Financial Analysis in Business
Businesses tend to use a combination of financial analysis methods to analyse the financial strength and weaknesses from all angles. Several methods of financial analysis exist, each having different advantages and benefits. Here are the main ones:
Vertical Analysis
Vertical financial analysis consists in comparing each item in a financial statement (such as the balance sheet or the income statement) to another reference item, often total assets or liabilities. This type of analysis highlights the financial structure of a company and check the distribution of resources between the different posts.
The main benefits of vertical financial analysis are the following:
- It allows the determination of the relative share of each position in relation to all the resources of the company. This can help identify the positions that are most important and have the greatest impact on the company’s financial situation.
- It facilitates the comparison of different companies or different periods within the same company. By highlighting the variations in the relative share of a given positions, vertical financial analysis allows us to identify trends and developments over time.
- It can help detect anomalies or imbalances in the financial structure of the company. For example, too large an increase in the share of overheads in total expenses can indicate a poor cost management.
Horizontal Analysis
Horizontal financial analysis allows the comparison of the financial data of a business over several periods, usually over several years. The main advantages of this analysis are:
- Identifying trends: The horizontal analysis allows you to identify changes in the company’s key figures over a given period. This can detect positive or negative trends in the financial performance of the company.
- Performance comparison: By comparing the figures year on year, it is possible to assess the progress or regression of the company over time. This can highlight the areas in which the company has improved or regressed.
- Anomaly detection: The horizontal analysis enables you to quickly identify the important gaps between the different periods. This can help identify potential accounting frauds or financial problems requiring special attention.
- Decision making: Through horizontal analysis, leaders can make informed decisions about the strategy to adopt for the future of the company. This analysis allows managers to anticipate risks and identify growth opportunities.
Ratios Analysis
Financial ratios are summary measures assessing the financial health and performance of a company. Here is some of the benefits of financial ratios:
- They allow the comparison of the performances of a company to those of its competitors or those of the sector of activity in which it evolves.
- They help investors make better decisions in investment matters by providing information on profitability, liquidity and solvency of a business.
- They help business managers identify the strengths and weaknesses of their company, which gives them the opportunity to make strategic moves aimed at improving the financial performance.
- They help lenders assess the risk related to the granting of a loan to a business in analysing its ability to repay debt.
- They help managers understand the evolution of the company’s financial performance over time and to detect trends.
Cash Flow Analysis
Cash flow analysis presents many benefits for businesses, including:
Financial health visibility: Cash flow analysis allows companies to closely monitor the financial health of the company by monitoring cash inflows and outflows. This allows you to forecast future cash flow needs and make sound decisions.
- Decision making: Cash flow analysis provides decision makers with a clear vision of the company’s financial situation and allows them to make intelligent decisions regarding investments, financing and expenditure.
- Effective Cash Management: By closely monitoring cash flow, businesses can better manage their treasury, avoid liquidity shortages and optimise their financial management.
- Financial Problem Identification: Cash flow analysis can quickly identify the potential problems in terms of treasury and resolve them before they become major problems.
- Communicating with Stakeholders: In-depth cash flow analysis enables companies to convey effectively to investors, lenders and other stakeholders the financial situation of the company.
An MBA in Finance would equip managers with the skills required to perform these types of analysis and come up with a financial diagnostic of the company on which to base strategic recommendations.
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Written by Philippe Riewer,
GROUP CFO, Stafford Global
