Best Tools for financial analysis of SME

• October 15, 2020

The performance and overall success of your company depend on many factors, i.e. the industry in which you operate, your country, its economic conditions, your managerial skills, employees, etc.. Among these factors the size of business plays an important role and as small and medium-sized enterprises (hereafter SME), you must conduct an overall analysis to discover all the characteristics of your business for better managing resources and surviving among the huge enterprises.

So for ensuring that your business is financially healthy, you should periodically conduct a financial analysis that will give you information about the use of your limited resources.
Your advantage as SME is the flexibility of your business which enables you to react fast to any economic, market, or technological changes. But you must be very careful because these changes often bring financial risks that should be well managed.

For small or medium-sized enterprises, financial risks can differ from the risks encountered by large companies. Therefore, it is particularly important for SMEs to fully understand the causes of financial risks in order to be able to detect and control them on time and also to survive on the market and support further development (Shuying, & Mei 2014).

There are a huge variety of financial analysis models designed for different industries and types of companies. Here you can find key financial tools and techniques that will help you to build strong financial management for your SME.

Understanding financial statements

If you want to know your financial position and discover ways for continual improvement of business operations you should prepare precise and accurate financial statements which are the written summary of your company’s financial activities for a given period. A complete analysis of these three financial statements may provide you the information for diagnosing the financial strengths and weaknesses of your company:

1. Balance sheet is a detailed listing of the company’s assets, liabilities, and the value of the stakeholder’s equity. Assets and liabilities are classified in “current” and “non- current’’ types. Current refers to a period of fewer than 12 months and non-current is any period greater than 12 months. Current assets are likely to be turned into cash within a 12-month period and current liabilities must be repaid within that period. So, from this statement, you can understand what resources your business owns and what are the creditors and owner investments that supplied these resources. By analyzing the balance sheet you will discover what financial or physical resources you have for future business activities.
2. Profit and loss statement shows the company’s income and expenses over a certain period of time. By analyzing this statement you will know whether you had profit or loss which is the main indicator of your business productivity. This is the indicator that every stakeholder needs to know for making further decisions about the business continuity.
3. Statement of cash flows shows the summary of money coming into and going out of the business over a specific period. This statement can be very useful for your planning purposes and can warn you about the danger of cash flow difficulties. In comparison to large companies, your small business might not be well-diversified with credibility and assets and you might have limited access to a bank loan. So, you should regularly (monthly, quarterly, and yearly) analyze your cash flow statement to make sure that you are able to pay bills and that your business doesn’t run out of cash. This statement separately introduces your cash flows from operating, investing, and financing activities and shows how changes in balance sheet accounts and income affect cash and its equivalents, so you get a thorough understanding of your operations effectiveness.

Conducting ratio analysis

Apart from the analysis of financial statements you should also use their data to conduct ratio analysis which will give a clear view of your financial position. Ratios analyze and compare the relationship between key elements of your financial statements. There are four main categories of ratios that will give you a valuable information:

1. Profit and profitability (Profit Margin, Return on assets, etc.),
2. Firm efficiency (Asset turnover, Working capital, etc.),
3. Leverage (Debt equity, Interest coverage, etc.),
4. Liquidity (Cash/Total assets, Current ratio).

After calculating each ratio you should compare them to industry standards and understand your gaps or competitive advantages. You can also use ratios to compare your company’s current performance with past performance and indicate your developments or losses.

All these tools and techniques are just a small part of financial management, you should also analyze your company’s market and economic data, and be aware of any internal or external factors and changes that affect your financial and operational performance. Only then your small or medium-sized enterprise can be profitable and you will be able to think about future progress and extensions.