Business leaders today don’t need to be big data gurus to discover new ways to boost revenue and earnings as long as they understand the basic fundamentals of data analysis and have a few minutes to spare. Analyzing your financial statements can reveal a bounty of insightful trends and potential moneymaking opportunities that warrant and inspire a journey into the details.
Executives tend to discount the strategic value of traditional accounting reports like financial statements because they recap prior activity. But when complemented by operational measures, balanced scorecards and strategic performance measurement systems, valuable results may be found.
A dive into financial statements can create a competitive advantage by helping executives proactively identify trends and even predict future demand for products and services, says Kristy Towry, associate professor of accounting for the Goizueta Business School at Emory University.
“Consultants have traditionally used accounting data to make agile, first-mover decisions that are crucial to advancing and sustaining growth,” says Jeff Thomson, CMA, president and CEO of the Institute of Management Accountants. “Executives can follow suit as long as they know where to look and understand how to analyze data.”
Explore your income statement
Even if revenue is growing, a dive into your income statements and its supporting data can help you capitalize on emerging opportunities or head off a looming sales decline.
Which products and services are selling and which ones aren’t? Are customers responding to social media outreach or specific promotions? Are they opting for lower-price items with fewer frills or are they willing to splurge on luxury models? And what do these trends mean for the future?
A review of sales records may reveal an opportunity to sell more products and services to existing customers or shift your product mix without increasing overhead. A review of operational data may highlight areas of excess capacity that can be used to generate additional sales and profits.
“Segmenting your customer base by key demographics and tracking their activity and behaviors can illuminate opportunities to grab additional market share through upselling or by offering current customers discounts for purchasing greater quantities,” Thomson says.
Simply repositioning a product or putting it on the front page of your website can boost sales and profits without raising costs, says Alan Reinstein, professor of accounting at Wayne State University. In fact, storing raw materials and products for an extended period of time can tie up cash and erode profit margins.
“Grocery stores put milk near the back of the store because it forces customers to stroll past higher margin products,” he says. “It doesn’t cost them a dime to evaluate sales data or use the results to craft or validate the efficacy of a product-positioning strategy.”
Since a rise in customer satisfaction increases retention and generally precedes a growth in sales, using a balanced scorecard or dashboard to track revenue, sales activity and customer sentiment can help business leaders interpret the needs of the marketplace and make advantageous moves.
Robert Kaplan and David Norton of the Harvard Business School originated the balanced scorecard to give managers and executives a more poised view of organizational performance by adding strategic, nonfinancial performance measures to traditional financial metrics. A holistic view of the organization allows executives to synthesize multiple data streams and accurately predict future performance, Towry says.
“I’m an advocate of the balanced scorecard because it helps business leaders change course or adjust their strategy on the fly by aggregating financial data and other key metrics and compares them to the goals in their business plan,” she says.
Unearthing moneymaking gems is often just a case of exploring your company’s financial statements
Activity-based analysis and costing is a way for managers to assess the performance of assets on their balance sheet and which products and customers are generating the most revenue and profits. The process also helps managers determine where improvements in quality, efficiency and productivity will yield the best return.
“Comparing costs with activities is common among certified management accountants because it helps management identify key cost drivers and potential savings by allocating direct and indirect costs to every stage in the order, manufacturing and distribution process,” Thomson says.
The analytical methodology often highlights opportunities to increase profit margins by outsourcing distribution or ancillary services to less costly external providers or automating manual manufacturing processes, or it may disclose an opportunity to increase cash flow by offering quick-pay discounts or incentives to major customers.
If reducing costs isn’t an option, business owners may be able to raise prices and margins for a particular product by using a formula to calculate elasticity of demand, which measures how the demand for goods and services varies with changes in price.
Generally speaking, the greater the number of substitute products available, the greater the elasticity will be. Naturally, very high price elasticity means that customers are sensitive to price changes, while very low price elasticity means you can raise the price of a top-selling product without effecting demand.
From a trend perspective, a sudden rise in price elasticity may portend an upcoming decline in sales unless executives initiate discounts or take steps to develop and launch new products.
Business owners often decide to eliminate unprofitable divisions or product lines after conducting an activity-based analysis, but they should proceed with caution, Towry says.
“Executives assume that eliminating unprofitable segments will increase profits, but the fixed expenses don’t go away,” she says. “They may end up launching a fatal cash crunch or death spiral once the revenue from that discontinued segment is no longer offsetting those fixed expenses.”
By using the financial data from your accounting system and applying alternative costing models, you’ll be able to determine how much overhead is being covered by the sales of each product and whether it makes sense to discontinue a particular segment or service.
Dare to compare
Comparing key ratios and data from your accounting system to similar companies in your industry can highlight opportunities to lower costs, increase efficiencies and improve your company’s bottom line.
Industry associations often provide benchmark data, and sites like Valuation Resources.com aggregate and provide information, research and analysis for more than 400 industries.
Start by breaking down your company’s accounting and operational data into standard industry measures, such as sales per square foot, same store sales growth or something as simple as the number of gallons of water used per car wash. Then compare your results to the standard for your industry to see where you have a competitive advantage or need to improve.
Major deviations from industry norms should invoke questions and a search for solutions, Reinstein says.
For example, a competitor may have lower selling, general and administrative expenses because they use e-commerce or distributors to push products instead of salespeople. Or they may be experts at using their point-of-sale system to increase loyalty and market share by offering customers incentives or rewards for making additional purchases.
“It’s critical to dive into the details and not ignore the trends, because a svelte, nimble company with ample cash reserves can force a sluggish competitor out of business in a heartbeat in a tepid economic environment,” Reinstein says.
Cash is king
While profits are important, cash is the key to survival for any growing company.
A cash-flow analysis tracks the movement of money in and out of your business by looking at operating, investment and financing activities. It also provides business owners with an accurate picture of their company’s profitability by using noncash items and expenses to adjust profit figures.
Another useful way to spot trends and analyze financial statements is by performing either a horizontal or vertical analysis, which compares numbers from one period to the next. The analytical methodology may point to favorable or unfavorable changes in cash flow that could spell trouble unless they’re corrected.
You’re probably in good shape if your cash is growing, and it accounts for 10 to 20 percent of your assets. If it’s not, then you need to figure out where it’s going. Is it costing you more to manufacture the same products, or have competitive pressures forced you to reduce prices during the last year?
Vertical analysis lets you compare each component of your financial statements over time to determine if and where significant changes have occurred. You may need to focus on collections or stop extending credit to major customers if receivables are growing too quickly, or you may need to reduce inventory if the payments on your short-term line of credit are chewing up cash and affecting your company’s liquidity.
Managing fixed expenses is critical for growing companies, Towry says. Otherwise, a blip in the economy can lead to an insurmountable cash shortage. Don’t just look at expenses when reviewing your financial statements. Break down fixed and variable costs and apply varying revenue forecasts to see how changing circumstances affect your cash position.
“Companies that overinvest in equipment, building leases or inventory can’t manage those costs down when the economy heads south,” Towry says. “Business owners need a cash budget and an awareness of cash in relation to profits because there’s no magic bullet for a major cash crisis.” ?
How to reach: Goizueta Business School at Emory University,
www.goizueta.emory.edu; Harvard Business School, www.hbs.edu; Wayne State University, www.wayne.edu; Institute of Management Accountants, www.imanet.org