To check the status of their business activities, each entrepreneur relies on assessments, regardless of the size of his company. In order to actually carry out these assessments, it is first necessary to collect and compare useful company data. A financial analysis, better known as a balance sheet analysis, offers an overview of a company’s economic, financial and equity situation . To carry out a budget analysis you can turn to professionals, but it will then be necessary to know how to read and interpret the data provided. Using the due care and the right degree of attention, it is also possible to independently prepare the budget analysis.
- Budget analysis: a definition
- The importance of a financial analysis
- The structure of the budget analysis
- Draw up a budget analysis
- Budget analysis: the key terms
Budget analysis: a definition
Budget analysis: budget analysis is an accounting tool that provides an assessment of a company’s economic, financial and equity status. It is based on the financial statements and reports the data. There are limited profits and losses of a company and therefore serves to derive the general performance of the company.
Financial statement analysis or financial analysis serves to understand the economic, financial and asset management of a company. In summary, this document analyzes the important aspects of business management, comparing the financial statements of the same company (or possibly the financial statements of other companies operating in the same sector), so as to be able to assess the current situation of the company, but also the future one. The budget analysis is therefore also useful for convincing future investors of the validity of their project.
To prepare the financial statement analysis, we start from the financial statements and can be conducted both by an internal analyst and by an external analyst. The data collected will vary accordingly, as turning to external professionals, they will not have the same information available as an employee who works directly within the company for which it is necessary to prepare the budget analysis.
The analysis can be of two types: static , based on indices or quotients, or dynamic , also known as analysis of financial flows . By opting for a static analysis, there are many indices available , including those of profitability, liquidity and structure. When undertaking an analysis of financial flows, on the other hand, cash flow is often used .
In order to have a correct balance sheet analysis, it is necessary to take into account several years in which the company has been active (and therefore to use multiple financial statements) and it is necessary to make sure that the preliminary requirements are respected. This means that the accounting principles and the evaluation criteria must have been respected , as well as the values of the financial statements have been reclassified, using a precise scheme.
The importance of a financial analysis
Companies are not normally obliged to draw up a financial statement analysis, yet having one could prove beneficial. In particular there are some subjects for which a financial analysis is important, for example:
- business consultant: during the investigation to get to know the company and understand if there are situations to be remedied or not;
- auditor: to identify and evaluate risk areas;
- tax consultant: to define budget policies;
- tax inspector: when identifying possible areas to analyze;
- capital manager: to find companies to invest in;
- entrepreneur: to evaluate the position of your company in relation to the competition;
- manager: to verify and evaluate the effect of the decisions taken;
- employee: to evaluate the company for which you work thanks to concrete data, aimed at revealing its solidity or not.
Given its usefulness, it is therefore important that the financial statement analysis is clearly structured and is as easy to understand as possible for all those involved. Therefore, there are data that should appear in a financial analysis, as we will see in the next paragraph.
The structure of the budget analysis
Essentially, a financial statement analysis presents costs and revenues, based on the balance sheet asset-liability model . As mentioned above, the financial statements are first reclassified and then indices are used to evaluate the performance of the business.
We start by indicating the turnover from which to deduct the costs of raw materials and services, thus obtaining added value. This removes the personnel costs, from which the gross operating margin (EBITDA) results , which without the provisions returns the corresponding value of the net operating margin. Finally, operating profit is obtained , ie EBIT , where taxes or interest are not considered, which once subtracted will generate net profit.
Below is a diagram for the financial statement analysis, obtained by building indices between different quantities of the balance sheet and income statement:
Draw up a budget analysis
If you rely on professionals outside the company, you will not have to worry about the preparation of the budget analysis, because they will take care of everything. However, it is also possible to carry out a financial analysis on your own: there are in fact specific software that help you with the assignment or you can always rely on Excel.
Do you need a hand for the preparation of the budget analysis? Read our article on how to do a financial analysis with Excel.
Budget analysis: the key terms
Drawing up a budget analysis is as complex as reading this document and interpreting it in the right way. To be complete, a financial analysis must include the reclassification of the financial statements (including all its parts, including the balance sheet and income statement) and then it will be necessary to calculate the indices . To allow you an easier understanding of the budget analysis, we present in a table the meaning of the terms of the above scheme:
|Company turnover||This is the company’s total gross turnover.|
|Value added||This is the surplus value generated by the simple sale of goods and services.|
|Gross Operating Margin (EBITDA)||It is an indicator that highlights the company’s income, excluding taxes, interest, depreciation of assets and depreciation.|
|Provisions||It is a fund, necessary later when you are aware of the real amount of the expenditure to be undertaken. Here there will be some money set aside which can be used for the expenses.|
|Net operating margin||This is another profitability indicator used for the reclassification of the income statement. It is obtained by subtracting the EBITDA from provisions and depreciation.|
|Depreciation and write-downs||Depreciation can be tangible (e.g. a computer) and intangible (e.g. a patent). Here are understood the costs incurred that are dilated over time. By write-downs we mean the depreciation of a good or service.|
|Operating profit||It is the difference obtained between revenues and costs, excluding charges and taxes. It also takes the name of EBIT, an English acronym for Earnings Before Interests and Taxes.|
|Net income||This is the overall profit of the company, after paying taxes and interest.|
After reading this short legend, you should be able to orient yourself better in a budget analysis. In any case, it may be worth turning to professionals who will take care of the budget analysis for you or rely on accounting software that will guide you in the drafting.