Based on the data in these reports a financial analyst will try to get insights into several factors that contribute to a company’s overall financial health:
- One of the most important ones is Liquidity: Without sufficient cash generation, the business has very little chance of surviving.
- Next is Profitability: this refers to the ability of a business to generate profits.
- Another one is Efficiency: how well is the company using its assets and liabilities to generate income? For example, how often is inventory turning over or how long are receivables outstanding; how long are we waiting to get paid?
- And finally Leverage. Meaning to which extent is the company depending on borrowing to finance its operation.
A lot in financial analysis comes back to context. For example, if I tell you that the company Office Plus has profits of 1 million dollars, is that good? Or liabilities of 2 million. Is that a lot?
It’s hard to tell without knowing the relation to other numbers like sales or total assets. Or compare them to prior year numbers or the results from competitors.
So, putting the numbers from financial statements into context is important. That’s why financial analysts work a lot with ratios.
And it’s equally important to consider ratios that analyze all factors of a company’s health. Because it’s not enough to just look at profitability. A company can be profitable on paper but not generate much cash. Or the return on equity may look great but it’s highly leveraged which carries a higher risk if there’s a downturn in the economy.
A good financial analyst takes different aspects of a business into consideration when it comes to evaluating the business or making strategic decisions about the future growth of the business.