What Is Involved in Financial Information Analysis?

Financial information analysis is the use of historical financial data to evaluate the profitability and long term stability of a business or organization for investment purposes. A financial information analyst reviews a company's balance sheet, income statement, and cash flow statement to gather necessary facts and figures related to financial information analysis. He then inputs certain figures into formulas used to calculate ratios that provide insight into the financial health of the company. The ratios are then compared to those of the company's competitors or the industry as a whole. If the company's ratios are not auspicious when compared to industry competition, the company may not be a viable investment.

Evaluating a company's financial statements is the most important aspect of financial information analysis. A balance sheet contains information about a company's assets and liabilities and about shareholders' equity. Assets are cash, equipment, or property that have value in the open market or create value. Assets must equal the sum of liabilities and shareholders' equity.

Liabilities are debts owed by the company. Shareholders' equity represents the net worth of the company assuming the company sold off all its assets and used the value received to pay off all its liabilities. If financial information analysis reveals that shareholders' equity is low or negative, the company is in debt.

During financial information analysis, income statements are reviewed to determine a company's net earnings for a given period. At the top of each income statement is the total amount of sales or revenue generated. The costs and expenses associated with the creation of such revenue are then subtracted from the figure. The remaining total is net income. Negative net income indicates to financial information analysts that the company is not profitable.

Cash flow statements demonstrate how much cash a company generates. The figures contained in a cash flow statement are believed to be more accurate representations of a company's financial health than net profit. Consequently, financial statement analysis places great importance in whether or not the statement shows a net increase or decrease in cash for the period covered.

Ratios provide financial information analysts with efficient ways of determining the financial health of a company using the data contained in financial statements. The liquidity ratio indicates a company's ability to pay its liabilities. Liquidity ratios lower than those of competing companies or industry standards indicate poor management or a need for an infusion of cash.

Leverage ratios show how much of a company's capital is provided by loans. This ratio uses the debt and equity figures found on the balance sheet. A high proportion of debt to equity shows a company that is highly leveraged and vulnerable to risk.

Financial information analysts utilize profitability ratios to discern how well management is employing the company's capital. This ratio is often compared to the company's competitors or other industries. If the ratio does not draw a favorable comparison, it is an indication that better returns on investment exist in other companies or industries.