What is Business Analysis?
Business analysis is a methodological process of evaluating a company’s economic prospects and risk in the light of the entity’s strengths and weaknesses. It is an attempt to X-ray a business through the lens of a well informed finance professional. This exercise is done in order to come to a consensus business valuation terms i.e. making willing parties agree on an intrinsic value of a company.
Business analysis serves as the foundation upon which decisions like; investing in equity or loan, extending credit facility or not, deciding the value of a business for initial public offer (IPO), restructurings, and divestures are built. This is to say that business analysis aids management make sound economic decisions through proper evaluation of a company’s business environment, strategies and financial perspectives (financial position and profitability stance).
What is Business Valuation?
Business valuation the aspect that attempts to place monetary value on all future prospects of a business. Business valuation is a necessary evil that must be embraced by all stakeholders in the business community. It is the conversion of forecasted benefits of a company into an estimated value of a business. To determine the value of an entity, a financial analyst, who is most likely to be an investment accountant, selects a business valuation model and determines the company’s cost of capital. It is usually subjective however but, serves as a useful guide.
Another problem that needs to be settled in business valuation is to determine from whose perspective a business is being looked at. A seller would always see a business as having more value while a buyer would tend to downplay the intrinsic value of a business. In practice, they usually end up coming to a common ground. For the purpose of this article, we shall be looking at the absentee owners (investors)
Through business analysis, information intermediaries come to a reasonable estimate of what a business is worth. The information intermediary includes the auditors, who are effectively accountants hence, the importance of business analysis and business valuation skills to every accountant.
Financial statements analysis is a part of business analysis. This is where many people get it wrong. They tend to see business analysis and valuation as the process of analysing financial statements. The main difference lies in the fact that financial statement analysis does little in taking account of environmental factors and strategies of company.
In as much as financial statement analysis is a major task in valuing a business, there are more to ascertaining the value of a business than crunching figures. This will smoothly lead us to the types of business analysis that we have
TYPES OF BUSINESS ANALYSIS
Businesses are analysed for the two main reasons; the first being to find out its credit worthiness, and the other being to understand the owners claim on the assets. The two main business analysis are: Credit analysis, and Equity analysis. The argument for these two broad categories is that the assets of a company are tied to debt and equity.
By analysing these aspects of the business, one gets an insight that may lead to reasonable foresight information. Our concern in this article is to give an overview of what an analyst must know (equity analyst or credit analyst)
It is worth mentioning that there is no clear cut distinction between business analysis, business valuation and financial statement analysis. They all overlap and complement one another.
The ultimate aim of business analysis is to enhance business decisions e.g., capital budgeting by evaluating available information about a company’s financial and non-financial situations – this includes; its management, strategies, internal control, corporate governance, business risks, plans, and its business environment (micro and macro).
COMPONENTS OF BUSINESS ANALYSIS
As a result of noise created by some imperfections in the production of accounting information, investors heavily rely on equity analysts to help remove the noise in reported account of an entity; in an attempt to do so, financial professionals carryout four kinds of analysis. Hence, business analysis has the following components;
BUSINESS STRATEGY ANALYSIS: the purpose of business analysis is to identify key value drivers and business risk, then assess the business’s profit potential at a qualitative level. Value drivers are those economic activities that have the potential of generating future cash flows to the company.
Business analysis involves analysing a firm’s industry and its strategy to create a sustainable competitive advantage. Though qualitative, this is an essential first step as it gives the analyst enough room to frame the subsequent accounting and financial analysis better.
For instance, identifying the key success factors and business risks makes it easier for key accounting policies to be identified from the accounting information. The assessment of a company’s business strategy gives room for broader assessment of profitability and to find out if it is sustainable in the long run. Finally, business analysis allows the accountant or whoever is acting as the financial analyst make sound assumptions in forecasting a company’s future performance. The environment which the company operate in is equally taken into account while carrying out strategy analysis.
ACCOUNTING ANALYSIS: accounting analysis is performed to determine the degree to which a company’s accounting information system captures the business reality of the company that we are analysing. What we primarily do here is to identify those places where there is flexibility in treating a particular item and appraise its appropriateness – taking into account the firm’s unique or specific circumstance.
Accounting policies and estimates can distort the economic reality of a business greatly, hence, analysts or business advisors asses the degree of distortion in an entity’s accounting figure. Another important step in accounting analysis is to re-state the figures found in the financial statements of the company on more economically realistic basis. The essence of performing accounting analysis is to increase the reliability of the conclusion that we make from financial analysis. One of the importance of accounting is that it provides information that we use to carry out our analysis successfully.
FINANCIAL ANALYSIS: here, what the analysts do is to use current and past financial data to assess a firm’s ability to maintain and sustain her financial stand. Two important skills are needed here. First, the ability to systematically and efficiently carryout analysis. Second, the ability to use financial data in exploring business issues.
The two most commonly used financial analysis tools that the analyst employ here are; ratio analysis and cash flow analysis. While ratios focuses on evaluating a firm’s product market performance, cash flow analysis focuses on the flexibility and liquidity of a company from financial perspective- this can also be referred to as going concern analysis. Financial analysis consists of three broad areas- profitability analysis, risk analysis, and analysis of sources and uses of funds.
PROSPECTIVE ANALYSIS: the final step in business analysis is the prospective analysis. It focuses on forecasting a firm’s future- typically earnings, cash flows or both. Prospective analysis draws on the findings from; accounting analysis, financial analysis, strategic and business environment analysis. The output here forms the basis of estimating company value.
What are Valuation Methods?
Business valuation methods are techniques chosen by valuation experts in order to arrive at a perceived value for the business. It is not my intention to delve much into business valuation methods as much has already been written on that. However, it is beneficial to note at this point that the most popular business valuation method known to our generation is the one that employs Capital Assets Pricing Model (CAPM). Other methods still exist, like the dividend valuation model. I encourage you to read up other materials found here for more information.
I would like to again bring to your notice that business analysis is an art not a science, this makes the use of professional judgement and intuition greatly pronounced in business analysis. As always, you cannot expect to find all that you need to be a successful business valuation professional by reading an article on business valuation of this length. You need to make more research and reading.
Be sure to use the external sources of information for strategic decision making discussed in the referenced article as a guide to gathering all the needed information for your business analysis and business valuation exercise.