Three Essential Components of a Financial Analysis

Three Essential Components of a Financial Analysis
Understanding the framework of a financial analysis can help you determine profitability and future earnings potential for your business. Here’s a rundown of what to know as well as the calculations needed to conduct a financial analysis.
by Square Jun 11, 2018 — 6 min read
Three Essential Components of a Financial Analysis

What is a financial analysis? A financial analysis is a process that helps business owners determine their company’s performance, sustainability, and growth by reviewing various financial documents like their income statement, balance sheet, and cash flow statement.

Here’s a deep dive into what you need to know about each of these statements, along with specific ratios and calculations to help you conduct a business financial analysis:

The framework of a financial analysis

1. Income statement

When you do a financial analysis it’s important that you have all the necessary documents to give you a clear picture of your business. An income statement shows the company’s financial performance over a given period of time and highlights a business’ profitability. It can be used to predict future performance and assess the capability of future cash flow. You might also hear people refer to this as the profit and loss statement (P&L), statement of operations, or statement of earnings.

The “top line” of the income statement displays the business revenue in a given period of time. Cost of goods sold (COGS) and other operating expenses are deducted from revenue. The net income, or “bottom line,” is the remainder after all revenues and expenses have been accounted for.

Here are important analysis ratios to compute when reviewing your income statement, a part of your overall financial analysis:

2. Balance sheet

Another document you’ll need to complete a business or product financial analysis is a balance sheet. A balance sheet reports the company’s assets, liabilities, and shareholder equity at a specific point in time. In every balance sheet, assets must equal the total of your liabilities and equity, meaning the dollar amount must zero out.

Assets = (Liabilities + Equity)

Your balance sheet can help you determine how efficiently you’re generating revenue and how quickly you’re selling inventory. There are three types of ratios that can be computed from your balance sheet during a financial analysis:

Liquidity ratios are portions of the company’s assets and current liabilities. They are used to measure a business’ ability to pay short-term debts. A few liquidity ratios include:

Leverage ratios in a financial analysis report look at how much capital comes in the form of a debt (or loan). Too much debt can be dangerous for a business and turn off investors. Some leverage ratios you can use include:

3. Cash flow statement

One of the last pieces of a business financial analysis is the cash flow statement. A cash flow statement reports the amount of cash generated during a given period of time. It’s intended to provide information on a business’ current liquidity and solvency as well as its ability to change cash flows in the future.

The three main components of a cash flow statement in a financial analysis are:

These three sections highlight a company’s sources of cash and how that cash is being used. Many investors consider the cash flow statement to be the most important indicator of a business’ performance in a financial analysis.

There are a variety of ratios you can put in your cash flow statement. Here are a few to help you start measuring the quality of your cash flow and create a cash flow analysis:

This is a general overview of what goes into a financial analysis. If you want to put together one for your business, don’t hesitate to contact a professional to get their advice and expertise.

*Running a business is no easy feat, but Square is here to help. We have all the tools you need to start, run, and grow your business, whether you’re selling in person, online, or both. And we’ve made all our tools to work together as one system from point of sale systems to Hardware, saving you time and money—making decisions, business financial analysis, and other business reports. So you can get back to doing the work you love and focusing on whatever’s next. *

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