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Analysts use this information to produce reports usually based on ratios. Ratios provide a method of directly comparing complex financial statements. Their accuracy depends on the adherence to Generally Accepted Accounting Principles (GAAP). The standards are drafted and maintained by the Federal Accounting Standards Advisory Board (FASAB). GAAP provides the framework for business accounting. Basic financial analysis focuses on profitability, liquidity, activity, shareholder return, and leverage. Many financial analysts are involved in the study of securities and investments.  

Securities and Investment analysts work both sides of the business. On the buy side, analysts work for companies or individuals with money to invest. They look for good deals for insurance companies, mutual funds, hedge funds, and non-profits like hospitals or colleges. They can also work on the sell side, packaging bond or preferred stock issues. Many financial analysts specialize in rating securities and companies. This rating is used to assign the degree of risk associated with the purchase of an intuitions stocks or bonds.

Corporate Financial Analysts provide the data used to make important business decisions. They are often asked to evaluate the performance of products or services. This type of analysis can discover ways to save money and improve productivity through the most efficient use of resources. For example, financial analysts can provide useful information regarding the price trends of raw materials or sales peaks and lows.

Process improvement is a necessary part of the business cycle. Analyst data is critical in determining proper degree of research and development. Financial analysts work in conjunction with business analysts to determine improvements necessary to maintain a competitive edge. Research of the competition and the market in general can provide guidance for strategic decision making. Once the appropriate amount of capital available for new process improvements or new product development is determined, the business analyst helps to prioritize and select the projects to be performed.

Companies have a fixed amount of money for projects. They look to financial analysts to provide the data for project selection and scheduling. Proposed projects can run from a few weeks to several years. In order to provide a comparison it is necessary for the figures to be converted to a common value. The most common method is to convert everything to Net Present Value (NPV).  Each project involves a series of cash flows. NPV measures these cash flows after the cost of financing in current dollars.

NPV =R_t/(1+i)^t

Where:

 i = the discount rate (used to discount future cash flows to their present value)

t= the time of the cash flow

Rt =the net cash flow

When interest is calculated in reverse it is referred to as the discount rate. Resulting NVP depends on the method of calculating the discount rate. In project comparison it is common to use the opportunity cost which is the amount or cost of the next best investment alternative. For long projects with long pay back periods discount rates can vary over time.

The most important metrics for this process are, Internal Rate of Return (IRR), Payback period, and Return on Investment (ROI). IRR is the discount rate that results in a NPV of zero. The payback period is usually calculated by taking the total cost of a project and dividing by the annual cash inflow. This will show the number of years required to reach the breakeven point. The Return on Investment (ROI) is the benefit, less the cost, divided by the cost. The higher the IRR or ROI the more attractive the project or investment is.  Risk is another important consideration. Higher yields are normally accompanied by a correspondingly higher degree of risk.

Careful financial analysis is necessary to determine acceptable levels of risk.  Once a given project is selected additional risks are uncovered during the project planning and execution phases. The financial analyst must work closely with project management and business analysts to help develop mitigation strategies. Risks are ranked by their probability of occurring and their impact. Impact is almost always calculated in financial terms.

Financial analysts must also monitor the company’s degree of operating and financial leverage. Operating leverage is determined by comparing fixed costs with variable costs to find the breakeven point. If a company has relatively large fixed costs compared to variable costs it is considered highly leveraged. The higher the degree of operating leverage the more susceptible the business is to changes in sales. Financial leverage refers to the degree of debt carried by the business. Capital for projects should be secured in advance at the most favorable terms. Market forces are constantly changing and changes in interest rates often dictate modifications to the degree to which a business carries debt and the types of debt instruments employed.

Financial analysis is an important part of strategic and tactical planning for businesses of every size. Home based businesses are susceptible to the same market forces as multi-national corporations. This article has attempted to provide the barest outline of financial analysis.

Dr. Samuel Baker of the University of South Carolina has kindly provided a series of basic economics tutorials. If you want find out more about the metrics of financial analysis you can find them at: Economics Interactive Tutorials

Developing the requirements list also indentifies associated risks. Risk identification and risk management are two of the most important functions of the business analyst. Risks are rated by probability and impact. Contingency plans should be developed for those risks with a high probability of occurrence or a large potential effect. Many project teams limit their Risk assessments to potential disasters. It is important to remember risks can also be opportunities. For example, software development can lag behind schedule due to supplier issues. With proper analysis the resulting delay can allow the incorporation of new technology in a process or product that was not available during the initial planning stages.

The requirements list forms the basis for either process improvement or development of a new project. Ongoing process improvement is vital to maintaining a competitive edge. The development of a new product or process is best performed through the use of a structured project methodology based on an accurate and comprehensive requirements list. These requirements provide the structure for determining the functional specifications for the new product or process.

The business analyst provides a vital link between functional management and the project manager in the process of developing a project plan. Project plans are best researched from the bottom up and developed from the top down. The work breakdown structure is instituted at a high level to convert the functional specifications to work packages that are progressively broken down in greater detail until project cost and duration can be estimated accurately.

The business analyst is also a technical writer and is responsible for producing the documentation describing the current or future business process and outlining steps necessary to achieve the indicated changes.  The documentation can include business plans, business cases, requirements lists, process flow diagrams and RAID (Risks, Assumptions, Issues, and Definitions) documents. Development of these documents is usually an iterative process. After the process change or project is complete, they comprise an important part of the historical record and can provide a baseline for future work.

The business analyst is often charged with developing a comprehensive report plan including status and progress reports. Reports should be clear, focused, and directed to a particular audience. Upper management usually needs an overview or ‘dashboard’ while the project team members will require detailed information. The business analyst must be familiar with report generation tools and understand the unique requirements of each stakeholder group.

Techniques for performing business analysis include M.O.S.T (Mission, Objectives, Strategies, and Tactics) and S.W.O.T (Strengths, Weaknesses, Opportunities, and Threats) analysis. There are many tools on the market to aid these processes. A good knowledge of database design and familiarity with a tool such as Microsoft Access will allow the business analyst to gather the data effectively and a good spreadsheet program like Microsoft Excel will provide a platform for complex financial analysis.

The business analyst is an agent of change and is usually tasked with developing the formal change management process. Successful change management will often mean the difference between project success and failure. Well defined requirements will produce a clear scope, setting limits and defining the project. The most common cause of project failure is scope creep. In addition to project change management the analyst can provide requirements and help develop plans for organizational change management.

New products and changes in processes require adaptation by the people involved. Humans are by nature resistant to change. Organizational change management is a set of processes designed to counter this resistance. Training materials are required to ease the transition and gain the acceptance of employees and end users. Business analysts are intimately familiar with the new process or product and frequently assist in the development of these user manuals and presentations.

Business analysts break large businesses down to discrete processes or manageable sized pieces and organize these pieces in useful ways. Each process, from the ordering of office supplies, to the construction of an office building can be seen more clearly as a list of requirements and the steps necessary to satisfy those requirements. In business, today’s projects become tomorrow’s ongoing processes.