The Complete Guide to Creating a Financial Analysis
How do you know if your business is profitable? According to a recent survey by Guidant Financial, 78% of small business owners report having a profitable company, and yet 33% report that cash flow is their number one obstacle. Many businesses still rely on intuition and the “end of the day” numbers to determine profitability. But sometimes, this just isn’t enough.
Financial analyses let you get a bird’s eye view of your business finances as a whole, so you can make plans, invest smartly and, most importantly, have an accurate view on your stability and profitability. Drafting a solid financial analysis isn't a quick process, but you can make it easier if you walk through each step carefully. From liquidity ratios to revenue per employee, our complete guide will help you better understand your financial statements and your investment.
In this article, you'll find:
The types of financial analysis you can use to evaluate your business.
Why financial analyses are important
Important financial ratios to include in your analysis.
How to interpret your financial statement analysis results.
What is Financial Analysis?
Performing a financial analysis involves evaluating projects, budgets, and other finance-related entities within a business or asset. It allows you to understand and examine the business's performance and make strategic decisions about your company’s future growth and opportunities.
When working with a small business, a financial analyst will usually complete the analysis using several factors, which we’ll explore more below. If possible, ask your mentor or financial advisor for a financial analysis example to get a clearer picture of what to expect. Remember that there are several types of financial analysis, however, and finding the perfect one for you requires you to take a look at your business type, industry, and goals.
Purpose of Financial Analysis
Financial analysis allows you to understand and examine the performance of a business or asset. It highlights:
If the business or asset is stable.
If the business or asset is solvent (has more assets than liabilities).
If the business or asset is liquid (can easily be converted into cash).
If the business or asset is profitable.
In short, the purpose of financial analysis is to test the profitability and financial health of the asset. This process can include examining additional areas such as a business's Operating Profit Margin, revenue growth, debt to EBITDA* ratio and efficiency.
The purpose of reviewing these factors is to get a clear view of exactly where a business or asset is financially, without question. To be able to answer all questions about a business's financial standing. And, at times, to give leadership a solid understanding from which to build a new strategy.
*EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization.
Key Elements of a Financial Statement Analysis
A financial statement analysis varies depending on the purpose, industry, and asset type. For this guide, we will cover key elements suitable for a variety of business purposes.
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Income Statement
The income statement reports the company's financial performance over a chosen period to highlight its profitability. It can also help predict future performance and cash flow. Businesses that use a card reader at POS systems will need to show the associated charges on their income statement. The same is true for any company that regularly handles credit card processing or uses invoice software for functions like sending pro forma invoices.
An income statement might include:
Gross Profit Margin – The percentage of revenue, minus your cost of goods sold. Calculated by dividing your gross profit by your revenue from sales.
Operating Profit Margin – The amount of remaining revenue after operating costs and COGS. Calculated by dividing your earnings by your revenue.
Net Profit Margin – The percentage of revenue minus all expenses from sales, to determine profit capability. Calculated by dividing net profit by your revenue.
Revenue Growth – The growth percentage of a given period. Calculated by subtracting last period's revenue from the current period's revenue, then dividing by the previous period's revenue.
Revenue Concentration – The assessment of which clients generate the most revenue. Calculated by dividing the revenue from a single client by your total revenue.
Revenue Per Employee – The assessment of business productivity and employees needed. Calculated by dividing revenue by the number of employees.
Balance Sheet
The balance sheet reflects your company's total liabilities and equity by reporting all assets, liabilities, and shareholder equity at a chosen point. The total dollar amount must zero out. A balance sheet might include:
Assets (Liabilities and Equity) – Your assets can be divided into liquidity ratios, leverage ratios, and efficiency ratios to determine how efficient your company generates revenue.
Liquidity Ratios – Liquidity ratios are current liabilities that measure your ability to pay short-term debts. They include current ratios, quick ratios, interest coverage, and net working capital.
Leverage Ratios – Leverage ratios examine how much capital comes to a business in the form of debt. They can include debt to equity ratio, debts to assets ratio, debt to EBITDA ratio, debt to capital ratio, interest coverage, and fixed charge coverage.
Efficiency Ratios – Efficiency ratios measure your company's ability to manage liabilities and use assets to generate income. It can help determine inventory turnover, account receivable days, net asset turnover, and total asset turnover.
Cash Flow Statement
The cash flow statement reports the amount of cash generated during a specific period. It provides information on liquidity, solvency, and future cash flows. You can generate your own cash flow statements by using invoicing software or even an excel sheet or collect data on assets like credit card payments automatically via your virtual terminal.
A cash flow statement usually includes:
Inventory Turnover – How many times your business sold its total inventory, in dollar amount, over the past year. Calculated by dividing COGS by average inventory.
Account Receivable Days – How efficiently the business used its assets. Calculated by dividing your net value of credit sales by average accounts receivable.
Total Asset Turnover – The business's ability to generate sales from assets. Calculated by dividing your net sales by average total assets.
Net Asset Turnover – The value of your business's sales compared to the asset’s value. Calculated by dividing your sales by average total assets.
Important Financial Ratios
If you're short on time and want to draft a quick financial analysis, start with only the most important financial ratios. Your short ratio analysis list should include:
Debt to Equity Ratio – Calculated by dividing total liabilities by shareholders equity.
Current Ratio – Calculated by dividing current assets by current liabilities.
Quick Ratio – Calculated by dividing current assets, minus inventories, by current liabilities.
Return on Equity – Calculated by dividing net income by shareholder's equity.
Net Profit Margin – Calculated by dividing net profit by net sales.
How to Use Your Financial Analysis Findings
Professionals investing in small businesses use financial analysis findings for business success evaluation. They examine past and current financial statements to determine investment expectations/value.
For small business owners, financial analysis can also help you weigh the impact that financial decisions might have on your company. For example, if you are considering borrowing money to launch a new product, your financial analysis can show how much you need, your historical success with similar products, and what you can expect from the launch.
Whether you’ve been in business for years, or are just starting, the right time to invest in financial analyses is right now. With SumUp’s Card Reader and POS software, you already have a leg up with expert reporting on your profits.
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