BATANGAS STATE UNIVERSITY

College of Accountancy, Business Economics and International Hospitality Management

GRADUATE SCHOOL

BA 500 MBA ORIENTATION

Written Report on the Topic

FINANCIAL ANALYSIS
Adajar, Rhona C.

INTRODUCTION

Financial analysis is nowadays considered as the main ingredient in business

activity, without this, to run business will turn out to be futile. Hence for every

organization, to do financial analysis is not only necessary but to handle the same diligently

and all the findings of the analysis should get duly implemented.

The financial analysis section of a business plan should contain the data for

financing your business for the present, what will be needed for future growth, and an

estimation of your operating expenses. This may be the most challenging for you to

complete on your own, but it also could be the deal-maker or deal-breaker when you are

searching for funding. This should be based on estimates for new businesses or recent data

for established businesses.The financial analyst uses these documents to derive ratios,

create trend lines, and conduct comparisons against similar information for comparable

firms.

This report will just be an overview of the financial analysis. This does not include

computations since it entails mastery and is a tedious thing. Sample analyses are presented

on the report (check slide presentation on financial analysis).

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College of Accountancy, Business Economics and International Hospitality Management

GRADUATE SCHOOL

DISCUSSION

Financial analysis is one of the key tools needed by the managers of a business to

examine how their organization is performing. For this reason, they are constantly querying

the financial analyst about the profitability, cash flows, and other financial aspects of their

business.

A financial analysis includes the following:

1. Balance sheet – this contains your assumed and anticipated business financials,

including assets, liabilities, and equity.

2. Cash-flow analysis – it is an overview of the cash you anticipate will be coming

into your business based on sales forecasts, minus the anticipated cash expenses of

running the business.

3. Profit-and-loss analysis - Your income statement that subtracts the costs of the

business from the earnings over a specific period of time, typically a quarter or a

year.

4. Break-even analysis - Demonstrates the point when the cost of doing business is

fully covered by sales.

5. Personnel-expense forecast - The expenses of your team, as outlined in a

management summary section.

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 BATANGAS STATE UNIVERSITY

College of Accountancy, Business Economics and International Hospitality Management

GRADUATE SCHOOL

Completing a financial analysis section for a business that hasn't been started yet

requires some assumptions. However, these aren't guesses. What you expect from the

business needs to be based on detailed research and data.

The discussion will involve the different types of analysis, examples of financial

analysis and different financial analysis tools. Also, possible advantages and disadvantages

of using financial analysis is included.

I. Types of Analysis

1. Horizontal Analysis

The horizontal analysis measures the financial statements line of items with the

base year. That means, it compares the figures for a given period with the other period. In

Horizontal Analysis financial statements of the company is made to review for a number

of years and it is also called a long term analysis. It is useful for long term planning, and it

compares figures of two or more years.

Here we find out the growth rate of the current year as compared to the previous

year in order to identify opportunities and problems.

• Pros – It helps to analyze the growth of the company from year on year or quarter

on quarter with the increase in operations of the company.

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College of Accountancy, Business Economics and International Hospitality Management

GRADUATE SCHOOL

• Cons – The company operates in the industrial cycle and if the industry is

downgrading in spite of company is performing better, due to specified factors that affect

the industry; trend analysis will show negative growth in the company.

2. Vertical Analysis

The vertical analysis measures the line item of the income statement or balance

sheet by taking any line item of financial statement as a base and will disclose the same in

percentage form.

Vertical Analysis is a technique to identify how the company has applied its

resources and in what proportion its resources are distributed across the income statement

and the balance sheet. The assets, liabilities and shareholders’ equity is represented as a

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percentage of total assets. In the case of Income Statement, each element of income and

expenditure is defined as a percentage of the total sales.

For example, in Income Statement, to disclose all the line items in percentage form

by taking base as Net sales. Likewise, in the Balance sheet on the asset side, to disclose all

the line items in the percentage form of total assets.

• Pros – The vertical analysis helps in comparing the entities of different size, as it

presents the financial statements in absolute form.

• Cons – It represents the data of a single period only, so miss comparison across

different time phase

3. Trend Analysis

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College of Accountancy, Business Economics and International Hospitality Management

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Trend analysis means identifying patterns from multiple time period and plotting

those in a graphical format such that actionable information could be derived.

4. Liquidity Analysis

Liquidity Analysis determines the company’s ability to meet its short term financial

obligations and how it plans to maintain its short-term debt repayment ability. Its main

intent is to verify the appropriate liquidity being maintained thoroughly for the given period

and all the liabilities are being met without any default.

The short-term analysis focus on routine expenses. It analyses the short-term

capability of the company with respect to day-to-day payments of trade creditors, short-

term borrowings, statutory payments, salaries etc. Its main intent is to verify the appropriate

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College of Accountancy, Business Economics and International Hospitality Management

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liquidity being maintained thoroughly for the given period and all the liabilities are being

met without any default.

The short-term analysis is carried out using the technique of ratio analysis, which

uses various ratios like liquidity ratio, current ratio and quick ratio.

5. Solvency Analysis

The long-term analysis is also termed as Solvency analysis. Focus under this

analysis is to ensure the proper solvency of the company in the near future and to check

whether the company is able to pay all the long-term liabilities and obligations.

It gives stakeholders confidence about the survival of the entity with proper

financial health.

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College of Accountancy, Business Economics and International Hospitality Management

GRADUATE SCHOOL

Solvency ratios like Debt to Equity ratio, Equity Ratio and debt ratio give a correct

picture of the financial solvency and burden on the firm in the form of external debts.

6. Profitability Analysis

Profitability financial analysis helps us understand how the company generates its

profit from its business activities.

The investment decision is one of the most important decisions to be taken by all

the businessperson. The main aim of all the investment decisions is to ensure the maximum

profit out of the investment made in the project. In order to verify the viability of the

decision, they carry out profitability analysis, which will check the rate of return in a given

period. This will help the investor in obtaining assurance of safekeeping of funds.

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College of Accountancy, Business Economics and International Hospitality Management

GRADUATE SCHOOL

7. Scenario and Sensitivity Analysis

In business, day in and day out various changes keep on coming. In addition, based

on the economic outlook, various kinds of changes in tax structures, banking rates, duties,

etc. Each of this determinants highly affects the financials, hence it is utmost important that

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treasury department does such sensitivity analysis with respect to each factor and try to

analyze the effect of the same with the company financials.

8. Variance Analysis

Variance analysis will help in checking any loopholes in the process and hence it

will help an entity to take corrective actions for avoidance of the same in the future.

Variance analysis can be carried out by standard costing technique, comparing budgeted,

standard and actual costs.

Business runs on estimates and budgets, after the completion of transactions, it is

utmost important to check the variance in between budget and estimates with the actuals

one.

There are two types of variance – Controllable and Uncontrollable.

9. Valuation

Valuation analysis means deriving the company’s fair valuation. Valuation

Analysis helps us identify the fair value of the business, investment or a company. While

valuing a business, choosing the correct valuation methodology is very important.

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10. FP&A

It is the systematic process of analyzing or examination of financial information of

the company to reach a business decision. People in the company examine how stable,

solvent and profitable business or any project of the company and these assessments are

carried out by examining the income statement, balance statement and cash flow statement

of the company.

Analysis and examination of financial statements are important tool in assessing

the company’s health and it provides information to company management and then it is

used by them for future planning and decision making. It helps the company to raise capital

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College of Accountancy, Business Economics and International Hospitality Management

GRADUATE SCHOOL

in domestic as well as overseas. With the help of various Financial Analysis methods as

mentioned above the company can predict the future of a company or individual projects

and it helps company management to take decisions by examine the recommendations

made in a report. It helps investors whether to invest funds in a company or not by assessing

the company’s financial reports.

Every company will be having its own financial planning and analysis (FP&A)

department whose main work is to analyze the internal organization’s various data points

and to construct the Management Information System (MIS), which will be reported to top

management.

11. Financial Risk Analysis

Here we measure how leveraged is the company and how it is placed with respect

to its debt repayment capacity.

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College of Accountancy, Business Economics and International Hospitality Management

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12. Stability Ratio

Stability ratio is used with a vision of long term. It uses to check whether

company is stable in the long run or not.

𝐹𝑖𝑥𝑒𝑑 𝐴𝑠𝑠𝑒𝑡𝑠
𝐹𝑖𝑥𝑒𝑑 𝐴𝑠𝑠𝑒𝑡 𝑅𝑎𝑡𝑖𝑜 =
𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐸𝑚𝑝𝑙𝑜𝑦𝑒𝑑

13. Coverage Analysis

This type of coverage financial analysis is used to calculated dividend which

needs to be paid to investors or interest to be paid to the lender.

14. Control Analysis

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Control ratio from the name itself it is clear that its use to control things by

management. This type of ratio analysis helps management to check favorable or

unfavorable performance.

There are mainly three types of ratios used here – Capacity Ratio, Activity Ratio,

and Efficiency Ratio

1. Capacity Ratio Formula = Actual Hour Worked / Budgeted Hour * 100

2. Activity Ratio Formula = Standard Hours for Actual Production / Budgeted

Standard Hour * 100

3. Efficiency Ratio Formula = Standard Hours for Actual Production / Actual Hour

Worked * 100

15. Rate of Return Analysis

The internal rate of return is a metric employed in capital budgeting which is used

to measure the extent of profitability of potential investments. It is also known as ERR or

economic rate of return. IRR is defined as the discount rate that sets the NPV of a project

to zero is the project’s IRR.

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College of Accountancy, Business Economics and International Hospitality Management

GRADUATE SCHOOL

II. Examples of Financial Analysis

Financial Statement Analysis is considered as one of the best ways to analyze the

fundamental aspects of a business. It helps us in understanding the financial performance

of the company derived from its financial statements. This is an important metric to analyze

the company’s operating profitability, liquidity, leverage, etc.

The following financial analysis example provides an outline of the most common

financial analysis used by professionals.

1. Liquidity Ratio

Liquidity ratios measure the ability of a company to pay off its current obligations.

Common types:

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 Current Ratio measures the extent of the number of current assets to current

liabilities. Generally, the ratio of 1 is considered to be ideal to depict that the

company has sufficient current assets in order to repay its current liabilities

 Quick ratio helps in analyzing the company’s instant paying ability of its current

obligations.

2. Profitability Ratio

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Analyze the earning ability of the company. It also helps in understanding the operating

efficiency of the business of the company. Few important profitability ratios are as follows:

 Operating Profitability Ratio

 Net Profit Ratio

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 Return on Equity (ROE)

 Return on Capital Employed (ROCE)

3. Turnover Ratio

Analyze how efficiently the company has utilized its assets. Some important

turnover ratios are as follows:

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 Inventory Turnover Ratio

 Receivable Turnover Ratios

 Payable Turnover Ratios

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4. Solvency Ratio

This measure the extent of the number of assets owned by the company to cover its

future obligations. Some important solvency ratios are as follows:

 Debt Equity Ratio

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 Financial Leverage

It is important to understand that financial ratios are one of the most important

metrics used by finance professionals in analyzing the financial performance of companies.

Also, it helps in understanding the relative performance of two or more companies in the

same industry.

III. Tools for Financial Analysis

Financial analysis tools are different ways or methods of evaluating and interpreting

company’s financial statements for different purposes like planning, investment and

performance where some of the most used financial tools based on their usage and

requirement are common size statement (vertical analysis), comparative financial

statements (comparison of financial statements), ratio analysis (quantitative analysis), cash

flow analysis and trend analysis.

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College of Accountancy, Business Economics and International Hospitality Management

GRADUATE SCHOOL

When an analyst, business executive, or student is dealing with a financial issue or

wishes to understand the financial implications and economic trade-offs involved in

decisions about business investment, operations, or financing, a wide variety of analytical

techniques—and sometimes rules of thumb—is available to generate quantitative answers.

To choose the appropriate tools from the available alternatives is clearly an important

aspect of the analytical task.

Top 4 Most common financial analysis tools are:

1. Common Size Statement

This is the first financial analysis tool. In the market, companies of different size

and structures are available. In order to make them comparable, their financial statement

must be prepared in absolute format, which brings all the particulars at one level. The

globally acceptable format to disclose the financials for comparison is to bring in data in a

percentage format. The organization will prepare main financial statements like Common

size Balance sheet, Common size Income statement and Common Size Cash flow

statement.

For example, in balance sheet- base of total asset, in income statement- base of net

sales and in cash flow statement – base of total cash flows can be taken and all the line

items will be disclosed in percentage form, which can be adequately used for doing internal

analysis or for doing external analysis with peers group.

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2. Comparative Financial Statements

Comparative financial statements are used in horizontal analysis or trend analysis.

It helps in analyzing the periodic change in various components of the financial statements

and displays which component has the maximum impact. Such comparative financial

statements can be either prepared in currency amount terms or in percentage terms.

The comparative financial statement has advantages like easy comparability,

observing the trend, periodic performance evaluation, etc. However, it has disadvantages

like ignoring inflationary impact, high dependability on financial information, which can

be manipulated, a different method of accounting used by different entities, etc.

3. Ratio Analysis

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Ratio Analysis is the most commonly used financial analysis tool used in the market

by an analyst, experts, internal Financial Planning & Analysis department and other

stakeholders.

Moreover, an entity based on their requirement can prepare the ratios for their

analysis and try to manage the operations.

However, below are the odd side of ratio analysis:

 Highly relying on past information

 Inflation impact is ignored

 Chances of manipulation/window dressing of financials, which can enhance the

fairness of ratios

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 Any seasonal changes, based on the nature of business will be ignored, as it cannot

be directly adjusted in financials

5. Benchmarking Analysis

Benchmarking is the process of comparing the actuals with the targets set out by the

top management. Benchmarking also refers to the comparison made with the best practices

and strive to achieve the same keeping the same as the target.

Benchmarking is the practice of being humble enough to admit that someone else is

better at something and wise enough to learn how to match and even surpass them.

In benchmarking below steps are to be performed:

Step1: Select the area which is needed to be optimized.

Step2: Identify the trigger points with which it can be compared.

Step3: Try to set up the better standard for the same or take industrial standards as the

benchmark.

Step4: Evaluate the periodic performance and measure the trigger points.

Step5: Check whether the same is achieved or not, if not do variance analysis.

Step6: If achieved, then strive to set up the better benchmark.

For doing the above benchmarking, ratios, operating margin matrix, can be used.

Operating margin of industry average can be compared and should try to arrive at the better

position. The company named Xerox, in order to sustain in the photocopy business,
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initiated Benchmarking. Presently, they have optimized more than 100 functions in

comparison to industrial standards. Benchmarking can be observed as a tool for

improvement with the aim of customer-focused improvement activities and should be

driven by customer and internal organization needs.

There are numerous tools available in the market to carry out the financial analysis

based on the various needs. In addition, organizations based on their need, also build up

various in-house tools, which help them to track their requirements. In today’s competitive

world, it is of utmost importance to track the performance of own organization, as well as

of the competitor as it will help in maintaining the performance and help in thriving the

business.

To summarize these, here are the advantages and disadvantages of Financial

Analysis.

Advantages of Financial Analysis

1. With the help of financial analysis, method management can examine the

company’s health and stability.

2. It provides investors an idea about deciding whether to invest a fund or not in a

particular company and it gives the answer to a question such as whether to invest,

How much to invest? And what time to invest?

3. It simplifies the financial statements which help in comparing companies of

different sizes with one another.

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4. With the help of a financial analysis company can predict the future of the company

and can forecast the future market trends and able to make future planning.

Disadvantages of Financial Analysis

1. One of the disadvantages of financial analysis is that it uses facts and figures that

are as per current market conditions which may fluctuate.

2. False data in the statement will give you false analysis and data may be manipulated

companies and it may not be accurate.

3. Comparison between different companies is not possible if they adopt different

accounting policy.

4. If any company is working in a rapidly changing and highly competitive

environment, its past results shown in the financial statement may or may not be

indicators of future results.

5. When companies do financial analysis, most of the time they fail to consider the

price changes and due to this they unable to show inflation impact.

6. It only considers the monetary aspects of companies’ financial statements and does

not take into consideration the non-monetary aspects of financial statements.

7. It is totally based on past data in financial statement and future results can’t be like

a past.

8. Many Intangible assets not recorded in the statement, due to this Intangible assets

don’t consider while doing financial analysis.

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9. This is limited to a specific time period and not always comparable with different

company’s statement due to different accounting policies.

10. Sometimes financial analysis is the influence of personal judgment, and it doesn’t

necessarily mean that strong financial statements analysis of companies have a

strong financial future.

REFERENCES

https://www.wallstreetmojo.com/examples-of-financial-analysis/

https://www.cfainstitute.org/-/media/documents/support/programs/cfa/2019-L1V3R26-

footnotes.pdf

https://www.myaccountingcourse.com/financial-ratios

https://www.investopedia.com/terms/f/financial-statement-analysis.asp

https://marketbusinessnews.com/financial-glossary/financial-analysis/

https://thebusinessferret.com/financial-analysis-report-samples/

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