It is important to assess the performance of your company from time to time. This helps keep tabs on its growth, letting you plan future changes and improvements. In order to get a clear picture of the status of your company in this regard, it is essential to run a thorough financial analysis. Many business owners are unaware of their own finances, and that could be very dangerous for the organization. It could reduce potential profits and put you in a huge risk. Below is a discussion on the various ways a company can do financial analysis.
Vertical Analysis
Vertical analysis is performed on financial statements in order to measure the performance of the company over a given period. This compares the items in the financial statements over a base that is set as 100%.
In the balance sheet, total liabilities and assets are set to 100%, whereas the revenue is kept as 100% on the income statements. The results of this type of analysis can be very insightful when every line is matched for two years, or compared versus an industry benchmark.
Horizontal Analysis
Horizontal analysis is a method used to learn about a company’s financial situation by collecting results and then evaluating the year-by-year data on the balance sheet. By doing this, you would be able to identify a company’s strengths and weaknesses.
Trend Analysis
This type of analysis is performed in order to mark trends in decreases or increases over a certain time interval for financial statements. It can be completed for past years, as well as for forecasting future performance and sales. The percentage change in each item is reviewed, and this gives a fair idea of possible future trends. That way, you would be able to plan proper strategies to ensure maximum profit.
Ratio Analysis
This is the ability of the company to pay off existing liabilities, collect receivables, sell inventory, and finish off long-term and short-term debts. It allows firms to analyze their profitability, and also use stock well as an investment alternative. Two of the most common ratios are the following:
- Current Ratio: This is obtained by dividing the total current assets by the total current liabilities. It reflects the company’s ability to pay off all existing liabilities using the assets it has at its disposal.
- Acid-Test Ratio: This is obtained by adding short-term investments, cash, and net receivables, and dividing the total amount with total current liabilities. It gives a picture of how the company would be able to pay off liabilities if they were due immediately.
- Price/Earnings Ratio: This measures your firm’s current market price per share over its earnings per share. Principally, this ratio shows the amount shareholders are prepared to pay for each $1 earned. The formula is calculated by dividing the market value per share by the earnings per share. If the ratio drops, the company’s stock becomes less attractive for keeping.
