Whenever you make decisions around investments, trades or other business dealings, you go through a process of financial analysis.

It’s a key part of assessing vialibility and financial health, and can take many forms, depending on the context. It’s important to understand how and when to conduct financial analysis, the scenarios in which it’s useful, and the types of analysis that are most relevant to your situation.

Financial Analysis Basics

At a basic level, financial analysis simply means looking at information and data about something in order to asssess its current and future financial health.

A simple financial analysis example could be assessing the viability of a new marketing plan for your own business, where you might look at costs versus projected sales; or it could be an in-depth analysis of a multi-million-pound company ahead of a potential merger.

In the context of trading and investing, financial data analysis is a useful way to learn more about a company and its infrastructure, and to make judments on its solvency, security, and profitability.

Essentially it’s a framework that traders can use to look at a potential investment and ask: “Is this somewhere that I want to put my money? Is this going to be a sound trade?”

Financial analysis can help traders to:

  • Gain a clear understanding of an entity’s financial health
  • Minimise risk
  • Identify trading opportunities
  • Optimise financial returns
  • Make well-informed decisions

How to Conduct Financial Analysis

Good financial analysis involves a systematic approach that combines quantitative techniques, industry knowledge, and analytical skills to interpret financial data accurately.

The exact process will vary depending on the context and the depth of the analysis – the steps in our marketing campaign example may be shorter than the large-scale merger, but the principles remain the same.

Data Gathering

The first step is basic research, gathering all of the key financial information about a business. This includes annual accounts, balance sheets, and cash flow statements. It’s important at this stage to standardise your data if you are comparing more than one trade option. This could mean converting everything into one currency, adjusting for inflation – anything that means you can make a fair comparison.

Calculate Ratios and Metrics

You can now use the data you’ve gathered to perform some financial tests and calculate various metrics for an indication of an entity’s financial health and suitability for investment. Liquidity ratios, profitability ratios, and solvency ratios can all provide a snapshot of a company’s financial performance.

Trend Analysis

Tracking financial data over time allows analysts to identify trends and patterns. This is crucial for identifying potential growth opportunities or warning signs of financial distress.

Qualitative Factors

Financial analysis isn’t just about the figures.

It’s important to get a broader picture too, so look at things like management structure and any recent or imminent changes, general market and industry trends, and global or political factors that could be a future opportunity or threat.

Interpretation and Reporting

The final step is to bring together all the information you’ve gathered and to look at the picture it creates.

Reports should be clear and actionable – the purpose of financial analysis is to inform decision-making, so at this point you should have clear takeaways.

Types of Financial Analysis: Fundamental vs. Technical

There are two primary types of financial analysis: fundamental analysis and technical analysis.

These two distinct approaches offer traders different ways to evaluate assets, and they each come with pros and cons.

Fundamental Analysis

Fundamental analysis is a deep dive into the value of an investment by evaluating the underlying factors that drive its worth.

The aim with fundamental analysis is to determine whether something is undervalued or overvalued. It’s great for getting a very detailed, long-term perspective of a company, but it’s very time-consuming and its use of qualitative data can make it subjective.

Fundamental analysis uses:

  • Financial statements, revenue, and profits data
  • External economic indications like interest and inflation rates
  • An analysis of the whole industry and growth potential
  • Information on the quality of the company’s management team and track record

Technical Analysis

Technical analysis, by contrast, looks at quantitative data like price patterns, trading volume, and historical market data to forecast future price movements.

The difference between fundamental analysis and technical analysis is that technical analysis assumes that the valuation is accurate and looks instead at price movements.

It’s more objective, easier to interpret and great for short-term analysis, btu it can be a little too superficial and may miss important underlying factors.

Technical analysis uses:

  • Price charts showing historical price movements, patterns and trends

  • Technical indicators like Relative Strength Index (RSI) and Moving Average Convergence Divergence (MACD) for insights into price momentum and potential trend reversals

  • Volume analysis to help indicate the strength or weakness of a price movement

As an investor or trader, financial analysis is an indispensable tool, and no one should make significant decisions without first gathering and assessing financial information.

With an understanding of the value and techniques of financial analysis, you can navigate trading and investments with confidence, paving the way for a more secure and prosperous financial future.

If you’re keen to find out more, you can set up an INFINOX trading account today.
It’s a simple process, and our trading platforms are backed up with a wealth of resources, insights, and educational material – so that you can learn on the go!

This material is for general information purposes only and is not intended as (and should not be considered to be) financial, investment or other advice on which reliance should be placed. INFINOX is not authorised to provide investment advice. No opinion given in the material constitutes a recommendation by INFINOX or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.

All trading carries risk.