Why Is Financial Data Critical to Valuation?

Company valuation is an essential step in succession planning and the best basis for price negotiation. Even the owner who wants to hand over their company to a successor within the family and put their successor on an equal footing should have a good idea of its market value and financial management. Financial management is at the heart of the company’s overall strategy.

Good financial management concerns both the sustainability of the company and its development.

Financial Management and Budgets

Financial management often starts with company budgets. The budget is the primary financial management tool for companies and is used to plan corporate operations and projects. Its implementation and maintenance in large groups require entire battalions of financial controllers and consultants. They involve hours and hours of exchanging information, consolidating figures, and going back and forth between decision-makers and operational managers. Setting a budget is like projecting yourself a year ahead. It can transform an accounting system into an operating management system.

Contrary to popular belief, budgetary control is not reserved for big companies. It allows companies of all sizes to protect themselves and achieve ambitious goals. It is fundamental to understand that a budget is a tool of management and motivation. Its implementation requires upstream strategic work, discussions between managers and operational staff, and constant updating.

Managers and their financial partners must set up smart objectives and build a budget structure to manage the business effectively. The company will then have an optimal management tool, making it possible to achieve its goals.

What Is the Purpose of an Annual Financial Statement Analysis?

Financial analysis is the process of comparing recent financial statements to historical financial statements. This process assists valuation analysts in identifying unusual increases or decreases on the profit and loss statement and balance sheet. This instrument is used to obtain information about the actual economic situation of a company.

The financial statements are a set of documents showing the current financial situation of the company. These states indicate more precisely:

  • How much money the business generates and spends—shown in the income statement
  • What the company owns and how much it owes—shown in the balance sheet
  • Source and use of funds—indicated in the statement of changes in its financial position
  • The amount kept in the business by the owners—shown in the statement of retained earnings.

Entrepreneurs need to know what to look for in financial statements and adequately analyze them to make informed decisions for their businesses. Many pieces of information are available at a glance, while other insights require further analysis.

Investors look at financial statements and conduct even more in-depth analyses to determine whether to invest more in a business or leave it.

Analysis of the Balance Sheet

The company’s balance sheet represents its assets, including everything the company possesses and all its debts. The financial analysis of a company involves the study of the following elements:

  • The result of the current and previous financial years, which is found on the liabilities side of the balance sheet: Does the company generate profit, or does it incur losses?
  • The company’s equity, which is at the top of the balance sheet’s liabilities: Equity is a source of information on the value of a company. When dividends are distributed each year, this should be taken into account because these distributions reduce the amount of shareholders’ equity.
  • The company’s indebtedness: It is necessary to analyze the company’s debts, in particular its loans, the debt suppliers, taxes, and social debts. A business that is over-leveraged risks having cash flow problems in the future.
  • Fixed assets of the business: Are there many machines? Buildings? Patents? It is necessary to take an interest in the company’s fixed assets because they are important indicators of whether additional investments (such as new equipment) will be soon required.
  • Availability of cash: This is the company’s cash flow and indicates whether the company is financially sound.

Analysis of the Income Statement

The income statement summarizes the company’s operations over a given fiscal year and includes all sales made and expenses incurred. The financial analysis of a company involves the study of the following elements:

  • The turnover achieved over the last financial year: Is it increasing or decreasing and why?
  • Company margin: Is it in line with industry averages? If not, what reasons explain this discrepancy?
  • Payroll: Is it competitive in the sector and, if not, why?

If the result of this exercise is negative, we can try to identify the responsible expense items. When it is positive, we must ensure that it is due to the company’s activity.

So, Why Does All This Matter?

Analysts use historical performance to predict future performance. Sometimes companies may record expenses unrelated to the business, causing profitability to be skewed and not accurately reflected. If this is not caught by or revealed to the analyst, the company’s reported profitability will be skewed and most likely understated. If the company’s profitability is skewed, then its value will be likewise inaccurate. Hence, the financial analysis enables accurate judgment of a company’s health, particularly in terms of solvency and profitability.

In particular, financial analysis is used when buying a company or when opening up one’s social capital to new investors.

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Matt Lawver

Matt Lawver

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