In business, as in any endeavor in which you want to be successful, you must know where you stand, how you got there, and how you will get to where you want to go. To know and understand these things requires that you analyze your current situation and your historical performance. It also requires that you set goals and develop a plan to achieve those goals, and then measure your performance against your plan and goals. In business, this is called financial analysis.
Monthly financial analysis is a significant factor in business success. After you close your month and prepare your financial statements, you should assess your current financial condition. You should also assess how well your business performed for the month and for the year-to-date period. How did it perform against budget? (We’ll get to the importance of budgeting later.) How did it perform against the same month and same year-to-date period for last year? If it performed significantly better or worse against budget and/or prior year, why did that happen - - what drove the change in performance? All of these questions can be answered through financial analysis.
Assessing the financial condition of your business involves analysis of your balance sheet. In addition to the amount of cash you have, there are certain simple ratios and calculations that indicate how strong or weak your financial position is. For example, do you have positive working capital (do current assets exceed current liabilities, and by how much)? What is your quick ratio (cash and cash equivalents divided by current liabilities)? How much equity do you have? What is your debt-to-equity ratio? How many days’ sales are outstanding in your accounts receivable balance? How many days’ purchases are outstanding in your accounts payable balance? How many times are you turning over your inventory - - are you carrying too much inventory, which hurts your cash position?
Assessing business performance requires analysis of your income statement and your cash flow statement. (Note: Many small and medium-sized companies do not prepare monthly cash flow statements, but they should. Cash flow statements are important analytical tools. Knowing why cash increased or decreased - - knowing the sources and uses of cash - - is very important.)
Accurately assessing business performance requires comparing actual results to anticipated results and historical results. Anticipated results are in the form of an operating budget. Every business should prepare a monthly operating budget for the twelve months of each fiscal year. Budgets are typically prepared one or two months before the fiscal year starts. (Budgeting is another whole topic that requires significant discussion. It will be addressed in a future NextGen CFO communication.) Each month, your income statement should be compared to the budget for that month, and every significant variance - - positive or negative - - should be researched to determine the cause. Likewise, your income statement should be compared to the income statement for the same month of the prior year, and significant variances should be researched. This process of comparison and research produces great information. Knowing why actual results varied from anticipated results and from prior year results is very valuable to owners and managers in making business decisions.
There are many aspects to the value of monthly financial analysis. The above discussion is just a start. Many owners have wondered why net income stayed flat, even though sales were up. Many manufacturers have wondered whether they were producing and selling some products at a loss. Do you have similar questions about your business?
If you would like NextGen CFO to help you with your financial analysis, including preparing budgets and cash flow statements, analyzing variances, setting up templates for calculating ratios and other key performance indicators, and training your current finance and accounting staff to do all of the above, please visit our web site at nextgencfo.com. Review the bios of our professionals and call or email us to schedule a free consultation.