It is always a great time for analyzing financials statements, to get a feel for just how well your company performed in the past year.
While “financial statement analysis” sounds a bit intimidating, it really just means looking over the company’s financial reports to get a sense of how well —or how badly—the company performed over a period of time. To do this, there are many methods of analysis that accountants use.
Today, we’re just going to look at three excellent techniques that are easy enough for a beginner but can give even licensed CPAs plenty of great information to assess a company’s performance. Through these methods, not only can you reflect on past performance, you can also create new goals for the company, realign the company’s focus to a more profitable area, or make other changes that will improve future performance.
Technique #1: Trend Analysis
A trend analysis is one of the simplest methods of analyzing financial statements, but it can reveal some extremely useful facts when done correctly. This type of analysis compiles data on some sort of horizontal axis – for most companies, success would be measured over time.
However, you may find that you can get better information if you measure revenue over the number of marketing emails you sent out per month, the number of employees you had at a given time, or some other piece of data.
- If a piece of data changed more than once during your past year, you can create a trend analysis graph to see how it affected your revenue.
But, since most companies are interested in seeing how their revenue changed during the past year, month, or accounting period, let’s stick to that for our example.
Say you’ve plotted your revenue for the past 36 months, and have noticed three major spikes equally spaced throughout the graph. Those correspond to the month of August in each 12-month period, and you know that in August, you ran an extra radio advertisement. This can show you where your marketing money is being well-spent, and where you can afford to cut back.
Trend analyses can also give you a great overall picture of progress in your company.
- If the graph has an overall upward growth, then you know that your company is expanding.
By setting goals for future months, and plotting them on the same trend analysis graph, you can help yourself visually understand your growth in real-time. You can also compare growth charts for multiple periods of time, to understand how you’ve improved vs. the year before, and so on.
Technique #2: Benchmarking
Benchmarking is a type of financial statement analysis wherein a company compares their financial health to that of another company in the same industry. This is extremely useful for small businesses and startups, even if it seems like a waste of time at first.
Your business may be small and earning only a pittance of what your large, established competitor is—but through benchmarking analysis, you can find out if you are on track with growth the way you should be, how much more you need to push in the coming accounting period, and get an idea of what may be working better than what you’re already doing.
This technique usually involves comparing company ratios, which we’ll talk about in technique #3. However, benchmarking can be a comparison of whatever type of financial statement the companies are willing to share with one another.
The most important thing is to ensure that the method of collecting data is exactly the same for each company.
Benchmarking should always focus on following best practices, and is primarily for helping each company improve by providing them with comparable data.
When discussing what financial statements you’ll be comparing with another company, it’s important that you ensure the metrics are exactly the same. You’ll need to know:
- What you are measuring
- How the units will be classified
- What should and should not be included
- How the calculations are being made.
It’s a good idea to get a few examples so that you can be absolutely sure the data will match.
If you don’t have a willing competitor to partner with, be sure to check your industry for existing information. There are quite a few benchmarking banks available that have information about industry leaders online.
You can also go outside your industry and compare your company to a company of similar size; this type of benchmarking will give you a good idea of how your service or product compares to a totally different service or product, and can help you refine what you offer to your clients.
Technique #3: Ratio Analysis
A ratio analysis is a slightly more advanced financial statement analysis, but it can be one of the most important rubrics you use to investigate your success.
This type of analysis measures performance in one area of your business against another. This can help you understand how efficiently your assets are being used, your company’s liquidity and growth rates, and much more.
To perform a ratio analysis, you’ll be comparing parts of your income statement against parts of your balance sheet, to determine the relationship between certain aspects.
For example, if you want to understand how efficiently your assets are being used, you need to find the relationship between assets and sales. Divide your total assets by your sales.
- If the assets to sales ratio is small, this means that you have used your assets very efficiently, because you’ve used less assets to earn more sales.
- In other types of relationships, you’ll want to see a higher number.
To find out your profitability and cost management, you need to compare your gross profit to your sales.
- If the number is larger, you are performing at a very profitable rate.
There are quite a lot of different ratios that can be compared and used to help you understand your company’s performance. Therefore, while ratio analysis requires a deeper understanding of accounting, it is one of the most informative analyses you can perform.
Put Them in Action
Now that you have your financial statement analyses done, it’s time to put that knowledge into action. Now that you can see where your profits are the highest, you can begin to replicate the parameters that caused that spike in your trend analysis.
From your benchmark analysis, you know where you are on the road to success, and can work to meet new goals based on what you learned from your competitors.
And with your ratio analysis, you have an in-depth view of how well your company is performing on every single level, and can work to improve those numbers with better business practices.
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