The financial analysis of a firm assesses the stability and profitability of a business and gives an overall view of the company.
Your company financial statements help you determine your liquidity status, income and expenses, profitability or losses, potential investment opportunities, and expected return, among several other things. Based on this review, you can make smart decisions about where and when to invest your capital.
Your company’s stability in the market depends on your ability to stay afloat, which depends on your resources and their proper allocation. Without sound financial analysis, you cannot plan anything.
If your business is losing money, you cannot devise an elaborate marketing plan or expand. Instead, your strategy will shift towards cost-cutting tactics.
A sound financial review is only possible if you update your data daily and then review your financial statements every month, which can help minimize many problems. Additionally, running a monthly financial analysis with your team will provide a more comprehensive view of where the company stands and what you should do next.
Let us break down how you can conduct a financial analysis of your business into simpler steps.
Step 1: Compare Your Financial Plan with Actuals Every Month
Every month, companies review the current month’s financial performance, allocate resources, and plan for the coming month accordingly.
Opting for a certified accounting course or going through the Wiley CFA prep course can help you learn all about making financial plans for a firm and conducting financial analysis to determine equity, investment potential, and risk management.
Ideally, use financial software like LivePlan to crunch data for analysis and compare your forecasts and actual performance side by side. Use a singular financial dashboard to make charts and graphs for more accessible visual representation, and make it easier to draw comparisons.
Step 2: Identify Key Reasons for Better or Worse Performance
Discuss the financial comparisons with all the key members of your team. It may include the finance department or heads of all the departments. You would typically require input and feedback from all departments.
Identify key reasons for poor, exceptional, or average actual performance and compare them to forecasts. If the sales dropped compared to the last month or the forecast, was it because of increased costs, poor customer service, low quality, or any external factors?
On the other hand, if your business performed well, was it because of improved quality, a sound strategy, or seamless operations? Defining your business’s strengths and weaknesses is vital to devise a relevant and realistic strategy for the coming month.
Step 3: Devise a Financial Plan for the Next Month
Your plan for the next month will depend on the previous month’s performance. After identifying where you are lagging, plan a sound strategy and work on it in the coming month.
Ideally, only store your finished goods as much as you plan to sell within the month. For example, if your factory or warehouse loses money because of increased storage costs, you need to manage your inventories accordingly. Ask your supply chain manager to draft the best inventory management method for the firm.
On the other hand, if your sales skyrocketed this month due to a successful campaign, set higher targets for the next month, and manage your operations to make them more efficient to cover the increased demand.
Step 4: Update and Assess Your Financial Statements
Ideally, you should update the business’ financial statements and assess them monthly, quarterly, and yearly. Use financial software and a singular database for easy access.
An organization’s balance sheet is one of the most significant financial statements updated daily. It briefly describes your company’s position and keeps a check of inventories, assets, and cash flows against liabilities and equity. If there is any lost money, your balance sheet will detect it, as it will not balance out. A consolidated statement tells you where your company stands on the said date.
The second most important financial statement is the income statement, or the profit and loss statement. It is a summarized statement of your company’s income and expenses. However, your company is doing fine if the income you are generating is more than your expenses. If your costs exceed the income, you need to figure out which part of the company is responsible for it and take the required action.
A cash flow statement includes cash inflow and outflow from operations, investments, and financing options. As long as your cash inflows exceed cash outflows, you are cash-stable. However, if the outflows exceed inflows, you may need to set a target to recover the required cash to keep yourself afloat.
Step 5: Assess the Overall Growth of Your Business
Every quarter, take a step back and assess the previous quarter’s performance. How has the overall growth of your business been? Have you made a profit or loss? Which sectors of your business are performing well, and which ones are eating up resources?
Any business owner aims to grow, increase financials, and stay ahead of the competition. Focus on your goal and assess how close or far from it you are. You can make a quick analysis by analyzing some of the financial ratios like the debt-to-equity ratio, return on equity, net profit margin, and a quick ratio which calculates financial standing by dividing assets by liabilities.
Answering these questions will help you make the required business decisions. It will set the pace for your next steps and let you develop a strategy for the coming quarter.
How to conduct the financial analysis of a business?
Here are some simple steps to take when conducting the financial analysis of a business:
- Compare your financial plan with actuals every month.
- Identify key reasons for better or worse performance.
- Devise a financial plan for the next month.
- Update and assess your financial statements.
- Assess the overall growth of your business.
Conducting a financial analysis of your business lies at the centre of all your business decisions. You cannot plan without allocating resources efficiently, cutting your costs, and increasing profit margins without doing some number crunching.
Consequently, you must follow these steps to assess your firm’s financial health to ensure that your company performs well. Always start by comparing your plan with the actual monthly output. Identify reasons for any discrepancies and plan accordingly.
Regularly updating your financial statements will save you from lost data and help you make well-reasoned, judicious decisions. Lastly, compare your business goals with your performance each quarter and make plans to overcome any gaps in the actual and projected earnings.
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I am Adeyemi Adetilewa, a media consultant, entrepreneur, husband, and father. Founder and Editor-In-Chief of Ideas Plus Business Magazine, online business resources for entrepreneurs. I help brands share unique and impactful stories through the use of public relations, advertising, and online marketing. My work has been featured on the Huffington Post, Thrive Global, Addicted2Success, Hackernoon, The Good Men Project, and other publications.