Tools Used to Analyze Financial Performance
Companies use financial-performance tools to determine whether operating strategies are working. Corporate leadership relies on them to project financial success and cushion the effect of flaws in previously issued operating forecasts. By comparing prior data with current information, management can detect errors and adjust present-period performance data based on economic conditions and the competitive landscape. Financial tools include accounting reports and performance metrics.
Investors who doubt a firm's ability to access capital markets often review the company's pro forma statements. These are accounting reports with projected numbers. Capital markets are also called financial exchanges and enable businesses to raise funds.
Budgeting is an effective tactic for a company eager to curb operating costs and rein in excessive spending. By delving into corporate budgets, department heads can analyze the financial performance of each business unit and single out processes generating mediocre numbers.
In the modern economy, strong balance sheets are generally rife among businesses that consistently generate profits and run tight ships. By analyzing a balance sheet, investors can calculate a company's assets and compare them to its liabilities.
Business-unit chiefs rely on efficiency metrics to determine whether their strategies are bearing fruit, comparing operating blueprints to rivals'. Examples include inventory-turnover ratio and accounts-receivable turnover, which equals net sales divided by accounts receivable. Inventory-turnover ratio equals material costs divided by inventory.
Corporate leadership looks at negative income statements as a learning opportunity. They use bad performance numbers as a benchmark to correct inefficient mechanisms. Income statement components include revenues and expenses.
Security exchange players rely on profitability ratios to determine firms that could escape unscathed from a bad economic scenario. These metrics show net profits and the consistency with which businesses generate these earnings. An example is net profit margin, which equals net income divided by sales.
A statement of cash flows is an effective tool to gauge a company's liquidity movements over a specific period, such as a quarter or fiscal quarter. Investors sifting through this report watch three items closely: cash flows from operations, investments and financing activities.
Company principals use liquidity ratios to anticipate the funding needs of business units and operating segments. Building on cash-flow statement analysis, senior executives appraise how much cash the company will need in the next 12 months. Liquidity ratios include working capital, which equals short-term assets minus short-term debts. The metric gauges short-term cash availability.
Safety indicators are key barometers in debt management. Companies use them to understand how operating activities may fare under worst- and best-case scenarios. An example is debt-to-equity ratio, which measures a company's vulnerability to risk. The metric equals total liabilities divided by total equity.