Blog · Finance metrics and formulas · Finance and FP&A teams
Financial analysis connects a company's revenue, costs, earnings and cash to the decisions managers need to make. Use a checked quarterly example to read the statements together, explain changes and assign the next investigation.
Financial analysis connects revenue, costs, profit and cash so managers can decide what to change. Read the financial statements together, compare consistent periods and investigate the operating rows behind the movement. Higher sales alone do not establish that growth is profitable or that the company has enough cash to fund it.
Write the question before selecting measures. A pricing review needs revenue, discounts and product costs. A staffing decision needs workload, capacity and payroll. A funding review needs cash timing and obligations as well as earnings.
The SEC's guide to financial statements distinguishes the balance sheet's position at a point in time from income and cash flow statements covering a period. It also describes the statement of shareholders' equity, which explains changes in owners' interests. Those statements serve related purposes:
| Statement | Management question | Useful supporting export |
|---|---|---|
| Income statement | Did sales cover the costs recognized in the period? | Revenue and expense ledger by department or product |
| Balance sheet | What resources and obligations exist at the reporting date? | Receivables, inventory, payables and debt schedules |
| Cash flow statement | Where did cash come from and where did it go? | Cash movements and the profit-to-cash reconciliation |
| Statement of equity | How did earnings, distributions and owner transactions change equity? | Equity account detail and approved transaction records |
Use closed periods with the same entity scope, currency and accounting policies. Keep actual, budget and forecast amounts labeled. The detailed balance-sheet analysis process addresses individual balances; this overview focuses on how the statements inform one management decision.
Start with the dollar change between periods. Then ask whether the change is large relative to the business. Common-size analysis expresses income statement lines as a share of revenue; ratio analysis compares related flows or balances.
Dollar change = Current period amount − Prior period amount
Percentage change = Dollar change / Prior period amount
Gross margin = (Revenue − Cost of goods sold) / Revenue
Operating margin = Operating profit / Revenue
Current ratio = Current assets / Current liabilities
The CFA Institute's financial analysis techniques reading explains time-series comparisons, common-size statements and the main ratio families. These methods organize the evidence; they do not supply a universal threshold that makes every company healthy.
If a prior-period amount is zero, its percentage change is undefined. Show the dollar movement and label the percentage unavailable rather than replacing the denominator or presenting a misleading zero.
An illustrative US distributor compares two consecutive quarters of equal length. All figures are USD, the accounting policies are unchanged and no acquisition changes the reporting scope. Depreciation is already included in the costs above operating profit.
| Income statement line | Quarter 1 (USD) | Quarter 2 (USD) | Calculation |
|---|---|---|---|
| Net revenue | 2,000,000 | 2,400,000 | Ledger total |
| Cost of goods sold | 1,200,000 | 1,560,000 | Ledger total |
| Gross profit | 800,000 | 840,000 | Revenue − COGS |
| Operating expenses | 500,000 | 600,000 | Ledger total |
| Operating profit | 300,000 | 240,000 | Gross profit − operating expenses |
| Interest expense | 20,000 | 20,000 | Ledger total |
| Income tax expense | 60,000 | 40,000 | Recorded expense |
| Net income | 220,000 | 180,000 | Operating profit − interest − tax |
Revenue grows by $400,000, or 20.0%. COGS grows by $360,000, leaving only $40,000 of additional gross profit. Operating expenses grow by $100,000, so operating profit falls by $60,000, or 20.0%.
The operating-profit bridge proves the explanation:
$300,000 + $400,000 − $360,000 − $100,000 = $240,000
Gross margin falls from $800,000 / $2,000,000 = 40.0% to $840,000 / $2,400,000 = 35.0%. Operating margin falls from 15.0% to 10.0%. Percentages are rounded to one decimal place; the dollar amounts are exact.
The action is to investigate price, unit cost and sales mix before assuming that the revenue increase justifies more spending. The gross profit margin article develops those drivers. Department detail is then needed to explain the operating-expense increase; a total expense line cannot establish which costs were avoidable.
The controller next reconciles net income to operating cash flow. In this simplified example, depreciation and the listed working-capital movements are the only adjustments. In a real company, include all other applicable noncash items and operating balance changes.
| Cash reconciliation | Quarter 1 (USD) | Quarter 2 (USD) |
|---|---|---|
| Net income | 220,000 | 180,000 |
| Add depreciation | 50,000 | 60,000 |
| Subtract increase in trade receivables | −40,000 | −120,000 |
| Subtract increase in inventory | −30,000 | −70,000 |
| Add increase in trade payables | 20,000 | 30,000 |
| Operating cash flow | 220,000 | 80,000 |
| Opening cash | 300,000 | 380,000 |
| Subtract capital purchases | −100,000 | −120,000 |
| Net borrowing less debt repayments | −40,000 | 20,000 |
| Closing cash | 380,000 | 360,000 |
Quarter 2 operating cash flow is $180,000 + $60,000 − $120,000 − $70,000 + $30,000 = $80,000. The closing-cash check is $380,000 + $80,000 − $120,000 + $20,000 = $360,000. It must agree with the balance sheet and reconciled cash accounts.
Operating cash generation falls by $140,000 even though sales rise. That makes customer collections and inventory commitments part of the decision, alongside margin. The distinction between cash flow and profit matters whenever a spending request relies on earnings as evidence of available funding.
Assume the following are the distributor's only current asset and current liability categories:
| Closing balance | Quarter 1 (USD) | Quarter 2 (USD) |
|---|---|---|
| Cash | 380,000 | 360,000 |
| Trade receivables | 400,000 | 520,000 |
| Inventory | 300,000 | 370,000 |
| Current assets | 1,080,000 | 1,250,000 |
| Trade payables | 280,000 | 310,000 |
| Short-term debt | 120,000 | 140,000 |
| Current liabilities | 400,000 | 450,000 |
| Current ratio | 2.70 times | 2.78 times |
The current ratio improves from $1,080,000 / $400,000 to $1,250,000 / $450,000, rounded to two decimals. Yet cash falls. The improvement comes from receivables and inventory, whose increases also appear in the cash reconciliation.
Finance should therefore ask the credit team about collection dates and operations about stock demand before approving a cash commitment. A current ratio is a position measure, not a payment calendar. Use financial ratios for the detailed liquidity and profitability calculations, and adapt the operating questions for specialized businesses such as healthcare financial analysis.
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Common methods include period comparisons, common-size statements, ratio analysis and bridges explaining dollar changes. Each serves a different purpose. A period comparison locates movement, percentages show relative size, ratios connect related balances, and a bridge explains how individual changes produce the reported result.
Financial reporting presents a company's results and position using defined accounting policies. Financial analysis interprets those results for a decision. The same reporting package might support questions about pricing, staffing, inventory or funding, each requiring a different comparison and different supporting rows.
Yes. Revenue may be recognized before customers pay, and inventory purchases may absorb cash before goods are sold. Capital spending and debt repayments also affect cash differently from earnings. Reconcile profit to operating cash flow, then include investing and financing movements before assessing available funding.
Finance normally owns reconciled inputs, accounting definitions and consistent calculations. Department managers own the operating explanations and proposed actions. Treasury reviews funding and payment timing, while the authorized business leader decides which commitments or changes to approve based on the evidence and remaining uncertainty.