Why Conducting a Financial Analysis Could Save You Money
by Michelle Wang, on Mar 21, 2019
Are you hesitating to enter uncharted territory?
Conducting a financial analysis for your company might seem like a difficult and daunting prospect, and there are several possible reasons you might be avoiding it. Maybe you’re worried that your accounting has been inconsistent, resulting in data that is not thorough, accurate, and/or easy to access. Maybe you are so caught up in other aspects of the business that you don’t have time to even think about financial analysis. Perhaps you don’t think the results will be worth the time and expense. Or you don’t really know where to start or what to do—and neither does anyone on your staff.
Another reason for holding off (and this one is surprisingly common, especially among young entrepreneurs)? You might actually be afraid of your numbers and what you might find when you start digging into them.
Whatever the reason, once you dive in and see the many ways financial analysis can benefit you, you’ll never turn back.
What is involved?
Broadly, a financial analysis accomplishes three goals: (1) to show how the company’s performance compares to earlier periods of time; (2) to compare it to its competitors within the industry; and (3) to provide insights on how to enhance the performance going forward.
The first step is collecting the information. If you have a good, streamlined accounting system and have been compiling reliable income statements, profit and loss (P&L) statements, cash flow statements, balance sheets, and shareholders’ equity statements, then you are ready to put them to work. If you are behind in compiling company data and creating those reports, then you will need to get caught up, possibly with hired help. Meanwhile, you should be collecting industry information and trends as you go.
Armed with all of the data you need, you can now perform any number of analyses. You can look at revenue, expense, and profit trends from year to year. You can scan your balance sheet to see if there are any significant changes in assets, liabilities, and equity. You can analyze trends in cash flow and turnover of your receivables, payables, and inventory. You can analyze any of several commonly used financial ratios, and look at key performance indicators and how they have changed over time. You can identify which divisions or products are performing well and which ones not so much. And with industry data at hand, you might gain insight into new opportunities to grow your business.
A job with benefits
Now, of course you aren’t doing all of this just so you can say “I’ve looked at my numbers, now on to the next project!” Yes, you’ve looked at your numbers—now look at them again and use the stories they tell you to bring your company some concrete benefits. Here are several examples:
1. Analyzing line items on the income statement.
Your income statement should show different classifications of revenue and expense as a percentage of total or net sales. Take, for example, payroll expense. If it was 25 percent three years ago and now it’s closer to 30 percent, it’s probably cutting into profits and may indicate a need to cut back. On the other hand, if payroll as a percentage of sales is steadily shrinking, it might mean that your company is running more efficiently—or that you need to hire more staff to keep the momentum going and the profits rolling in. You can also compare the line-item numbers to industry averages to see how you stack up to your competitors.
2. Identifying poorly performing divisions or products.
By breaking out revenues and expenses by company divisions, product lines, geographic areas, and marketing strategies, you can better understand what’s driving your sales and what isn’t, and then adjust accordingly. For example, if you are exploring multiple marketing strategies and tracking them by product line, time frame, etc., and adjust your marketing spend toward the strategies producing the best results. Or let’s say you’re a retailer, and you’ve been looking at cumulative sales numbers without breaking them out by location—and when you do, you discover that sales are lagging in specific areas because of consumer income, cultural preferences, or competitor strength, and you can act on that data.
3. Identifying growth opportunities.
Let’s say you have a division product line that is bringing in a small amount of revenue compared to the company’s overall sales picture. Let’s also suppose that this line has a healthy sales-to-expense ratio, but that your competitors are outpacing you in sales of this product.
Armed with this information, you might want to spend more money marketing the product and increasing the inventory to boost sales and cash in on the latent demand in the market. Speaking of competitors, a thorough analysis of market data might identify opportunities for growth by adding new products and/or services, and expanding your distribution channels for great penetration within your immediate market. And in your local market, if you are showing healthy upward sales trends over a sustained period, it might be time to expand that loyal customer base geographically.
4. Tracking the turnover of accounts receivable and accounts payable
This is where financial analysis can help you separate the concepts of profit and cash flow. We’ve seen plenty of companies that seem to be making money on paper but never seem to have enough money in the bank. There are several ways to proactively accelerate your accounts receivable, and the best way to find out if this is a worthwhile pursuit is to analyze your current aging/turnover compared to past years and also to industry standards. You can also slow down on payables if the standards warrant it—renegotiate your payment schedules for better terms.
5. Tracking the turnover of inventory
As for inventory, it’s possible that you’re carrying too much even though you’re turning a profit—and that excess is tying up your money. Conversely, if you’re conserving cash by keeping inventory at a bare minimum and waiting for new orders before replenishing, you are extending customers’ wait time--this will show up in your customer-satisfaction surveys, and may lose sales if they try a competitor instead--so you might want to track how sales correlates to inventory on hand. Keeping a close watch on inventory turnover also can quickly identify products that are on the way to being obsolete and are gathering dust on your warehouse shelves. A good financial analysis can help you determine the right amount of inventory to keep in stock.
6. Planning for the long term.
Say your company is turning a profit and also growing, but your current cash flow is tight. You’d like to hire more employees and invest in equipment, but you’re worried it will place too much strain on your bank account. Using a good long-term cash-flow analysis can give you a better idea when you’re going to have enough money to increase your expenditures. If you’re looking for credit and investment opportunities to accelerate that growth, the various statements generated by a financial analysis can provide potential lenders an array of tools to evaluate your financial health and level of risk.
We’re here to help
If your organization doesn’t have any financial advisors on staff, freelance financial professionals, such as those in the Paro network, can help your organization conduct a financial analysis easily and cost-effectively. The longer you wait to do this, the longer you’re missing out on financial tools that can guide you through growth, expansion, phasing out poor performers, increasing profit margins, obtaining new investment, and so much more. Paro professionals have the expertise to conduct this analysis for you and lead you into a new phase of business success.