This analysis will help you better understand the following:
- Your small business performance
- What areas require improvement?
- What is your future likely to bring you?
You need to focus on a few key components to guide your business’s growth. These elements will help you develop a complete picture of the financial health of your small company.
Components of financial analysis at a Glance
Three of the most critical financial analysis components are listed below. They provide an accurate picture of your business’s performance. These specific components of economic analysis can help you better predict the direction your business will take when used correctly.
Statement of Income
The income statement analysis shows how your business performed during a specific period, usually between three and twelve months. Calculate by subtracting your business’s total earnings from all expenses over that period. Your business will be profitable as long as sales revenue exceeds costs. Profit and loss statements are often called income statements.
A balance sheet analysis, also known as a financial statement, provides an overview of:
- What assets your small business has, including equipment, inventory, and cash? It also includes accounts receivables (accounts payables), investments, and prepaid expenses.
- What you owe your small business, including liabilities like debt, merchant advance, account payables, interest payables, wages payables, and equity in the company.
Balance sheets usually have assets and liabilities/equities on either side, with totals in both columns ideally equal to zero.
Cash flow statement
Cash flow analysis shows how much money your business made (and lost) by selling products, for example. It can also include income from other sources, such as bank loans, investor financing, and dividends generated by side investments.
A cash flow statement will tell you how liquid you are in any given situation. You can use it to predict your ability to pay short-term expenses or absorb shocks (e.g., a pandemic).
Quick Definitions of Small Business Financial Analysis
You can gain valuable insight into the performance of your business by analyzing data from these three key components. Here are the three most essential components of this analysis.
Revenue growth and revenue
All sales and cash are included in revenue. Most small businesses calculate their revenue growth by using the formula shown below:
If you earn $225,000 this quarter compared to $150,000 the previous quarter, your growth rate would be 50%. This calculation can be used for any period: monthly, quarterly, or bi-annually.
The goal is obviously to increase revenue over time. You can make much more revenue but still be harmful, so the next metric will often be more helpful.
Profit is what you have left after subtracting your expenses. Profit margin is a popular focus for entrepreneurs. It can be calculated using the formula below:
If you sell jeans for $50 and they cost $15 to make, then your gross margin is 70%.
The net profit margin is a better indicator of your company’s financial health, as it considers all costs.
For example, if you run a lawn care service and earn $10,000 per month but have to spend $3,000 on services (e.g., equipment, transportation, and payroll), your net monthly profit margin is 70%. You’re losing money if your net profit margin results in a negative number. If the result is positive, you can pay yourself and your shareholders or reinvest in the business.
This equation measures the efficiency with which you use resources to generate sales. Operational efficiency is a way to calculate how much you can make based on the cost of running your business.
Divide operating expenses by revenue to calculate the cost of goods sold. Operating expenses can include inventory costs, payroll, marketing, and insurance.
Most small business owners focus on marketing and advertising to boost profits. If you can keep your sales at the same level while reducing costs, it will help to increase profits. Even something as simple as switching suppliers or investing in technology that saves time can reduce expenses and improve your operational efficiency.
Capital efficiency is the ratio of money you spend to increase revenue and what you get in return. If you make one dollar for every dollar you spend on growing your business, this is a ratio of 1:1.
Solvency & Liquidity
Solvency measures financial health. It measures whether a company has enough cash to meet its debt obligations. While many entrepreneurs use loans for their small businesses, lenders and investors want to know the debt-to-equity ratio to determine whether you can repay your loans and generate profits. This ratio can be calculated using the following formula:
Liquidity is the amount of cash available to cover short-term liabilities and debts. This ratio can be calculated in several ways, but the formula below is one of the easiest.
Best Practices for Small Business Financial Analysis
Financial analysis can be confusing and overwhelming for small business owners.
Regular financial analysis will help you run your business more efficiently and profitably. This analysis will be more successful if it is more detailed. It’s essential to:
- Understanding generally accepted accounting principles
- Regularly perform a small business financial assessment
- Verify your calculations by double-checking them
- Asking for financial help is never a bad idea
It would help if you automated all of the above. Our POS solutions have tracking capabilities that allow you to instantly generate financial statements without crunching numbers or manually collecting receipts.