Financial Statements Analysis Methodology

You fundamental business management objective is two-fold: (1) maximize financial and aggregate value of your company and (2) transform your company into a powerful money-making machine that will operate at maximum performance (and, therefore, generate the maximum amount of financial and aggregate value) at all times. Obviously, these objectives are closely interrelated.

No less obviously, your financial statements analysis (FSA) is only as good and valuable as it helps you achieve these two fundamental objectives.

On the surface, your FSA deals with just numbers. Numbers that appear in corresponding accounts on your financial statements plus your key financial ratios. But it is just the surface, or a ‘front-end’. Front-end of the issue (object) that needs to be analyzed and optimized. The object that yields the value at the front-end.

The object in question can be your accounting receivable management system or an investment project financed by your bank loan or a piece of equipment (also an investment project, by the way) financed by a long-term note payable and the like.

More specifically:  

Your front-end – the numbers. The values of items on your financial statements (which are actually your financial KPI). Which need to be optimized (not all KPI values must be maximized).

Your back-end systems (such as your A/R management system that I mentioned). Such system typically includes (1) description; (2) methodology; (3) process; (4) tools; (5) in-house personnel and might also include (6) external providers of goods or services, such as a collection agency in the case of A/R management. This system, obviously, needs to be optimized to maximize its efficiency.

Your back-end projects such as the ones that I mentioned. These projects must generate the maximum amount of financial value measured by their financial KPI (NPV and IRR). They need (1) financial model; (2) operational plan; (3) business plan; (4) all relevant project-related corporate documentation and (5) project managers and personnel. Obviously, you will need to maximize financial value generated by each project.

To make a valuable contribution to achieving your fundamental business management objectives, you must analyze and optimize both front- and back-end. And to do it in the right way:

The numbers on financial statements. You deal with these KPI like with any other KPI – look at their current and historic values – benchmark, planned and actual; analyze KPI dynamics, develop conclusions; write recommendations and comments and develop and implement financial and operational plans for optimizing KPI values.  

Your key tool for analyzing your financial KPI are the dedicated KPI scorecards – KPIS – which are a part of both the CBA Toolkit and the by far more functionally rich Comprehensive Business Analysis Workbench (CBAW).

The back-end systems and objects. You thoroughly document them; analyze them using the appropriate CBA questions; develop conclusions; write recommendations and comments and develop and implement financial and operational plans for optimizing these systems and objects.

With objects you always have a choice of use ‘as is’, use for a different purpose (not with all objects); upgrade or sell/lease out. With loans and other debt instruments there is almost always an option of refinancing.

Obviously, you must always make a choice based on thorough financial analysis of available options using solid financial models and supporting documentation.