Different Roles a Financial Analyst Can Play In Your Business
What are the Different Types of Financial Analysis
and What Role They Play in Judging Financial Position of any Business?
There are different types of financial analysis which can be performed to evaluate how well your company is performing. Our aim here will be to look into different types of analysis that can be performed and their usefulness.
Different Types of Financial Analysis
Factor #1: Material Used
On the basis of material used, financial analysis could be of 2 different types:
- External analysis
- Internal Analysis
External Analysis: Such analysis is performed by outside entities without any access to accounting records of your business. These outside entities comprise of creditors, investors, potential creditors, potential investors, credit agencies, government agencies and general public. Analysis is performed by these entities on the basis of financial statements published by the business and as such external analysis serves very limited purpose.
Internal Analysis: When analysis is performed by someone with access to accounting records of your business then it is called as internal analysis. As such, this type of analysis is conducted by executive working for the organization.
Factor #2: Technique of Operation
As per method of operation, financial analysis can have two types, these are:
- Horizontal analysis
- Vertical analysis
Horizontal Analysis: Here comparison is done for financial data of your firm for multiple years. The data is presented horizontally in different columns and information for multiple years is compared with data for the base year. Here, any specific year is selected as the base year or the starting point for such analysis. This type of analysis helps in focusing on aspects which have undergone significant change over a certain period of time. Such analysis clearly highlights trends developing for any specific item when comparison is performed between base year value and values for multiple years.
Vertical Analysis: Here analysis is performed for relationship between items present in financial statements in a single accounting period. In vertical analysis, figures are compared with base value that has been selected from same year itself. Some of the tools which are utilized for such financial analysis include different financial ratios and common size financial statements. When used in conjunction with horizontal analysis, it can be quite effective in highlighting financial position of your firm.
Factor #3: Entities Involved
According to entities involved, such analysis can be:
- Inter firm analysis
- Intra firm analysis
Inter Firm Analysis: As the name suggests, here financial data for your company is compared with data for other companies or with industry averages over a certain period of time.
Intra Firm Analysis: Here performance is analyzed for your company for a specific time period.
Factor #4: Time Horizon
On the basis of objective of analysis or time horizon, the financial analysis that can be performed includes:
- Short term analysis
- Long term analysis
Short Term Analysis: This type of analysis helps in measuring your company's liquidity position and paying capacity for short term (current) obligations.
Long Term Analysis: Here your firm's ability to meet its long term obligations is judged. The aim here to be analysis stability, solvency and profitability of your firm.
Thus, we can see that true financial position of your firm can be judged by performing different types of analysis and help the management take better as well as informed decisions.