The process of evaluating businesses, projects, budgets, and other finance-related transactions to check their performance and suitability is known as financial analysis. Also, evaluating economic behavior, build long-term plans for business activity and identify projects or organizations for investment comes in the purview of financial analysis. This is carried out using the combination of financial data and various statistical measures.
Financial analysis is generally done by professionals who prepare reports using ratios that make use of information taken from the balance sheet and other financial reports. The analysis reports are then presented to the top management for making informed business decisions. This analysis can determine if a business will continue or not, it also helps to make investment decisions in the targeted organization. The financial analysis process also entails financial data to assess a company’s performance and make a recommendation on the required improvements.
Financial analysts primarily carry out their work in Excel using a spreadsheet which helps to analyze historical data and make predictions about the future performance of the company. There are many different types of analysis which are used by the analyst for the evaluation of the company.
A proper financial analysis consists of five major areas which include revenues, profit, operation efficiency, capital efficiency, solvency, and liquidity. The final part of the financial analysis is to draw a comparison to determine if the performance is aligned with appropriate benchmarks. The first basis is the company’s historical records, to determine if the financial condition has improved or is it getting worse. The second basis is the direct competitors and the final basis is the contractual covenants.
Understanding The Bottom-Up Approach
Bottom-up financial analysis is an investment approach that has focuses on the analysis of individual stocks. A bottom-up financial analysis includes the price to earnings (P/E), current ratio, return on equity and net profit margin. It also considers the assessment of earning growth including future expected earnings. In a broad sense, the bottom-up approach starts with specifics and then moves to general.
The bottom-up approach invests in stock where the factors are positive for the company. Bottom-up investors believe in individual scrutiny, they are of the opinion that one company’s success in a sector does not necessarily mean that all the companies in that sector will follow the trend. These investors try to search out the companies that would outperform the others. This is the main reason why bottoms-up investor spends so much time analysing different companies. Bottom-up investors review the research reports on a company presented by the analysts because they have intimate knowledge of the companies given their assessments. Moreover, bottom-up investors will compare companies and invest in them based on their beliefs.
Bottom-up investors are those people who employ long-term strategies that rely on financial analysis. This is because this approach gives a deep understanding of a company and its stock value. Bottom-up investors can be most successful when they would invest in a company, they are familiar with on the grass-roots level. Google, Tesla, etc. are some good examples of this practice, because they have many known products/services that are being used frequently. When an investor looks at the company from the bottom-up approach his first thought is to understand the value from the perspective of the relevance of consumers in the real world.
Facebook is a good candidate for a bottom-up approach because investors understand the products and services well. Once a candidate like Facebook has been identified as a good prospect, an investor conducts a deep dive into the management, financial statement, marketing efforts and also the price per share which will include calculations of financial ratios for the company. Analysing how these figures have changed over time and projecting future growth is also an important aspect of this strategy.