When reviewing a company's financial statements, there are various types of analysis that one can perform to gain insights into the company's financial health and performance. In this article, we will discuss the three main types of analysis, namely vertical analysis, horizontal analysis, and key metrics, along with some unique metrics that can be used for further analysis.
The vertical analysis involves looking at the numbers as a percentage to a baseline number. For instance, in a profit and loss (P&L) statement, expenses are analyzed as a percentage of sales. This analysis helps keep expenses within reasonable benchmark percentages. Similarly, in a balance sheet, assets or liabilities are analyzed as a percentage of total assets or liabilities. For example, analyzing inventory value constantly increasing as a % of total current assets can be insightful.
Horizontal analysis, on the other hand, involves comparing data from the current period with that of previous periods. This analysis helps in identifying trends across periods. For instance, one can analyze the growth rate of sales, the rate of increase in marketing expenses, or the increase in receivables from customers as a percentage of sales.
Key metrics are the primary 4-5 things that one wants to evaluate to check the health of a business based on the objective the business is trying to achieve at that point and the industry/type of business model. These metrics can vary from one business to another. For instance, the key metrics for a service company may include revenue per employee, while for an early-stage startup, the burn multiple (how much is spent to earn Re 1 of
revenue) may be a critical metric. For SaaS, the rule of 40 (Sales Growth Rate
% + Net Profit %) is often used, while D2C brands may use CM1, CM2.
Apart from the three main types of analysis discussed above, there are many other metrics that can be used to gain deeper insights into a company's financial health and performance. These metrics can vary depending on the industry, business model, and objective. For example, some unique metrics for retail businesses can include footfall conversion rate, customer lifetime value, and inventory turnover ratio. In the tech industry, metrics such as Monthly Recurring Revenue (MRR), Churn rate, and Customer Acquisition Cost (CAC) can be used.
In conclusion, analyzing financial statements is crucial for understanding a company's financial health and performance. Vertical and horizontal analysis, along with key metrics, can help in gaining insights into various aspects of a business. Additionally, using unique metrics specific to a business's industry and objective can provide deeper insights into the company's financial health and performance.
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