There are basically two broad ways of financial analysis one basing on the users and basing on the method of operations. Now basing on users meaning who is doing this analysis or to whom this is for. So, we have two types of financial analysis, external analysis and internal financial analysis. And on the basis of operations, how we are going to do this financial analysis, we have dynamic analysis and static analysis. So, let’s try to understand this external analysis.
What is this external analysis?
you know, analysis on your company,
So, usually investors can do that creditors can do that before they give the loans to government agencies, including police and investigation department if needed, then credit agencies then general public also. So, all these people who are not part of this company, they do this external analysis if they do the other than the company, we told them that financial analysis becomes external. No internal.
What is this internal analysis?
So, again internal is anyone who have access to internal accounting records of the company. Like for example, accounting department, your CFOs CEOs, anyone doing that, it becomes your internal analysis, internal financial analysis. Now, these two these are quite simple now coming to on the basis method of operations, you have dynamic analysis and static analysis important guys.
What is this Dynamic analysis (Horizontal)?
So, dynamic analysis is also known as horizontal analysis. So, what is this how horizontal analysis basically it’s comparing financial data of any company for the last several years it can be five years 10 years 20 years maybe.
This type of analysis here, you’re going to look at different tiers how you like for example, how you are in 2025 years back how you were or 10 years back how your growth was. So, when you are comparing with different several years are different tiers to the current one.
So, this type of analysis is known as horizontal analysis or it’s also known as dynamic analysis. Why make analysis because this is done from ear to ear rather than a singular meaning you’re not doing within that year you are comparing this year with several other years. So hence it is known as dynamic.
why do we call it as dynamic is because, it is moving from one year to another year and it is moving horizontally year to year we are not comparing within that year? So, since it is based on year to year data so hence it is known as dynamic. Now, this analysis is not you can do either in terms of percentage or absolute number differences a difference some cases case to case. So, this is known as horizontal or dynamic analysis.
What is this Static analysis (Vertical)?
Vertical analysis when you’re going to start see basically in horizontal analysis you are comparing again; you’re looking at the relationship between two defer to same entities have different dears to same entities on to same things between different tiers. But in vertical analysis, the relationship is on various items, well this financial statement of one accounting period or of that particular accounting period only, we are not going to compare even 2019.
There are so many things to analyze it always when you’re analyzing the financial, you need to have a specific objective, otherwise you will get confused and you will lead to somewhere . So first you need to set the objective, why are you doing it?
You have to define to what extent are you going to analyze so in this weather, I’m going to analyze the past three years data, five years data, 10 years data, what am I going to use the statement.
Step Financial Analysis:
Keep your analysis to that extent. Say curd is reorganized and rearrange financial data Yeah. So, whatever if you have to reorganize your financial data as per your analysis you have to do it need not be exactly the same as what.
Now also relationship among financial statement with the help of tools and techniques, so, you need to clearly look into different relationships within the financial statement. So, again how we are going to look at different relationship between two or more than two entities that is going to depend on your objective and then of course, you have to interpret the information.
There are many techniques but then these six are very very common in financial analysis. One is comparative statements second is trend analysis. Third is fund flow analysis for this cash flow analysis, phase ratio analysis 60s, common size statements.
What is comparative statement?
let’s say you’re doing P&L account statement? Then you have to compare with only the P&L account. So, your complicated or let’s say you’re doing within the same company different Yes. Then comparative accounts are different tiers accounts. So those things comparative statement you need to have those statements vary and you need to be able to compare them trend analysis.
What is trend analysis?
Analysis is basically you use like she said graphical presentation. So, you’re going to let’s say you are going to look at how the cost reduction or how the company as you know got into cost reduction. You will take last three years how the company has spent and then you put in a line graph or scatterplot or whatever.
And then you will see a line or histogram whatever. And it will show the trend how it is moving the cost line. And here trend analysis we use only for one line item it can be expenditure, it can be income, it can be inventory control, anything? trend always gives one idea. Next comes fund flow analysis.
What do you what do you think is cash flow & Cash flow?
fund flow statement basically it’s going to look into working capital flow in cash flow so, we can we use the working capital items. So, but predominantly when we are doing fund flow analysis like you said balance sheet etc. and always cash flow, we can do it for month on month. But fund flow cannot be for month or month usually between year on year like he was saying balance sheet loans etc.
You can get every month fund flow statement. Also, one can always compare between two different what we call ears fine flow usually the banks they are more interested in that fund flow because they want to know how the capital working capital were having which are the other entities financial institutions they have gotten so that they know overall liability .
So, net cash and fund flow more or less the same only thing fund flow Yeah, like you say rightly said yeah, it includes all the bigger aspects. Cash flowed smaller aspects it can be smaller things within that particular period. So, this analysis on these analysis area fund flow and cash flow, issue analysis.
What is ratio analysis?
Ratio analysis is a quantitative method in which the line items are expressed in terms of ratios. And with that ratios, you can derive a certain relationship. So that becomes the finances.
What is common size statement?
Common size statement is important guys, this note, take a note. . So basically, it’s also a kind of, it’s basically an income statement, . Now, here are the line items are the items within that particular statement, . It is always shown in terms of percentages.
What is liquidity Ratio?
Company is going to if at all there is any requirement of money, urgent require of band of money, whether it is going to meet that obligation or not, . So that becomes the liquidation but tell me higher the liquidity ratio.
Your assets are their liquid definitely. And if you have not invested in some risky investments like capital market or so, let’s suppose your liquidity is in terms of your cash balance or
gold or some, you know, bonds or something like that. Usually what happens is you have to look at the return on investment How much are you getting out of that. And if you’re working capital the interest what you’re going to pay on working capital, if it is higher than your
interest, what you’re going to get your cost of funds are very high. So, always you know, if you have a liquid cash you should always look at clearing off working capital First of all, you should not take working capital if you’re already rich, but again working your liquidity increases if you are let’s say your bank suddenly got more account receivable. So, then you should not sit silent immediately clear of your working capital short term working capital loans.
What are these leverage ratios?
when you are leveraged issues are basically it is going to show how your debt and equity, the firm’s assets unbalanced. So, whenever this is balanced, we call it as leveraged.
What are these activity ratios?
Activity ratio talks about activity of the form, what is activity of the form? Let’s say you are manufacturing cars. What is your activity? Again, you require you’re using steel, you’re using other raw material, you’re using components to manufacture something. Your activity ratio is going to reflect your efficiency of utilizing your assets. So all these assets, assets can be inventories, assets, again, your machines, your land, whatever you call, all these things, how you’re using company’s assets? how efficiently are using the company’s assets,
What is this profitability ratio?
Profitability ratio. So, these ratios are going to talk about your overall performance in terms of your revenue in terms of your effectiveness of the firm in terms of your managing of taxes, all these things, it’s going to talk about profitability ratios.