Money doesn’t make the world go ’round anymore. Data does.
In today’s rapidly changing business landscape, successful business owners are learning to harness data, particularly financial data. Unfortunately, many entrepreneurs either: (a) take this for granted or (b) have no clue how to use it.
This blog post will help you make sense of your financial data and maximize its potential through financial management and financial analysis.
Every time you make a judgment on how your business is performing based on your financial situation or your operating performance, or when you make predictions on what could happen, you’re doing financial analysis. When you make financial decisions within your business, such as securing loans, acquiring new assets, or issuing stocks and bonds, you’re performing financial management.
Preparing financial reports for financial management and analysis
Financial management and financial analysis start with accurate and complete financial statement data, which come from three financial reports:
1. Income statement: This shows your business activities as far as how much revenue or sales you are bringing in, minus your expenses.
2. Balance sheet: This is an overview of your assets (what you own) and liabilities (what you owe).
3. Cash flow: This statement shows how cash goes in (cash inflows) and out (cash outflows) of your business.
Most businesses prepare financial reports, as these are necessary for compliance with government regulations, external and internal transparency, and comprehensive and integrated financial management. But to promote successful financial management practices, you need a sound financial analysis.
Financial analysis goes beyond looking at numbers, graphs, and charts; it involves using different techniques and tools, depending on the nature of your business. In other words, the data are just a set of random photos on a wall, and what’s important is how you put them together to tell a story.
Many small business owners, however, are stuck with old practices and misconceptions that impair their ability to come up with good financial analysis.
Common misconceptions about business financial analysis: Are you still making these mistakes?
1. Doing the math…and ending it there
As mentioned, financial analysis involves more than just putting numbers together and compiling them to generate fancy-looking reports. It also isn’t just about calculating ratios and percentages and filling out variables in formulas at the end of every month, quarter, or year. The numbers are just building blocks. In a nutshell, financial analysis should answer the question, “How did my business do and why?” in more qualitative terms.
To achieve this, start by asking the right questions. Which of the numbers or ratios are useful to evaluate your business? What are you supposed to compare or use as benchmarks? Depending on the nature of your business, you also need to know:
- Which metrics are critical in your industry? How well did you do in those metrics?
- What factors affect these metrics?
- How will external and internal changes or trends affect your business?
- What steps does management need to take to address these?
2. Analyzing financial data for generic reasons
Different businesses have different needs and objectives. To meet your unique business requirements, clearly define the purpose of performing financial analysis in more specific terms. To come up with this, ask the following questions:
- What purpose will your financial analysis serve?
- What problem or issue are you trying to resolve?
- What scope and depth of analysis can you achieve?
- Are you doing a horizontal/dynamic financial analysis (comparing financial statements over a number of years) or vertical/static (just for one year)?
- What kind of data do you have? How are these variables related to each other (dependent or independent?), and how will your data affect your analysis?
3. Using generic methods to analyze financial data
Once you’ve answered the “why” of financial analysis, figure out how you will go about it by choosing the financial analysis techniques that are appropriate for your objectives. Ratio analysis, cash flow analysis, comparative financial statements, and trend analysis are just a few examples.
Although there are different ways to analyze data based on your needs, the process must be scientific. As a guide, you may use the following framework:
- Define your purpose and context. Find out what your objective is, what issues you intend to address, what kind of report you aim to produce, when you plan to accomplish your analysis, and, if applicable, how much you plan to spend on it.
- Data collection. This is where you gather both qualitative and quantitative data such as financial statements, other financial reports, industry news, discussions with stakeholders, and other information relevant to your analysis.
- Data processing. You need to process or adjust data before analyzing it for the numbers to make sense. For instance, raw data may not be enough to compare profitability of a small business to a large one, or to compare a business from a high-income locality to a low-income one. Adjusting and processing the data will enable you to perform cross-section analysis.
- Data analysis and interpretation. This is where you relate, compare, or contrast your different variables with each other, taking into consideration the context of the problem or issue at hand.
- Conclusions and recommendations. From the data gathered and your analysis of it, address the objectives and issues you identified in the beginning of the process.
- Follow-up. What are your next steps? How does your report help your business in the long term? While your report may answer some questions, it may also stir up more questions, which you may also ask within this step
4. Making errors in accounting and financial reports.
Even the smallest inaccuracies can throw your entire financial report off course. Whether it’s due to human error or deliberate attempts to conceal suspicious activities, these mistakes not only harm the integrity of your financial analysis; they can also do permanent damage to your business.
Data entry errors, misclassification of data, omission, and transposition errors are common mistakes that can diminish your ability to stay competitive. In preparing balance sheets, for instance, a common error is the misclassification of assets and liabilities. Entering a long-term liability into the current liability column can make your business appear less solvent, which could turn off potential financiers or investors. Missed entries on income statements, meanwhile, can make your business look less profitable than it actually is.
Because of these errors, you can miss out on opportunities to secure funding or make wrong decisions based on your financial health. No matter how time-consuming you think it might be, it’s wise to invest time and resources into reviewing your financial data by implementing efficient review processes to ensure the accuracy and integrity of your reports.
5. Creating complex, error-prone spreadsheets
Inaccuracies in accounting can be largely attributed to the use of manual spreadsheets. Setting it up, manually entering formulas, controlling who has access to it, managing which versions of which spreadsheets to update – you have to do all these steps and more to ensure that your reports are accurate. But despite all the time and labor you put into your spreadsheets, mistakes are still inevitable. Besides, perfecting your spreadsheets doesn’t even accomplish half of what financial analysis and financial management require.
As a business owner, you would make better use of your time by analyzing the data and figuring out what decisions to make based on the data.
6. Using outdated, manually entered data
In today’s fast-paced business landscape, your numbers can change quickly. Transactions move at the speed of light, the value of stocks and currencies fluctuate, and that report your accountant spent all last night preparing may be totally useless after everything that happened this morning. To ensure accurate, updated information, invest in accounting tools that can process your data in a matter of seconds and show your financial information and status in real-time.
Modernizing financial reports and financial analysis
More businesses are modernizing their financial management functions through automating processes that otherwise take too many resources and are prone to human error. One way to do this is through investing in business technologies such as enterprise resource planning (ERP) solutions.
With these tools, small and midsized enterprises can reduce up to 100% of financial forecasting errors with dynamic planning and analysis tools while cutting as much as 50% of working days spent on closing annual books through instant profit-and-loss insights, real-time cost control, and more.
Businesses are also moving away from traditional data infrastructure that may incur delays in delivering information by shifting to cloud-based solutions that automate processes, process data in real-time, and deliver vital information to decision-makers. This helps business owners and managers shift the use of resources from tedious, repetitive calculations to tasks that could use more human judgment and intelligence. Instead of spending hours crunching spreadsheets, business owners could use that time coming up with creative solutions to business challenges while also minimizing the cost of human error and delays.
Through technology, business owners and finance professionals can put resources to better use and come up with more efficient ways to look at data and data analytics beyond looking at the numbers.
A cloud-based ERP solution that consolidates all your financial transactions, reports, and spreadsheets empowers you to do this. It gives you a clearer picture that allows you to tell your story more accurately.
Blog originally published on the Digitalist Magazine.