Corporate Financial Analysis: How It Works and Why You Need It

Corporate Financial Analysis: What Is It?

Corporate financial analysis is the process of evaluating a company’s financial performance. It is an ongoing activity you can perform in various ways and directions. No matter the intent or type, the financial analysis process involves collecting a company’s financial data and then using it to assess overall financial health and determine liquidity, profitability, efficiency, solvency, sustainability or any combination thereof.

Companies use corporate financial analysis to

• Assess potential investment opportunities.
• Create or adjust financial strategies. 
• Evaluate the performance of products or projects.
• Identify growth opportunities.

Because it offers a combination of real-time data, information that highlights problem areas and more accurate forecasts, corporate financial analysis gives you the information you need to make the most effective choices for your business.

Why Is Financial Analysis Important?

Comprehensive financial analysis reveals the data you need to make both short- and long-term business decisions. Potential investors, for instance, perform an external financial analysis before choosing which company to invest in.  

Corporate financial analysis, however, is performed internally to

• Measure your company’s profitability.
• Evaluate your operational efficiency.
• Improve business processes.
• Manage your business risk.
• Sustain your cash flow.
• Support your strategic growth.

Understanding the Different Types of Corporate Financial Analysis

There are several types of corporate financial analysis. Though they all involve examining financial information, each has different starting points and a unique analytical approach.

Horizontal Analysis

A horizontal analysis measures sets of comparable financial data over time to examine overarching patterns of change. For example, you would use horizontal analysis to examine year-over-year changes in your core accounts such as expenses or revenue. Because examining the results of the same data set makes it easy to track developments like growth and decline, this approach is also called trend analysis.

Let’s look at a sample income statement to illustrate this concept. Although this company saw increased sales in 2024, higher cost of goods sold (COGS) and higher operating expenses show that its net income fell 3.6% compared to 2023:

Vertical Analysis 

A vertical analysis determines the proportionate size and significance of financial line items expressed as a percentage of a chosen benchmark. For example, a standard benchmark in vertical analysis is net sales. You would then examine other key line items, such as your gross profit and net income, as a percentage of your net sales, to establish the relative proportions of each in the overall benchmark. This table illustrates that concept: 

Vertical analysis also lets you compare different categories within a single line item. For example, consider ABC Clothing Company, which had $500K in net sales last year. Dividing the sales for each inventory category against the net sales total gives you the relative percentages for each:

Ratio Analysis 

This method calculates ratios to compare your financial statement line items to those of specific competitors or broader industry standards. This comparison lets you evaluate your performance over time and position your company among its peers. 

Ratio analysis helps assess your company’s liquidity, profitability and solvency.

Liquidity:

Current Ratio

The current ratio compares current assets to current liabilities. To calculate the current ratio, divide the company’s current assets by its current liabilities.

Current ratio = current assets / current liabilities

For example, Company A has current assets of $750K and current liabilities of $300K, for a current ratio of 2.5. Company B has current assets of $1M and current liabilities of $750K, for a current ratio of 1.3. Company A is in a stronger position and is more likely to receive short-term credit.

Traditionally, a current ratio of 2 has been seen to indicate that a company has enough cash to meet its obligations. However, this does not apply to every industry. 

Quick Ratio

The quick ratio assesses a company’s ability to pay its current liabilities with existing reserves (that is, without selling inventory or acquiring additional financing). To calculate the quick ratio, divide the company’s most liquid assets (cash, accounts receivable, marketable securities) by its current liabilities.

Quick ratio = liquid assets / current liabilities

Because the quick ratio excludes inventory and other less liquid current assets, it is more conservative than the current ratio. 

Profitability:

Gross Margin Ratio

The gross margin ratio compares a company’s gross margin to its revenue and shows how much profit a company generates after paying its COGS. To calculate the gross margin ratio, subtract the COGS from total revenue, then divide the result by total revenue.

Gross margin ratio = (revenue – COGS) / revenue

For example, if a company’s revenue is $150K and its COGS is $50K, its gross margin ratio is 66.67%. For every dollar this company earns, $0.33 pays for the cost of goods sold and $0.67 can be used for other expenses.

Profit Margin Ratio

The profit margin ratio measures the percentage of profit that a company earns from its total revenue. To calculate the profit margin ratio, divide net income by net sales.

Profit margin ratio = net income / net sales

Calculating your profit margin ratio can also help determine how well your company manages its expenses: a ratio that falls over time indicates that expenses are growing faster than sales.

Solvency:

Debt-to-Equity Ratio

The debt-to-equity (D/E) ratio compares a company’s total liabilities with its total shareholder equity. To calculate shareholder equity, subtract liabilities from total assets. Then, calculate the D/E ratio by dividing total liabilities by total shareholder equity.

Debt-to-equity ratio = total liabilities / total shareholder equity

Measuring your company’s D/E ratio can help assess its ability to meet long-term financial obligations.

Interest Coverage Ratio 

The interest coverage ratio measures a company’s ability to pay any outstanding debt. To calculate the interest coverage ratio, divide the company’s earnings before interest and taxes (EBIT) by its interest expenses.

Interest coverage ratio = EBIT / interest expenses

A higher interest coverage ratio means your company will be better able to access financing or attract investors. Conversely, a lower interest coverage ratio may mean that a company’s debts exceed its earnings.

Cash Flow Analysis

This approach examines your company’s ability to cover operating expenses, pay down any debt and invest in growth. You can use current and past cash flow statements to analyze how cash moves into, out of and through your business. 

One important cash flow metric to consider is the operating cash flow ratio. This ratio measures the relationship between operating cash flow and current liabilities:

Operating cash flow ratio = net cash flow from operations / current liabilities

For example, consider a company whose statements for the last quarter show $100K in net cash flow and $80K in current liabilities. This company earns $1.25 for every dollar of current liabilities.

How To Conduct a Financial Analysis 

Here are some steps to take for the front end of the financial analysis process.

Step 1

Gather all necessary financial statements, including balance sheets and cash flow income statements.

Step 2

Choose your analytic approach and prepare your data. For instance, if you’re performing a horizontal analysis, ensure you have data from each period you want to compare.

Step 3

Identify the key performance indicators (KPIs) you want to examine. Common choices include cash flow, liabilities and profitability.

Step 4

Compare your chosen metrics against time, other benchmark line items or competitors. Analyze and interpret the results.

Step 5

Identify patterns and trends. Locate outliers that represent future profit or loss. Develop actionable recommendations based on your conclusions. 

Most importantly, you must ensure the accuracy and timeliness of your financial data. Inaccurate data will compromise your analysis and potentially weaken your company’s strategic position. Growing businesses with lean finance functions can benefit from experienced outside help to optimize their financial data and extract the most relevant analysis.

Unlocking Business Growth: The Benefits of Expert Financial Analysis

Expert analysts can use your financial data to forecast the coming fiscal year, strategizing and adjusting revenue goals. Paired with examinations of broader industry and market conditions, experienced corporate analysts can build financial models, identify growth opportunities and capture a snapshot of your company’s financial health.

These essential models maximize your decision-making capability, boosting your ability to:

• Divest underperforming assets. 
• Identify areas for strategic growth.
• Make strategic acquisitions.
• Prepare a valuation for a sale or IPO.
• Raise and allocate capital.

When To Hire a Financial Analysis Expert

In a growing SMB, day-to-day operations can require all the finance function’s resources, leaving little time and bandwidth to conduct detailed financial analysis. Paro can match you with an experienced financial analyst who can help build a sustainable profit model for your company, highlight your operational risk and opportunities, locate the key drivers of your success and much more. 

Get the financial analysis you need to assess your company’s ongoing financial health, solvency and opportunities.