The Importance of Financial Analysis
Financial analysis is the study of a business financial information so that a business decision is reached. It is vital for you to understand that financial information is examines by a financial analyst to find out the viability of a business project. The previous and predicted cash outflows and cash inflows are examined. You should be aware that financial analysis is carried out to by looking at the profitability of a business project for the past few years and the profitability that the business hopes to achieve in future. Business risks are also looked at when analyzing the financial information of a business.
The type of financial analysis carried out is determined by whether it is for external investor’s investment decisions or for internal investor’s investment decision making. The financial information of an organization is reviewed by an external investor with the help of a financial analyst so that they find out if it is a wise decision to invest in the company. Ratios are usually made to find out a number of financial viability, for example, the liquidity of a business.
The following aspects will determine if an external investor will invest in your company or not. The proportion of your assets compared to your liabilities is examined by external investors. A high liquidity ratio shows that the company has many current assets at hand. If your company has a lot of liquid assets, it is not making and investment decision. Low liquidity shows that the companies liabilities are falling due and may use up all the current assets. It is, therefore, essential that the business has an optimal liquidity ratio so that an external investor will come to invest. The other ratio that external investors look at is the debt ratio. A higher debt ratio shows that the company is financed by debt in a large proportion. Too much borrowing discourages external investors. That is why some companies commit financial statements fraud by changing the value on financial statements so that good financial ratios are found to attract external investors.
The other reason for financial analysis is to make internal investment decisions. It will be easy to make the decision of operating a certain part of a business or to eliminate by looking at how profitable it is. Financial analysis also helps a business know the perfect source of financing. A business will find out if a certain investment is making enough profits. A company will also find out its solvency status by carrying out financial analysis. It is vital for a company to know if it has a positive cash flow by doing financial analysis. In the event that you want to purchase machinery for your business, you have to carry out financial analysis.