The Importance of Accounting Analysis

by Gena Sanford SEO Executive at eBetterBooks

The importance of accounting analysis

Your accounting reports offer you valuable information to make future decisions that affect your business.

When we talk about accounting, we are not only referring to invoices, expenses, delivery notes, credit notes, etc. We are also talking about a sequence of processes that include what we call the financial statements and their communication to the interested parties.

The financial statements synthesize very valuable information for your own company and analysts, investors, partners, and even your employees. They offer a map of the equity, economic and financial situation, and the future expectations of your business.

Correct analysis and interpretation of the financial statements facilitate decision-making by reducing the degree of uncertainty.

Who is interested in the information in the financial statements?

To start your own business. But also to the following external and internal users (in the accounting vocabulary) for the following reasons:

Creditors and suppliers, who will be interested in the short-term liquidity of your company;
Obligors and lenders, who will be concerned about your ability to pay periodic interest and repay your debts, your degree of indebtedness and solvency, etc.
Potential shareholders, partners, and investors, who will be interested in knowing the financial return on equity, the dividend policy, and the stability of earnings.
The management, who will want to examine the economic profitability of the investments, the degree of fulfillment of the established objectives, the efficiency in the allocation of resources, the cost of the financial resources used, and in maximizing the value of the company;
Your employees, who will be interested in their contribution to the company's profits, their solvency, and their ability to self-generate resources (among other things, because it is their job that is at stake if things go wrong)
Auditors, analysts, and financial advisers, who will want to detect anomalies (auditors) and predict the benefits for future decisions and quotes.
Your clients, who will be interested in the solvency of your company so that it does not suspend payments and thus ensure the supply of goods and services;
The public administration, which will be interested not only in your ability to generate taxes (Treasury) but also in creating jobs, complying with environmental regulations, etc.

So many people - you may be wondering - may be interested in this information about my company?

This is an upward generalization, which depends, among other things, on the size of your company. If you are self-employed, accounting analysis is always easier, since the information to be analyzed is smaller. And, of course, your contribution to the entire business ecosystem is much more modest, so there will be fewer stakeholders. But that doesn't mean you should underestimate it!

What are the financial statements?

We keep talking about the time financial statements - which, as in all good families also are known by other names: financial reports, financial reports, etc. - and we still haven't made the introductions. Here they go:

The balance sheet, which shows the financial situation ( assets, liabilities, and net worth) of a company at a given time;
Profit and loss account (income statement), that is, the summary of the income and expenses that your company generates during an accounting year.
Balance of sums and balances or trial balance, which shows the balance of the debit and credit balances of your company's accounts at a given time;
Statement of changes in net worth, which shows how the capital of your company varies (both that of the owners and that of the partners), taking into account all the income and expenses that appear in the income statement;
Statement of cash flows, which reports on the use of your company's cash, as well as that of other liquid assets, by activities. It also indicates how they vary during the accounting year.

To make a complete accounting analysis, it is also advisable to take into account the accounting report, the management report, and the audit report. And if you want to aspire to excellence - and by the way to the madness of the world of economists - you should include the behavior of macroeconomic variables ( GDP, inflation, unemployment rate, etc.).

But without wishing to be exhaustive, we will leave it here.

What can we learn from financial statements?

The accounting analysis is divided into three areas, according to the objectives of our analysis (liquidity of our assets, financial profitability, etc.) and the accounting report that we analyze (balance sheet, profit and loss account, etc.):

Equity analysis. It allows you to evaluate the degree of indebtedness of your company and its financial balance. This analysis reflects the guarantee that the company offers to its lenders, suppliers, creditors, and third parties; as well as knowing the degree of liquidity to meet immediate obligations. Its main analysis report is the balance sheet.
Economic analysis. It shows you the evolution of your company's results and its margins. That is, it allows you to see which elements provide you with the desired profitability. The reference report is the profit and loss account.
Financial analysis. As its word indicates, it is about analyzing the financial structure of your company. In other words, it consists of studying the profitability of investments and own resources, as well as the cost of the financial resources used. The balance sheet, the profit and loss account, the statement of origins and applications of funds or financing table, and the statement of cash flows are used as a basis.

How do we do the accounting analysis?

Accounting analysis has two faces: one static and the other dynamic. In other words, it can show you a specific moment in your company (equity analysis from the balance sheet) or its evolution (economic and financial analysis from the income statement and other reports).

Various instruments are used to carry out the accounting analysis. In order not to tie you up, we will mention the most used, which is none other than the ratios method.

The ratios method is the most generally accepted instrument for analyzing accounting information.

A ratio is a quotient between two quantities. From the accounting point of view, we speak of ratios as the quotient between the amounts of two items or groups of items included in the accounting reports.

For example, if you want to find out how many raw materials your company consumes by sales, you would do the following ratio:

Consumption of raw materials / Sales

This way you will know the sales margin with which your company is carrying out its activity.

It is not a question now of reciting the different types of ratios as if the list of the goth kings were involved. Therefore, if you are interested in this, you can consult the economic ratio and solvency ratio in our Dictionary of accounting terms.

The main advantage of this method is its simplicity to analyze the economic, financial, and patrimonial evolution of your company taking the same ratio as a reference at different times of economic activity.

However, for this analysis to be more valid, that is, to serve you for accounting analysis, you must take into account the following considerations:

Few ratios should be used so as not to complicate the analysis. Remember the maxim of Baltasar Gracián: "The brief, yes good, twice good";
They must be significant. That is, if you are interested in knowing the liquidity of your company, you would make a ratio between current assets and current liabilities.
Do not use isolated ratios, as the ratios have to provide an overview.
The ratios are neither sufficient nor self-sufficient. That is, you have to use additional information to interpret them correctly.
It is good to take into account the industry average as well as that of the leading company.

Finally, remember that the analysis of your accounting documents is not the last word to make future decisions for your company. But make no mistake about it that their analysis will help you make the decisions you make the least wrong.

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