The examination of a business from a variety of perspectives in order to fully understand the greater financial situation and determine how best to strengthen the business, it looks at many aspects of a business from its profitability and stability to its solvency and liquidity:
1. Profitability: review the levels of current and past profitability and decide what they need to do to increase profitability in the future. Measure the company’s ability to earn income and sustain growth in both the short- and long-term.
2. Solvency: businesses are also concerned with making sure that they do not fold because they are in debt. A financial analysis will highlight the debts they owe, and help create a pay-off plan. Measure the company’s ability to pay its obligation to creditors and other third parties in the long-term.
3. Liquidity: understand business’ cash position and make sure that the company has the ability to maintain a positive cash flow, while still being able to pay for what they need immediately. Measure the company’s ability to maintain positive cash flow, while satisfying immediate obligations.
4. Stability: the company’s board and partners also wants to make sure that the company is financially stable, and does not have components that could cause it to fold. Measure the company's ability to remain in business in the long run, without having to sustain significant losses in the conduct of its business.
Financial analysis may determine if a business will:
- Continue or discontinue its main operation or part of its business;
- Make or purchase certain materials in the manufacture of its product;
- Acquire or rent/lease certain machinery and equipment in the production of its goods;
- Issue stocks or negotiate for a bank loan to increase its working capital;
- Make decisions regarding investing or lending capital;
- Make other decisions that allow management to make an informed selection on various alternatives in the conduct of its business.