Company Analysis

What is Company Analysis Meaning, Factors, Measures, Indicators

Table of Contents:-

  • What is Company Analysis?
  • Factors of Company Analysis
  • Earnings Measures
  • Financial Indicators
  • Balance Sheet
  • Ratio Analysis

What is Company Analysis?

Company analysis evaluates, examines and measures the performance and various aspects of a company to understand the cause of performance, financial health, management strategy, competitive advantage, marketing activities, prospects and its strengths or weaknesses.

If a company performs well irrespective of economic or industry failures it indicates that the company has certain unique characteristics that have made it successful. The process of identifying these characteristics whether they are quantitative or qualitative factors is known as company analysis.

Company analysis includes a detailed analysis of the following factors:

    1. industry characteristics;
    2. corporate profile;
    3. supply of products/services;
    4. financial ratios.
    5. pricing; and
    6. demand for products/services;

The most popular tool used widely in company analysis is spreadsheet modeling of financial statements. This tool is used to analyze and forecast operating and net income, revenues, and cash flows. 

Factors of Company Analysis

Quantitative indicators in company analysis refer to the numerical measures that focus on the measurable parts of the company such as financial, operational and overall performance. These indicators are generally used with the combination of qualitative indicators to help investors make informed decisions by understanding the company’s overall weaknesses, strengths, opportunities, and threats.

Qualitative factors refer to the non-numeric aspects of the company that cannot be easily quantified or standardized. Qualitative factors include industry trends, customer preferences, competitive advantages, company goodwill, innovation, management reputation, culture, risks and so on. These factors provide a subjective and conceptual understanding of the company.

In the case of company analysis, the balance sheet data should be first analyzed for:

  1. Efficient use of capital.
  2. Leverage enjoyed in the use of capital.
  3. Return on net worth.
  4. Return on equity.

The capital to be taken, the cost of different types of capital, and the problems of servicing the borrowed funds are to be taken into account. For this purpose the interest burden, tax and depreciation provisions are to be examined the cash profits and profit after depreciation should be considered equity and net worth.

The sales turnover is an important indicator of the activity of the company and an assessment of gross profits about sales is to be made sales to equity would be high to indicate a good turnover of sales for equity capital employed in the business. The profit margins earning per share and P/E ratios will indicate the earning potential of the company for the equity holders.

Earnings Measures

The most immediately recognizable effect of economic and industry influences on a specific company is probably the impact on revenues, the sales of some industries tend to be more positive with the business cycle; ethers are relatively immune to the cycle, while others (such as housing) move counter-cyclically. From the viewpoint of the individual company, adjustments to changes in the general business cycle can be different from those of the industry in general.

Product mix and pricing peculiar to specific firms can cause total revenues to respond more or less to broad economic and industry impact. For example, diversified product lines, allow a company to spread cyclical effects.

A variety of information will influence the investment decisions. Investors need to know the characteristics of various investment alternatives and must keep informed on the institutions and markets where they are available. Up-to-date information is required on the status of and trends in the economy, particular industries, and firms.

For analyzing a company, an investor needs to examine the nature and sources of relevant information about it This helps them to make judgments about expected return and associated risk.

Generally, there are two major categories of information:

1) Internal Information: Internal information consists of the data and events relating to the enterprise as publicized by it. It involves data and events made public by the company regarding its operations. The principal source of internal information about a company is its financial statements. In addition to financial statements, internal information may also come from annual reports, public and private statements of the managers, etc.

2) External Information: External information comprises the reports and analyses made by sources outside the company viz., media and research agencies. It helps to overcome biases inherent in internal information. It also provides certain information that is not found in internal information.

Financial Indicators 

Financial statements are a primary source of information and a detailed understanding of companies well being. It helps in evaluating the investment potential of companies. Financial analysts interested in making investments in equity shares of a company will be concerned with the prospects of a rise in the value of the firm The asset value of a security is determined by estimating the liquidating value of the firm.

The asset value of a security is determined by estimating the liquidating value of the firm, deducting the claims of the firm’s creditors and allocating the remaining net asset value of the firm over the outstanding shares of stock.

The asset value is usually estimated by consultation with:

  1. A specialist who appraises asset values, and/or
  2. An accountant who gives the book value of the firm.

The method is suitable only for companies heading towards bankruptcy. The firm’s income and dividends will be declining and discontinuous for them. Hence, they will have negligible value. On the other hand, forgoing concerns, the intrinsic value far exceeds the value of the firm’s physical assets. There is a definite lack of relationship between book value and real value, in the case of prosperous firms.

The analyst makes use of balance sheets, various ratios and statements of cash flows to analyze the financial statements.

Balance Sheet

A balance sheet is a summary of the account balance carried out after the appropriate closing of the books. Income statements deal with flows, whereas balance sheets deal with stocks.

A balance sheet refers to a financial statement that provides details about the company’s financial health including assets, liabilities and shareholders’ equity at a specific time generally at the end of a quarter or a year.

The balance sheet is one of the three financial statements that are used for evaluating the performance of a business. The other two financial statements include an Income Statement and Cash Flow Statement.

A balance sheet also provides details about the economic stability, liquidity and financial health of the company.

By the use of a balance sheet stakeholders and investors can compare the current assets and liabilities to determine the business’s liquidity. It enables them to calculate the rate at which the company generates returns. The comparison between two or more balance sheets from different points in time can represent how a business has grown over time.

Balance sheets can be used to calculate financial ratios and to conduct fundamental analysis.

The impact of inflation should be considered while making the balance sheet items realistic. The measures suggested are

1) Assets Side

i) Marketable Securities at Current Market Value.

ii) Inventory at replacement cost

iii) Land and Natural Resources at Net Realizable Value

iv) Plant & machinery at replacement cost

v) Goodwill.

vi) Research & Development Expenses (R&D).

2) Liabilities Side

i) Debt Repaid in Cheaper Money Units

ii) Deferred taxes.

iii) Retained earnings.

Ratio Analysis

Ratio analysis is a well known and widely used tool of financial analysis. It allows one to calculate various ratios by comparing different financial statement data points of firms and inter-firms.

Ratio analysis is referred to as the analysis of the financial information present in the financial statements of the company. External analysts use ratio analysis to determine the efficiency and other factors of the company such as liquidity, profitability and solvency. They use ratio analysis to compare the company to its competitors, track trends over time and make informed investment decisions.

Since ratios are future-oriented, the analyst must have the ability to adjust the factors that influence the relationship when analyzing ratios to accurately predict their future shape and size. Therefore, the usefulness of the ratio analysis depends on the intelligent and skilful interpretation of the analysts.

Many ratios can be developed from the various items included in the company’s financial statements such as balance sheet, income statement, and cash flow statement,

Analysts and Investors majorly focus on the profitability and leverage position of a company to understand its financial health and potential for future growth. To assess these factors, they analyse the following ratios.

1) Profitability Ratios

The following are the main types of profitability ratios:

Besides these ratios, equity investors consider investment through the secondary market (buying existing shares from other investors) and therefore, consider the following market-related measures.

In practice, the market price per share is calculated by calculating the simple average of the opening and closing prices or the high and low prices during the specified period. Other things being equal, investors prefer companies that have a consistent track record of profitability over those companies that experience sharp fluctuations in their profitability. A company that had inconsistent profitability in the past tends to have a higher degree of business risk.

2) Leverage Ratios

Leverage ratios help companies in evaluating financial risk. The typical ratios that are explained are:

A company with a high debt-equity ratio (say more than 2:1) and a low-interest coverage ratio (say less than 2) is perceived to have a high degree of financial risk. Equity investors demand a high rate of return on their investment to compensate for a high degree of business and financial risks.

Other ratios used to calculate the company’s financial health are liquidity ratios such as the current ratio and quick ratio and asset turnover ratios such as inventory turnover ratio, total assets turnover ratio, accounts receivable turnover ratio, fixed assets turnover ratio, and average collection period.

3) Return on Investment (ROI)

Return on Investment is a performance measure used to evaluate the efficiency of investment. It compares the profit from an investment to the costs of that investment. It calculates the financial impact of the business investment, action or decision.

When investing it is important to consider those companies that have a positive Return on Investment (ROI). If an investment has a higher ROI then it must be undertaken. A higher ROI indicates that the gains from the investment are more as compared to the investment cost.

ROI is an important financial metric for:

1) Asset purchase decisions (such as machinery, computer systems, or service vehicles)

ii) Approval and funding decisions for projects and programs of different types (for example marketing programs, recruiting programs, and training programs)

iii) Traditional investment decisions (for example management of stock portfolios or the use of venture capital).

To calculate return on investment, the benefits (or returns) of an investment are divided by the total cost of the investment. The result can be expressed in the form of a percentage or a ratio.

Return on Investment (ROI) = (Gains from Investment – Cost of Investment) / Cost of Investment


Return on Investment = Net profit after interest and tax / Total Assets

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