Types of Financial Analysis

Author: James Clark

Do you want to learn about the types of financial analysis used by companies? We share the different types of financial analysis right here.

Most companies use different forms of financial analysis externally and internally. The analysis provides businesses with an excellent way to evaluate their financial stability. It also allows investors to evaluate whether the company is worthy of investment. This article will look at the definition of financial analysis and describe the different types of financial analysis used by companies today.

What is Financial Analysis?

Financial analysis is the process of analyzing the various finances of a business to evaluate its future and financial stability. Business owners employ financial analysts to determine necessary actions they must take to keep the business in operation and make profits and avoid bankruptcy.

Investors can also use financial analysis to decide whether it makes sense to invest in a business. During the financial analysis, the company's financial statements, like their balance sheet and income statement, are thoroughly analyzed.

Types of Financial Analysis

Several types of financial analysis can be used by companies and investors alike. These include the following types:

1. Vertical

In the vertical financial analysis, the different items on the financial statement and their relationship to one another are analyzed. For instance, an item is measured with another thought to be the original during an accounting period, and the relationship between them is the percentage. Even though it is only used for one accounting period, it will help you recognize the changes and compare different items.

2. Horizontal

In the horizontal analysis, the study of changes in figures of the financial statement over periods is conducted. It essentially compares one item with another in a separate period. It helps analyze the finances of the business from one year to another. It is also called trend analysis or dynamic analysis.

3. Liquidity

In liquidity analysis, ratios are used to determine if a company will pay back its debts and expenses. The analysis helps because if a company can't pay off its debts, it will run into financial problems in the future. Creditors or lenders prefer using this analysis as it gives them insight into the business's financial standing before they approve a credit or loan.

4. Profitability

In the profitability analysis, the rate of return of a company is evaluated. All companies want to be profitable, so profitability analysis is often used to measure the cost and revenue generated in a period. If the business's revenue outweighs its expenses, it is profitable.

5. Scenario and Sensitivity

The scenario and sensitivity analysis measure an investment's value based on current changes and scenarios. For instance, it will analyze how a variable has been affected by sensitivities and changes in other variables. It helps analysis predict different outcomes based on variables.

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