January 21, 2022
How-to

How to measure your company's financial performance to stay on track

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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: 


Balance sheet


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.  


Income statement


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. 

General ledger


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. 


P&l statement


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.

Metric
Explanation
Formula
Gross profit magin
The gross profit margin is calculated by subtracting the cost of sales from revenue, dividing that number by revenue, then multiplying the result by 100 to make it a decimal. This metric is a measure of profitability that is useful to both executives and shareholders.
[(Revenue - Cost of Sales) / Revenue] * 100
Net profit margin
Net profit margin is like gross profit margin, but it takes all costs into account, not just cost of sales.
(Net Profit/Revenue) * 100
Working capital
Working capital is a measure of liquidity. Use the numbers on the balance sheet. The difference is the amount of working capital the company has to work with.
(Current Liabilities - Current Assets)
Current ratio
The current ratio is also a measure of liquidity. It’s the number used to determine whether a business can pay its short-term obligations due within a year.
(Current Assets / Current Liabilities)
Quick ratio
The quick ratio is also known as the “acid test ratio.” It accounts for only assets that can be quickly liquidated, like cash, marketable securities, and accounts receivable. The quick ratio is used to determine a business’s ability to pay short-term bills.
[(Current Assets – Inventory) / Current Liabilities]
Debt-to-equity ratio
The debt-to-equity ratio is a measure of solvency. It measures how a company finances itself by dividing total equity by total debt. This ratio shows a company’s ability to use shareholder equity to cover debt in the event of a closure or business downturn.
(Total Debt/Total Equity)
Leverage
Financial leverage, which is also known as an “equity multiplier,” measures the amount of debt used to buy assets. If all assets are financed by equity, the equity multiplier is “1.” If the company is using debt to buy assets, the equity multiplier increases, indicating a higher risk for investors.
(Total Assets/Total Equity)
Return on equity
Return on equity (ROE) is a number for shareholders and potential investors.
[Net Profit / (Beginning Equity + Ending Equity)
Return on assets
Return on assets (ROA) is a profitability ratio. It’s calculated by dividing net profit by average assets. The formula is like the formula used for return on equity.
[Net Profit / (Beginning Total Assets + Ending Total Assets) /2
Operating cash flow
This final ratio is the simplest one to calculate. It’s at the bottom of the cash flow statement. To simplify your analysis, use that number.
Check 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:


Disconnected systems

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.   

Manual mistakes

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. 


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