The Role of Financial Analysis in Strategic Planning for Businesses
Concept of financial analysis
Financial analysis refers to a method of assessing a business, budgets, projects and different types of negotiation related to finance that helps in determining suitability and performance. In other words, financial analysis helps analyse if an entity is a liquid, stable, and solvent capable enough to warrant a monetary investment (Fuertes et al. 2020). Financial analyses are always conducted internally, and such analysis helps fund managers make decisions in future business and evaluate the previous trends that have resulted in past successes. However, the financial analysis may also be conducted externally as it can aid the investors in selecting the best possible investment opportunities.
The economic trends are evaluated using financial analysis, and with that help, the financial policies are set that help create long-term business activity plans (Gartenberg et al. 2019). An organisation’s financial statements comprising the cash flow statement, balance sheet and income statement, are analysed thoroughly by a financial analyst. In both corporate and investment settings of finance, financial analysis can be conducted
- Corporate financial analysis
The accounting department and the management analyse corporate finance to make improved business decisions (Palepu et al. 2020). This internal analysis comprises the internal rate return and net present value.
- Investment financial analysis
An external analyst to the company does the investment financial analysis family for various purposes of investment. The analysts can adopt either a top-down or a bottom-up approach. The former approach analyses the macroeconomic opportunities, and the latter approach helps conduct the ratio analysis (Hitt et al. 2019).
- Kinds of financial analysis
Financial analysis is mainly of two kinds . These are fundamental analysis and technical analysis.
In the former type of analysis, the ratios are acquired from the data, such as the company’s earnings per share, which helps determine the business value (Gartenberg et al. 2019). On the other hand, the later type of analysis is done using the statistical trend that is acquired using the trading activity. The market condition behind the pricing trends is analysed with the help of technical analysis.
Concept of strategic financial analysis
A strategic financial analysis refers to the review framework where the performance is analysed, goals are assessed, adjustments are made per the forecasts and strategies are made with the help of actual results (Gartenberg, 2019). The strategic financial analysis intends to analyse the framework where the performance can be analysed, goals can be assessed, and adjustments can be made according to the forecasts and the various types of strategy based on the actual results.
When reviewing the business financials, it is necessary to focus on the three key areas. These are cash flow, profit and loss and balance sheet.
What are the steps to conduct a strategic financial analysis?
Five steps shall be followed while conducting the strategic analysis of the financial statements
- Comparing the forecasts with that the monthly actuals
Reviewing the business financials regularly is regarded as a good start. For instance, using the LivePlan software helps compare work; hence, no spreadsheets will be required.
- Identification of the exceeding projections
In a given month, the actual financial performance can vary. In this regard, it is essential to identify the exceeding projections.
- Reviewing the income statements
Also known as profit and loss, the income statement helps document income and expenses (Gartenberg et al. 2019). Compared to the forecast, it will be seen whether the sales can meet the goals and whether the expenses align with the budget.
- Analysing the cash flow statement
The cash flow statement helps tell how the cash moves into the business.
- Reviewing the balance sheet
The balance sheets give a complete overview of the financial position. For instance, the number of assets the business possesses and the money owed is assessed with the help of balance sheets.
The function of financial analysis in the strategic planning for the business
In the strategic planning of a business, financial analysis plays a critical role as it offers the essential information which can state the development of a strategic plan. Suggested below are some of the ways that can be contributed by financial analysis to strategic planning of the growth of the business.
- It helps in assessing financial health: The company’s financial health is assessed by the financial analysis, which further helps in strategic planning. Various types of financial analysis tools assist in identifying the areas in which a company is encountering financial challenges (Fuertes et al. 2020). This can be due to low profitability, poor cash flow and increased debt. Information of this type is adopted to develop strategies, and after that, the company is assured a consolidated financial footing before it adopts a growth strategy in business.
- Determining the growth opportunities: The possible growth opportunities for a company can be assessed by financial analysis. For instance, the areas of a declining or rising business can be revealed by trend analysis. The ratio analysis can highlight the areas where the company performs better than its competitors (Gartenberg et al. 2019). Relevant information of this type can be used to develop strategies that help fund the business’s capitalising growth opportunities and recognise the profitable new markets or the product lines the company can pursue.
- Evaluation of risk: The risks associated with the business’s different growth strategies are evaluated with the help of financial analysis. For instance, if a company decides to expand to new areas, financial analysis helps identify the potential risk associated with that new place. This can comprise the regulatory issue and competitive economic conditions (Palepu et al. 2020). The information used to develop suitable strategies helps mitigate the risk and further ensures that the company is displaced in a safe position to expand the business in the new market.
- Allocating Resources: Companies are helped to allocate their resources by financial analysis to achieve their strategic objectives. For instance, if a company thinks of expanding its product line, it can identify which product lines are the most profitable, and this is done with the help of financial analysis (Palepu et al. 2020). In addition, the companies are also assisted by financial analysis to determine which product lines require additional investment so that they can become profitable in future. Thus this information helps determine how to allocate the resources so that they offer the potential for the company to achieve its objectives.
- Monitoring progress: A company can monitor its progress towards its strategic objectives. By analysing financial data regularly, companies can track their progress to track their goals and make necessary adjustments accordingly. For instance, if a company fails to meet profitable targets, financial analysis helps identify areas where expenses can be reduced, and extra revenue can be generated to develop and increase profitability.
Importance of financial analysis in a business
There are various benefits of financial analysis in a business. Companies can make informed decisions related to business planning with the help of financial analysis. The business leaders get informed about where to invest the money that will help them earn substantial profits. Business leaders better understand financial statements and this in-depth understanding helps evaluate past performance and foresee prospects. Moreover, financial analysis helps develop communication between various organisations and their stakeholders (Hitt et al. 2019). By presenting lucid and precise information about the business’s financial health, stakeholders are well-informed about the opportunities and risks associated with the business. In an organisation, greater transparency can be promoted with the help of financial analysis. It also helps to improve the efficiency of the business (Palepu e al. 2020). Finally, it helps analyse the competitors so that an organisation can acquire a competitive advantage, overcome their weaknesses, ad overcome their strengths.
- Fuertes, G., Alfaro, M., Vargas, M., Gutierrez, S., Ternero, R. and Sabattin, J., 2020. Conceptual framework for the strategic management: a literature review—descriptive. Journal of Engineering, 2020, pp.1-21.
- Gartenberg, C., Prat, A. and Serafeim, G., 2019. Corporate purpose and financial performance. Organization Science, 30(1), pp.1-18.
- Palepu, K.G., Healy, P.M., Wright, S., Bradbury, M. and Coulton, J., 2020. Business analysis and valuation: Using financial statements. Cengage AU.
- Hitt, M.A., Ireland, R.D. and Hoskisson, R.E., 2019. Strategic management: Concepts and cases: Competitiveness and globalisation. Cengage Learning.
1. What do you mean by financial analysis?
Ans: Financial analysis refers t the method of evaluating a business, finance-related transactions and budgets to determine their suitability and performance. In other words, it analyses whether the entities are profitable enough to warrant a monetary investment.
2. Define corporate financial analysis.
Ans: The analysis in corporate finance is conducted internally by the accounts department, and it is shared with the management so that they can develop their strategies related to decision-making. The internal analysis comprises the NPV, Net Present Value, and IRR or Internal Rate of Return.
3. Mention any two steps of conducting the strategic financial analysis.
Ans: The two steps that are needed in conducting the strategic financial analysis are:
- Allocating resources: Companies are associated with allocating their resources through financial analysis to achieve their strategic objectives. Furthermore, companies are also helped by financial analysis to comprehend which product lines require additional investment to become profitable in the future.
- Risk evaluation: The risks associated with the business’s different growth strategies are assessed with the help of financial analysis. In other words, it refers to evaluating the probability that an investment or a financial asset can lose value.
4. State the two kinds of financial analysis.
Ans: The two kinds of financial analysis are `technical analysis and fundamental analysis, in which fundamental analysis use financial statements and ratios to evaluate the value of intrinsic security. On the other hand, a security value is assumed by the technical analysis, which determines the price and mostly focuses on trends.
5. How is financial analysis important in strategic planning for business?
Ans: In the strategic planning of a business, financial analysis determines the growth opportunities, looks for allocation of resources, monitors progress and evaluates risks.
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