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What is Financial Analysis?
Financial analysis is the investigation and interpretation of financial statements and related financial reports. Trained and certified accountants usually complete this type of analysis. The role of a financial analyst is to use computer software, standard ratios, and other proven calculations to analyze account activity and identify areas of strength and weakness.
There are four types of analysis: internal, fraud investigation, external and formal audit review. The ratios and tools used vary according to the purpose of the analysis and the intended audience. The overall role of financial analysis is to identify patterns, opportunities, weakness, and strength in the business operations.
Internal analysis is also called management analysis. This role is responsible for running and reviewing reports of monthly and annual financial activity. They investigate the details in a specific area of the company and prepare summary reports for senior management.
Financial reporting is critical to identify how money and resources are spent, to track internal revenue sources, and to compare actual results to budgets and forecasts. Weak internal financial analysis can lead the company to overspend or fail to capture key market share due to lack of cash flow and poor planning.
Fraud investigation techniques rely on analysis to identify departments with weak internal controls or business procedures. The transactions in these areas can be reviewed in detail using auditing or financial analysis software tools. All financial transactions have an impact on the reported account value. Comprehensive analysis often uncovers fraudulent activity, due to their impact on the financial statements.
Financial analysis is also completed by external agencies, ranging from potential investors to financial institutions. These parties typically use the financial statements as their source of information. The field of financial analysis is quite mature, with a wide range of computations that are used to investigate transactions in a firm’s financial reports. They can also highlight areas that are inconsistent and uncover accounting errors.
In a formal audit of the financial statements, the auditors complete an analysis exercise to validate the information in the statements. In addition to an actual audit of the transactions, an analysis allows the firm to provide an opinion on the financial stability and longevity of the firm. Both these functions add value to the audit report.
Accounting professionals are all required to complete courses in intermediate and advanced analysis. In addition, they also complete courses in statistics, data management and computer systems. The combination of these skills allows them to quickly and accurately understand and interpret the results of the analysis.
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Discussion Comments
I always felt kind of sorry for the fraud investigators that they had to bring in to the place where I worked. Even though they were there to help with preventing fraud, rather than discovering it, people just didn't treat them very well.
I guess they knew that it was going to end up giving us even more paperwork, and it felt like the business didn't trust us on top of that.
But, the poor guys were only doing their job. I suppose they chose to go into that kind of job, so I shouldn't worry too much about it.
@pastanaga - I agree, particularly in the case of small businesses, or even when it is a person who just owns a few houses as rentals or something like that.
Instead of hiring someone to do the job for you, you can spend the same amount on taking a course so you can do it for yourself. In the long run you'll save money.
Now, I'm not talking about the bigger jobs, like if you are about to be audited or whatever. But you should at least know how to do your taxes and understand where the money is coming from and going.
If nothing else, simply because you want to be able to tell if the person you hire to do your business financial analysis is doing a good job.
I would argue that if you want to have a healthy small business, you ought to be able to do a bit of financial analysis of your own.
Too often I've seen people assume they were doing OK, because it seemed like money was coming in and not realize they were on the brink of having a financial collapse or that they were spending more than they made.
Even before you start, you should try to analyze these kinds of things. Yes, it would be nice to be able to afford a professional accountant, but sometimes you just can't, and in that case you need to step up and do your own strategic financial analysis.
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