Every entrepreneur needs to understand their business’s most relevant financial indicators to make strategic decisions. After all, management must understand these figures and monitor them as part of the corporate routine to achieve business objectives.
It’s common for entrepreneurs to focus on the day-to-day management of the company and neglect the financial area. This practice makes it difficult to measure the company’s performance, potentially leading to cash flow problems, excessive debt, and even bankruptcy.
To avoid this kind of situation, it’s worth knowing which metrics to follow. In this article, learn about the 8 key indicators in financial statement analysis that deserve your attention!
Which indicators to analyze in financial statements?
Each financial indicator offers a different perspective on the company’s health. Part of the analysis process should involve considering how they relate to and contribute to your business’s overall financial picture.
The analysis should be conducted with the company’s strategic objectives in mind. For example, if the goal is to improve liquidity and ensure sufficient resources for daily operations, data on current liquidity and drought may be crucial.
Furthermore, the assessment must consider the company’s context, including its operating sector and specific financial conditions. Thus, even though some indicators may be more critical in certain contexts, they should be evaluated together to form a comprehensive view.
See 8 essential indicators in the analysis of financial statements
Below, see the 8 most important indicators for analyzing a company’s financial statements!
1. ROI
ROI ( return on investment ) is one of the most useful indicators for understanding whether a business is financially successful in its initiatives. Simply put, it reveals the return obtained from a given action.
For example, if a company invests in a marketing campaign and wants to know whether the money allocated generated a positive return, ROI provides the answer. The index can also assess the return on investment for an entire department, as well as individual projects.
The metric is widely used to inform decisions involving capital investment initiatives within a company. Another function of ROI is to help compare performance across different companies.
ROI is calculated using the following formula:
ROI = Operating profit / Investment
2. ROA
ROA (return on assets) is a financial indicator similar to ROI, but with a different purpose. It serves to assess the efficiency with which a company uses its assets to generate profit. This provides a clear understanding of the effectiveness of investments in them.
The formula for calculating ROA is:
ROA = Operating Profit / Assets
A high ROA indicates that the company is using its assets efficiently to generate profits.
The indicator also helps you see how your business stacks up against its competitors. By analyzing other companies’ ROA, you can identify whether your company is utilizing its assets optimally or whether there are opportunities for optimization.
3. ROE
Rounding out the trio of financial indicators that analyze different types of returns is ROE (return on equity ) . It measures a company’s ability to generate value from its own resources.
To calculate ROE, use the following formula:
ROE = (Last 12 months net income / Shareholders’ equity) x 100
A high ROE indicates that the company generates a good return on the capital invested by shareholders, which is usually a sign of efficiency and profitability. Conversely, the opposite tends to indicate operational problems, poor management, or unprofitable investments.
4. EBITDA Margin
The indicator can be a great ally when it comes to determining how decisions unrelated to the company’s core operations or core business affect its results. This tends to mask its true productivity, requiring careful analysis.
5. Liquidity ratios
The ratios that calculate a company’s liquidity show the available capital it has to meet its financial commitments. As a result, they speak of the business’s capacity to fulfill its commitments.
Using the company’s balance sheet, it is possible to calculate liquidity ratios. It is worth noting that the higher the result, the greater the liquidity.
Below, learn about the main types of liquidity and find out how to calculate them!
Current liquidity
Current liquidity measures the company’s short-term availability of resources. It can be calculated as follows:
Current liquidity = Current assets / Current liabilities
Dry liquidity
Dry liquidity indicates the funds available for short-term obligations without the need to sell inventory. To calculate dry liquidity, use the following formula:
Liquidity = (Current assets – Inventories) / Current liabilities
Immediate liquidity
To calculate this metric, simply apply the following formula:
Immediate liquidity = Available resources / Current liabilities
General liquidity
Overall liquidity considers the calculation of short-, medium-, and long-term rights and obligations. To calculate this, use the following formula:
Overall liquidity = (Current assets + Long-term receivables) / (Current liabilities + Non-current liabilities)
6. Net margin
It provides a clear picture of how much revenue is converted into profit after deducting all costs, expenses, taxes, and interest.
The formula for calculating net margin is:
Net margin = Net profit / Total revenue
7. Contribution margin
A product’s contribution margin reflects the company’s gross profit from that item at that price. Thus, the contribution margin is the value of sales minus the costs and expenses generated by them.
A negative contribution margin represents an operation that generates losses for the company. In fact, it’s normal for a company to have products with different margins, reinforcing the importance of individual analysis.
Some items have higher margins but low unit prices or sales volumes. Conversely, there are products with lower margins but also higher sales volumes or higher prices.
8. Break-even point
After calculating the contribution margin for products and services sold, you can calculate the minimum sales volume needed to cover business expenses. This is the break- even point .
Analyzing your company’s break-even point helps you avoid operating at a loss and understand the revenue you need to generate a surplus.
