Financial analysis allows business owners to determine the current situation and future decision-making in the search to improve business performance. It uses the study of financial statements through different indicators to evaluate the profitability, liquidity, assets and liabilities of an organization. These items are important for the decision-making process. Randall Castillo Ortega, the founder of SME investor RACO Investment, details why this is true.
The fundamental purpose of accounting is to provide useful information about an economic entity, and to facilitate the decision-making of its different users (shareholders, creditors, investors, customers, administrators and government). Consequently, as accounting serves a set of users, various branches or subsystems originate. Based on the different information needs of different user segments, the total information that is generated in an economic entity for different users has been structured into three subsystems:
The financial reporting subsystem is composed of a number of elements, such as registration rules, accounting criteria, forms of presentation and more. This information subsystem is financial accounting, because it expresses in quantitative and monetary terms the transactions carried out by an entity as well as certain economic events that affect it, in order to provide useful and secure information to external users for their decision-making.
Accounting considers that every business must submit four basic reports. In this way, there is the income statement that reports on the profitability of the operation. It provides information about the liquidity of the business. That is, to present a list of the sources of cash and the disbursements of the same, which constitutes a basis for estimating future cash needs and their probable sources.
Explains Castillo, “Financial analysis is a key point at the end of the accounting cycle. This analysis is based on relative ratios or values. The analysis of reasons comprises two aspects, including the calculation and the interpretation, with the aim of trying to know the performance of the company.”
For users of the financial report, it is very important to know non-financial data of the company, since this allows them to expand the user’s vision and understand in an analytical and logical way the behavior of the financial data that is presented in the annual report.
Financial analysis consists of the study of the information contained in the basic financial statements through indicators and methodologies fully accepted by the financial community, with the aim of having a more solid basis for decision-making.
Financial indicators are used to weigh and evaluate the results of the company’s operations. Such indicators are the relationship of one figure to another within or between the financial statements of a company that allows one to weigh and evaluate the results of the company’s operations.
“It is indisputable that accounts receivable are in relation to the sales made by a company,” adds Castillo, “since they are conditioned according to the period of credit granted to customers. The greater the number of times that credit sales represent accounts receivable.”
A variant of this financial reason is to use credit sales as a numerator, since these are directly related to accounts receivable from customers. However, this data is not usually presented in the financial reports of the companies and for practical purposes, the data of the net sales of the period is used. As with the acid test, for comparison purposes, the same criteria of financial analysis must be maintained.
Financial analysis is the method developed by which financial statements are used and the information is evaluated in such a way that the current state of a company can be determined. Through the study of the financial statements, it seeks to identify the deficiencies and potential problems of a company, and thus be able to take measures that can correct them. Not only does financial analysis allow us to evaluate current events, but it also gives us the possibility to make future decisions related to the management of a company and maximize its usefulness.