Business analysis is a process of identifying and creating solutions for business needs. In simple terms, it means evaluating a company’s economic health in a form of the entity’s strengths and weaknesses. This practice is done in order to come to a consensus business valuation terms i.e. making willing parties agree on an intrinsic value of a company.
Business analysis serve as the base upon which various decisions are built like; investing in equity or loan, extending credit facility or not, deciding the value of a business for initial public offer (IPO), Business restructuring, and divestures.
Business analysis helps to make economic decisions through proper evaluation of a company’s business environment, strategies and financial perspectives (financial position and profitability stance). To determine the value of a firm, a financial analyst (example, an accountant), selects a valuation model and determines a company’s true value. It is usually subjective however but, serves as a useful guide. Through business analysis, financial analysts come to a final conclusion of what a business is worth.
There is no clear cut difference between business analysis, business valuation and financial statement analysis. They all overlap and complement one another. The main aim of business analysis is to enhance business decisions. For example, capital budgeting – examining available information about a firm’s financial and non-financial situations.
Types of Business Analysis
Businesses are analysed for the two main reasons;
- To find out its credit worthiness, and
- To understand the owners claim on company’s assets.
The two main type of business analysis are: Credit analysis, and Equity analysis. It explains that the assets of a company are tied to its debt and equity. By analysing these aspects of the business, one gets an insight that may lead to reasonable foresight information.
Components of Business Analysis
1) Business Strategy Analysis:
Strategy analysis refers to the process of conducting in-depth research on a firm and its operating activities to formulate a strategy. It is designed to achieve the competitive advantage of a company over another in the long term.
This is a first step (Though qualitative research) as it gives the financial analyst enough information to prepare the subsequent accounting and financial analysis better.
Generally, determining the key success factors and business risks makes it easier for key accounting policies to be identified from the accounting information. The evaluation of a firm’s business strategy gives analysts a room for broader assessment of profitability and to find out if it is sustainable in the long run.
2) Accounting Analysis:
Account analysis is a process of analyzing the detailed line items in a financial statement for a given account (often done by a trained auditor or accountant). Here, generally an accountant identify those places where there is flexibility in treating a particular item and appraise its appropriateness.
Another important step in accounting analysis is to re-state the figures found in the financial statements of the company on more economically realistic basis. Accounting analysis is performed to increase the reliability of the conclusion while performing financial analysis. Accounting analysis is an important step because it provides necessary information that accountant use to carry out our analysis successfully.
3) Financial Analysis:
In this step, financial analysts use current and past financial data to evaluate a company’s ability to maintain and sustain her financial stand. Here, accountant need two important skills. First, the ability to systematically and efficiently carryout analysis in-depth. Second, the ability to use financial data to find business issues.
The two most commonly used financial analysis are – ratio analysis and cash flow analysis. Ratios analysis focuses on evaluating a company’s product performance in a market. While cash flow analysis focuses on the flexibility and liquidity of a company from financial perspective. Financial analysis further consists of three major studies i.e.- profitability analysis, risk analysis, and analysis of sources and uses of funds.
4) Prospective Analysis:
This is the final step in business analysis and it can only be undertaken only after the financial statements have been properly adjusted to accurate results of the economic performance of a company.
It focuses on forecasting a company’s future- typically earnings and regular cash flows from a business. Prospective analysis draws on final conclusion of business analysis by examining the accounting analysis, financial analysis, strategic analysis and business environment analysis. The result here forms the basis of estimating a company’s true value.
Prospective analysis is also useful to examine the viability of firm’s strategic plans i.e., whether they will be able to generate sufficient cash flow from its operations to invest in mergers or acquisition or for business restructuring or whether they will be required an investment bank to seek for external funding.