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Financial Analysis

Understanding the purpose
of Financial Analysis

The main purpose of the financial analysis
is to gain an understanding
of the major issues for the company:

The main purpose of the financial analysis
is to gain an understanding
of the major issues for the company:

  • Profitability- company’s ability to generate return on the invested capital
  • Earnings Capacity – company’s effectiveness in converting revenue to profit (return)
  • Capital Adjustment – adjusting capital base in line with the changing activity levels
  • Solvency – ability of the company to pay its debts
  • Liquidity – company’s ability to honor its short-term debts

Steps for Financial Analysis

The main purpose of the financial analysis
is to gain an understanding
of the major issues for the company:

  • Calculation of ratios
  • Interpretation of ratios
  • Evaluation of results

While making comments we focus on:

  • The direction of speed of the change. How large is the change? Is it positive or negative?
  • The level of the ratio and basis for comparison
  • The cause of the development

To assess the performance of a customer or supplier
To assess performance of a takeover target or a potential investor in one’s own company
To assist in investment decisions of various kinds (buying shares in other companies)

The right order of full financial analysis

  • Variable cost separate (independently of which function they belong to)
  • Marketing fixed cost separate
  • Remaining external fixed costs
  • Depreciations
  • Interest income
  • Interest expense
  • Extraordinary items

An overview on the Financial Ratios

  • Profitability- company’s ability to generate return on the invested capital
  • Earnings Capacity – company’s effectiveness in converting revenue to profit (return)
  • Capital Adjustment – adjusting capital base in line with the changing activity levels
  • Solvency – ability of the company to pay its debts
  • Liquidity – company’s ability to honor its short-term debts

Profitability ratios

Return on investment (ROI) – Return on Assets (ROA) ROI = Profit before interest*100 Average Total Assets

 This ratio expresses the relationship between the profit generated by the business and capital employed.

  • Shows the percentage of profit that a company earns in relation to its overall resources (total total assets can be year-end only or average of opening and closing balance, but whatever you use it must be used consistently. 

Need for comparison

  • Past periods
  • Planned Performance
  • Similar businesses