International Journal of Accounting Research

Financial Analysis: Evaluating Company's Financial Health and Future Prospects

Gal Hammoudeh^* Department of Finance, Sapienza University of Rome, Rome, Italy
^*Correspondence: Gal Hammoudeh, Department of Finance, Sapienza University of Rome, Rome, Italy, Email:

Received: 01-Feb-2023, Manuscript No. IJAR-23-20981; Editor assigned: 03-Feb-2023, Pre QC No. IJAR-23-20981 (PQ); Reviewed: 17-Feb-2023, QC No. IJAR-23-20981; Revised: 24-Feb-2023, Manuscript No. IJAR-23-20981 (R); Published: 03-Mar-2023, DOI: 10.35248/2472-114X. 23.11.316

Description

Financial analysis is the process of evaluating a company's financial performance to determine its financial health and future prospects. It involves analysing various financial statements such as the income statement, balance sheet, and cash flow statement to gather information about a company's financial position, profitability, liquidity, and solvency. The information obtained from financial analysis is used by investors, lenders, and other stakeholders to make informed decisions about the company.

Methods of financial analysis

Horizontal analysis: This method involves comparing financial data from two or more periods to identify trends and changes in the company's financial performance over time. Horizontal analysis is useful for detecting changes in revenue, expenses, and other financial indicators that may indicate a company's financial health or performance.

Vertical analysis: This method involves analyzing a company's financial statements to identify the proportion of each line item in relation to total assets or revenue. Vertical analysis is useful for identifying the composition of a company's assets, liabilities, and equity and how they are utilized to generate revenue.

Benefits and limitations of financial analysis

Identifying financial strengths and weaknesses: Financial analysis helps stakeholders to identify a company's financial strengths and weaknesses, which can help them make informed decisions about investing or lending.

Evaluating profitability: Financial analysis helps stakeholders to evaluate a company's profitability by analyzing its income statement and identifying its sources of revenue and expenses.

Assessing liquidity and solvency: Financial analysis helps stakeholders to assess a company's liquidity and solvency by analyzing its cash flow statement and balance sheet.

Making informed investment decisions: Financial analysis helps investors to make informed decisions about investing in a company by providing insights into its financial health and future prospects.

Despite its numerous benefits, financial analysis has some limitations that need to be considered.

Some of the key limitations of financial analysis include

Historical data: Financial analysis relies on historical data, which may not be a reliable indicator of a company's future performance.

Incomplete information: Financial analysis is based on information that is publicly available, which may not provide a complete picture of a company's financial health and future prospects.

Interpretation: Financial analysis involves interpreting financial data, which can be subjective and prone to errors.

Key ratios used in financial analysis

Financial analysis involves calculating and interpreting various financial ratios to gain insights into a company's financial health and performance. Some of the key ratios used in financial analysis includes

Liquidity ratios: These ratios gauge a company's capacity to fulfil its immediate commitments. The current ratio, quick ratio, and cash ratio are the liquidity ratios that are most frequently utilized.

Solvency ratios: These ratios measure a company's ability to meet its long-term obligations. The most commonly used solvency ratios include the debt-to-equity ratio, debt-to-assets ratio, and interest coverage ratio.

Profitability ratios: These ratios measure a company's ability to generate profits. The most commonly used profitability ratios include the gross profit margin, net profit margin, and return on equity.