Our Favorite Financial Analyses

  • By Bryan Lapidus, FPAC
  • Published: 5/7/2024

Our Favorite Financial Analyses HeaderAs a fun activity to accompany the release of the AFP FP&A Guide to What Is Financial Analysis, we asked the members of our three global FP&A Advisory Councils to share their favorite financial analyses. (Well, this is how FP&A nerds have fun!)

Some of these analyses may be familiar to anyone studying the FPAC; others reflect the working experience of our advisory council. Read on to see if your favorite made the list.

AFP FP&A Guide to What Is Financial Analysis

Featuring comprehensive insights into the role of financial analysis within the CFO framework, this guide offers theoretical insights and practical strategies, equipping you with the necessary knowledge of financial applications and modeling tools essential for the job.

Download the Guide

Income Statement Analyses

Gross Profit Dollars

Gross Profit = Revenue – Cost of Goods Sold (COGS)

Jeff Zielinski: Gross profit dollars are the "fuel" for the entire business, paying for R&D and Sales. They are also an acid test of the company's value-add to customers. One caveat is that our technology business is not capital-intensive, so there is less variance between accounting profit and free cash flow; gross profit dollars are less appropriate for capital-intensive businesses.

Gross Margin Before Slotting, After Direct Marketing Expense and Brokerage

(Gross Profit + Slotting – Marketing Expense – Brokerage) / (Net Sales + Slotting)

Danny Shiu: This measures the true margin of a product, the bottom-line impact, if we sell one more or one fewer unit. “Slotting” is a trade expense above Net Sales, defined as new item funding and new distribution expenses; it is amortized on the P&L and is not necessarily associated with the current period's sales, so I prefer to add it back. “Marketing Expense” is a direct expense, including advertising, media and shopper marketing activity but excluding marketing overhead. “Brokerage” is the commissions paid to brokers for representing the company with customers. I like to incorporate those because they can be directly attributed to the unit sold.

Berry Ratio

Berry Ratio = Gross Margin / Operating Expenses

Connagh Hopkins: This helps to understand a company’s cost structure by comparing the profitability of the product, defined as gross margin, to the administrative overhead in the operating expenses. While the calculation will tell you if you are operating at a profit (a ratio greater than 1) or loss (a ratio less than 1) for a given period, the ability to track progress over time or benchmark is valuable.

Profitability Ratios

ROI = Net Income / Investment Cost * 100%

Gross Profit Margin = (Revenue - COGS) / Revenue * 100%

Mario Vasquez: ROI is calculated for every possible company investment. We typically have multiple possible investments to compare at one time, and having ROI calculated for every option provides a point of comparison. The option with the highest ROI has a good chance of being the one to move forward with, but not always.

Gross Profit Margin has multiple uses, including monitoring trends to know which areas of a company's business are doing well and which are struggling. We look at this ratio to see which areas might need to be doubled down on or possibly even shut down.

Price/Volume/Mix Analysis and a Waterfall Chart

Price Variance Analysis: (Current Price – Prior Price) x Current Unit

Volume Variance Analysis: (Current Unit Sales – Prior Unit Sales) x Prior Price Per Unit

Douglas Yeung: Price/volume variance analysis is a very good tool for understanding whether the change in sales (or earnings) across periods was due to changes in price or the number of units sold (volume). This can tease out the impact of product mix over time as most companies sell products at various price (and profitability) levels.

Presenting these components in a waterfall chart allows finance to present a series of business drivers that contribute to the KPI measured, each driver with specific owners and actions.

Contribution Margin (CM)

Gross CM = (Revenue – Variable Costs)
Where variable costs include materials, labor, commissions

CM Ratio = CM/Revenue

Marcus Gadson: A measure of marginal product profitability, literally what each unit contributes today exclusive of the fixed cost investments which cannot be impacted in the short term. For companies with different business units, products, and services, this is helpful in determining where leadership attention should be allocated.

Balance Sheet/Cash Flow Analyses

Gearing Ratio (Financial Leverage Ratio)

Gearing Ratio = Total Debt / Total Equity

Reda Shousha: This measures the proportion of a company's capital that is financed through debt compared to equity. Total Debt represents all the financial obligations of the company, including short-term and long-term debt. Total Equity represents the shareholders' equity or the value of the company that belongs to its shareholders.

A high gearing ratio suggests that a company has more debt relative to equity, which can amplify returns on equity if growth projects are being funded by debt (assuming the projects make more money than the cost of the debt). However, a high gearing ratio increases financial risk due to the obligation to pay interest and principal on the debt and may scare creditors. If cash flows slip, the company may not be able to service the debt (i.e., pay their bills). A low gearing ratio is the inverse and shows fiscal conservatism and the ability to take on future loans.

Cash In/Out Ratio

Cash In/Out Ratio = Period Cash-In / Period Cash-Out

Sultan Mujallid: This is an easy way to analyze or forecast your cash balances. A ratio greater than 1 means cash is coming in the door and adding to the available balance; a ratio less than 1 means cash is leaving and, if it continues, will require the company to tap alternative sources to pay bills. The ratio can be applied to monthly, quarterly and yearly figures and is used as a benchmarking ratio against periods or industry peers.

Cash Conversion Cycle

Cash Conversion Cycle (CCC) = Days Inventory Outstanding (DIO) + Days Sales Outstanding (DSO) – Days Payable Outstanding (DPO)

Scott W. Corvey: This is used to calculate the number of days to “turn inventory, then trade receivables back into cash.” Each component in this chain is individually measurable and thus actionable to “optimize” this cycle. Generally, a shorter cycle (in days) is preferred because it means more cash is flowing in to fund operations. Some companies take your payment before building your product (famously, Dell Computers), leading to a negative CCC. Furthermore, benchmarking this metric against yourself over a time horizon (improvement/erosion) — and, if possible, your competitors, industry and industry leader — lends even more value to this metric.

Crossing Income Statement and Balance Sheet Analyses

DuPont Formula

Return on Equity = (Income/Revenue) * (Revenue/Assets) * (Assets/Equity)

Bryan Lapidus: ROE is a key metric for shareholders to determine whether they are getting their money’s worth on an investment, and the DuPont formula disaggregates ROE into component parts that span the income statement and balance sheet. The first term tells you your profit margin, the second tells how well your assets are generating revenue, and the third tells your financial leverage.

Economic Value Added (EVA)

EVA = Earnings – Cost of Capital
Where Earnings is Net Operating Profit After Taxes (NOPAT), and CoC is (Invested Capital * Cost of Capital)

Hesham Mokhiemer: EVA goes beyond traditional accounting metrics by subtracting the cost of capital from the operating profits. The inclusion of the cost of capital helps to assess whether a company is creating or destroying shareholder value and provides a clearer picture of a company's true profitability. Positive EVA suggests that a company is generating earnings above its cost of capital, indicating value creation, while negative EVA may signal value destruction. I find EVA valuable for evaluating the economic performance of a business and aligning it with shareholder interests.

Other Analyses

Scenario Analysis

Calculating the effect on outputs when multiple input values are changed simultaneously.

Rosemary Linden: Scenario analysis helps me make informed decisions in uncertain situations. I use scenario analysis to determine the impact that variables, such as fluctuating exchange rates, sales growth rates, interest rates or commodity prices, have on a company's financial performance. I typically create three scenarios: baseline, better and worse. I consider the potential implications of each scenario and develop strategies to mitigate risks or capitalize on opportunities.

Key Performance Indicator (KPI) Analytics

Augment a driver's unit value by running a statistical analysis (e.g., correlation analysis) to determine the validity of the relationship, its threshold (i.e., how much is needed to move the needle), and most importantly, its impact.

Lawrence Maisel: It is critical to assess the cause-and-effect relationship between an operational driver and a financial result, both actual and forecasted value. I use KPI analytics to analyze financial results in a current period and on a quarter-on-quarter basis (traditional volume/usage analysis). It is also used for forecasting future periods (rolling forecast), developing scenario analyses based on the threshold level and calculating the financial impact (quantity times driver unit value).

Decomposition Tree

A PowerBI interactive visual for ad hoc exploration and conducting root cause analysis. It's also an artificial intelligence (AI) visualization.

Mohamed ElRouby: A decomposition tree interactive chart is used to split the values of a measure into multiple groups based on dimensions and view the data in each dimension. I use it frequently to analyze the sales drivers by country, product, franchise, business unit, SKU, etc. Start with the variance, then click on it, and it will show you the drivers at level 1 (e.g., sales by country). Then click on the variance at a certain country, and it will give you which region. Then click on the region, and it can give you the drivers by each sales rep. You can design the structure as you wish.

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