Financial analysis or financial statement analysis is that aspect of business analysis that is carried out with the intention of getting financial insight of a business by an analyst. It is the traditional function of accountants and other finance professionals to carry out business analysis. But, armed with the information in this article, you too can do your own business analysis and financial analysis of the financial statement of companies. Note that fundamental analysis is part of a broader aspect of business analysis and valuation.
Financial analysis/ financial statement analysis is done with one objective in mind- to get insight into the financial affairs of a business and thereupon make sound economic decision that will ensure profitability and sustainability of the business. To effectively do this, the following aspects of a company’s financial statements must be looked into:
- Financing activities
- Investing activities
- Operating activities
- Profitability
- Liquidity
- Risks
- Vulnerability
The subject matter of each of the points made above can form a textbook. So, have it at the back of your mind that this article gives an overview and not an in-depth treatment of each of these topics. But nevertheless, you will be doing just fine by the basic knowledge acquired in this article.
ANALYZING FINANCING ACTIVITIES
Every business needs financing, these financing comes either in form of equity or liability. Company’s financing needs includes; purchasing of raw materials for productions, paying employees their salaries, acquiring assets and technologies, etc. All what a company do to raise finance for these needs are referred to as financing activities. A lot insight can be obtained from analyzing financing activities of a company.
Financing decision/ financing activities of a company will help an analyst determine a company’ finance structure, growth prospect, risk landscape, and outsiders influence on the business of the company. Recall that a company’s financing needs are met by either liabilities or equity.
Analyzing liabilities in the finance structure of a business
Getting auditor’s report is one way of getting assurance that liabilities stated in the financial statements represents fairly the state of affairs of the company. Minimum disclosure requirements of debts provision vary from country to country but, the gradual convergence of International Accounting Standards (AIS)/ International Financial Reporting Standards (IFRS) and Accounting Standards of many countries of the world has made it possible for a consensus to be reached that disclosure of any breaches in loan provisions that potentially limits a company’s activities or increases its risk of insolvency is to be expected from any financial statement.
Liabilities should be analysed based on; terms, conditions, and complexities. In fact, the points below summarize the important features in analyzing liabilities:
- Terms of debt- maturity, interest rate, payout pattern and amount.
- Restrictions on entity’s activities.
- Flexibility with refinancing
- Restriction/ prohibition in dividend distribution.
- Clause requiring minimum working capital, debt to equity mix, and other financial parameters
- Conversion features of liabilities
This analysis should be extended to include leases, as leases form part of liabilities.
Equity
Nature of equity should be verified. Equity are the interests of the owners of the business. Most company used to hide under the umbrella of hybrid issue to class convertible stocks equity. So, look out for this from the disclosures and other related documents.
Take a closer look at the equity structure of the business. This may save you a lot of headaches in the near future. Loans that have the option of being converted into shares in the future might have dilative effect on the earnings and earnings capacity of the business. From the investors’ perspective, understanding the equity structure of the business you are about investing in is a must.
This article is already long enough. So, in order not to get you bored, I will have to continue the analyzing investment activities on a different page. Read on
To your successful financial analysis!
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