How Financial Statement Analysis Helps Strategic Decision Making
Conducting effective financial reviews require in-depth examinations into the overall, financial performance of the business. Preferably, you would perform these checks monthly but, the more often company’s finances are reviewed; the more likely they are to find new growth opportunities and operational errors that could be fixed.
Financial accounting affords companies the opportunity to monitor all of its financial transactions conducted in general business operations. The process keeps all business records and reports the finances moving in and out of the business. Most countries have their own form of generally accepted accounting principles (GAAP) that delineates the standard practices all companies, in that nation, must follow.
Although these do not limit all the potential; decision-making benefits any business can take advantage of using three key financial statements.
The Three Financial Statements to Be Analysed
Income statements
The income statement (also known as ‘profit and loss’) records all of a company’s income and expenses. By comparing the income statement to the economic forecasts of the company, they are given an opportunity to decide if sales are meeting expectations as well as ensuring that all expenses are keeping in line with their budget.
Cash Flow Statements
Determining exactly how cash moves into and out of a business is vital to keeping business plans on track. Cash flow statements provide this information and – when compared to cash flow forecasts – inform businesses if they are growing at the rate they should; or, if things are not going as well as they had hoped for, to apprise why things are off track.
Balance Sheets
The balance sheet provides a complete and comprehensive overview of a business’s financial position. It allows them to keep up with how much money is owed to them and how much they owe to others as well as tracking the financial assets the business owns. The balance sheet will help determine if a company is collecting money at the necessary and correct rate as well as spending, so as to not accrue any unnecessary debt.
Key Takeaways:
There are many ways that careful consideration of these financial statements can help a business but, there are three main ways in which analysing these statements can facilitate much smarter, better informed and more strategic decision making:
- Providing investors with a baseline of data to be used for the analysis and comparison of the financial health, between and among corporations that offer similar securities.
- Creditors are able to determine the solvency, liquidity and creditworthiness of any particular business.
- In combination with their managerial accounting, a business is able to make informed and strategic decisions about allocating scarce resources.
Investing
Comprehensive financial analyses rely on the accurate and actionable information revealed in a company’s income statements, cash flow statements and balance sheets. All publicly traded companies create these statements – and report them – according to the financial accounting standards of their country.
This information affords investors the opportunity to consider the value and creditworthiness of a business they are looking to invest in. If not for the information provided by financial accounting, an investor would have little understanding of the business’s financial health or history. In addition, the consistency and accuracy are critical to investors making better and more strategic decisions about the potential future value of stocks and bonds issuing by a particular company.
Lending
Investors are not the only professionals who benefit from the lessons learned in a company’s financial accounting. It is also key for lenders to determine the creditworthiness of a company because, and the released financial statement provides a quick and easy presentation of all their assets as well as their short and long-term debt.
Debt-to-equity (D/E) ratios and times-interest-earned ratios are some of the accounting ratios that creditors rely on; measured using a company’s financial statements. If a private business does not follow the same standards as publicly traded companies, it means a large business loan’s liability would fall on the lending organisation.
A lender’s primary goal is to determine the extent of the risk involved in lending to a business. The financial statements are a critical to keeping a lender as informed and up-to-date as possible when deciding how much money to lend – and at what interest rates.
Corporate Governance
The benefits of reliable and precise accounting are not limited to investors and lenders; the firm itself is made stronger and safer by having accessible information about the movement of their money. Meeting all the regulatory and legislative responsibilities expected of public companies is made easier by having honest and accurate data, about their financial activities, published frequently.
Beyond the regulatory, loan and investment benefits of financial accounting, it helps businesses make more strategic decisions and improve their corporate governance and productivity. These numbers help managers create budgets, track operational efficiency, analyse product performance, read public perception and develop real, actionable short and long-term strategies.
Making Strategic Decisions
Monitoring a gap between the actuals and forecasts of a business is good way to keep track of that business’s finances. Financial statements offer a snapshot of the company’s financial health that gives them an opportunity to analyse their statements, compared to previous ones, to expectations and to other competitors. This empowers the firm – as well as their lenders and investor’s – who, armed with the knowledge gained by financial statement analysis, to greater their strategic decision-making possibilities.
