How to Use Financial Analysis to Improve Your Business

Introduction

Financial analysis is the process of identifying reliable facts and figures, understanding trends and formulating recommendations based on these findings in order to make informed decisions for improving business. Financial analysis helps entrepreneurs make sound decisions and take better control of their business finances.

Specifically, it can help entrepreneurs understand cash flow, track their income and expenses, determine the financial efficiency and performance of the business, and make decisions that enable the business to reach its financial goals.

In this blog post, we will discuss how entrepreneurs can use financial analysis to improve their business. We will discuss the definition of each component, explore the process, and provide tips on how entrepreneurs can get started.

Analyzing Financial Statements

Financial statements and other reports provide a valuable tool for you to use to analyze your businesses’ financial performance and make decisions to guide growth. When reviewing the different financial statements available, it is important to understand what they are, and how to interpret them accurately.

Review Financial Statements

The financial statements that business’ produce are four main types - Balance Sheet, Income Statement, Cash Flow Statement and Statement of Changes in Equity. Each of these documents provides information about the business, however, the information that is being reported will differ for each one.

• The Balance Sheet gives a snapshot of the current position of the business and measures the assets, liabilities and equity of the business at a certain point in time.
• The Income Statement is used to analyse the net income of the business and provide information on revenue, cost of goods and services and operating expenses.
• The Cash Flow Statement documents the cash received and expended during a period and also lists any debt repayments and investments.
• The Statement of Changes in Equity documents the changes to total equity during the period.

Comparing Period-to-Period Performance

In order to appropriately evaluate your business’ performance, you will need to compare period-to-period data. By taking into account multiple years of data, you can identify trends and developments in your business. It is important to note that analysing your financial performance only for the current period will not provide an accurate picture of the overall financial position of the business. Comparing multiple periods of data will provide a thorough view on the financial performance and potential areas in which you can improve.

Identifying Weaknesses and Strengths

When using financial statements to analyse your business’ performance, it is important to focus on both the weaknesses and strengths. Recognising areas which are dragging down your businesses performance as well as highlighting areas in which you have strengths is vital for improving you business. Once you have identified areas for improvement, you can create action plans to help achieve the goals established. This process provides an excellent way to monitor the progress of your business and allow for the implementation of tactics that are necessary for increasing success.

Capturing Key Indicators

Financial analysis is one of the most important methods to uncover how well a business is doing. It involves in-depth examination of the financial statements including balance sheet, income statement, and cash-flow statement. This analysis facilitates the detection of key indicators that quantify a business’s financial health. By understanding these indicators, businesses can identify areas of improvement and develop strategies to increase profits.

Calculating Basic Ratios

The first step of a financial analysis is calculating basic ratios such as the current ratio, debt-to-equity ratio and return on equity. These ratios provide a general overview of the business's financial health by showing how well capital is managed, how much debt is carried and how efficiently the business is operating.

Identifying Areas of Cost

Another important part of analyzing the financials is identifying areas of cost. This can be done by comparing the organization’s expenses to industry averages or examining the income statement to identify areas where the business is spending more than it should. Additionally, businesses should track the changes of their costs to measure the effectiveness of the strategies implemented to reduce costs.

Analyzing Performance vs Industry Profiles

Finally, businesses can benchmark their performance against industry averages by comparing key financial ratios to the industry profile. This allows businesses to identify areas where they may have an advantage over the competition, as well as areas where they may be lagging behind. By understanding where they are weaker than the competition, businesses can target their efforts towards those areas to gain competitive advantage.

Analyzing Cash Flow

Cash flow is an essential metric for businesses of all sizes to review for indications of economic performance and effectiveness of operations. By performing a comprehensive cash flow analysis, business owners and financial managers can address unforeseen hindrances and leverage opportunities for growth.

Assessing Cash Flow Sources

Cash flow consists of both funds that have been received as well as funds that have been expended in order to maintain operations. These are derived from varying sources such as revenue generated, loans, or investments. It is important to evaluate cash flow against revenue, expenditures, and investments in order to identify trends and illustrate performance.

Examining Current Liabilities

Current liabilities such as credit payments, payroll invoices, accounts receivable and other obligations require payment within a twelve-month period. Utilizing financial analysis helps business owners and financial managers understand the enterprise's ability to comply with such obligations. Furthermore, by determining the amount of current liabilities associated with the company's cash flow, business owners may estimate the ongoing financial commitments of the business.

Evaluating Short-term and Long-term Solvency

The primary purpose of a financial analysis is to determine the solvency of the business. This metric indicates if the company can satisfy its business commitments while meeting other operational objectives. Short-term solvency is evaluated by analyzing the ability of the company to cover expenses based on the funds being held. Long-term solvency is judged based on the company's ability to service long-term debts, pay out dividends, and fund large investments.

By utilizing financial analysis, business owners and financial managers can better understand the economic stability of their enterprise, identify any financial limitations, and actively make decisions of how to utilize available resources. With this knowledge, business owners can mitigate risks, address economic difficulties, implement strategies to improve cash flow, and make well-informed decisions to become better equipped for long-term success.

Cost Control and Measurement

Financial analysis can be a powerful business tool when it comes to improving expense control and tracking. Effective cost control and measurement requires identifying and understanding the drivers behind your expenses and then exercising control over them. When you have a firm grasp of your cost structure, you can then look for opportunities to reduce your costs, making your business more competitive.

Determining Cost Drivers

The first step in cost control and measurement is to identify and understand your cost drivers. A cost driver is a factor in the cost structure that affects the cost of an operation. These drivers can be divided into two categories; direct and indirect, depending on whether they are closely associated with a function or process, or whether they provide a more general support. Examples of direct costs might include materials and labor related to specific functions, where indirect costs could include software and office supplies used by all departments.

Identifying Cost Savings Opportunities

Once you have identified the cost drivers in your business, you can begin to identify potential opportunities for cost savings. When evaluating cost savings opportunities, use your budget as a benchmark and consider both short-term and long-term savings. For example, you may want to review pricing options from suppliers, consider outsourcing specific tasks, or look for ways to automate processes. You can also look for ways to reduce general overhead costs such as office and travel expenses.

Monitoring Key Cost Ratios

Financial analysis can help you monitor key cost ratios over time to gain further insights into your cost structure. These ratios can provide important insights into where you have opportunities for cost savings. For example, you can monitor your profit margin, total cost of goods sold, gross and operating margin, and general and administrative expenses. Additionally, you can compare your cost ratios to industry averages, to help you identify where you can improve and make cost cutting decisions.

Improving Profitability

Strong financial analysis helps you assess the current performance of your business, revealing opportunities to increase profitability. Here are some ways to turn financial analysis into action.

Enhancing Pricing Strategies

Competitive pricing can be a powerful tool to help businesses increase their profits. Financial analysis helps you identify your current pricing strategy and assess whether you should adjust your pricing and by how much. You can compare your product or service prices to those of your competitors and also consider any costs that could affect the amount you charge. Analysis will also allow you to understand and forecast the estimated demand for your product or service.

Increasing Operational Efficiency

Understanding the areas of your business that are the most efficient and the least efficient is key to improving profitability. Financial analysis can provide data about production costs, wages of employees, supplies and other factors to help you pinpoint which areas of your business are most cost-effective and which need to be improved. You can use this data to make decisions about how to allocate resources more effectively and improve operational efficiency.

Identifying Investment Opportunities

Analysis of financial data may also reveal new opportunities for investments that can increase profitability. Financial analysis can help you weigh the risk and rewards associated with different investments, enabling you to make more informed decisions. Additionally, financial analysis can help you evaluate the potential returns on investments, such as stocks, bonds, real estate, or other assets and decide which ones may be right for your business.

Conclusion

Mastering financial analysis is a powerful skill to help your business achieve its goals. Ultimately, by understanding your financial data, you can make informed decisions that will help your business meet its objectives.

By reviewing the following best practices, identifying potential avenues for improvement and re-assessing your business’s progress toward its goals, you can use financial analysis to take your business to the next level:

Reviewing Financial Analysis Best Practices

• Become familiar with basic financial terms, principles, and metrics.
• Understand the purpose of various financial statements and reports.
• Be aware of industry or area-specific reporting requirements.
• Consider hiring a financial analyst to review your data.
• Make sure to periodically review and update your financial analysis.

Identifying Actions for Improvement

• Identify areas of potential cost savings.
• Analyze customer data to look for areas of potential growth.
• Analyze your pricing structure to ensure it’s competitive in the market.
• Explore new strategies or partnerships to drive growth.
• Invest in technology or personnel to improve your operations.

Re-Assessing Progress Toward Goals

• Set measurable goals for your business.
• Track key performance indicators to measure progress toward your goals.
• Check-in regularly to monitor progress and identify areas of weakness.
• Readjust goals and strategies as needed.
• Seek help from professionals if needed.

By leveraging financial analysis, you can make informed decisions that will have a positive effect on your business’s future. Whether you take the necessary steps yourself or hire a financial analyst to help, it’s important to leverage your financial data to make decisions that will help your business reach its goals.