One of the ironies in business is that insufficient data analysis is often caused by too much information, not too little. A few well chosen statistics that highlight critical trends and pinpoint areas that require follow-up may be much more useful than reams of reports. There are four standard ways of analyzing financial information:
- Variance (change) from last year, budget, etc., as a dollar amount or a percentage
- Vertical analysis for a particular fiscal period, expressing all items as a percentage of the top line (normally sales)
- Horizontal analysis shows percentage changes of a particular item over time
- Ratio analysis compares relations between two numbers and how they vary over time
For the revenue cycle, many standard measurements are based on vertical analysis of the income statement; that is, looking at gross margin, cost of sales or operating profit as a percentage of sales. Other measures use horizontal analysis; that is, how sales have changed over time.
Gross margin
The gross margin measures the amount of profit being generated by the operation of the business before selling and administrative expenses and non-operating costs such as interest and taxes. It measures the efficiency of the sales and production processes. Gross margin may be expressed directly as a number (Net Sales less Cost of Goods Sold) or as a percentage:
Gross Margin = (Net Sales – Cost of Goods Sold) / Net Sales
The trend in gross margin over time can be a critical leading indicator of positive or negative factors in the business. This analysis should be done by product or product line to permit detailed comparisons and review changes over time. Competitors’ gross margins can be gleaned from their annual reports.
Operating profit
The operating profit measures the amount of profit generated by the operation of the business before non-operating costs such as interest and taxes. It measures the efficiency of the entire business process before financing costs and taxes. Operating profit may be expressed directly as a number (Net Sales less Cost of Goods Sold less Selling and Administrative Expense) or as a percentage:
Operating Profit = (Net Sales – Cost of Goods Sold – Selling and Administrative Expense) / Net Sales
The trend in operating profit over time can be a critical leading indicator of positive or negative factors in the business. This analysis should be done by product or product line to permit detailed comparisons and review changes over time. Competitors’ operating profits can be gleaned from their annual reports.
In addition, Statistics Canada publishes extensive information by industry. For example, Quarterly Financial Statistics for Enterprises (catalogue number 61-008) is available at www.statcan.gc.ca. It includes information on the last five quarters.
Selling expense ratio
The selling expense ratio measures the efficiency of the sales force by expressing Selling Expense as a percentage of Net Sales:
Selling Expense Ratio = Selling Expense / Net Sales
For this measure, the important information lies in the trend, not the absolute number. Either Net Sales or Gross Sales may be used as long as the same number is used consistently over time. Net Sales is Gross Sales, less discounts and allowances.
See the Revenue Cycle chapter of Finance and Accounting PolicyPro from First Reference for more details.
Jeffrey is a popular presenter, and was an adjunct professor at York University for 15 years. He is a frequent course director and course author for many organizations, including provincial bodies of Chartered Professional Accountants across Canada.
He has written over 20 books including: Canadian Treasury Management, Canadian Risk Management, and Financial Instruments: A Guide for Financial Managers (all published by Thomson-Reuters/Carswell), as well as Finance and Accounting PolicyPro and Information Technology PolicyPro (guides to governance, procedures, and internal control), and Cash Management Toolkit for Small and Medium Businesses (all published by Chartered Professional Accountants of Canada [CPA Canada]).
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