What is Financial Analysis? 4 methods and metrics you should know

In order to grow or avoid a financial crisis, companies must regularly check their financial condition. Just as it is important for humans to have regular check-ups such as physical examinations and comprehensive medical examinations, companies also need to check the same. That’s financial analysis.

In this section, we will explain the basics of financial analysis and what is revealed by conducting financial analysis.

What is Financial Analysis?

Financial analysis refers to analyzing a company’s profitability, safety, productivity, and growth potential based on the figures in financial statements such as balance sheets and income statements, and comparing them with those within the industry and with competitors. increase. Managers, business partners, investors, etc., can use financial analysis to grasp the current situation and problems, and can specifically grasp the overall picture and problems of the company.

By checking whether there are any points for improvement and whether there are any problems in the management of the company, management crises can be avoided and future profits of the company can be predicted. Financial analysis enables us to make the best decisions by accurately grasping the current situation and predicting the future.

4 Classifications of Financial Analysis

Financial analysis is classified into four types according to its purpose: “profitability analysis”, “safety analysis”, “productivity analysis” and “growth analysis”.

Profitability analysis

Profitability analysis is a method of analyzing how profitable a company is. It is characterized by looking at the ratio rather than the specific amount of profit.

Businesses use a variety of capital to operate their businesses and generate profits by generating sales. Without making a profit, a company cannot continue to operate. Therefore, profitability analysis is a method to understand whether the capital used by the company is making profits efficiently. Profitability analysis is performed using numerical values ​​such as gross profit margin and operating profit margin.

Gross profit margin (gross profit margin)

“Gross profit after deducting the cost of sales from sales” is the gross profit, and the gross profit ratio is the ratio of gross profit to sales. It is a basic indicator of a company’s rough profit margin.

Gross profit margin (%) = Gross profit on sales / Sales x 100

Operating profit margin

The ratio of operating income to sales is a numerical value that expresses how much operating income remains in relation to sales. It is an index for judging the efficiency of sales (sales and management). The higher the ratio, the better. If this index is low, no matter how high the sales, it means that there is no profit left.

Operating profit margin on sales (%) = operating profit / sales × 100

Safety analysis

Security analysis is a technique to analyze how much the company is able to pay. This analysis tells you whether the company is financially sound (financially sound or not). A number of indicators are used for safety analysis, but the main ones are liquidity ratio and capital adequacy ratio.

Current ratio

The current ratio is a comparison of current assets, which represents the amount of cash and deposits a company can obtain within one year, and current liabilities, which represents the amount of cash and deposits to be paid within one year. If the current ratio is small, it means that there are many short-term payments, and it can be judged that financial stability is low.

Capital adequacy ratio

The capital adequacy ratio is an index that expresses the ratio of equity capital to total capital (equity capital + external capital). You can check whether the company’s funding sources are equity capital or third-party capital (such as loans from banks). If the capital adequacy ratio is low, it means that the influence of external capital is large, and management is judged to be unstable.

Equity capital ratio (%) = Equity capital ÷ (Equity capital + Other capital) x 100

Sales growth rate (sales growth rate)

Sales growth is an index that can be used to check how much sales have increased in the current period compared to the previous period. It is basic to see the transition of sales by confirming the growth rate for the past several years, not just for a single year. In addition, when the sales of the current period decreased compared to the sales of the previous period, it is called “decrease in sales”.

Financial analysis can also be used for peer-to-peer and period-to-period comparisons

Financial analysis methods are classified into four, but there are also various other analysis methods such as “activity analysis” to see whether the company’s management is active. Depending on what kind of information you want to know, the analysis method you use will change. Let’s use them properly according to the element and purpose you want to know.

In addition, the indicators obtained from financial analysis can be applied to comparisons between other companies in the same industry and for each period. By comparing with other companies in the same industry, you can find your company’s weaknesses and strengths in terms of management, and by comparing each period, you will be able to accurately grasp the results of corporate activities.

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