Making effective investments is one of the major decisions in any business. Investments are very important for the long-term gains of an organisation. Financial statement analysis provides a detailed report about the financial situation of a company which helps stakeholders to make investments in multiple areas, accordingly.
Investment decisions take into account the buying and selling of funds. It also throws light upon which funds the company needs to hold and which they can release. However, investment decisions must be taken after keen observation and making nearly accurate predictions or else it can result in huge losses or insolvency for the company.
An insightful financial analysis course can help finance professionals know about better investment decisions with the help of financial analysis. Read on to know the importance of financial analysis in making investment decisions.
Table of Contents
- 1 Investment Financial Analysis
- 2 Importance of Financial Analysis in Investment Decisions
Investment Financial Analysis
For investment purposes, a firm generally appoints a financial analyst external to the organisation who performs a thorough analysis for finding out effective investment areas. Analysts might use either a top-down or bottom-up approach to investing.
In the top-down approach, the analyst searches for macroeconomic opportunities like the higher valued sectors that yield maximum results. It then dives into investing in the best-performing companies in the high-performing sectors after a deep evaluation of the financial statements of the company. Financial modelling is also performed for scanning through all the financial reports to opt for the best investment area. The analyst then analyses the stocks of various companies in order to choose the possibly profitable ones to invest in.
According to the bottom-up approach, analysis chooses a specific company and performance ratio analysis of its past and present performance. Analysts also make predictions about the future performance of the company and decide whether it will be profitable to invest in its stocks or not. While making investment decisions analysts also consider various factors like the overall health of the business, its financial accounts, the supply and demand for its goods and services, evaluate its performance over time and so on.
Importance of Financial Analysis in Investment Decisions
Financial statement analysis is integral for businesses to ascertain the overall financial health of the company and to see what the worth of the business is. For investment purposes, the role of financial analysis cannot be overlooked. Without any financial record, it becomes very difficult for companies to know where they should invest. So financial analysis provides a basis for making profitable investments by looking at the past and present performance of various organisations.
The importance of financial analysis in making investment decisions can be stated as follows:
Identifying trends for making investments
The financial market is huge and it is not possible for anyone to conduct a search on all the companies in each sector. So with the help of financial analysis companies find out the growing and profitable trends or sectors. After identifying the recent trends that are resulting in profits, the management locates the best companies and their stocks to invest in.
These investments are generally done for long-term purposes for yielding more stable and high-value returns.
Evaluating the performance of potential companies to invest in
Financial analysts while performing analysis of financial statements also look to find the best companies to invest in for profit maximisation and minimising risks of losses. After the identification of the growing and profitable financial trend, financial analysts search through various companies in that sector and evaluate their stocks.
After searching through a whole list of potential opportunities to invest in, financial analysts make predictions as to what stock of which company will result in the maximum profit and balance out the risks.
The financial analysis consists of the income statement that shows the profit and loss of the various dealings the company has conducted in the past years. It provides a clear picture of the shares or investments that have yielded profits for the organisation. With financial analysis, companies can find out the potential areas in which they should continue to invest in.
Thus, looking at the profit and loss statement and the invested stocks that result in profit, businesses can continue to hold or retain those shares for future profits. It also has to find new investment areas for better increasing the company's worth.
As financial analysis consists of the profit and loss statement, it gives a clear picture of the financial position of a company. It shows the areas that have proven to be profitable for the business and also the ones that have resulted in a loss.
So keeping in mind the growth of the business, the investors can easily release the shares or holdings that are not profitable. The financial analysis gives detailed information about the financial performance for the accounting year and provides stakeholders with data on profit and loss in the income statement.
Making informed plans and decisions regarding investments
Financial analysis is important for companies when formulating major investment decisions and plans. The financial reports provide all the required financial facts that the stakeholders need in order to decide upon the investment options for the next financial year.
Additionally, businesses also get the opportunity to identify any potential financial risk and reference from investing in those areas. Performing financial analysis provides assistance to the stakeholders in making informed investment decisions which can minimise the risk of losses.
Better allocation of resources
Financial analysis showcases the financial health of the company which in turn allows the management to better allocate resources in the required areas. As resources are limited, proper allocation is a necessity. Performing financial analysis makes the job of resource allocation a bit easier for the stakeholders which also increases the profitability and efficiency of the business.
This is one of the functions of financial management which helps invest the funds in the areas that will yield more profit and identify the areas where cost can be reduced.
Financial analysis is an important tool for making more informed and smarter investment decisions. It analyses the various financial reports of a company to understand its worth. Financial analysts are scaled professionals who find out the prospective investment areas that can increase the profitability of a business.
If you are a finance professional and want to enhance your decision-making ability regarding investments then the Financial Analysis Prodegree In Collaboration With KPMG course by Imarticus is the best pick for you. Register for the course to better perform financial analysis and make more sound investment decisions.