After reading this article you will learn about external and internal financial analysis of a firm.
Financial analysis performed by creditors of the firm, shareholders or investment analysis is called External Analysis. It makes use of existing financial statements and involves limited access to the confidential information of the firm.
Financial analysis performed by the financial and accounting departments of the firm is known as internal analysis. These are more detailed than the external analysis. The simple reason is that these departments have available more detailed and current information than what are available to outsiders. Financial analysis consists-of general managerial activities.
It is through it that the manager attempts to analyse the historical record of his firm with a view to identify those factors which influence significantly the wealth of the shareholders of the firm. Financial analysis and financial planning are inter-related processes.
Here financial analysis is used as the process of reducing a large amount of historical financial data taken from financial accounting statement to a smaller set of information which is more useful for decision making.
Financial ratios comprise an important part of that smaller set of information. Authors on financial management have developed a large number of ratios. Different authors have classified them into different groups.
We have adopted the group of ratios as under:
(i) Profitability group,
(ii) Liquidity group,
(iii) Structural group and
(iv) Turnover group.
All these ratios are of great help in the financial analysis of business enterprise.
Financial analysis rely heavily upon standard accounting information. These are normally available to the firm. The balance sheet and income statement of the firm are most important among the useful types of accounting information. However, it should be noted that use of accounting data is both a strength and a weakness.
Its strength lies in its ready availability. Its weakness is that it is sometimes very difficult to interpret. Financial analysis is used primarily to gain insights into operating and financial positions of the firm.