January 21, 2022
How-to

How to interpret your company’s financial metrics and measure performance

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Analyzing the financial performance metrics of a company provides a clearer picture of its overall health. 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 financial data to do it accurately and at a regular cadence.    


What is a financial performance analysis?

A financial performance analysis is a review of a company’s overall financial health and stability over a given time period. This analysis involves examining financial statements and performance metrics. These include key financial performance indicators, such as accounts receivable turnover, operating profit, operating expenses, cash flow, debt-to-equity ratio, etc.

The process requires an understanding of the structure of financial statements, the ability to identify areas of concern, the company’s financial KPIs 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 forecasts 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’s financial performance 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: 


1. 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 by enabling a detailed view of financial performance measures.  

 

2. Income statement

 

The income statement shows sales revenue, cost of goods sold (COGS), gross profit, expenditures, and EBITDA. The income statement is an effective tool to track business expenses because it itemizes them into separate business expense categories

 

3. 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 a company’s financial KPIs. 

4. 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. 

 

5. 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 financial performance measures (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 margin
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.  



4 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:


1. 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.  

2. 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.   

3. 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.   

4. 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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FAQs
How do you measure a company's financial performance?

You’ll need your balance sheet, income statement, cash flow statement, general ledger, and P&L statement. You can then closely review these documents to get a handle on cash inflows and outflows, revenue, and operating profit, as well as expenses and liabilities. All this information gives you a good idea of your overall business performance and the status of your bottom line.

What are the most important performance measures for a company?

The financial health of a company depends on many metrics that tend to change depending on external and internal factors. Financial ratios and KPIs to consider include ROI, ROA, and debt-to-equity ratio, amongst others. The most important measurements of performance for a company are typically sales, revenue, and gross and net profit margin. Health in these metrics ensures that the company is making more than it is spending.

What is the difference between gross profit and net profit?

The main difference is that gross profit doesn’t account for expenses. To calculate gross profit, you subtract the cost of goods sold from your revenue. Net profit is typically used to determine a company’s profitability. To calculate net profit, you simply deduct expenses (including taxes) from your gross profit.

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