Understanding the Elements of Fundamental Analysis

Understanding the Elements of Fundamental Analysis

The fundamental analysis scope is not only vast, but it also covers various elements, some of which we shall discuss in this article.

Working Capital Evaluation

The working capital evaluation is one of the most crucial fundamental analysis elements. It determines the availability of prevailing assets for the liabilities the company has. Working capital evaluation calculates the company’s liquidity—the limited ability to cover the limitless and determines the company’s performance in the market.

Investors can calculate working capital by the inventory and add the receivable accounts and cash in hand. The last stage involves subtracting the entire total among payable accounts and other accrued costs.

Free Cash Flow Evaluation

This approach determines a company’s profitability after removing non-cash income statement costs and adding equipment expenses and possible changes in the working capital from the balance sheet. FCF (free cash flow) evaluation indicates the entire company value and can illustrate its trend value.

Operating Profit Limit

This is the operating income ratio divided by a company’s total volume. These limitations illustrate the firm’s profitability.

Ratio Analysis

Eight ratio analysis tools are available to determine the general company performance and help predict the company’s future valuation. These ratios include:

·         Price Earnings (PE) Ratio

To calculate the PE, an investor should divide the prevailing company’s share by its EPS (Earnings per share). The PE gives a clear illustration of the money an investor would be prepared to invest for every company share, for each cent of its earnings.

·         ROE (Return on Equity)

ROE is an excellent instrument that calculates a company’s financial performance by dividing its net income by the shareholder’s equity. ROE is a return on the net asset because it involves obtaining the shareholder’s equity by eliminating debt from the organization’s assets.


·         Debit-Equity Ratio

This financial ratio helps investors understand the relative debt proportion accrued to cater to the shareholder’s equity and company’s assets. It is illustrated by dividing the company debt by the shareholder’s equity.

·         Dividend to Price Ratio

This is a percentage that investors use to illustrate the number of dividends a company pays out annually as its stock price percentage. To calculate the dividend to price ratio, investors should divide the yearly share dividends by the prevailing market share price.


EBIT (earnings before interest and taxes) is a company’s net income before tax and interest costs are deducted. It provides a fair interpretation of its performance and min operations without factoring in tax costs. The cost of capital composition influences the company’s profits. The EBIT formula is:

Interest expense + net income + tax expense

Earnings before interest, taxes, depreciation and amortization (EBITDA) consider amortization, depreciation, taxes, and interest as a sign of the company’s position based on earnings potential and financial performance. This concept enables investors to ascertain a company’s cash net flow. The EBITDA formula is:

Interest expense + net income + depreciation + tax expenses + amortization

EBIT is usually considered a good sign of a company’s performance, while EBITDA is a sign of its spending potential. EBITDA is ideal in high-capital companies because amortization and depreciation consume a significant percentage of the operating budget. These factors may generate a false ideal of the company’s financial performance.

Evaluating a Company’s Annual Reports

One of the best ways of determining a company’s financial position in the market is by analyzing the annual reports and identifying signs of decline or growth.

The profit and loss statement is a crucial document that comprehensively views the expenses and revenues incurred during the financial quarter or year. It illustrates the company’s inability or potential to meet costs while increasing revenue, generating profit, and cutting down costs. An investor or trader should be able to read and evaluate the profit and loss statement, which comes in two different parts; expenses and revenue.

To find the total revenue, investors should add the varying types of revenue and subtract any paid excise duties. The different expenses are subtracted from the total revenue to calculate profit before taxes.

Profit after tax is the result you get after deducting different income taxes from the revenue. Usually, investors analyze the PAT figure to gauge a company’s potential to generate ROI. The profit after tax calculation also includes operating incomes and incomes from varying sources.


Fundamental analysis comprises sector, company, and industry-specific research. When using this concept, investors can rely on financial reports like the balance sheet, cash flow statements, and income statement to evaluate the firm’s financial standing.