Please enable JavaScript.
Coggle requires JavaScript to display documents.
The need for financial analysis - Coggle Diagram
The need for financial analysis
Interested parties and stewardship
Different parties are interested in financial statements and their analysis for various reasons
Stewardship refers to the traditional approach of accounting under which the owners entrust the management to manage the company on their behalf
Shareholders entrust the board of directors with the responsibility for managing the resources entrusted to them by giving it direction and providing both control and strategy
The board employs managers to implement their strategic vision and to help ensure the investment of owners are maximised
Key financial indicators
Profitability
The main objective of a company and its management is to earn a satisfactory return on the funds invested by the investors or shareholders
Financial analysis ascertains whether adequate profits are being earned on the capital invested
It is also useful to understand the earning capacity of a company, its wellbeing and its prospects including the capacity to pay the interest and dividends
Trend of achievements
Analysis can be done through the comparison of financial statements with previous years especially in relation to trends regarding various expenses, sales/revenue, gross profits and operating profits
Users can compare the value of assets and liabilities and forecast the future prospects of a company
Growth potential of a company
Financial analysis indicates the growth potential of a company
Comparative position in relation to similar companies or businesses
Financial analysis help the management to study the competitive position of their company in respect of sales/revenue, expenses, profitability and capital utilisation
Overall financial strength and solvency of a company
analysis helps users make decisions by determining whether funds required for the purchase of new equipment and other assets are provided from internal sources or received from external sources and whether the company has sufficient funds to meet its short term and long term liabilities
Fundamental analysis
Fundamental analysis is the systematic approach to evaluating company performance based on the analysis of its published financial statements
An in depth study of the underlying forces that drive a company's performance which considers the overall state of the economy in which the company operates, the industry which it belongs to and other factors including
Interest rates
Production
Earnings
Employment
GDP
Housing
Manufacturing
Management
The combination of qualitiative and quantitative data septics a holistic picture of the company.
The end goal of this analysis is to generate insights and forecasts about the company's future performance
There are several other objectives including
Valuing the company
Evaluating the performance of company management and auditing business decisions
Determining the company's intrinsic value and its growth prospects
Benchmarking the performance of the company against its industry and the wider economy
Economic analysis
The performance of the company mirrors the performance of the economy in which it operates.
Different companies and industries perform differently during the various stages of an economic cycle
Recovery (expansion)
After reaching bottom, the slow growth starts to kick in under the expansion phase
This is characterised by gradual recovery with increasing employment, economic growth and upward pressure on prices, wages, profits, demand and supply of products
Boom (peak)
Post-recovery, the growth in business activity reaches a peak (the highest point in the business cycle)
The real national output is rising at a faster rate than the average growth rate and the economy is producing at maximum allowable output
Recession (contraction)
After reaching a peak, business activity remains stagnant with a significant decline in economic activity spread across the economy lasting more than a few months
It is normally visible in real GDP, real income, employment, industrial production and retail sales
Depression (trough)
In this phase, business activity is declining with output reaching its lowest point
The economy has hit bottom, from which the next phase of expansion and positive sentiments start to kick in. Essentially this phase is a combination of negative and positive sentiments
Industry analysis
Companies operate within an industrial context, it is important to conduct industry research while assessing company performance and formulating strategic plans for future growth
Industry analysis refers to an evaluation of the relative strengths and weaknesses of particularly Indsutries
Facilitates a company's understanding of its position relative to other companies that produce similar products or services
Pioneer stage
This is the first stage of a new industry where products and technology are newly introduced and have not reached a state of perfection
There is an opportunity for rapid growth and profit
Expansion stage
This is the second stage of expansion of those that survived the pioneering stage
Companies grow large and are quite attractive for investment purposes
Stagnation stage
Growth stabilises and sales grow at a slower rate than that experienced by competitive industries or by the overall economy
Decay stage
The industry becomes obsolete and ceases to exist with the arrival of new products and new technologies
Five forces collectively determine the long term profit potential of the industry
Barriers to entry for new players to enter the market
This refers to how difficult or easy it is for a new player to enter the industry
In an industry with little to no barrier to entry, new players have a competitive advantage while existing suppliers constantly face a new set of competitors
Barriers to entry include heavy capital requirement, significant differentiation via technology, regulation challenges and poor distribution channels
Bargaining power of customers
A strong buyer can make an industry more competitive and can push existing to lower their prices or offer additional services in comparison to its competitors
Customers now have more bargaining power as they can switch between suppliers
Bargaining power of suppliers
Suppliers in a strong bargaining position can choose to reduce the quantity of the product available
If there are few close substitutes, buyers can switch as and when the switching cost to new suppliers is too high
The suppliers hold the power to influence the customers and establish competitive advantage
Suppliers are also in a strong position if the product or service they supply is an essential component of the end product
Availability of substitute goods
Product substitution occurs when customers can switch easily between competitors
IF all players are producing similar products with little to no differentiation, pricing is fixed
However, businesses can work against this by adding significant product differentiation with a clear focus on consumer requirements
Competitors and nature of competition
The rivalry among players places significant barriers to the indsutyr
This rivalry can result in price wars, constant innovation in product offerings and new product launches, leading to lower profits
In the long term, it increases fixed costs for businesses, lowers growth rates for the industry and stagnates company performance
Company analysis
Company analysis evaluates information relating to the company's profile, product and services as well as its profitability and financial position
During the process of company analsysi, an investor also considers factors that have contributed to shaping the company
Different companies from the selected indsutry are usually analysed and evaluated so that the most attractive company can be identified
Elements of a company analysis include
An overview of the company
The most important points about the company, like its mission statement, legal structure, goals and values, history, maanegemnt team and location
Other useful information includes the company's service performance, product lifecycle stages, competitive strategy, sales and marketing practice, management track record and its future prospects
Analysis of competitive strategies
Broadly, the company will either have a low-cost approach or a product/service differentiation approach when combating competition
Analysis of financial statement
Conducted using trend analysis, financial ratios and other financial statistics