Top 5 Financial Analysis Techniques for Business Analysts
Financial Analysis Techniques explore financial aspects (benefits and costs) of an investment. Business analysts should consider, initial cost with time frame of investments, expected financial benefits with time frame, ongoing usage and support costs, and risk factor. When making a comparison between potential investments, use same period for both investments.
Financial Analysis Technique # 1 Cost Benefit Analysis
Cost benefit analysis computes net benefit which is calculated as Expected total benefits – Expected total costs. Total benefit is the sum total of all benefits for a given period. This may be additional revenue earned or reduction in operational costs.
Total cost of ownership (TCO) is calculated as Cost of investment+ costs of transitioning (includes training cost) + (Usage cost + Support cost) for a given period.
Financial Analysis Technique # 2 Return on investment (RoI)
The return on investment (ROI) of a planned change is expressed as a percentage measuring the net benefits divided by the cost of the change. Companies usually have a benchmark for ROI for projects to be accepted. ROI is calculated using the following formula: (Total Benefits – Total Cost of Ownership) *100 / Cost of Investment). The larger the ROI, the better the investment.
Financial Analysis Technique # 3 Payback period
Time period required to generate enough benefits to recover cost of change. Companies usually have a benchmark for Payback period for projects to be accepted. The shorter the payback period, the better the investment. check more information about business analyst and Business analyst Interview Questions
Financial Analysis Technique # 4 Net present value (NPV)
Net Present Value is computed as Present Value – Cost of Investment. Present value (PV) is the Sum of (Net Benefits in that period / (1 + Discount Rate for that period)) for all periods in cost-benefit analysis. Present value does not consider cost of original investment.
PV = C1/(1+r) + C2/(1+r) 2 + C3/(1+r) 3 + C4/(1+r)4 +….
Here C indicated
Net present value (NPV) must be positive for the project to be valuable to the organization. The larger the NPV, the better the investment.
Financial Analysis Technique # 5 Internal rate of return (IRR)
Internal rate of return (IRR) is the Discount rate at which NPV becomes 0. Internal rate of return (IRR) MUST be greater than cost of funds for an investment to be viable. The higher the IRR, the better the investment. Check out more courses like cbap training, ccba training and ecba training
- Objective (quantitative) comparison of investments.
- Assumptions and estimates are clearly stated.
- Reduces uncertainty by identifying and analyzing influencing factors.
- Costs and benefits are difficult to quantify.
- Inability to account for no-financial benefits and costs
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