A company's current and past financial health are key indicators of its long-term growth potential. So, it follows that a proper modern business analysis relies upon various sets of financial data points and ratios. Further, financial data point analysis is critical to strategic planning, which is, in its final stage, about allocation of resources limited by the business's financial realities. Therefore, the company's financial position, goals, performance and resources are integral to strategic planning, implementation and performance monitoring processes.
Formulating Business Strategy
To formulate a long-term strategy, a business can aim for one of a number of competitive market advantages. For example, you may find that your business is positioned to make strides toward low-cost leadership, differentiation, focused low-cost (niche markets), or other such market distinctions. Of course, in addition to financial determinates, customer satisfaction, staff learning and development, internal business processes, and other primary considerations must be included in analyses. But, here we will examine financial data points that are key to formulation of a viable business strategy.
Working with the commonly used balanced score card (BSC), as your instrument for monitoring and managing execution of your business strategy, helps in aligning your elected strategy with performance expectations. It further facilitates translating strategic plans into concrete objectives, and further into actionable operational directives that ultimately can advance the business toward financial goals.
Finance Role in Business Strategy
Financial metrics are the essential tools for measuring business performance. Your BSC supports your reliance on financial information in establishing strategic financial goals that are coordinated and effectively integrated into your company's operational and financial management systems. Financial metrics are used for benchmarking and goal-setting in asset management, risk management, tax optimization, and financing decisions, among many other areas of a business leader's strategic decision-making. Here are some primary data points to be included in processes for development of business strategy:
1. Net Cash Available
Net cash is the measure of a business's financial fitness. It indicates the level of efficiency with which the company is utilizing its financial resources to generate more cash for new investments. It is the amount of cash available after subtracting investments and increases in working capital from the company's operating cash flow. Companies can use this metric in planning for major capital expenditures or advancement of current projects.
2. Revenue Growth
The quantity, timing and quality of your revenues are determinates of your business's potential level of long-term success, a fundamental concern in strategic planning. The revenue growth calculation subtracts your last period's revenue from the current period's revenues, then divides that outcome by the total of last period's revenues. (One-time revenues are not included, as those distort this analysis). (A note regarding revenue concentration: Your percentage of total revenues that are coming from a single client should not exceed 10 percent of your total revenues.)
3. Profitability Ratios
This ratio is one measure of your company's operational efficiency. It also indicates areas requiring corrective action. And, it measures the relationships between profits and sales, total assets, and net worth. A business must establish goals for its profitability ratio, when it is necessary to plan for increasing effectiveness of operations and improving value-chain activities.
Having a healthy margin of gross profit enables your company to absorb negative impacts to costs of goods sold, or to revenues, without risk of inability to pay for routine expenses. Your operating profit margin is the determinate of your company’s ability to generate a profit, irrespective of how your business finances its operations, whether by equity or debt. Net profit margin measures remaining profits that can be reinvested into your company, or distributed to your shareholders as dividends.
5. Economic Value-Added
This is a contributor to the bottom-line, but one that is contingent upon risk adjustment. It helps in making timely decisions about expanding your businesses to increase its economic value. And, it highlights needed corrective actions in areas that are diminishing its value. It is calculated by subtracting your business' cost of operating capital from its net income. Your business's goals for adding economic value are used to assess its value contributions and to improve your process for resource allocation.
6. Growth Indices
The growth indices are the evaluations of your company's sales growth and market share growth. They indicate the financial acceptability of the trade-offs made for growth, in terms of reduced profit margins, ROI, and cash flow. Typically, growth drains cash and reserve borrowing funds. Aggressive asset management may become necessary to maintain sufficient cash and reduce borrowing. Your business must set strategic goals to improve its growth index, if growth rates are below normal for your industry, or if your operating leverage is very high.
7. Operational Efficiency
This is the measure of how efficiently your business's resources are being used. Poor operational efficiency results in lower profits and anemic growth. Areas included in this evaluation include accounts receivables turnover, which measures your level of efficiency in managing customers' credit accounts with you. Another example is inventory turnover, which is the measure of your efficiency in managing inventory, based on sales levels.
A liquidity analysis examines your company's ability to generate enough cash to pay all of its cash expenses. Profits or revenue growth, regardless of amounts, cannot compensate for insufficient liquidity. The Current Ratio calculation, which divides current assets by current liabilities, measures your business's ability to cover short-term obligations with cash and current assets. A ratio under 1 indicates that a business has insufficient liquid resources to meet such obligations. A value above 2 indicates a more appropriate level of liquidity. (Note: An Interest Coverage value under 1.5 is concerning to lenders.)
9. Capital Efficiency and Solvency
Investors and lenders are interested in a business's capital efficiency. This figure quantifies the return that your company's operations are generating for your investors. Return on equity (ROE) divides net income by shareholder equity). Your debt to equity ratio, debt divided by equity, indicates how heavily your operations are leveraged, and should not exceed a ratio that is reasonable for your business.
Financial Analyses for Strategic Decision-Making
Key financial data points are utilized in a variety of analyses. Outcomes of essential analyses below constitute additional data points that can be utilized in other analyses listed here as well as in other business analyses not discussed here.
- External Analysis — This analysis involve examination of your business's trends, external opportunities, resources, and applicable core competencies.
- Internal Analysis — This kind of assessment helps in understanding your company's level of opportunity for technology upgrades, more advantageous product pricing, innovation, value services enhancements, actions regarding marginal products, production and sales cost reductions, market share increase/saturation, effective growth management and value-chain activities, redirection to fast-growing market segments, and initiatives to advance your market position as, for example, a low-cost industry leader.
- Value-Chain Analysis — This analysis clarifies your business's process for value-creation through both primary and secondary activities. It is an important costing and benchmarking tool for highlighting major costs, competencies, resource strengths, and for identifying areas of needed improvement, to evaluate decisions on re-engineering to increase economic impact.
- SWOT — An assessment of Strengths, Weaknesses, Opportunities, and Threats, this internal and external analysis provides information that helps decision-makers set priorities and maximally utilize a company's competencies and other capabilities. It helps in understanding possibilities for taking advantage of external opportunities, correcting critical weaknesses, and addressing existing threats.
Final Analytic Application of Data Points
Financial analysis is used to establish a thoroughly reasoned basis for understanding how closely your business's performance is aligned with appropriate industry and internal benchmarks. This applies to each financial data point and to your business's overall financial condition as well. The following three bases for comparison should be included in the final analysis:
- Your Business's Past — To determine whether your business's financial condition is improving or worsening, reviewing its financial performance over the last three years is usually sufficient. However, you should extend your review to older data as well, if available. Also, examining your firm's past and present financial condition helps you identify trends in its performance. Noticing a steady decline in liquidity, for example, can prompt you to make needed changes.
- Your Primary Competitors — This data can be eye-opening. For example, after being satisfied for a time with an annual average of 11% revenue growth, discovering that your competitors have been growing at rates of 24 and 25 percent exposes hard evidence of your business's under-performance.
- Your Contractual Agreements — Managing key financial data points and ratios within preset limits can help interested third parties protect their stake in your business's success. For example, investors, lenders, and large customers typically demand that specified financial performance benchmarks are reached.
A balanced scorecard emphasizes a business's financial performance as a key indicator of its potential for future success. It links performance to strategic goals, and provides decision-makers with information necessary for well-considered strategic decisions as well as for the most effective operations management.