When investing in the stock market, it is crucial to know how a company is doing. Financial analysis is a great tool to help you understand the financial situation. It is not enough to look at a company's financial statements. Financial statement analysis is a valuable tool to gain insight into the company's performance.
These methods are not only useful for the stock exchange. Here are some interesting uses of tools for financial analysis.
1. These are used by valuation professionals for advice on mergers or acquisitions
2. These tools allow banks to make decisions about the solvency and creditworthiness of a company.
3. These may be used by regulators and auditors to spot discrepancies in financial statements or business transactions.
4. Financial analysis could be used by credit rating agencies and insurance companies to evaluate various risks.
5. These can be used by companies to make business decisions, such as where to allocate resources or which unit to close.
Two schools of thought are generally accepted when it comes to investing in stock of a company using financial analysis tools.
a) Fundamental Analysis: This is where information from financial statements is used to determine the true value of a company. This involves the calculation of ratios like price-to-equity and earnings-per-share to determine how far a company's stock has fallen from its true value.
b). Technical analysis: It is believed that the stock price reflects the fundamentals of the business. To get an idea of its movement, the investor looks at data about the trading momentum to determine this.
Financial analysis of a company uses various data points from its financial statement, namely the income statement or the balance sheet. As the name implies, the income statement shows how a company's topline and bottomline indicators are doing -- net income, gross sales, earnings. The balance sheet gives details about the company's assets and liabilities.
Here is a list containing some financial statements analysis methods that investors can use to determine whether to invest in a company.
1 Trend analysis
Trend analysis is a process of charting the stock price movement to determine where they are heading. A trend can indicate a bull or bear market and it can either be upward or down. This is a special tool in financial analysis because it can be used for predicting the effect of various external factors on a stock.
2 Vertical analysis
Vertical analysis is where all financial statements are expressed in a percentage of one particular heading. A percentage of sales could indicate a company's net profit, different expenses, input costs, etc. This tool can be used to determine the relationship between various production factors and performance indicators.
3 Horizontal analysis
This is one of most common methods for financial statement analysis. It is common for news anchors to say that XYZ's net income has increased by a specific percentage each year or sequentially. Horizontal analysis allows us to understand how various financial indicators such as sales, income, and interest margin (for lenders), have changed over time.
4) Analysis of cash flow
Cash flow analysis is the process of tracking income and expenses for a given period. This helps to determine the company's working capital needs and, consequently, the company's speed of growth in the market.
5) Ratio analysis
Ratio analysis can be used to help investors compare a company to its peers, which is a group of companies that are in the same industry and have the same size. The earnings to price ratio (net income to sales ratio), and the return on assets ratio are just a few examples. This method is useful for identifying the missing links in private companies.
Before you invest in the markets, it is important to be familiar with fundamental and technical concepts.