from numbers to insights: why financial analysis matters

The Importance of Financial Analysis for Business Success

When I think about a business's success, financial analysis immediately comes to mind.  How are business owners reviewing their financials?  Are they using an accounting system or relying on Excel worksheets? 

​It's crucial for small business owners to understand the significance of performing financial analysis.  To grasp the monthly activities of their business, owners should be familiar with the following aspects of financial statement analysis:

Key Elements of Financial Statement Analysis

1. Trends. Identify trends by creating trend lines for key items in the financial statements over multiple periods.  This helps in assessing the company's performance.  Common trend lines include revenues, gross margin, net profits, cash, accounts receivable, and debt.
2. Proportion analysis. Utilize various ratios to understand the relationship between different accounts in the financial statements.  For instance, the quick ratio estimates a company's ability to pay its immediate liabilities, while the debt-to-equity ratio indicates if the company has taken on too much debt.  These analyses often compare revenues and expenses on the income statement with assets, liabilities, and equity on the balance sheet.

The Power of Financial Statement Analysis

Financial statement analysis is an exceptionally powerful tool for various users, each with different objectives in understanding the financial circumstances of a business.

Users of Financial Statement Analysis

• Creditors. Lenders are interested in a company's ability to repay debt, focusing on cash flow measures.
• Investors. Both current and prospective investors examine financial statements to assess a company's ability to issue dividends, generate cash flow, or maintain growth.
• Management. The company controller conducts ongoing analysis of financial results, particularly in relation to operational metrics not visible to outsiders (e.g., cost per delivery, cost per distribution channel, profit by product).
• Regulatory Authorities. For publicly held companies, financial statements are reviewed by the Securities and Exchange Commission (SEC) to ensure compliance with accounting standards and SEC rules.

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