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Financial Analysis, Planning, and Control
Financial analysis is an essential finance practice that shows an organization’s performance periodically. The assessment of a business’s vital financial relationships shows the firm’s liquidity, profitability, creation of shareholders’ relationships, and shareholders’ value. The income statement and balance sheet of a firm provide figures that are used to perform a financial analysis.
Liquidity is the rate at which a firm can convert its assets to cash. Ratios used to test for liquidity include current ratio, quick ratio, and cash ratio. The current ratio of a business is calculated as current assets/ current liabilities. Additionally, an organization’s quick ratio is determined by dividing the firm’s quick asset by current liabilities (Keown, Martin, & Petty, 2019). Finally, the cash ratio is measured as total cash assets divided by current liabilities. In contrast, the profitability of an organization is the number of profits received after labor, capital, and management investment. Profitability ratios include return on equity, return on assets, operating profit margin, and net profit. The net profit is expressed as a dollar value and is determined by subtracting expenses from a company’s revenue.
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Moreover, a company’s financial decisions may be determined using profitability and liquidity ratios. For instance, a high ROA means that the business is very profitable, while a cash ratio below 1 indicates that an organization is illiquid. Finally, shareholders’ value shows the rate at which equity invested by shareholders is profitable. Shareholders’ value is determined using the return on invested capital ratio. When the ROIC is above 2%, the firm is creating shareholders’ value while a low ROIC below 2% indicates that a business does not create value. The ROIC of a business is calculated as:
Net income – Dividend
Debt + Equity
The financial performance of a company is determined by analyzing its balance sheet and income statement. The key financial relationships deduced show if an organization is profitable or liquid. Moreover, financial ratios can be used to make financial decisions or to determine shareholders’ value.
References
Keown, A. J., Martin, J. D., & Petty, J. W. (2019). Foundations of finance (10th ed.). Pearson.
