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18/10/2020 03:21:01 PM

Business Analysis

Business analysis is the evalua­tion of a company’s prospects and risks for the purpose of making business decisions. These business decisions extend to equity and debt valuation, credit risk assessment, earnings predictions, audit testing, compensation negotiations, and countless other decisions. Business analysis aids in making informed decisions by helping structure the decision task through an evaluation of a company’s business environment, its strategies, and its financial position and performance.

Financial statement analysis is an important and integral part of business analysis. The goal of business analysis is to improve business decisions by evaluating available infor­mation about a company’s financial situation, its management, its plans and strategies, and its business environment.

Types of Business Analysis

Credit Analysis

Credit analysis is the evaluation of the creditworthiness of a company. Creditworthiness is the ability of a company to honor its credit obligations. Stated differently, it is the abil­ity of a company to pay its bills. Accordingly, the main focus of credit analysis is on risk, not profitability. Variability in profits, especially the sensitivity of profits to downturns in business, is more important than profit levels.

Credit analysis focuses on downside risk instead of upside potential. This includes analysis of both liquidity and solvency. Liquidity is a company’s ability to raise cash in the short term to meet its obligations. Liquidity depends on a company’s cash flows and the makeup of its current assets and current liabilities. Solvency is a company’s long- run viability and ability to pay long-term obligations. It depends on both a company’s long-term profitability and its capital (financing) structure.

The tools of credit analysis and their criteria for evaluation vary with the term (maturity), type, and purpose of the debt contract. With short-term credit, creditors are concerned with current financial conditions, cash flows, and the liquidity of current assets. With long-term credit, including bond valuation, creditors require more detailed and forward-looking analysis. Long-term credit analysis includes projections of cash flows and evaluation of extended profitability (also called sustainable earning power). Extended profitability is a main source of assurance of a company’s ability to meet long-­term interest and principal payments.

Equity Analysis

Unlike credit analysis, equity analysis is symmetric in that it must assess both downside risks and upside potential. Because equity investors are affected by all aspects of a company’s financial condition and performance, their analysis needs are among the most demanding and comprehensive of all users.

Individuals who apply active investment strategies primarily use technical analysis, fundamental analysis, or a combination. Technical analysis, or charting, searches for patterns in the price or volume history of a stock to predict future price movements. Fundamental analysis, which is more widely accepted and applied, is the process of determining the value of a company by analyzing and interpreting key factors for the economy, the industry, and the company. A main part of fundamental analysis is evaluation of a company’s financial position and performance. A major goal of fundamental analysis is to determine intrinsic value, also called fundamental value. Intrinsic value is the value of a company (or its stock) determined through fundamental analysis without reference to its market value (or stock price). While a company’s market value can equal or approximate its intrinsic value, this is not necessary. An investor’s strategy with fundamental analysis is straightforward: buy when a stock’s intrinsic value exceeds its market value, sell when a stock’s market value exceeds its intrinsic value, and hold when a stock’s intrinsic value approximates its market value.


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