Financial Analysis Techniques
Discuss at least 3 techniques of financial analysis (one must be ratio analysis). The techniques chosen can be either quantitative or qualitative. Comment on the pros and cons/limitations of each technique.
The use of ratios analysis is one of the most prominent and widely used financial analysis techniques. The ratio analysis is used to explain aspects of a company’s performance and the health of the company’s financial prospects. Such prospects include profitability, inventory management, return on equity, debt, payables, total asset turnover, among others (Alexander-Joseph, 2017). The use of ratios in financial analysis enables an understanding of what happened in the market and not why it happened. In turn, the ratio analysis impacts on creating a clear view of the current financial health of a company based on the assessment of the past performances (Lakada, Lapian & Tumiwa, 2017). Hence, it is used to inform future forecasts and projections of the company to increase competitiveness and performance.
The ratio analysis is used to inform operational efficiency, changes in the industry in which the company operates over time, financial flexibility, and opportunities, as well as the performance of the company relative to the industry (Lakada et al., 2017). As a result, this enhances the company’s competitive advantage through extensive understanding of the market environment and the capacity financial capacity to venture into new areas.
The cons of using ratios analysis entail the need to use judgment in interpreting the data. Also, it is impossible or difficult to compare ratios of different divisions of operations. Hence, it impacts in undermining the consistency of results acquired in the analysis of short-term company performance.
The use of a common-size approach in financial analysis entails the comparison of the performance of different companies within the same industry over time. Vertical common-size analysis of the balance sheet divides each item by the total assets for a specified period. It is expressed in percentage (Martinez, Galvan & Alam, 2017). Horizontal common-size analysis of balance sheet analyzes each item in relation to the same item in a base year. This impacts an extensive understanding of the performance of each item of the balance sheet in a specified period as compared to the performance of other companies in the same industry.
The cons of using common-size analysis entail the growth of assets at a faster rate than the revenue. This indicates that the company’s spending rate is higher than the revenue generated. This makes the operating cash flow to be negative and indications of poor inventory and receivables management.
The regression analysis is used to explain the relationship (correlations) between variables. This is fundamental to understand the performance of each item as compared to others (Kumari & Yadav, 2018). Hence, it impacts in increased competitiveness of respective items to perform better than the other.
Ratio Analysis & Common Size Statements (Trends)
(1) Using Appendix 5: Summary of Financial Ratios choose two ratios from each category (liquidity, activity, leverage, profitability, and market). You will have a total of 10 ratios for each of the three years presented. Display ratios in a chart as follows.
Use the three most recently completed years for which financial statements are available.
|20XX||20XX (2)||20XX (3)|
(2) Create a common size balance sheet and income statement for the same 3-year period.
|20XX||20XX (2)||20XX (3)|
(3) Discuss the overall results of the ratios and common-size statements. Be specific and thorough. It’s okay to speculate about what the numbers may mean and the potential impact on the company. What trends do you notice?
The liquidity ratio and common size statements show a decreasing trend in comparing ratios 1 and 2. This stipulates an expansion of liquidity by the company in its operations. A similar trend is experienced in the activity analysis of the company. This creates the assumption that the performance of the company is on an upward trajectory on the evaluated year. With 20xx being the most recent year, the previous years have lower performance capacity as compared to the current. Walmart’s operations continue to financial potential to compete effectively in the market (Martinez et al., 2017). However, the market analysis drop from the previous years is a result of increased new entrants into the market. This impacts the drop in the market share and profits generated annually. In terms of leverage, the company shows profound resilience and competitiveness to generate value in the industry. Hence, it remains relevant and competitive as the years pass.
Alexander-Joseph, D. T. (2017). Strategies and Processes for Implementing Financial Analysis for Business Success.
Lakada, M. N., Lapian, S. J., & Tumiwa, J. R. (2017). Analyzing the financial statement using horizontal–vertical analysis to evaluating the company financial performance period 2012-2016 (Case Study at PT. Unilever IndonesiaTbk). Jurnal EMBA: Jurnal Riset Ekonomi, Manajemen, Bisnis dan Akuntansi, 5(3).
Kumari, K., & Yadav, S. (2018). Linear regression analysis study. Journal of the practice of Cardiovascular Sciences, 4(1), 33.
Chatterjee, S., & Hadi, A. S. (2015). Regression analysis by example. John Wiley & Sons.
Martínez, A. B., Galván, R. S., & Alam, S. (2017). Financial Analysis of Retail Business Organization: A Case of Wal-Mart Stores, Inc. Nile Journal of Business and Economics, 3(5), 67-89.