Financial analysis: What is it?

En­tre­pre­neurs – re­gard­less of whether the business is small, medium or large – are dependent on eval­u­a­tions of their business ac­tiv­i­ties. For these kinds of eval­u­a­tions, key figures must be set in relation to each other and a lot of different in­for­ma­tion must be collected. A financial analysis gives an overview of the current economic situation of the company. Many busi­ness­es have the report prepared by pro­fes­sion­als, and then are faced with the question: How do I interpret the in­for­ma­tion? Others prefer to prepare the financial analysis them­selves, and then need an answer to the question: How can I create a financial analysis myself?

A financial analysis is a report that presents the current economic situation of a company – on the basis of figures from the ac­count­ing de­part­ment. Larger companies usually have a more com­pre­hen­sive reporting system, but can benefit from this form, too. Free­lancers may not have the available data to create these as­sess­ments.

Many CEOs hand over creating a financial analysis to their tax con­sul­tant. The tax con­sul­tant then prepares a monthly eval­u­a­tion. But even if you create the financial analysis yourself, a monthly cycle is rec­om­mend­ed. In this way you can see the current ex­pen­di­tures and proceed promptly and have an overview of the economic ef­fi­cien­cy of your own en­ter­prise – and not only with the annual accounts. In addition, many lenders regularly demand an economic eval­u­a­tion in order to be able to better assess a company and its economic situation. For the same reason, investors are also often in­ter­est­ed in the financial analysis.

The basis of the financial analysis is the profit and loss account (P&L) and its contents. Financial analysis therefore includes all sales revenues, other income, and expenses. As a result, decision-makers of the company and external fi­nanciers have a detailed insight into the economic per­for­mance of the business. To ensure that financial analysis also presents de­vel­op­ments, it makes sense to include the previous year’s figures. Changes can be rec­og­nized directly at a glance.

The financial analysis only contains in­for­ma­tion that can be found in an income statement. At the top of the list are sales revenues, cap­i­tal­ized own work (for example, if the company itself has developed software that is used in the company), and changes in in­ven­to­ries. The total is then the total output. The material usage or the purchase of goods is deducted from this total. The result is the gross profit.

All operating expenses (= total costs) are deducted from gross profit. Operating expenses include, for example, personnel costs, occupancy costs, and taxes. The result is the EBIT or operating result. Neither taxes nor interest are taken into account.

Finally, interest expenses are deducted from the operating result and interest income is added. In the next step, you deduct the taxes from the pre-tax profit cal­cu­lat­ed in this way and obtain the pre­lim­i­nary result.

The values from the financial analysis can be vi­su­al­ized in various diagrams. The quotients are displayed in pie or ring diagrams, the temporal de­vel­op­ment is best seen in line diagrams. The vi­su­al­iza­tion helps, above all, un­in­formed third parties to quickly grasp the economic situation of the re­spec­tive company.

If the ac­count­ing has been out­sourced to a tax con­sul­tant, the latter normally also takes over managing a financial analysis, and will send man­age­ment a cor­re­spond­ing report once a month. However, it is also possible to create your own financial analysis. This can be done either with ac­count­ing software or a well-main­tained Excel file. These tools then also allow vi­su­al­iza­tion in the form of diagrams and graphs.

The com­plex­i­ty of a financial analysis varies a lot. Some are simple and straight­for­ward to read, but others are in­cred­i­bly complex, with lots of different figures which may seem daunting to the untrained eye. Here is a straight­for­ward example, to help you get to grips with the concept:

Having lots of numbers in front of you can be daunting. It is often enough to con­cen­trate on a few key features, however:

• • Sales: The revenue that the company generates is the most important factor in terms of profit. To increase profit, either sales must increase or costs must decrease. What does COGS mean? This is quite simple: it simply stands for “Cost Of Goods Sold.”
  • Total expenses: In addition to sales, total expenses also include changes in outgoing costs.
  • Gross profit: In operating gross profit, sales are adjusted for the cost of sales and other revenues are added. It rep­re­sents the gross margin of the company.
  • Total expenses: Total expenses include all op­er­a­tional items that reduce profits. However, this subtotal does not yet include interest and taxes. This result, also known as EBIT, gives an im­pres­sion of the company’s profit without including the financing strategy or tax burdens.
  • Earnings before taxes: The above example does not include in­for­ma­tion for taxes, so bear these in mind as you create your financial analysis.

In addition, there are the previous year’s figures which show the man­age­ment in the above example financial analysis that the company was able to record higher sales with slightly higher costs.

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