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

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.

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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.

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The process requires an understanding of the structure of financial statements, the ability to identify areas of concern, the company’s financial KPIs and comprehension 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.

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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.

Importance of performing routine financial performance analysis

Understanding how well a company is performing financially is important for everyone involved, including creditors and investors. Financial performance metrics shows how effectively a company is generating revenue, handling its assets and liabilities, and meeting the needs of its stakeholders.

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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.

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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 earnings before interest, taxes, depreciation, and amortization (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.

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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)

How do you evaluate a company's financial performance? 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.

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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.

1. Gross Profit Margin

This metric shows the percentage of revenue remaining after deducting the cost of goods sold, indicating the efficiency of production and pricing.

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Gross Profit Margin = Gross Profit / Revenue

2. Cash Flow

Cash flow refers to the movement of money in and out of a business. It's a crucial measure of a company's financial health, indicating whether your company can generate enough revenue to cover its operating expenses. 

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Cash Flow = Operating Cash Flow + Investing Cash Flow + Financing Cash Flow 

3. Return on Equity (ROE)

Measures how effectively a company uses its shareholders' equity to generate profits.

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ROE = Net Income / Shareholders' Equity

4. Debt-to-Equity Ratio

Debt-to-equity ratio (D/E ratio) measures the amount of money a business has borrowed vs the amount that is “owned.”

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Debt-to-Equity Ratio = total liabilities / shareholder equity

5. Current Ratio

Assesses a company's ability to pay its short-term liabilities with its short-term assets, providing insight into liquidity.

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Current Ratio = Current Assets / Current Liabilities

6. Quick Ratio

A stricter measure of liquidity than the current ratio, it excludes inventory to evaluate a company's ability to meet immediate obligations.

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Quick Ratio = (Current Assets - Inventories) / Current Liabilities

7. Operating Profit

Your operating profit is the money left over after you deduct all operating costs from your business’s operating revenue.

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Operating profit = Revenue - Operating costs - Cost of goods sold - Other day-to-day expenses

8. Accounts Receivable Turnover

The AR turnover ratio measures how quickly your customers pay their invoices. This metric is also called the debtor’s turnover ratio or receivables turnover. Its primary purpose is to measure how efficiently your company collects cash.

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AR turnover ratio = Net credit sales / Average accounts receivable balance

9. Net Profit Margin

Reveals the percentage of revenue that becomes profit after all expenses, taxes, and interest are deducted, indicating overall profitability.

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Net Profit Margin = Net Income / Revenue

10. Operating Expenses

Operating expenses, also known as OpEx, are recurring costs necessary to keep a business operational. These are day-to-day expenses like rent, utilities, payroll, office supplies, property taxes, legal fees, and others. Importantly, operating expenses aren’t directly related to the production of goods and services, which makes them different from the cost of goods sold (COGS).

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Operating Expenses = Wages + Rent + Utilities + Insurance + Marketing

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These metrics 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.

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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.

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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.

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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.

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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 tracking and banking account aggregation can help eliminate this problem.

How to improve financial performance

Improving your financial performance involves a combination of strategies focused on increasing revenue, managing costs, and optimizing financial management practices. Diversifying revenue streams, enhancing sales and marketing efforts, and optimizing pricing strategies can significantly boost your income. At the same time, controlling operating expenses, negotiating with suppliers, and investing in technology can help you manage costs more efficiently.

Also, optimizing your cash flow management by improving collection processes, managing inventory wisely, and planning for capital expenditures will strengthen your financial stability. Regularly monitoring key financial metrics and using financial forecasting tools can provide valuable insights, allowing you to make informed decisions and adjust your strategies as needed. Consider working with a financial advisor who can also offer tailored advice to help you navigate omplex financial challenges. By focusing on these areas, you can strengthen your financial performance, ensuring long-term success and sustainability of your business.

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.