Financial analysis involves utilizing financial data such as income statements, balance sheets, and cash flow statements to evaluate a company’s performance and provide recommendations for improvement. Some organisations may be hesitant to delve into their financial figures due to improper records, lack of expertise in data analysis, or simply not recognizing the need for financial analysis. However, once the importance of financial analysis is recognized, there is no turning back.
Typically, financial analysis serves the purpose of assessing an entity’s current performance by enabling comparisons with past periods, benchmarking against similar entities in the industry, and offering recommendations for future improvement. To conduct financial analysis, it is necessary to have access to the organisation’s financial data, which can be obtained from their financial records. Several types of analysis can be performed, including profitability analysis, liquidity analysis, and financial analysis.
Profitability analysis involves examining revenue, expenses, and profit trends over time to identify patterns and make informed decisions. Liquidity analysis focuses on cash flow and the turnover of receivables, payables, and inventory to assess the organisation’s ability to meet its short-term obligations. Financial analysis entails scrutinising significant changes in assets, liabilities, and equity. Additionally, it is important to consider key performance indicators (KPIs) to identify any notable changes that may provide insights into areas needing improvement.
Benefits of Financial Analysis:
- Identifying underperforming products or divisions: Analysing various revenue lines, products, and geographic areas can reveal areas where sales or profits are low. This helps organisations make necessary adjustments to enhance performance. For instance, if profits are declining across two product lines, conducting a revenue and expense trend analysis can identify areas of low sales or high expenses, enabling corrective action.
- Identifying growth opportunities: Thorough market analysis can help entities identify potential growth opportunities. For example, poor sales of a product or division may be due to inadequate marketing efforts. By recognizing this and implementing appropriate measures, the product can penetrate the market with an effective marketing strategy.
- Identifying profit and revenue trends: The income statement can highlight different revenue and expense classifications as a percentage of net sales. Comparing figures over time reveals trends. For instance, if the direct cost of sales constituted 30% of sales last year and now it is closer to 50%, it may be impacting profits and should be investigated. Conversely, a reduction in costs may indicate increased efficiency.
- Tracking payables and receivables: Monitoring the relationship between sales and cash flow reveals whether sales translate into actual cash inflows and whether favourable payment terms exist with suppliers. Tracking debtors’ payment patterns helps assess cash flow availability for projects. It also positions the organisation to negotiate improved payment terms with suppliers.
- Planning for the future: Conducting long-term cash flow analysis provides insights into when sufficient funds will be available for capital expenditures. If seeking credit or investment opportunities to facilitate growth, an organisation’s financial data provides potential investors or lenders with vital tools to assess its financial health and risk level.
It is crucial to understand that delaying financial analysis deprives organisations of valuable tools for enhancing performance, increasing profits, and planning for growth and expansion. If lacking the expertise to perform financial analysis, it is advisable to seek assistance from capable accounting professionals who can provide valuable insights.