As a small business owner, you may think it is difficult to learn how to apply financial analysis. As owner or non-financial manager without a financial education background, you might think financial analysis for your business is impossible or too complicated. This is fundamentally untrue. Although it would obviously be easier if you did have a financial background, it is entirely possible to get financial insights by performing your own, DIY financial analysis. There is absolutely no need to be a Wall Street quant to be able to perform decent financial analysis for small businesses. That’s why I will provide you with ten tips that will help you get to the point where you can make your own financial analysis for your business. In short, the ten tips are:
- Learn the basics of financial reporting and financial statements
- Learn how to use financial ratios to make calculations
- Make sure you know which metrics are relevant to your industry & business
- Improve your skills using free online resources
- Don’t make it too complicated
- Take cheap online courses on financial analysis
- Learn Advanced Excel (calculations, tables and visualization)
- Learn by doing
- Consider using financial reporting and analysis tools
- Learn to develop simple business cases
You also might think financial analysis is only useful to big companies. This is another myth that is completely untrue. That’s why I will start with explaining what financial analysis is and why it would be useful to your own (small) business.
What is Financial Analysis?
Financial analysis is about using financial data to investigate the performance of a business, product or service.
Some examples of financial analysis that are relevant to (small) businesses:
- Analyzing financial statements to investigate how a company is performing in general
- Using financial ratios to draw conclusions of a company’s performance over time
- Analyzing the performance of specific products
- Developing financial business cases to investigate the potential of a certain investment
- Creating different scenarios of what the future will look like and how this will impact a business
A sometimes forgotten but essential part of financial analysis is to be able to recommend improvements based on the analysis. If you don’t take any action based on the analysis, then the analysis itself is not very useful!
Why should I do financial analysis for my small business?
There are many reasons why you should apply financial analysis to your own business, even though you might think it is not useful for you. Some of these reasons are:
- Applying financial analysis helps you improve the business. Financial analysis can get you new insights into where you’re leaking money, and in which areas the business is performing well. Some products may be getting you a profit, while you may lose a lot of money on others that you thought were profitable. By doing financial analysis, you also get more understanding of your financial position. Is the company healthy enough? Does it have a buffer in case the market is unfavorable for a while?
- Financial analysis helps you make better decisions. The reason behind this is quite simple. Knowledge is power. When you have a better understanding of the company’s finances, you are able to base your decisions on that knowledge. Perhaps the results of financial analysis mean you won’t offer a product or service anymore because it just isn’t profitable. Or perhaps you decide to invest in a new opportunity or strengthen your cash low. Financial analysis can support your decision making significantly.
- It saves you money you have to spend on a financial advisor. If your organization is a bit bigger and more complicated, it may be valuable to get a financial advisor that actually studied finance. But if you own a small business that does not have a large amount of resources, doing your own analysis means that you can spend less on a financial advisor.
Tips to learn the skills of financial analysis for a small business
1. Learn the basics of financial reporting & financial statements
An essential part of financial analysis is that you have a good understanding of financial reporting and financial statements. If you don’t understand the basics, you won’t be able to make sound analyses. Don’t worry, it is not a requirement to be a financial guru. It would be if you want to work on Wall Street, but that is not what we are aiming for. If you just want to do some financial analysis of your own small business, you need to understand the basics. If you want to learn more about financial statements, check out this article.
2. Learn how to use financial ratios to make calculations
Financial ratios are certain calculations that allow you to judge how a company is performing. For example, conclusions about its profitability or cash reserves. I won’t go into detail about which calculations you could use and how to calculate them, that is a topic for another article. There is already a lot of information you can find about which ratios to use and how to calculate these ratios for your business.
3. Make sure you know which metrics are relevant to your industry & business
Not all metrics and ratios are equally useful to all businesses. Which metrics are most relevant to your company depends on factors such as the industry you are active in, whether you offer products or services and your company’s strategy.
To give you an example, let’s look at the inventory turnover ratio. This is calculated by dividing net sales by the average inventory for the same period. This ratio is insightful for retail companies, because efficient and effective inventory management is important. But to a services organization, this ratio is not useful since a product / materials inventory does not apply to them (at least not to the same extent).
Additionally, it is industry dependent what would be a good outcome of a certain ratio. That’s why, if that information is available, it helps a lot to compare your financial ratios against these of your competitors.
4. Improve your skills using free online resources
As a small business owner, you don’t have the time or money to invest in an expensive financial education. In my view, this is also not necessary. There is plenty of information available for free on how to perform basic financial analysis. YouTube is a fantasticsource forimproving your financial understanding. Investopedia is a great website if you’re looking for information on a specific topic, such as financial ratios. These are just two of the hundreds of great sources. Stratagoras also regularly writes about financial analysis.
5. Don’t make it too complicated
If you’re just making your first steps into the world of financial analysis, don’t overcomplicate things. It is okay to make certain assumptions that are not 100% founded on complex data analysis. As long as you’re aware of these assumptions, you’ll do fine.
When you gain more experience with financial analysis, you can start making more difficult calculations and doing more complex data analysis.
6. Take cheap online courses on financial analysis
A great way to learn the foundations of financial analysis is by doing one of the relatively cheap courses on financial analysis that are offered online. Since you are not aiming for an actual job in financial analysis, there is no need for expensive courses from renowned institutions. It’s all about gaining a good level of easily applicable knowledge. Have a look at platforms such as Udemy or Coursera. I am sure there will be plenty of reasonably priced options that will be useful to you.
7. Learn Advanced Excel (calculations, tables and visualization)
Knowing Excel is a fundamental skill to do financial analysis. For simple financial analysis you don’t have to be a complete Excel master, but it really helps to if you can have a good knowledge of Excel in general and know your way around spreadsheets.
The Corporate Finance Institute has a great YouTube Crash Course video about how to use Excel for financial analysis:
If you have no Excel knowledge at all, you may want to start at a more basic level. There are also plenty of free resources to help you understand the basics of Excel. Don’t be scared off it you don’t have any experience with Excel whatsoever. It is a tool you mostly learn by doing anyway.
8. Learn by doing
The absolute best way to quickly get skilled at financial analysis is to just do it. It won’t be perfect on the first try, but it doesn’t have to be. You are not a large corporate organization that has a responsibility towards shareholders. You’re doing financial analysis just for yourself. Your goal is to improve your business by doing financial analysis.
9. Consider using financial reporting and analysis tools
If your business is a bit more advanced and you have some cash to invest, you could consider getting financial analysis software. I would recommend this if you already have a good understanding of financial analysis and you are willing to invest extra money into it. If you don’t, Excel is definitely good enough for you.
10. Learn to develop simple business cases
One very useful skill for small business owners is to know how to write a simple business case. A business case is essentially a feasibility study of a certain investment or project. It compares the potential rewards with the costs, and also takes the risks into account.
If you know how to develop a basic business cases, this can help you massively in your decision making. If you want to learn more about how to write a business case, check out this article: How to write a business case
How to apply your financial analysis skills to your business: step by step
If you want to apply financial analysis to your business and you have the necessary foundational knowledge, I would recommend the following steps:
- Start with writing down the goal of your financial analysis. Some examples:
- Analyzing the profitability of the company
- Creating a business case for a certain investment to decide whether to invest or not
- Creating insight into the performance of one of the products
- Make a list of metrics that are helpful and that you need for this analysis. As we discussed earlier, this depends on your industry and also on the objective of your analysis.
- Do the actual financial analysis. Make the calculations that you need and make sure you do it in a simple and structured way.
- If relevant, compare the results with previous years and with the market (competitors). If you don’t have all the market information you need, you can make assumptions.
- Look for causes in the internal and external environment that influence the results. It could be useful to do an external factors analysis such as a PESTLE analysis: Learn more about the Pestle Analysis
- Validate your analysis. This is an important step if you have no experience with financial analysis. Perhaps there is someone in your family or friends with a financial background who could do a review. Or an employee. It is always smart to apply the four eyes principle to your analysis.
- Document the analysis. This could be done in several ways. Be it a Word document, PowerPoint or Excel. It depends on your preferences and who you write the analysis for.
- Define actions based on the outcomes of the analysis. The goal of financial analysis is not to make fancy calculations. It is to gain insights that help you make better decisions. That’s why it is important that you actually do something based on the outcomes.
Hopefully you learned a thing or two from this article on financial analysis for small business. Do you have any questions or remarks? Feel free to drop a comment.