Analyzing financial performance provides a clearer picture of the overall health of a business. This is particularly important today with the number of external variables affecting the ability to make a profit. Done correctly, this analysis can produce useful insights for hiring, vendor relationships, expense management, and more.
In this article, we’ll review financial performance analysis and why you need real-time visibility into your company’s finances to do it accurately and at a regular cadence.
What is a financial performance analysis?
A financial performance analysis is a financial management strategy that can help you better understand the profits or losses of a business and where they are coming from. For smaller businesses with no executive team, the responsibility falls on the owner’s shoulders.
The process requires an understanding of the structure of financial statements, the ability to identify areas of concern, and an understanding of the industry the business is operating in.
This analysis prepares the company for financial planning and analysis (FP&A) that includes forward-looking financial statements to project future profitability, accounting for risk, possible price increases, and depreciation of any company assets.
To start, you’ll need to use your business metrics and ratios to measure liquidity and the overall health of the company. These metrics include the current ratio and quick ratio, which measure liquidity, and the ratios for gross and net profit margin.
5 documents you need to analyze financial performance
To perform a financial performance analysis, you’ll need the company’s most recent balance sheet, income statement, and cash flow statement. For comparison, you should pull the same documents from previous quarters, along with the general ledger and P&L statement for checks and balances.
Here’s why each of these documents is important to the process:
Accountants create a balance sheet by taking information from the general ledger, categorizing it into assets and liabilities, and determining shareholder equity. For a financial performance analyst, the balance sheet provides a macro-level view of how the company is doing financially.
The income statement shows sales revenue, cost of goods sold (COGS), gross profit, expenses, and EBITDA. The income statement is an effective tool to track business expenses because it itemizes them into separate business expense categories.
Cash flow statement
The cash flow statement is important for calculating the liquidity of the company. It tracks net income, receivables, depreciation, and debt. These are all important numbers for determining key business metrics.
Though not necessary, it’s a good idea to have the general ledger handy when analyzing financial reports. With it, the analyst can back-check for erroneous entries that may have led to discrepancies in the final report.
Like the general ledger, the profit and loss statement can be used to check and balance other documentation. P&L statements are typically generated through accounting software, so the numbers are reliable. These statements are an essential component of sound P&L management.
10 important measures of financial performance (and how to calculate them)
Using the documents listed above, there are certain business ratios that the analyst is expected to calculate and provide to the owner, executive team, and shareholders if the company is a public entity. In cases where an in-house analyst is not on the team, it’s recommended that you hire an outside professional.
The following ten metrics are what you should concentrate on in a financial performance analysis. The numbers you need to calculate them can be found on the balance sheet, income statement, and cash flow statement.
The ten ratios listed in this section give the analyst the data needed for a proper financial performance analysis. They measure profit, liquidity, and returns for investors. They also show how a company is utilizing their assets and balancing debt vs equity.
5 common challenges of conducting a financial performance analysis
This analysis is the first step in the financial planning and analysis process, which is a more complex task that includes projecting the future profitability of a company and how that can be achieved. But mistakes with the former can lead to significant problems doing the latter. To avoid that, keep an eye out for these common challenges:
Connected systems that utilize expense automation and aggregated account data provide accurate numbers that can be reliably integrated into a financial performance analysis. Disconnected systems that don’t "talk" to each other can't provide this level of data. This creates an extra verification step for financial reporting and widens the margin for error.
Inaccurate business insights
This can be a side-effect of the first challenge because disconnected systems can produce conflicting data. This is a common problem with larger companies with multiple systems and departments. For instance, if each department manages its own budget and transaction ledger, financial reporting is dependent upon the accuracy of their numbers. An error at the department level affects the overall company financials, resulting in inaccurate business insights.
Humans are fallible, especially when they’re overworked and not provided with automated tools. Manual processes that involve paper filing systems and excessive time-on-task can rarely be relied upon for accuracy.
Lack of real-time data
Calculating business ratios with outdated numbers doesn’t benefit anyone, and it could lead to legal and regulatory violations. Real-time expense management and banking account aggregation can help eliminate this problem.
How to streamline the financial analysis process for your business
The primary purpose of financial performance analysis is to measure and improve profitability and efficiency. The best way to streamline this process is to improve the quality of the data you’re using for it. With Ramp, spend analysis and spend control can all be managed from a single platform, powered by automation. These analyses and insights will provide you with accurate expense numbers necessary to complete the financial analysis process.
Ramp also integrates with accounting systems that feature automated account aggregation, ensuring that all transactions are synced and in real-time. Using an integrated system eliminates the problem of conflicting data that can be found with disconnected systems. This is critical when preparing the balance sheet, income statement, cash flow statement, and P&L reports.
To learn more, visit Ramp.com today.