What is Financial Analysis? Understanding the Fundamentals

If your business needs a better understanding of its current financial condition, you must conduct a financial analysis.  

By exploring critical financial insights, you can determine the strengths and weaknesses of your business, which will assist you in your planning and strategic decision-making.  

In this article, we'll uncover financial analysis in greater detail, including types of financial analysis, best practices, and how intuitive financial analysis software supersedes boring spreadsheets!

What is financial analysis?

Financial analysis is where financial statements and other relevant financial data are used to assess business health and performance.  

A financial analysis will assess the following performance criteria:  

• Profitability  
• Liquidity  
• Solvency  
• The business's overall financial position  

Typically, it will leverage the right financial analysis tools and techniques for analysing financial data and use insights to recommend improving business performance and help you predict future performance.  

Fathom's financial analysis software is aimed at forward-thinking businesses of every size and industry, powering insights for over 75,000 companies worldwide.  

Why is financial analysis important?

Conducting a financial analysis enables businesses to identify the strengths and weaknesses of their financial position and build a clear picture of their financial profile.  

Financial analysis is vital for your business in identifying and preventing potential risks. You can also leverage analysis to build confidence amongst your investors and stakeholders, including banks and other finance lenders.  

With a holistic view of your performance and the right financial analysis tools, you can make better-informed decisions about your strategy and plan for your future.  

Key financial analysis outcomes your business needs to know

Financial analysis can lead to many necessary outcomes for effectively managing your business, including:  

• Improved communication: Financial analysis will provide you with the skills for communicating financial information to your team, shareholders and other stakeholders.  
• Strategic planning: The valuable insights into your financial health gained from financial analysis will aid your strategic planning, budgeting and resource allocation.  
• Allocating resources: With a fundamental analysis, you can make better-informed decisions about where you place your resources and why, for example, capital investments, growth, or dividends.  
• Credit evaluation: Your creditworthiness will be ascertained throughout the financial analysis process, putting you in good stead for banks and other lenders looking to determine the terms of a loan and credit and influencing how much you can borrow.  
• Predicting the future: Analysing your historical data and trends can help you forecast your future performance and lead to predictions about your business's future cash position.  
• Mergers and acquisitions (M&A): Financial analysis is crucial in potential businesses during M&A transactions.  

Financial analysis best practices

Financial analysts must implement best practices while they are at work. There is always the possibility that errors in large data sets can slip through the cracks without checks and balances in place.  

Financial planning analysis best practices should include:  

• Developing an extreme attention to detail  
• Being well-organised with financial data  
• The ability to make sound assumptions based on all data at hand  
• Factoring in a process for other individuals to review work  
• Conduct stress testing and auditing  
• Keeping your formulas and calculations as simple and easy to understand as possible  
• Use visualisation techniques, including charts and graphs to present data in an accessible manner.

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The challenges of financial analysis

Even though financial analysis is critical to business decision-making, it has challenges. Some of these challenges can include:  

• The quality and availability of financial data: A financial analysis relies heavily on accurate and timely data. Without the right financial analysis software or adopting best practices within your business, there can be challenges in getting complete, reliable and up-to-date financial information.  
• Complex reports: Understanding and interpreting complicated financial analysis reports, which include balance sheets, income statements and cash flow statements, can be a challenge for those of us who are not well-versed, and it can also be tricky for diverse organisations with multiple business divisions, departments, locations or other business units. Fathom's financial analysis software has a new tracking feature for your divisional budgets. Please find out more about this in our release update.  
• Timeliness: Your financial analysis may need to be conducted swiftly if quick decision-making is required. This tight deadline can spawn issues with the accuracy and thoroughness of your analysis.  
• Subjectivity: Conducting a financial analysis often means making specific estimations about your business. We are all guilty of employing subjectivity when making assumptions, which can filter through to different interpretations and conclusions during the financial analysis.  

The different types of financial analysis

A financial analysis combines several techniques to provide a holistic view of your business's financial performance and prospects.  

Some of the most common types of financial analysis techniques include:  

• Scenario and Sensitivity  
• Financial Statement  
• Financial Ratio  
• Rates of Return (RoR)  

This section will explore each of these financial analysis types and how they can help your business.  

Scenario and sensitivity analysis

Performing a scenario and sensitivity analysis is where a company assesses its best-case or worst-case future.  

A scenario and sensitivity analysis helps businesses to measure risk exposure when preparing their budgets and forecasts.  

Learn how scenario planning can help with risk identification and resilience building in our article: Preparing for the Unexpected: How Scenario Planning Can Help Business Stay Ahead.  

Financial statement analysis

A financial statement analysis can include an examination of one of three key financial reports:  

• An income statement: also called a profit and loss, this financial analysis report shows a business's income and expenses over a given period, including gains, losses, revenue and expenses.  
• A balance sheet: a summary of your business's financial health, containing an overview of all your assets, equity and liabilities.  

• A cash flow statement: this is a statement of cash flows generated by your business, including the revenue, expenses, gains and losses, as well as your cash from debts, equity purchases and sales, and long-term liabilities, including loan payments and equity.  

A financial statement analysis can help businesses to understand their overall health and evaluate their financial performance and value.  

Fathom's product feature for financial statements includes custom terminology. Please read our blog for a quick wrap-up of everything we've recently released.  

Financial ratio analysis

A financial ratio analysis compares line-item data from your business's financial statements (income statements, balance sheets and cash flow statements) to show how you've performed over time.  

Financial ratios can be compared with industry averages to show how your business compares with others in the same sector.

Rate of Return analysis

Rate of return analysis (also known as RoR) can be applied to the net gains or losses of any of your business investments over a specific period, including stocks, real estate, bonds, and more.  

A RoR analysis is typically expressed as a percentage of its initial cost.  

Businesses can use this type of financial analysis to compare their investment performance with previous periods and returns from other investments.  

What about financial analysis software?  

With financial analysis software, you'll have an in-depth look at your business's financial and non-financial data. These software solutions can aid financial planning, budgeting, forecasting (learn more about what is cash flow forecasting), risk assessment and reporting.  

Some of the primary benefits of financial analysis software include:  

• Having better clarity over your numbers with our insights at a glance.  
• The ability to visualize the growth of your business over time.  
• Using key performance indicators to track your business more strategically.  
• The convenience of presenting business results visually and intuitively.  
• An automatic sync with cloud accounting software like our Xero integration and QuickBooks integration
• A management reporting software with pre-defined report templates that save you time crafting and scheduling reports

The choice of financial analysis software will depend on your business's specific needs and goals. Still, Fathom will give you a clearer picture of your business performance and an in-depth analysis of your financials.  

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Say hello to Fathom and goodbye to spreadsheets

With Fathom's financial analysis software, it is time to say goodbye to visually boring spreadsheets that limit you because you need to extract and prepare data manually. Instead, you can explore and visualise real-time, interactive data.  

Our financial analysis software will enable you to perform:  

• KPI tracking and analysis: supporting explanations to understand what your numbers mean  
• Profitability analysis: visualise the breakeven point and the margin of safety  
• Cash flow analysis: see cash inflows and outflows using the cash flow waterfall chart  
• Divisional analysis: track the profitability of your divisions, departments, locations or other business units  
• Goalseek: Understand the impact of changes to key business drivers.  

Fathom is the financial analysis tool of choice for over 75,000 businesses worldwide, who get an in-depth look at their financial and non-financial data.  

So why not start with Fathom today and see what all the fuss is about? Start your free 14-day trial today, completely credit-card-free.

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