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Comparative financial analysis is the process of analyzing the data found in a financial report in comparison with similar data from other reports. This allows whoever is doing the analysis to get some context which makes the raw numbers more meaningful. An individual can do comparative financial analysis by studying several reports of the same company from different time periods in an effort to spot trends. Another way to practice this type of analysis is to compare the reports of different companies that compete with each other in the same industry.
There are several different reasons why an individual would want to analyze the financial data of a certain companies. Investors analyze financial reports as a way of determining how they should invest their capital. In addition, management within a company may study its own reports to see how well the company is doing and whether any changes need to be made. Simply studying raw data can be meaningless without some comparisons to provide useful context, which is why this analysis is so helpful.
As time passes and companies age, their numbers may reflect their changing financial standing. Since this is the case, comparative financial analysis can be used to study those changes and to see if the company is trending upward or downward. Looking at reports from several past time periods and comparing those numbers with the numbers from the current period can shed a lot of light on a company's progress or lack thereof.
There are also times when it may be useful to see how a company is doing against its competitors. For this, comparative financial analysis within a specific industry is effective. This method of analysis is often used in conjunction with financial ratios, which are metrics that can be used to measure debt levels, efficiency, cash flow, and many other pertinent aspects of a company's operations. These ratios mean little on their own, but their relation to the ratios of similar companies can tell a lot about financial strength.
When doing comparative financial analysis within one industry, the choice of which set of numbers to use as the basis for comparison is an important one. One way to do this, again using financial ratios, is to get the industry averages for these ratios and use these numbers as way to judge one company within the industry. Since averages may be difficult to locate and cumbersome to calculate, comparative analysis can be achieved using ratios from a single, financially strong company as an industry benchmark, against which all other companies' ratios may be compared.