Regardless of the type of business you operate, success comes with a wealth of challenges. Making the tough decisions that allow your business to flourish can be daunting which is why it is essential to be aware of relevant financial indicators and targets which can highlight potential routes to success. An example being a group of people analyzing statistics rather than numbers on a page. Such an approach would aid a company in being able to effectively identify their goals while ensuring that they do while in line with other factors such as the corporate structure.
It is common for business owners to put too much concentration into running the day to day operations of the company exposing them to the risk of falling short of objectives that target the financial side of the company. Such an approach results in performance measurement and profitability to be quite difficult leading the company towards challenges such as bankruptcy and cash flow issues.
It is essential to set certain boundary along your goals and targets so as to be able to ensure that the company is on route towards achieving the desired performance metrics. In this article, we will outline the buzz words that will help you in performing financial statement analysis as well as highlighting the 8 key metrics which would make the great western world of business more comprehensible.
Why is it Important to Analyze Business Financials?
The ability to forecast and grow cash flow is crucial to a business’s financial health. If managed properly, it allows a business to meet its debt obligations as well as cover operational costs.
A further factor which upholds the importance of this management is that the indicators assist in determining whether the return on investment is acceptable and if the prices charged are correct. In short, regardless of the performance of sales, this is not the only area that needs consideration.
Additionally, financial indicators act as a platform for strategizing and operational making. If they do not exist, managers operate blindly without proper guidance which leads to making decisions based on either assumptions or feelings rather than solid evidence.
Which indicators to analyze in financial statements?
Each financial indicator offers a different perspective on the health of your business. Part of the analysis process should involve considering how they relate to and contribute to the overall financial picture of your business.
The analysis should be done with the company’s strategic objectives in mind. For example, if the goal is to improve liquidity and ensure that the company has sufficient resources for its daily operations, data on current liquidity and drought may be crucial.
Furthermore, the assessment should consider the company’s context, including its operating sector and its specific financial conditions. Thus, even though some indicators may be more critical in certain contexts, they should be assessed together to form a comprehensive view.
See 8 essential indicators in the analysis of financial statements
Given the importance of monitoring your business’s financial indicators, it’s important to familiarize yourself with the most strategic metrics in this regard. With them, you can carefully monitor your company’s financial health.
Below, see the 8 most important indicators in the analysis of the company’s financial statements!
1. ROI
ROI (return on investment ) is one of the most useful indicators for understanding whether a business is financially successful in its initiatives. In simple terms, it reveals how much return was obtained from a given action.
For example, if a company invests in a marketing campaign and wants to know whether the money invested has brought a positive return, ROI provides the answer. The index can also assess the return on an entire department, as well as individual projects.
The metric is widely used to support decisions involving capital investment initiatives in a company. Another function of ROI is to contribute to the comparison of performance between different companies.
ROI is calculated using the following formula:
ROI = Operating profit / Investment
The end result of the calculation is a percent that shows the economic return generated from each unit of investment made. If the ROI is superb, it method that the initiative generated extra money than was invested. Otherwise, the metric suggests a loss.
2. ROA
ROA (go back on belongings) is a economic indicator just like ROI, but with a one-of-a-kind motive. It serves to evaluate the efficiency with which a agency makes use of its belongings to generate earnings. This way, it’s far feasible to have a clean view of the effectiveness of investments in them.
The formula for calculating ROA is:
ROA = Operating Profit / Assets
A high ROA indicates that the corporation is the use of its property successfully to generate earnings. So, the better the ROA, the higher the company’s performance in transforming its assets into profits.
The indicator additionally enables you see how your business positions itself on the subject of its competition. By analyzing the ROA of other organizations, you could identify whether your enterprise is using its assets in the fine way possible or if there are opportunities for optimization.
3. ROE
Completing the trio of financial indicators that analyze different types of return is ROE (return on equity ) . It measures the company’s ability to generate value from its own resources.
To calculate ROE, use the following formula:
ROE = (Last 12 months net income / Shareholders’ equity) x 100
A high ROE indicates that the company generates a good return on the capital invested by shareholders, which is usually a sign of efficiency and profitability. The opposite tends to demonstrate operational problems, poor management or unprofitable investments.
4. Ebitda Margin (or Lajida)
The EBITDA margin (earnings before interest, taxes, depreciation and amortization) shows the company’s revenue generated by its main activity. As the name suggests, the metric is calculated before interest, taxes, depreciation and amortization are computed.
The indicator can be a great ally when it comes to checking how decisions unrelated to the company’s main operations or core business affect its results. This tends to mask its real productivity, requiring attention and analysis.
Therefore, to calculate the EBITDA margin, you must use the following formula:
Ebitda margin = (Ebitda / Net revenue) x 100
5. Liquidity ratios
The ratios that calculate a company’s liquidity display the to be had capital it has to fulfill its financial commitments. Therefore, they check with the business enterprise’s capacity to pay its responsibilities.
Liquidity ratios may be calculated from the organization’s balance sheet. It is well worth noting that the better the end result, the higher the liquidity.
Current liquidity
Current liquidity measures the availability of business resources in the short term. It can be calculated as follows:
Current liquidity = Current assets / Current liabilities
Dry liquidity
Dry liquidity indicates the resources available for short-term obligations without the need to sell inventories. To calculate dry liquidity, use the following formula:
Dry liquidity = (Current assets – Inventories) / Current liabilities
Immediate liquidity
Immediate liquidity indicates the percentage of commitments that the company is able to settle immediately. To arrive at this metric, simply apply the following formula:
Immediate liquidity = Available resources / Current liabilities
General liquidity
Overall liquidity considers the calculation of short, medium and long-term rights and obligations. To do so, use the following formula:
Overall liquidity = (Current assets + Long-term receivables) / (Current liabilities + Non-current liabilities)
6. Net margin
Net margin is a financial indicator that illustrates the profits generated by the company in relation to total revenue. It provides a clear view of how much of the revenue is converted into profit after deducting all costs, expenses, taxes and interest.
The formula for calculating net margin is:
Net margin = Net profit / Total revenue
A high net margin indicates that the business generates a good return on its sales.If the metric is low, it may indicate problems such as high operating costs or inefficiencies.
7. Contribution margin
A product’s contribution margin shows the gross profit the company makes from that item at that price. Thus, the contribution margin is the value of sales minus the costs and expenses generated by them.
Below, learn the formula for calculating the contribution margin:
Contribution margin = Sales value – (Variable costs + Variable expenses)
A negative contribution margin represents an operation that generates losses for the company. In fact, it is normal for the company to have products with different margins, reinforcing the importance of carrying out individual analyses.
There are items with a higher margin, but with a low unit value or sales volume. On the other hand, there are products with a lower margin, but also with a higher sales volume or higher values.
8. Break-even point
After obtaining the contribution margin of the products and services sold, it is possible to calculate the minimum sales volume required to cover the business expenses. This is the break- even point .
Analyzing the company’s break-even point helps you avoid operating at a loss and ensures you have a clear idea of the revenue you need to achieve to generate a surplus. The index shows the amount of revenue at which the company starts to generate a profit.
The breakeven point is proportional to the business risk. So, the lower it is, the less risky the company is. Likewise, the higher the percentage of projected revenue needed to reach it, the greater the risk.
Now you know the 8 most important financial indicators for a good analysis of your company’s financial statements. Using them as a basis allows you to make more strategic decisions and see an accurate picture of the situation your business is in.