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19 Financial Analysis Approaches Business Leaders, Managers, and Professionals Should Know

It is not often that I write about numbers. Why, because some professionals find it boring and want to nod off at the mention of numbers, while others simply say, well my numbers are giving to me by someone else.

Here’s the thing, you may not create the numbers, but you need to know how to read them and understand what they mean. At least you need to be able to have a meaningful conversation with a financial analyst, accountant or chief financial officer.

Recently I have been working on three separate strategic planning and business analysis initiatives. We followed standard best practices. That is to say, identify the current state, define the future state, assess the risk and create the strategic plans and roadmap so the clients could implement. As part of these initiatives, we have had to gather the numbers, which essentially means ask for them, and use them to help assess the current state financially. Eventually, we used the number to do future state projections and budgeting. I am a big believer in the adages, the numbers don’t lie, and you need to know where you are to determine where you can and need to go. Numbers help in making better business decisions.

So I thought I would provide some of the more common financial analysis options used to help business leaders and professionals make better business decisions. The type of financials you require will be driven, in part, by the type of initiative. You can use the following as a checklist for the types of financials you may need to understand. You should ask your accountant, financial analyst or CFO what other numbers maybe be required as I can’t cover them all here but I do hope this blog on the numbers helps.

Vertical Analysis is used on financial statements where each entry of the major accounts, assets, liabilities, and equities in the balance sheet are represented as a proportion of the account totals. It shows the relative sizes of different accounts on a financial statement. When done on an income statement the top line of sales (100%) is broken down by percentage of product or service sold. It can be used on a project to understand top line spend (100%) against a category of spend. For example, labor, hardware, software, etc. However, if you are looking at a company’s financials overall, you may want to understand the financial breakdown of sales vs. expenses regarding percentages. (PS: you should know what an incomes statement and balance sheet, and how to read them)

Horizontal Analysis is sometimes called trend analysis and should be something you understand and monitor. You compare ratios or line items in financial statements over a certain period. It’s a useful tool evaluate trend situations. You can use this analysis against a balance sheet, income statement, industry data or a multi-period project budget to understand what is going on.

Forecast to Budget: The use of historical data to determine the direction of future trends. Forecasting is used by companies to determine how to allocate their budgets for an upcoming period. It is also used to budget for projects.

Run-Rates: If a company has revenues of $100 million in its latest quarter, the CEO might say: “Our latest quarter puts us at a $400 million run rate.” All this is saying is that if the company were to perform at the same level for the next year, they’d have annual revenues of $400 million.

Productivity: Productivity is the relationship between the quantity of output and the quantity of input used to generate that output. It is a measure of the effectiveness and efficiency of your organization in generating output with the resources available. Productivity = output/input.

Return on Assets: Investors and managers base the market value of the business on the profit it generates. The return on assets, or ROA, of business, is a ratio commonly used to calculate profitability.

Inventory Turnover: Companies that are based on the sale of a product depend on regular sales to generate a profit. In these cases, the financial health of a business depends on its inventory turnover, or in other words, how many times a year it sells its average inventory.

Cost-Benefit Analysis is a systematic approach to estimating the strengths and weaknesses of alternatives that satisfy transactions, activities or functional requirements for business. It is a technique that is used to determine options that provide the best approach for the adoption and practice regarding benefits in labor, time and cost savings.

Breakeven Analysis: An analysis to determine the point at which revenue received equals the costs associated with receiving the revenue.

Sensitivity Analysis: A technique used to determine how different values of an independent variable will impact a particular dependent variable under a given set of assumptions.

Profitability Analysis: A component of enterprise resource planning (ERP) that allows administrators to forecast the profitability of a proposal or optimize the profitability of an existing project.

Net Present Value (NPV): Defined as the sum of the present values (PVs) of incoming and outgoing cash flows over a period. Incoming and outgoing cash flows can also be described as benefit and cost cash flows, respectively.

Internal Rate of Return (IRR): Also called the discounted cash flow rate of return. It’s a rate of return used in capital budgeting to measure and compare the profitability of investments. ‘Internal’ refers to the fact that does not calculate environmental factors like interest rates or inflation.

Return on Investment: A performance measure used to evaluate the efficiency of an investment or to compare the efficiency of some different investments. You calculate ROI, the benefit (return) of an investment is divided by the cost of the investment; the result is expressed as a percentage or a ratio.

If you don't know your numbers, you don't know your business. Marcus Lemonis Click To Tweet

Asset Turnover:  Indicates business capability to generate sales per every dollar invested in total assets

Cash Conversion Cycle: Measures the effectiveness (average amount of time in days) to convert resource inputs into cash

Current Assets to Liabilities Ratios: It calculates the extent to which a firm can meet its short-term obligations.

Debt to Equity Ratio: It indicates how much of total funds are provided by creditors versus by owners.

Market Segmentation Analysis: It indicates revenues by your business market segments and can be adjusted to segment product and service lines.

Final Thoughts

So, did I just bore you? Are your eyeballs rolling back into your forehead? Sorry about that. I know I didn’t provide you a lot of case examples. I have limited space in a blog. These are the financial analysis basics. When I am working on an initiative, I find myself working with a team. Most recently that team has included a combination of stakeholders all working to serve the client’s needs. It has included a senior consultant, project lead, a researcher, financial analyst and of course the client we are serving. As the management consultant wearing the hat of a strategic business analyst and business advisor, I get to work with a team of people who provide the information needed and packaged in a way that it can be analyzed. All I have to do is ask. I guess for you, as a business leader or professional, you need to be able to do the same thing. You may not have to create the numbers, but you do need to know what to request, how to read them and determine what they mean or at least ask what they mean.

Good luck!

Remember, do your best, invest in the success of others and make your journey count.

Richard

Staff, Investopedia. “Forecasting.” Investopedia. June 05, 2015. Accessed October 27, 2017. http://www.investopedia.com/terms/f/forecasting.asp.
“Run Rate.” WordReference Forums. Accessed October 27, 2017. https://forum.wordreference.com/threads/run-rate.3041745/.
Phillips, Jack J., and Patricia Pulliam Phillips. Handbook of Training Evaluation and Measurement Methods. London: Routledge, 2016.
Marshall, Alfred. Principles of Economics. Houndmills, Basingstoke, Hampshire: Palgrave Macmillan, 2013.
Smith, Charisma. “An Analysis to Determine the Point at Which Revenue Received.” Prezi.com. April 18, 2014. Accessed October 27, 2017. https://prezi.com/ghwtqx4172gc/an-analysis-to-determine-the-point-at-which-revenue-received/.
Staff, Investopedia. “Sensitivity Analysis.” Investopedia. December 03, 2015. Accessed October 27, 2017. http://www.investopedia.com/terms/s/sensitivityanalysis.asp.
“What Is Profitability Analysis? – Definition from WhatIs.com.” SearchERP. Accessed October 27, 2017. http://searcherp.techtarget.com/definition/profitability-analysis.
“Net Present Value.” SpringerReference. doi:10.1007/springerreference_2028.
Boundless. “Internal Rate of Return.” Internal Rate of Return | Boundless Finance. Accessed October 27, 2017. https://courses.lumenlearning.com/boundless-finance/chapter/internal-rate-of-return/.
Staff, Investopedia. “Return On Investment – ROI.” Investopedia. September 01, 2017. Accessed October 27, 2017. http://www.investopedia.com/terms/r/returnoninvestment.asp.

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