What Is Business Finance Analysis and Why Is It Important?

The process of finance analysis involves the assessment of data sets that are used to understand how stable a business is, how well it is performing, and how viable it is. Effective finance analysis will help to ensure that a business stays on the right track towards growth, manages its resources efficiently, and stays competitive in its sector.

There is much more to business finance analysis, of course, and if you are interested in looking further into the subject, below we’ll expand on these broad components, giving a deeper explanation on both what it is and why it’s important.

Primary Documents in Business Finance Analysis:

To start with, you’ll need three primary financial documents, those being your business’s balance sheets, income statements, and your cash flow statements. With these you can start to analyse your finances, starting with the balance sheet to get a picture of your liabilities, assets, and your equity at any given point in time, and this will tell us what your business owns and owes. Next we can take your income statement, also known as a profit and loss or P&L statement, which should be accurately tracking your business’s revenues and expenses over set periods and will tell you what your profitability is. Finishing with the cash flow statement, this will reflect the inflows and outflows of your business’s cash, and helps ensure your business can meet its day to day operations.

By carefully analysing these documents you can measure the financial health of your business, and determine both your profitability, and your chances of maintaining long term sustainability.

Business Finance Analysis Purpose and Importance:

Business finance analysis has become crucial for businesses who are looking to expand and achieve continued growth. Alongside helping you understand how you have been performing and how healthy your business currently is, analysis can help you anticipate future outcomes which is very important for developing growth strategies. Through finance analysis you can start forecasting your revenue streams, identify risks, and make plans for the growth of your business. As an example, by studying financial trends over a set period, you can start to predict sales cycles, particularly if you work on a seasonal business model, meaning you can be prepared for financial dips, or take advantage of high demand periods.

Alongside working on growth, finance analysis can also help your business in managing any financial risks by closely monitoring key metrics. Through this you can spot important issues such as increasing debt or decreasing liquidity early on, and once identified, you can develop strategies to alleviate them. Without these kinds of insights from finance analysis, your business can easily stroll its way into a financial crisis that could otherwise have been avoided.

The Long-Term Benefits of Business Finance Analysis:

There are many long term benefits to finance analysis, with the most important and broadest simply being the long term success of your business. Looking closer at the components that make up this success, one of them is the financial transparency that comes with analysis, as the regular reports that ongoing analysis provides will help build trust with key stakeholders, from investors through to employees. Being transparent with your numbers will help build confidence in your company’s stability, and ensure everyone is on the same footing and understanding where finances are concerned.

Being able to react quickly and effectively to market changes is another key benefit of business finance analysis, that also ultimately leads to long term success. We touched on it above, but if you can maintain a comprehensive understanding of your business’s financial position, it means you can respond quickly when opportunities present themselves or issues occur. In a case where competitors are lowering or increasing their prices, for example, you can evaluate your own margins and make a choice to either match the competition, or work on developing a strategy that would avoid making potential losses.

Accountability throughout your business is also achieved through regular analysis, as if you are tracking the performance of your business and its workforce against goals, it means your leaders or departments can be held to account. This doesn’t need to create a negative atmosphere in your organisation, in fact, when approached professionally, it can create friendly competition, and keep your teams aligned with your company’s financial goals, creating a rich environment for positive growth.

When performed correctly, you’ll find that business finance analysis is extremely important for achieving the growth you need for success. Consistent analysis will help ensure your finances are managed responsibly, and by being thorough with key performance indicators, you can get the insights you need to achieve your goals.

How Can Business Finance Analysis Help in Making Informed Financial Decisions?

Through business finance analysis, business owners can gather important insights that will allow them to develop strategies and make decisions that are based on data. The actionable insights gathered from those numbers can then be used to achieve long-term growth.

From managing costs and evaluating risk, through to investing in new projects, finance analysis can guide your business’s decision making. Below we’ll explore these areas to demonstrate to business owners just how important finance analysis is, and why it should be practised.

Decision Areas Supported by Finance Analysis:

Once you’ve started the process of finance analysis, you can begin using the gathered insights to support your decision making in the priority areas of your business that will affect its financial stability and overall performance. Below we’ll look at three key sectors where finance analysis most effectively achieves this.

• Revenue strategies: To begin with, you can use your financial data to better understand your customer’s buying behaviour and business’s sales trends, analysing what is most lucrative for your brand. With this information you can develop strategies to refine your pricing or choose to sell different products, but also get an idea on whether you should push for product promotions. In all, you should be able to maximise your business’s revenue potential through finance analysis, being better equipped to adapt to your market.
• Cost management: Analysing your operational expenses is another key area where you can identify inefficiencies in your business, and then find ways to reduce costs without compromising on the quality of your operations. Many businesses will be surprised at how much financial waste can be found through thorough analysis.
• Investment decisions: As you refine your revenue strategies and reduce the financial waste across your business, you will find yourself in a much more secure position to start investing and expanding. Finance analysis allows you to further assess whether your business has the resources to start pursuing that, whether it is for new projects or investing in new capital.

Risk Mitigation:

It isn’t unusual for businesses to face financial risks across the course of their operational life, from issues with market volatility or changes in the economy, to simply a fluctuating demand within your niche. By maintaining regular finance analysis, you can identify trend dips, and potentially stay ahead of the curve if you react quickly enough to change. It also helps seasonal businesses in particular who can identify which of their products or services will sell best over set periods of the year. The more you can identify these income risks, the better you can adjust to minimise their impact on your growth.

Without finance analysis you may be inadvertently exposing your business to unnecessary risks that can be mitigated with proper planning and understanding of your financial patterns, both past and projected. Whether the issues are with credit risk, market shifts, or a pattern of irregular expenses occurring, if you have a clear view of your business’s finances to compare them against, and a larger picture of your market, you can make informed decisions and implement cautious strategies to avoid problems. On the opposite end of the spectrum, you can also use your analysis to take advantage of opportunities that come out of an economic downturn.

Budgeting and Forecasting:

Budgeting and forecasting go hand in hand with your ability to manage financial risks, and are two of the largest factors that will determine how successful your business is. It is through finance analysis that you can get a complete picture of your financial position, whether you’re in a cash surplus or running towards a deficit, and then plan your strategies around allocating resources that will take advantage of, or address those factors. It is through the analysis of your numbers that you create budgets that are grounded in reliable historical numbers and past financial successes, rather than running the risk of making assumptions. This may be more difficult for startups, however you can still look to other brands in your market for examples, or even approach them for advice should they be willing.

With regards to forecasting, your finance analysis will give you a window to help predict your future financial performance to a degree of accuracy, whereby your historical financial records can be used to anticipate future trends and reliably predict seasonal patterns. With this information you can develop strategies that take advantage of these windows to capitalise and produce growth, whether that is from investing in higher inventory levels during a seasonal period, or if you are a brick and mortar store, making sure you have enough staff to cover the increased customer demand.

From your finance analysis you can also start to develop your scenario planning, which involves exploring different financial outcomes based on potential changes in your data. You might consider how entering a new market could impact your current operation, or whether a price increase on your most lucrative product or service would be more detrimental than beneficial, turning customers away. Having contingency plans for as many scenarios as you can consider will help develop possible solutions if those issues ever occur, and then you can preemptively act.

When performed thoroughly, which is made far easier by using Fintech tools like Pulse, you will find that business finance analysis becomes extremely useful for business owners who want to make more informed financial decisions, leading to the long term success of your brand, and helping you sustain your competitive advantage in your market. It is through turning your data into actionable insights that you can achieve this, and with those insights you can act to shape a more lucrative future for your business.

What Are the Key Metrics Used in Business Finance Analysis?

Finance analysis is a broad term that can effectively encompass every detail of a business’s financial health, with each metric being used to assess health and performance. Each has its own value, and will provide useful insights to help businesses make informed decisions with regards to maintaining financial stability and staying competitive in their market.

The metrics that are used in business finance analysis tend to fall into some shared categories, with profitability metrics, liquidity and leverage, and business operational efficiency, being primary areas to take actionable insights from. We’ll go deeper into these categories below, and look at the individual metrics that are used to help business owners plan better strategies for growth.

Profitability Metrics:

When combined, profitability metrics can effectively gauge how well your business is generating income compared to its expenses, and by tracking them, you can identify how profitable each is at different stages of the sales process. Improvements can then be suggested and implemented, with improved strategies ideally leading to a more lucrative operation. Let’s look at the key metrics that are most commonly analysed in this category:

• Gross Margin: Your gross margin will show you how efficiently your operation is producing its goods or providing its services, and is calculated by minusing the cost of goods sold, or COGS, from your total revenue, with high margins typically indicating an efficient and productive operation.
• Operating Margin: To understand how effectively your business is managing its day to day costs you can analyse its operating margin, which is used to determine the profitability of your business’s core operations minus your non-operating expenses.
• Net Profit Margin: Net profits is a percentage calculation that helps you understand how much of your revenue is being turned as a profit after all business expenses are deducted, and can be used as an effective measure into how profitable and healthy your business is overall.

Liquidity and Leverage Metrics:

Your liquidity metrics are useful for assessing your business’s ability to meet its short term obligations, and leverage will measure how your company is using its debt in its capital structure. We’ll start with liquidity below, covering current and quick ratio, then move to leverage which involves your debt-to-equity, and interest coverage ratios:

• Current Ratio: To understand this, you can compare your business’s current assets with its current liabilities to get an understanding of whether your business can cover any short term debts. Anything above 1 for your current ratio is considered positive, and healthy for a business.
• Quick Ratio: This ratio is similar to your current, however takes a more conservative measure, excluding your current inventory from the current assets, and is more ideal for businesses with a slower or no inventory turnover.
• Debt-to-Equity Ratio: For leverage, you can compare your total liabilities to shareholder equity to understand how much of your business’s operations are financed solely by debt. Higher ratios here will equate to more risk as you are relying more on borrowed cash.
• Interest Coverage Ratio: Through this ratio you can measure your business’s ability to repay interest on any outstanding debt, with higher ratios indicating that you are generating enough cash to cover your obligations without strain.

Efficiency and Cash Flow Metrics:

By tracking the right efficiency and cash flow metrics you can assess how well your business is using its assets and resources, and help you optimise the usage of them, ensuring that you maintain enough cash to stay operational. Ideally, you’ll use surpluses to re-invest in growth and expansion. Below are two important efficiency metrics, followed by cash flow:

• Return on Assets (ROA): This metric tells you how much profit your business is making by using its assets to generate earnings, and the higher your ROA is the better.
• Inventory Turnover: You can use inventory turnover to measure how quickly your company is selling and replacing its inventory, with higher rates suggesting your inventory efficiency and sales performance are both strong.
• Operating Cash Flow: You need this to help determine whether your business can sustain its daily operations, and is done simply by measuring the cash it generates from your core operations.
• Cash Flow: By measuring this metric you’ll get an understanding of how much cash your business will have after its capital expenditures, ideally it will be positive, and can be used for growth and dividends, as well as debt repayment.

Industry Specific Benchmarks:

As a business owner, it’s important to understand the variance in metric numbers you will find between different industries, which is why it’s important to benchmark your’s against your own industry’s standards. Retailers for example will have lower profit margins but higher inventory turnover compared to a manufacturing firm, making it worthless to compare ratio numbers between them as you will be unable to grasp whether your business is performing well or not.

Through the use of benchmarking tools—a service that Pulse provides—you can track how your numbers measure against competitors or industry averages, helping you to set realistic goals with a higher likelihood of achieving them and driving continued growth.

Getting a good grasp of, or using an efficient financial platform like Pulse to measure and automate metric data for you to generate actionable insights, you can dramatically improve your business’s performance across all areas of its finances. Metrics of profitability and liquidity, through to operational efficiency and cash flow can be analysed, with each helping to give a comprehensive picture of your business’s overall health.

How Often Should Business Finance Analysis Be Conducted for Optimal Performance?

For most businesses to maintain a reliable source of data from their key financial metrics, finance analysis should be practised monthly or quarterly. This is because regular reviews will give businesses a far greater chance of maintaining their financial health as they can respond faster to changes, and better align their operations with both short and long term goals.

If you are a business owner who has been trying to get a better grasp of the importance of finance analysis, and have been exploring Fintech tools like Pulse to help achieve this, keep reading, and below we’ll explain why analysis frequency is so important, with some suggestions on how you can manage your own.

Industry Depending Frequency:

To start with, it’s worth mentioning that different industries may require even shorter intervals between their analyses, with fast paced industries like hospitality or retail often needing to analyse their numbers on as short as a weekly basis. This is due to the hastily changing shifts in things like customer demands or product costs, both in production and in sales. With the sheer number of metrics that can alter how lucrative your operations are, making use of the insights you can take from regular analysis will become essential for how fast you can adapt to change.

Industries with longer business cycles like real estate may only need quarterly or biannual reviews due to the stability and predictability of the business model. Analysis is still important as it can help to track your long term investments and debt, ultimately leading to better investment decisions. Regardless of your industry, you should complete your finance analysis consistently, to ensure the insights you take from it are comparable with past trends, ensuring they are reliable when you plan your growth strategies.

Recommended Intervals in Finance Analysis:

It is not unusual for some business owners to prioritise analysing different key metrics more or less frequently, combining monthly, quarterly, and annual reviews for example to create a solid foundation of data that actionable insights can be drawn from. When speaking to business owners, these are some of the more general splits they make in their analysis process:

• Monthly reviews: Metrics that fluctuate on short term performances such as cash flow and expenses should be analysed most frequently, as you can catch minor issues quickly before they become larger. By assessing areas such as monthly financial statements you can easily spot cash flow shortages and then take corrective actions to resolve the issues.
• Quarterly reviews: Quarterly reviews are typically more comprehensive, covering a larger number of key performance indicators like business profitability across a period. You may also review major balance sheet items such as your assets and liabilities—things that are unlikely to change on a weekly or monthly basis, but still need to be closely reviewed in the long term. Quarterly finance analysis also aligns well with quarterly financial reports that stakeholders may be interested in depending on the size and model of your business.
• Annual reviews: Annual analysis should cover the entire fiscal year of your business’s performance, focusing on overall profitability and tax obligations, as well as other long term strategies for growth. With yearly reviews you can also compare them to prior years, and get a grasp of sales patterns or any other ambiguities in the market.

Triggered Events for Analysis:

As well as your scheduled analysis dates, you should also be ready to conduct finance analysis when large changes occur within your company, as they are likely to have significant financial impacts. By staying on top of your data during these transition periods it means your growth strategies are more likely to remain efficient, and you can keep the business on course towards growth. Some of the more common events we discuss with leaders are as follows:

• Major investments: We advise that, before making large investments into new technology or equipment, or even a location expansion, you conduct a detailed analysis of your finances to assess whether the prospective investment is both feasible, and also, if it will be profitable in return.
• Market changes: Another common event many business owners face is a change in market conditions, which often comes in the form of a shift in product demand as customer interests move on, however can be more serious such as a recession. In the event of a noticeable change, making a thorough assessment of your business’s health can help you adjust your strategies if and where necessary to survive.
• Leadership changes: Another common event across a business’s operational life is to have new leadership either step up or step in, and in cases like this, finance analysis can be used to set a financial baseline that the new leader’s performance can be measured against.
• Mergers or acquisitions: Mergers are generally large events, if not physically for the workforce, certainly for management, so ensuring that all business assets, liabilities, and cash flow projections are understood amongst all parties will help to smooth out the acquisition and will generally help reduce risk as everyone will be on the same page.

Pulse for Continuous Monitoring:

With our Fintech tool, Pulse, you won’t need to think about actively scheduling finance analysis, as our platform can automate the entire process using advanced AI algorithms. You can access real-time, continuous monitoring of your financial data and take insights from the breakdowns we provide. Pulse automatically tracks all of your key financial metrics, from cash and expenses through to performance indicators, meaning you can stay informed about your business’s health at all times, building strategies and acting quickly to resolve issues whenever necessary. Our real-time alerts will also alert you to irregularities in your finances and highlight potential risks, helping you to manage your finances proactively.

The optimal frequency for you to perform finance analysis will ultimately depend on the industry your business is in, its size, and also the complexity of your operations. More frequent analysis will of course provide the most detailed picture of your financial health, and tools like Pulse can provide that service for you, meaning you’ll never miss an irregularity and can focus solely on achieving the long term goals of your business.

What Tools and Techniques Are Utilised for Conducting Business Finance Analysis?

There are many tools available on the market to help business owners conduct business finance analysis, from accounting software to data analytic platforms, and also many analysis techniques that provide benefits to businesses looking to better interpret their financial data.

In the current year, Fintech tools like Pulse are becoming the go-to for business owners who want an all encompassing tool to process, analyse, and break down their financial data, providing access to actionable insights that can be used to improve business performance and health. To expand further on this topic, below we’ll explore some common software and techniques that can be adopted by business owners looking to achieve this.

Accounting Software:

If you are new to running a business and aren’t using accounting software you are effectively putting yourself at a considerable disadvantage compared to your competitors. Accounting software provides businesses with an ideal way to manage their finances efficiently, removing the hassle of holding onto and gathering ledgers full of papers and receipts to deliver to your accountant. Software that integrates with Pulse, like Quickbooks and Xero, are capable of automating a range of financial tasks, such as tracking income and expenses and then generating financial reports from that data.

These tools have been built to make maintaining accurate financial records simpler, and by using them, business owners can greatly reduce the chances of manual data entry errors. When accounting software is integrated with Pulse, we take the numbers they provide and use it to empower business owners with data driven insights into your key performance indicators, helping you to make smarter financial decisions.

Financial Modelling:

This is another technique that will help with your finance analysis, and involves creating mathematical representations of your business’s financial positioning. This is then used to forecast your future performance based on solid historical data. Anything from profit projections to cash flow forecasts can be presented in a model, and be used to assess whether things like a new product will improve overall business profitability. Factors such as initial investment and operational costs, along with expected sales, can be figured out, helping to give an idea of the product’s success before you commit to it. Scenario planning is another important factor in financial modelling, and similarly, can be used to assess how different business strategies or current market conditions may affect your finances.

Financial Data Analytics Platforms:

Our analytics platform, Pulse, is quickly becoming a favourite amongst business owners, accountants and advisors, and lenders, due to the real-time, actionable insights we can provide into the financial performance of either your business, or your client’s operation. Our Fintech integrates with Open Accounting and Open Banking systems, and with permission, will provide detailed access to up-to-date financial metrics and KPIs.

Our AI driven tool uses historical data analysis to offer predictive insights, and can help you identify trends in your operations, plus potential risks before they become a problem. With our help, you can make proactive decisions, based on data breakdowns that are accessible through our intuitive portal. Here, financial details are broken down into easy to grasp infographics and actionable insights, ready to help drive business success.

Getting the best out of business finance analysis relies on a variety of tools and techniques, whether that is through the accounting software that can be integrated with Pulse for the most effective data breakdowns, to the more nuanced and hands on techniques like financial modelling. Each method and resource brings its own value, and the more you are willing to familiarise yourself with and practise them, the more certainly you can have that the insights will be reliable and usable in your efforts to achieve long term success.