Short guide for business and financial analysis

Sometimes we are very busy fire-fighting and troubleshooting and therefore we have no time to analyze how the business is performing both operationally and financially.

In this post I would like to share my simple and short model to cope with the above mentioned situation. Obviously you don’t need to follow all. There are no fixed rules, just use common sense and check how the movements in both Balance Sheet and P&L are related.

First of all we need to minimize the effort: concentrate in “big numbers”. Use just a few ratios and only those you really understand the meaning. Look at the evolution and compare them with the competitors.

I will start for the analysis of the business as follows:

Sales/Commercial management and market

·         What do we sell ? What is our level of revenue? Did we have sales growth ? which is the impact in our operating needs of funds ?

·         Are our sales seasonal ? Check operational risk

·         To which customers do we sell? Big customers, small customers, many, few, etc. Check reliability and strength of those customers.

·         Competitors ? many ? strong? Focused on price ? on quality ?

Production management/Vendors

·         How is the production? Uniform or seasonal? Based on orders?

·         Production process: long or short? Check impact in inventory

·         Which the importance of the vendors ? many or just a few? Are the vendors stronger than us?

Senior Management/strategy

·         Is the senior management doing well?  We need to understand the impact of potential problems in the management decisions in a particular period in our balance sheet and profit and loss account. For example, what will be the impact in our balance sheet if the sales are seasonal? And if the production process is long? Or if we experience a decrease in our sales.

Now it´s time to look at the profit and loss account to review profitability

·         Sales. Growth, seasonality, variability

·         Key figures in the P&L. “Big numbers” which is critical? Check how the Margin, EBITDA, return on sales have changed as percentage of sales. Compare with main competitors.

·         Financial expenses, simple ratio EBIT/Interest charge

·         Did we have profit? Check ratios, return on equity, return on assets and analyze the size of the profit.

·         Risks: which is the change in profit when key figures are not doing well?

Balance sheet analysis/Financial situation

·         Big numbers in balance sheet. If our business is seasonal we need to identify the key periods, for example, the period with maximum cash and with maximum accounts receivable balances.

·         Identify the “big numbers“ in the balance sheet. It is likely you will find the problem, if any, here. We can do a short balance sheet. Assets: operating needs of funds + Fixed assets. Liabilities: debt + Equity

·         What has happened? We can use our cash flow statement. We can compare the period with one considered very good for the business. Just concentrate in the relevant differences as here we will have the problems. So now we need to know why. We need to review the operational ratios.

·         We need to analyze the evolution of our operating needs of funds and the working capital. Maximum and minimum periods, for example. If we are shortage of cash this is due to the increase in our operational needs of funds or that our working capital has decreased. There is no other possibility.

·         If we increase our operating needs of funds the reason is we are collecting worse, we have more inventories, we pay quicker or we are growing too much, sales are lower, etc. We need to do a root cause analysis by using the operating ratios.

·         If working capital decreased it could be because our net equity is lower, due to dividends paid or losses, also it could be that our long debt is down or an increase in our fixed assets.

·         It is important to review potential risks in the balance sheet and the evolution of the operating ratios in comparison with the industry. The operating ratios evolution impacts our cash conversion cycle.

Finally we should perform a quick review of the value chain which is associated to how we build our return on equity. This ROE is our margin x turnover x leverage. If we simplify the calculation of these 3 components we will end up the ROE is net profit/net equity. The action here is how to increase ROE. Normally there are 3 things to do:

·         Increase ROS ( return on sales) by increasing margins or reducing operating expenses

·         Increase turnover, by selling more using the same level of assets or selling the same using less assets so being more efficient.

·         Increase leverage, using less equity and more debt or the so-called spontaneous financing.

Annual business plan: what readers of the plan will look for

This is the first post published directly in English in my blog. From now on I will combine posts in English and in Spanish as it has been demanded by the followers of the blog.

It is likely that depending on your fiscal year end you will start to prepare your annual budget or plan shortly. As every year the plan will finally be presented to a group of stakeholders or even to investors outside the organization.

In this post I would like share my experience gained in different organizations and some important factors when presenting this document.

Assuming you know who is going to receive your plan, your first challenge is ensuring that it is read. This is why the presentation and executive summary have to be good. It is highly unlikely that anyone will read the plan to the beginning to the end.

If the plan is for internal purposes you should be confident that a plan for this use will be given some attention. You can also be certain that the plan will not be read in their entirety either. The best you can hope for is that readers will grasp some good points from the plan before the next meeting in the boardroom or in the CEO office. You don’t want casual readers to find things that they can readily pick on and criticize. Hence my advice would be, think about the people who will be sitting around that “polished table”.

With the personalities of your organization in mind, read the plan again and try to see where your opponents might find ammunition. Consider if you have mistakenly overemphasized a weakness or an uncertainty or whether you have made assumptions that can be torn apart. If possible discuss the plan with your direct boss to see where he or she finds weaknesses and where you can look for support.

If you are fighting in a tough “political atmosphere” don’t let your plan be discussed too freely in advance. Too much idle chatter give your opponents time to formulate strategies. Don’t show everyone your hand or your best ideas will turn on the boss´s desk in someone else´s memo two days before you can present your brilliant business plan.

But, who are the group of people that could be sitting in the conference table?

First of all ,the decision-maker.  Even if the EVP or CEO makes the decision, it might be based wholly or partly on feedback or recommendation from others therefore don’t focus on the head of the table to the exclusion of all others.

In the second position, let´s say, the influencer. Frequently there is a “wise man” exerting strong influence on the decision-maker. Win the influencer´s support and you might win the battle.

Next, your direct boss. In this case you can usually expect a constructive attitude from this person and you are strong if he or she is the key influencer.

And finally, my most like group. The opponents, the nasty “point-scorers” and the supporters.

It is likely you will have some opponents. They might be motivated by personal grudge against you, “personality disorders”, ambition or maybe “their divorce” is making them grouchy. Whatever the cause, they will pick up on anything negative in your business plan.

What to say about the point-scorers. There are invariably a few people knocking around   your company who spend their time looking for an opportunity to look good in front of the bosses or otherwise “score points”, even if it means wrecking a perfectly reasonable business plan just because it was not invented by them.

Finally, your fellow contributors, directors or managers that will gain from the plan and if this plan is sound are likely to be generally positive. But watch out for unexpected point-scorers and those with hidden agendas. Don’t rely on goodwill or friendship for getting support, prefer facts and good arguments.

Every reader will want to see you are presenting an attractive business and the track record is of overwhelming importance.