Metagenomic sequencing provides a unique opportunity to explore earth's limitless environments harboring scores of yet unknown and mostly unculturable microbes and other organisms. Functional analysis of the metagenomic data plays a central role in projects aiming to explore the most essential questions in microbiology, namely 'In a given environment, among the microbes present, what are they doing, and how are they doing it?' Toward this goal, several large-scale metagenomic projects have recently been conducted or are currently underway. Functional analysis of metagenomic data mainly suffers from the vast amount of data generated in these projects. The shear amount of data requires much computational time and storage space. These problems are compounded by other factors potentially affecting the functional analysis, including, sample preparation, sequencing method and average genome size of the metagenomic samples. In addition, the read-lengths generated during sequencing influence sequence assembly, gene prediction and subsequently the functional analysis. The level of confidence for functional predictions increases with increasing read-length. Usually, the most reliable functional annotations for metagenomic sequences are achieved using homology-based approaches against publicly available reference sequence databases. Here, we present an overview of the current state of functional analysis of metagenomic sequence data, bottlenecks frequently encountered and possible solutions in light of currently available resources and tools. Finally, we provide some examples of applications from recent metagenomic studies which have been successfully conducted in spite of the known difficulties.