Financial analysis and financial modelling are essential aspects of finance.
Key differences
Financial analysis is the process by which the performance and position of a company are critically assessed through data gathered from the past, such as financial statements and other information. This requires a diagnosis of the health status of an organization, setting trends, and making the right decisions for the future regarding the business. This may include many high-utility financial ratios like profitability (e.g., return on equity), liquidity (e.g., current ratio), and solvency (e.g., debt-to-equity ratio). Analysts of finance will study income statements, balance sheets, and cash flow statements to get clues regarding the operations and strategic direction of a company and its performance. These all purposes encompass investment analysis, credit evaluation, budgeting, and monitoring performance. Such models are typically applied to benchmark how well a firm has performed in the past and estimate future performance based upon past trends.
Financial Modelling
Financial modelling, in contrast, is the process of building an algebraic representation (often referred to as a spreadsheet model) of a firm’s financial condition. For instance, a financial model is frequently used to make future predictions about the performance of a company’s finances based on certain assumptions made upon revenues, expenses, and other key factors that may be important in the future. A financial model is often developed in terms of detailed projections for the income statement, balance sheet, and cash flow statement. It is frequently applied with various scenarios to evaluate how decisions in business may affect their determination, under changed market conditions or capital structures. For example, valuations are a large application of the financial modelling, including discounted cash flows, mergers and acquisitions analysis, budgeting, and financial planning. Models can become very complex and may use such techniques as sensitivity analysis, Monte Carlo simulations, or even scenario analysis in order to account for uncertainty and risk.
The main point of difference between them lies in the focus-while financial analysis, in principle, relates to the interpretation of past and present financial data that gives better understanding of the company’s performance and the subsequent decision-making, financial modelling is more forward-looking and is more into creating a predictive framework to simulate future financial performance. Financial analysis is a starting point from which building financial models often begins; however, the model itself is much more detailed, quantitative, and scenario-driven. Financial analysis helps inform decisions, whereas financial modelling is the tool used to quantify and test those decisions through projections and scenarios. Both are invaluable tools for making informed financial decisions but are used at different stages of the decision-making process.
CONLUSION
By definition, financial analysis and financial modelling are both considered to be parts of the process of financial decision-making, but they both have two different purposes. Financial analysis would take into account assessing both past and current performance so that you could decide on the basis of such information regarding the present health of the company. Financial modelling, on the other hand, is a tool forward looking in nature and creates very detailed projections so that future performance and the scenario can be assessed. While financial analysis is the bedrock of any decision-making process, financial modelling forms a framework to test and then quantify those decisions. Together, both provide the all-inclusive approach towards financial planning, strategy, and risk management to make more informed and strategic choices.