With so much effort put into looking forward, it is equally important to look back and review the financial year that has just passed.
When reviewing financial results the time horizon in which results are reviewed sets the scene for the entire analysis.
A year on year review will compare 12 months of financial results to the corresponding previous 12 months. This can of course be for any 12 month period however a 12 month period that corresponds with your reporting period, such as 1 July to 30 June, is most common. You will note that the standard convention of year end accounts is to show the previous year results, however this merely shows the results for the two years. By performing certain calculations and analysing the results, as outlined below, and even visualising the year on year changes, as outlined here [placeholder], far greater insights can be gained.
Here are four key items to look for in a year on year review. Although some may seem obvious, ask yourself, have you done the following calculations and do you know the results for your organisation?
Most of us when reviewing financial reports will look to revenue first. Revenue is one of the most insightful figures (in addition and in combination with other figures such margins and cash – outlined below) when reviewing and analysing financials. It is a key indicator of growth or contraction and is often sighted in long term strategic planning.
Determine how revenue has changed year on year with the following formula:
(Revenue most recent 12 months / Revenue corresponding previous 12 months)
Review the year on year percentage change against your strategic objectives. Broadly speaking if the result is below zero it may suggest that your organisation is contracting and a result above zero may suggest that you are expanding. You may choose to use inflation or a number around 2% as your base rather than zero as you are effectively contracting if you are growing at less than inflation.
Any changes in revenue should be reviewed in the context of the events in the last 12 months. A key question to ask when reviewing revenue changes is whether any changes are systemic or one-off. Systemic changes occur due fundamental factors that are not one-off in nature. Declining revenue due to an increase in customer attrition caused by poor customer service would be an example of a systemic issue.
Conversely revenue may change due to a one-off event that was unpredictable and hopefully will not be repeated in the future. Decline in revenue due Covid-19 related issues is an example of a one-off issue.
Being able to differentiate between systemic and one-off issues is critical in reviewing year on year changes and will play a vital role in the action required next. Systemic issues are more likely to be repeated if not addressed, whereas one-off issues may resolve themselves or require a strategic organisational shift if the one-off is deemed to have now changed the landscape and environment in which your organisation operates. Such is the case for many organisations with Covid 19.
Once issues causing a change in revenue are identified, ask yourself, how likely is it that the issues will be repeated?
Your organisation’s ability to cover all of its expenses is key to your long term financial sustainability. The level of surpluses generated also reflects the financial efficiency of your organisation and your ability to manage margins.
Determine how surpluses have changed year on year with the following formulas:
Net profit margin:
Most recent 12 months: (Surplus / Revenue) x 100%
Corresponding previous 12 months: (Surplus / Revenue) x 100%
Compare the two net profit margins. A higher result in the most recent 12 months suggests that the organisation is financially more efficient. A lower result in the most recent 12 months suggests that the organisation is financially less efficient and may be experiencing issues regarding margin management.
Again ask yourself if margins are being compressed because of systemic or one-off issues and how likely it is that these issues will be repeated? You may be less worried if margins this year have been compressed due one-off expenses that are unlikely to be repeated in comparison to margins falling due to systemic issues such as consistent overspending.
In addition to year on year changes in your net profit margin, it is worth noting that cash reserves are often built through year on year surplus. Each year your net profit margin should at a minimum beat inflation, and in addition to beating inflation contribute to your long-term cash target.
3. Key expense margins
Your organisation’s ability to manage margins is also key to the long term financial sustainability of your organisation. After all if expenses are increasing at a faster rate than revenue, financial losses will become inevitable.
To review key expense items, choose an expense item and review it as a percentage of revenue for both years.
Wages to revenue:
Most recent 12 months: (Wages / Revenue) x 100%
Corresponding previous 12 months: (Wages / Revenue) x 100%
Compare the two results. A higher result in the past 12 months suggests that the organisation is financially more efficient in relation to the expense item in question. A lower result in the past 12 months suggests that the organisation is financially less efficient in relation to the expense item and may be experiencing issues regarding margin management.
Margin management is vitally important to an organisation, particularly for a growing organisation. Organisations that are growing need to grow in a financially sustainable way and a key way to check this is by reviewing if margins are remaining stable or improving.
4. Cash position
It goes without saying that cash is critical to all organisations.
In relation to a year on year review, reviewing the closing cash position at the end of the most recent 12 months compared to the closing cash position at the end of the previous 12 months, allows you to cut through the noise that can occur in a raft of numbers. In 12 months many many transactions and changes would have occurred. Revenue may have increased, expenses may have increased and non cash items such as provisions may have changed.
By reviewing the closing cash positions, you can focus on the key question – “Are we holding more cash?”
Change in Cash held
Cash position at the end of the most recent 12 months
Cash position at the end of the corresponding previous 12 months
As mentioned earlier, it is also worth reviewing your closing cash position against your long-term cash target.
Each of the items above should be reviewed against your long term strategic objectives and considered specifically in relation to the goals and aspirations of your organisation.
Expanding your financial analysis and review to a 24 month – or longer – horizon will provide high level, longer term insights.
If you’d like any assistance with your end of year financial review, please call 1300 763 505 for an initial obligation free consultation with Dimitri.