What is the financial analysis process?

You can use different methods to analyse financial statements. Such methods include ratio analysis, common-size statements, and regression analysis, among others.

The financial analysis process can take different forms, but most take the following steps:

1 Define the purpose and the context of the analysis

You should understand the objective and background to the analysis. A list of questions or business problems to be addressed would help you to determine the objective of the financial analysis. For example, why have sales been declining quarter-over-quarter in the last year?

2 Collect the data

Collect data using different sources of information. You can use both internal as well as external sources.

Internal sources would include, for example, financial statements, historical analysis and reports, and other publications.

External sources would include government publications on economic data, tax publications, or financial databases published by the World Trade Organisation.

3 Process data

Such financial data can be processed using methods such as ratio analysis, common-size financial statements, and forecasts.

4 Analyse data and build insights

Once data is processed and analysed, you should start to make sense of the data and build insights.

5 Develop and communicate conclusions and recommendations

You can craft conclusions and recommendations based on financial analysis. For example, the sales declined quarter-over-quarter in the last year due to a contraction in spending power, increase in market share captured by competitors, and so on.

6 Follow up where on-going analysis is required

At times, you would not be unable to make conclusive recommendations since the analysis did not provide the complete picture — or it did not focus on the key priorities. Hence, you would need to conduct on-going analysis or use a third-party for this purpose such as a specialised consulting firm.

Critical success factors

Let’s look at the critical success factors that determine the success of the financial analysis process.

• Decide what to include in the analysis

  You should be very clear with the objective of the financial analysis. Is the objective to assess profitability? Is the aim to analyse operational efficiency? Once you decide on the objective, you should have a clear sense of what to include and exclude from your financial analysis.

• Identify best practices for financial analysis

  Identify the industry best practices to conduct the specific financial analysis. For instance, if you are conducting the financial analysis for a specialised industry such as the insurance or banking sector, the data used for financial analysis should meet the minimum industry standards and financial regulations. Highly regulated industries pose an added complexity to financial analysis.

• Conduct comparisons

  Comparisons across different time periods as well as across the industry help make more sense of insights generated through financial analysis. For example, if the company in concern has a 15% year-on-year profit growth and healthy financials, this does not necessarily mean the company is doing well. Once you benchmark with similar organisations, you would get a better picture of whether the company is actually profitable and if the profit growth trends are sufficient.