Financial Diagnosis:- When the words “income statement” and “balance sheet” are pronounced, the non-specialist says to himself: “it’s an accountant thing! “ But knowing how to decode these financial statements is proving to be a very valuable skill. As such, any leader should know how to interpret the accounting records of his company to verify the true impact of its strategy on its results.
Diagnostics Professionals
Business diagnostic consultants have this skill (or at least should). They are able to take a tax package and through some figures, some calculations, define the profile of the company: its position in the industry, its type of growth.
In digging, the problems become more and more precise without the entrepreneur saying anything about what motivated him to call on a consultant.
The latter will seek to understand what are the characteristics of the structure and operation of the company he is analyzing. It also defines the levers that explain its performance and / or its underperformance.
To interpret the accounts, the professional carries out two types of analysis. The first, the simplest since the information is directly available, is to compare the evolution of the results over several years. Any sharp decline or sharp rise has its explanation. Even stagnation can be indicative of a strategic fact. The second is to compare the figures observed with those made by other companies in the sector. By doing this, the analyst builds a standard that serves as a basis for assessing the specificity of his client.
Gross Margin, Revealing of Positioning
Some examples to illustrate our point, take the gross margin. To put it simply, this indicator is calculated by difference between the turnover achieved and the purchases consumed. Thus, it synthesizes much information that reveals the company’s position in its downstream and upstream markets, and its business.
Example: a first company (A) has a gross margin rate (gross margin / turnover) of 35%; a second (B) of 80%. They are competitors but do not have the same business model.
The first practices a trading activity. She buys and resells. All his business will be in this indicator, because the heart of his model is to buy at the best price to resell the most expensive possible. It has a 35% gross margin only because it brings almost no new value added to its product. She buys at 52 € and sells her product at 80 €.
The business model B is totally different. This is a manufacturer. He buys not finished products, but materials to manufacture it. He buys for 20 € and resells his product 100 €. Is it more profitable because it makes a gross profit of € 80 per product? The answer is no. His business model is simply different. The remaining margin will be used to finance the other valuable contributors: the staff who will manufacture the product and the means of production. Compared to company A, certainly, the stakes of the gross margin are important but everything is not played there. Production costs are also critical.
By practicing the analysis on the two axes evolution in the time and compared to the sector of activity, one realizes that the company which makes 35% of margin regularly improves this rate with a turnover which progresses strongly. The explanation is to look for the side of the decline in the ratio cost of purchase / turnover. This company is increasingly in the market and, as a result, obtains preferential pricing conditions from its suppliers.
We observe the gross margin rate of other market players; they are in the range of 75% -85%. Company B therefore has a very classic profile in a sector composed mainly of manufacturers. On the other hand, for the distributor A, this is not the case. In fact, this company is shaking up the manufacturers in place by practicing an aggressive price policy.
This is a very simplistic illustration but nevertheless shows the link between accounting results and strategy. It is easy to understand that beyond the name of the financial indicators, one has to control precisely their constitution. He who possesses this mastery is able to understand in detail the operation of the company and its stakes. There is nothing divinatory, it is not necessary to know how to read in the maps.
Hello everyone! This is Richard Daniels, a full-time passionate researcher & blogger. He holds a Ph.D. degree in Economics. He loves to write about economics, e-commerce, and business-related topics for students to assist them in their studies. That's the sole purpose of Business Study Notes.
Love my efforts? Don't forget to share this blog.
