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Financial analysis – a component of the FP&A process. High-level financial planning

11 września 2023 | Business Analysis EN
 

Are you at the business planning stage and are you creating a business plan that must also include detailed financial estimates? Is your business not doing well? Are you applying for a loan from lending institutions? Use financial analysis – a universal tool that allows you to estimate the profitability of investments and make key decisions for the company. Reliable calculations are used to assess the effectiveness of a business project. Economists and analysts who create financial analysis can take advantage of technological benefits, e.g. CPM tools (i.e. IBM Planning Analytics, Lucanet or Onestream), ERP tools, or – as is the case in most smaller companies – Excel. Check out our compendium and see why you should use CPM solutions in your company.


Financial analysis – definition


Financial analysis belongs to the group of quantitative economic research. It tests different values in monetary terms. It examines financial phenomena and processes that influence the efficiency of a given enterprise. It provides necessary information about the company’s current financial situation. Economists and analysts create financial analysis – they assess the financial liquidity of corporations, the amount of revenues and costs (assets and liabilities), financial result, and profitability.
The analyzed data are assessed, compared and interpreted in accordance with analytical standards and selected calculation models. The result of the financial analysis should be a report describing the current condition of the company.


Types of financial analysis


Economists distinguish several basic types of financial analyses. They take into account various criteria and ways of conducting monetary activities. The examples we will discuss here do not exhaust the topic – there are many more types of financial analyses.

If we consider the criterion of the scope of research, we can divide it into:

Comprehensive analysis – examines all interrelated phenomena from the structural and qualitative perspective (dynamics of events, causes of the situation).
Segmental analysis – quite problematic. It thoroughly examines and assesses a specific problem (part of the company’s activity).

Taking into account the criterion of time perspective, we divide into:

Retrospective (preliminary) analysis – includes an assessment of past financial results. It is carried out before any analytical activities are undertaken. This is the basis for the future action plan. It gives a real picture of the company’s current level of efficiency.
Current analysis – systematizes the control of all business processes in the company. It allows you to quickly detect irregularities in past decisions of the management board and verify errors.
Prospective (follow-up) analysis – enables the assessment of the results of past financial activities. Checks what benefits specific decisions showed for the company. It allows you to draw the right conclusions for the future.

The last criterion discussed is the degree of detail of the research. We distinguish:

General analysis – based on a narrow group of synthetic indicators, examines the most important issues in the functioning and development of the company. It is used in the overall assessment of the company.
Detailed analysis – deepening and developing the general analysis. It is quite time-consuming, but extremely useful when developing a company’s development strategy. It involves a thorough examination of a specific section of the enterprise or a specific problem. It is based on the scope of information and indicators enabling the capture of cause and effect relationships between defined phenomena.


What should a financial analysis include?


The financial analysis of a company is carried out on the basis of books and financial statements for a given period. It includes the balance sheet, profit and loss account, and cash flow statement. Other data to observe is business plans and cost estimates. External materials (market, customer and competition analyses) are also an interesting proposition to examine.

Stages of financial analysis


What does the exact course of financial analysis look like? There are two stages during which specific financial documents are examined. Finally, after calculations in the strict sense, financial forecasts are made. Here are the two basic phases of financial analysis:

• preliminary analysis of financial statements,
• analysis of financial statement ratios (ratio analysis) – detailed development of the preliminary analysis.

Preliminary analysis – what is it?


Preliminary analysis is an examination of the profit and loss account, the dynamics of financial assets, and balance sheet items. It provides information about the financial structure and dynamics of the enterprise, as well as the liabilities and assets in a given organization. On this basis, interesting correlations can be calculated (analysis of relationships between financing sources). We get to know the so-called the golden rule of financing – the value of equity capital warns against the company’s debt. Other important concepts are:

The golden balance sheet rule – fixed assets should be financed with equity capital.
Silver balance sheet rule – less restrictive. Fixed assets must be financed with permanent capital (combining equity capital and long-term external capital).

But that’s not all. Financial analysis also includes:

Vertical analysis (structure analysis) – helps to check the share of individual balance sheet components in the balance sheet total.
Horizontal analysis (dynamics analysis) – facilitates verification of how the values of individual items in the balance sheet changed over the period under review.

Ratio analysis – what is it?

Ratio analysis is based on four basic areas of a company’s financial position (key financial analysis indicators) – profitability, liquidity, accounts receivable turnover and debt. What is worth knowing about each of them?


1. The company’s profitability ratio allows you to get information about its profitability. The profitability of sales, assets, equity are examined.

2. Liquidity ratio shows what is the ability of the organization to pay current obligations. When calculating, we analyze the exponents: current ratio, accelerated liquidity ratio, cash ratio. To each of them can be assigned an ideal ratio between assets and liabilities – the closer to this result, the better for us. Remember! A high liquidity ratio (total current assets greater than total liabilities) is not always a good harbinger. Its excess may mean inefficiency in the management of current assets. However, such a situation is still better than the moment of reaching a low liquidity ratio.

3. Aaccounts receivable turnover ratio determines the timeliness of repayments (in days). It shows how long – averaging – the entity delayed repayment of liabilities. We find out whether the company had problems with timely payment and collection of receivables from counterparties.

4. The debt ratio helps to see to what extent the entity’s assets were covered by foreign capital. The higher the ratio, the higher the company’s debt. It has been established that the optimal level of debt should not exceed 66%.

What’s after the analysis? The final stage


After the financial analysis, it’s time for financial projections. Each of the studied parts should be projected for a period of 3-5 years. The most common practice is to make detailed plans for the first 2 years, and every year thereafter. The forecasts must extend – at least one year – beyond the point of break-even. This is not an accidental decision, it has a simple reason: a venture does not become profitable immediately; it takes a lot of time to develop the business, gradually increase sales. You can talk about a profitable project only after the company crosses the profitability threshold. Keep a large reserve when making forecasts – not all situations in an organization are foreseeable.

What does financial analysis give us? What is it needed for?


The way financial analysis is developed varies – it depends on the people who need it and their goals. It is used by companies per se – this is obvious. Financial analysis for companies assumes such roles as:

  • an excellent source of information on the financial situation in the company,
  • Exploring and evaluating the various scopes of the organization,
  • to make more informed strategic decisions, which affects the optimization of work in the company, to obtain new revenues.

Financial analysis in companies is the responsibility of financial departments. The target profession, which is in contact with the research, is a financial analyst (with economic education). Such a person is obliged to work closely with managers, the accounting department. Preparing financial analyses and reports are not her only duties. The financial analyst accounts for projects and investments, helps prepare annual, monthly and weekly budgets. He is the one who catches the first signs of financial fluctuations and declines.
Financial analysis is also relied upon by the company’s environment – investors, banks, creditors and shareholders, auditors, statistical offices and contractors who check the reliability of a potential business partner.

Performance management tools for the company


Finance departments in companies spend a lot on time-consuming tasks. Instead of dealing with important matters (creating data analysis, recommendations for the business), they waste time organizing and sorting information. Improper distribution of responsibilities works against the company. And, as is well known, the stability and effectiveness of the organization’s operations largely depend on good financial plans and the smooth flow of capital.

Any company that would like to improve performance management in the company should invest in CPM (Corporate Performance Management) class solutions, the so-called controlling systems. One of the most advanced and comprehensive means are IBM Planning Analytics (IBM PA), LucaNet and OneStream Software – an integrated tools for planning and budgeting, developing forecasts. They are based on AI – artificial intelligence helps to create plans, budgets, forecasts faster and more accurately.


An alternative to IBM PA and other CPM’s systems could be classic Excel, which is used by many financial departments. However, there is no denying that this tool is insecure and prone to many errors. The possibility of making a small mistake (such as moving a comma or 0) is unbelievable. It is also impossible to handle thousands of items in Excel…. The mentioned problems have no right to happen for instance in IBM Planning Analytics.