Financial Analysis

LECTURE 1
Overview of Financial Analysis
Scenario
Karan is a student of finance in a college. His father is a
Chartered Accountant by profession. He asked his father - I
have learned how to prepare Financial statements for a
firm. His father was happy to see his progress. His father
told him apart from knowing how to prepare financial
statements, it is also important to understand how to
analyze the financial statements. He further explained that
analysis of financial statements is very useful to gain
necessary insights about the financial health of the
company as well as the future prospects.

Now let us dive into what we mean by Financial Analysis.

What is Financial Analysis?

Financial Analysis is concerned with analysis and interpretation to financial statements in order to
draw meaningful conclusions. It includes establishing meaningful relationships between various
items of financial statements.

Watch the video to understand the meaning of financial analysis: Video Link

Significance of Financial Analysis

Financial analysis is the process of correctly establishing relationships between the various items of
the balance sheet and the statement of profit and loss in order to identify the firm's financial
strengths and weaknesses.
Management of the company may conduct financial analysis, or parties outside the company, such
as owners, trade creditors, lenders, investors, labor unions, analysts, and others, may do so.
Financial analysis plays a crucial role in decision-making for individuals, businesses, and
organizations. Here's how financial analysis is closely tied to decision-making:

§ Resource Allocation: Decision-makers use financial analysis to allocate resources efficiently.

This includes budgeting, capital budgeting, and determining the optimal use of funds.
For example, a company might decide whether to invest in new technology, expand operations,
or pay off debt based on financial analysis.

§ Investment Decisions: Investors use financial analysis to make decisions about buying, holding,
or selling financial instruments such as stocks or bonds. They analyze financial statements,
cash flow, and other relevant financial data to make informed investment choices.

§ Credit Decisions: Lenders and creditors use financial analysis to assess the creditworthiness of
individuals and businesses. They analyze financial statements, credit reports, and other
financial data to make decisions about extending credit or loans.

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§ Strategic Planning: Financial analysis is integral to strategic planning. Organizations use
financial data to set long-term goals, plan for growth, and align financial resources with
strategic objectives. This includes decisions about entering new markets, launching new
products, or making acquisitions.

Tool of Financial Analysis

1. Comparative Financial Statements
2. Common Size Financial Statements
3. Ratio Analysis
4. Cash Flow Analysis
5. Valuation Analysis

We will learn more about these tools in the sessions to come.

References:

§ Tuovila, A. (2023, November 2). Financial Analysis: Definition, importance, types, and examples. Investopedia.
https://www.investopedia.com/terms/f/financial-analysis.asp
§ Introduction to financial statement analysis. (n.d.). CFA Institute.
https://www.cfainstitute.org/en/membership/professional-development/refresher-readings/introduction-
financial-statement-analysis
§ Introduction to financial analysis. (2001, September 29). SCU.
https://onlinedegrees.scu.edu/media/blog/introduction-to-financial-analysis/
§ Team, C. (2023, November 22). Types of financial analysis. Corporate Finance Institute.
https://corporatefinanceinstitute.com/resources/accounting/types-of-financial-analysis/
§ Kenton, W. (2022, March 7). Financial Statement Analysis: How it’s done, by statement type. Investopedia.
https://www.investopedia.com/terms/f/financial-statement-analysis.asp
§ What is Financial Analysis? Types & Examples. (n.d.). Qlik. https://www.qlik.com/us/data-analytics/financial-
analysis