How To Do a Financial Analysis

Performing a financial analysis of a company, division or project can help to show the past performance and possible future profitability of that entity.  There are many different ways to analyze a particular financial profile, but the goal is always the same.

Most often, one of the goals of a financial analysis is to discover whether a company is financially solvent.  A financial analysis of a relatively long period of operational time will yield this type of result.  This is simply ensuring that the earnings of the company are the same or greater than the expenses accrued during the selected period.

In addition, the profitability of a company may be the target of the same financial analysis.  This number is determined in the same way as the solvency, but the amount of income generated above the amount needed for total expenses is recorded.

A financial analysis may also include the future profitability of a company.  In this case, the person performing the analysis will attempt to use predictive methods to plot out the course of the company over some future period.  If the company remains solvent and profitable despite increasing cost of goods or labor, then the analysis will prove favorable.

A slightly less common number that a financial analysis can use is called comparative profitability.  This takes other numbers from the analysis and scales them in order to accurately compare how one company has performed when compared to other companies within their industry.

Many investors and other firms which may be looking at different aspects of a company use these three numbers to form ratios which may be used to gain some rough knowledge of the health and viability of a company.  Financial analysis is heavily reliant upon exactly what information is needed and so no single formula exists that can be used as a benchmark.

There is also a differentiation between internal financial analysis and external financial analysis.  Internal analysis tends to be far more focused on individual areas of the company, while external analysis is broader in scope.  External analysis is used by lending institutions and sometimes by firms who are determining stock values.

A financial analysis can mean different things to different companies, but it almost always result in a better understanding of the current finances.


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