much helpful in determining the strength and weakness of a business firm. In this way, business owners and company managers gain helpful insights from their examination of company’s financial statements that in turn helps to improve profitability, cash flow and value of the firm.
The term creditor is frequently used in the financial world. They are the ones who are owed payments for raw materials or products’ component parts. Financial analysis is important to trade creditors, as they are interested to know the ability of the business firm to meet their claims over a short period of time. It’s thus the analysis for them is confined for evaluating the liquidity position of the firm. Similarly, the long term suppliers are concerned with the solvency and stability of a business entity. They therefore need to analyze the profitability over the course of time and to determine the ability of a business to generate cash and pay interest and pay back the principle amount of money. This also leads to conduct analysis for determining the future solvency of a business. Likewise, the steady growth of earnings of a business firm is a major concern for investors who invest their money in the firm’s shares. Like the long term supplies they are also interested in ascertaining the firm’s future earnings ability, solvency and risk.
Financial analysis is an important aspect of the overall business finance function. It is applied in a wide variety of situations. Thus, a business management would be concerned in every aspect of the financial analysis to get information that enables to make critical decisions; ensures the resources are being used effectively and efficiently and determines business entity’s liquidity, solvency, stability and profitability.
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A financial ratio or accounting ratio is a relative magnitude of two selected numerical values taken from an enterprise's financial statements. It may also be defined as the relationship between two accounting figures, expressed mathematically.
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