There are basically two ’schools of thought’ when it comes to analysing financial data and making assessments about the general performances of a business or a company. The first is the one which tells you that analysing financial data is not as big of a deal and that you can easily judge a financial situation by doing some basic calculations and looking at the certain numbers. The second is the one which advocates that a more thorough and meticulous approach needs to be conducted in order for these numbers to actually mean something.
In other words, analysing financial data can be looked at from two different perspectives: it’s either quite easy to gather the data, once you know which numbers are important; or, it’s a bit more complicated than this and you won’t get very far just by doing the math and sheer looking at the numbers you get.
In our opinion, the truth lies somewhere in between. And while doing a financial analysis can be an uncomplicated, undemanding, and pretty straightforward task, on the other hand, it certainly isn’t achieved without great effort and can present more than a few difficulties at times. Here LLB Accountants give you some of the most common tips on how to get better business outcomes by analysing financial data.
’The Big Three’ of financial analysis and management: income statement, balance sheet, cash flow
In order to get a clearer picture of your business’ current state of affairs, you need to perform a financial analysis that’s going to include the data from three financial reports – income statement, balance sheet, and cash flow statement analysis.
What is the income statement analysis?
The income statement is a simple financial report that shows the activities of your business or a company in terms of revenue or sales. Basically, it revolves around showing how much you’re spending and how much revenue or sales you’re bringing in. The questions like: ’How much revenue does a company have?’, or: ’Is the company profitable (enough)?’, or: ’What are the margins like?’, can all be answered by doing the income statement analysis.
Now you get a glimpse of how potent this method can actually be. But the story doesn’t end there, of course, as there are other layers to this. For instance, there are two main types of analysis that can be performed under income statement analysis: vertical analysis and horizontal analysis.
What is the vertical analysis?
The name already indicates the basic idea of the method: when doing vertical analysis, you are looking up and down the income statement. The reason why this represents a good method is that you can clearly see how every line item compares to revenue (in terms of a percentage). Each line item is seen as a proportion of revenue.
When doing the vertical analysis, some of the key metrics that you can look at are the cost of goods sold (COGS), gross profit, depreciation as a percent revenue, interest as a percent revenue, earnings before tax, tax as a percent revenue, net earnings as a percent revenue, etc.
What is the horizontal analysis?
As far as horizontal analysis goes, this data analysis covers the financial information as it changes from reporting period to reporting period. This method of analysis can be really helpful to the company’s leaders in terms of assessing and defining the progress of the business. The way this horizontal analysis operates is by contrasting and making a comparison between different line items on the financial statement. These are the key metrics that we’ve just mentioned: cost of goods sold, net earnings from one quarter to another, and so on.
The most important thing to do when you get these percentages and numbers is to interpret them correctly. That’s why it’s crucial to have a business leader who can look for the way the specific line items changed. So, although it is pertinent to do the calculations correctly, it’s not enough just to have them and look at the numbers, percentages, lines, and graphs.
If you’re in any way uncertain about what to take from the data that you’ve collected, or you need a second opinion on how to interpret the facts and statistics collected together for analysis, make sure to contact the professionals such as small business accountants in order to get a more complete and clear picture of things. This is what we meant when we said that financial data analysis can seem to be both effortlessly unchallenging and extremely demanding at the same time.
What are balance sheets and leveraging ratios?
The balance sheet is a financial statement analysis which evaluates the operational efficiency of the business. This step is equally important as the previous, and some would even suggest that you start with the balance sheet since it’s such a powerful form of financial statement analysis.
Either way, this particular financial statement analysis overviews what you own (your assets) and what you owe (your liabilities). The way this analysis works is that you take multiple items on the income statement and then contrast these with the capital assets of the company, that are on the balance sheet. This really isn’t that much different than what you do when you’re trying to assess your personal financial position: you would naturally define your own assets and liabilities and see how and where exactly you’re standing.
So, the format of this balance sheet usually includes items like assets, liabilities, and shareholder equity. You use the balance sheet to see if the accounts increased or dropped in comparison with the rise or fall in sales and total assets. There is even a simple formula which calculates the growth rate in inventory. For instance, you take the ending inventory year and subtract the beginning inventory year. Then you divide the result with the beginning inventory year to get a percentage which shows the growth or change in inventory.
You can perform these calculations for all balance sheet and income statement items, and then make a simple comparison between a couple of years worth of data. A more accounting savvy company’s leader or accountant can not only see the trends but further, interpret the data in order to make certain predictions.
What is a cash flow statement overview and analysis
And even though financial data analysis by no means represents the exact predictions about the future (this isn’t the business of fortune telling, no matter what you sometimes hear), there are various other methods which can help tremendously in speculating about the next steps that you should undertake.
One such method is also the cash flow statement overview and analysis, which shows how exactly cash flows in (cash inflow), and how it flows out (cash outflow) of your business, simply put. We take a certain period of time that we want to analyse, and then we look at the components like cash from operations, cash used in investing, and cash from financing.
All three of these components are important, and we shouldn’t overlook any of them since each and every one of them can tell us something momentous about the company’s overall performance. Basically, if you’re an investor, all you need to do is take a good look at the cash flow statements and you can easily determine if the company is making money or not and if it’s the one worth investing in.
Those were some tips for beginners when it comes to financial data analysis. By listing these basic methods we’ve tried to show you that although financial data analysis can be a pretty straightforward numbers game, making good assessments, reading and interpreting these numbers correctly can be a really tough task at times. That’s why it’s of utmost importance to get a professional opinion on these matters, especially if you’re not as accounting savvy as you should or need to be in order for your company to make more significant progress.
And although this list is inconclusive, these basic methods here that we’ve prepared for you can still offer you some good insight on how demanding and highly complicated interpreting and analysing financial data can be.