Financial data
The financial position of a business is crucial to all decisions that it makes. Using financial information, a business should be able to identify what options it can afford when making decisions. This financial data can be used to forecast how decisions might affect the business’ cash flowThe movement of money in and out of the business. and assess any impact on future profitsThe amount of money made after all expenses have been paid..
The financial data that can help to inform business decisions includes:
- Costs and revenues - A business should be aware of what is happening to its total costsTotal costs are calculated by adding total fixed costs and total variable costs together and represent all the costs of the business when producing a certain level of output. and revenueThe income earned by a business over a period of time from selling its goods or services., and how well it is able to control them. This makes it easier to forecast what might happen in the future.
- Gross and net profit - Identifying what is happening to costs and revenues enables a business to calculate how this might affect both gross profitThe difference between sales revenue and the cost of making the product sold. and net profitThis profit is calculated by deducting all expenses away from gross profit., using historical profit information.
- Profit margins - profit marginThe difference between sales revenue and total costs expressed as a percentage. can be calculated and compared either to the business’ previous figures or to competitors’ figures. They can help a business to understand what is causing any change in its profit levels.
- Cash flow - Businesses need access to cash in order to survive. Accurately forecasting the cash flow in and out of a business is crucial when deciding what a business can and cannot afford to do.
- Break-even - Knowing the break-evenThe point where the business is not making a profit or a loss. point in the business’ output is important when making decisions about which products to make. It can help a business to avoid making unprofitable products.
- Average rate of return - Whenever investment decisions are required, a business will want to compare the expected returns from the options available. Calculating the average rate of returnA method of comparing the profitability of different choices over the expected life of an investment. for each project enables a business to do this. This helps the business to identify the most profitableAble to make a profit. options.
Benefits of using financial data
Making use of financial data often requires the use of percentages and percentage change calculations over time. This enables a business to see trends and make comparisons, which can be helpful when making decisions. In addition, this data can be useful when communicating with shareholderA part owner of a private or public limited company. or potential lenders about the performance of a business.
Limitations of using financial data
Despite the benefits of financial data, there are significant limitations that business owners need to understand.
Financial data can only be used after it has been collected, meaning that it is always out of date. While it can give insights into how a business has performed, it cannot predict the future. Business owners must take this into consideration when using company accounts to make big decisions.
When making decisions, a business owner should ensure that they are using a sufficient time period of information and a wide range of sources. For example, comparing three years’ worth of financial data is better than using one year, as it enables a business owner to make more informed decisions. Additionally, understanding other information - such as market trends (via market researchMarket research involves gathering data about customers, competitors and market trends.) and the activities of competitors - is essential and complements financial data.
Another limitation of financial data is the fact that statistics and data can be interpreted differently using different methods, which can lead to different conclusions being drawn. For example, ‘90 per cent of customers were satisfied with the service’ could be interpreted as ‘one in every ten customers is not satisfied with the service’.
The final limitation of using financial data is that it only shows how successful a business is in financial terms. Financial success is not the only indicator of business success, although to many businesses it is the most important. Some businesses judge their success in terms of their environmental impact or according to their ethical aims.
