Financial Comparative Analysis

In terms of financial literacy, comparative analysis is a significant component that we need to consider. So, what is comparative analysis? It involves examining how your organisation compares to other organisations both within and outside of your industry, as well as assessing its performance over the years. Essentially, comparative analysis focuses on comparing historical performance and industry standards.

This can involve various calculations and ratios that help you analyse historical data and make comparisons with industry peers. Key types of analysis include:

1. Horizontal Analysis**: This compares financial data over two years.
2. Trend Analysis**: This observes financial data over three or more years.
3. Vertical Analysis**: This looks at the relationships within a single year’s financial statements, often by converting figures to percentages of sales to identify trends more easily.

A crucial concept to understand is the Compound Annual Growth Rate (CAGR). This is an imaginary number that represents the average rate at which an investment or other quantitative measure is growing at a steady rate. CAGR smooths out growth figures to make them easier to comprehend. However, it is also important to consider the actual growth rates, without smoothing, to gain a complete understanding of performance.

CAGR can be applied to a wide range of metrics, including investments, profits, sales, and customer satisfaction.

When conducting a situational analysis, you should focus on historical aspects such as liquidity, cash flow, profitability, stability, growth, and efficiency. These factors will help you identify key numbers that significantly impact your organisation. A critical aspect to examine is the relationship between debt and equity.

Here are a few key points to remember:

• Debt is generally cheaper but riskier: It must be repaid, along with interest.
• Equity is more expensive: Although it does not require repayment, issuing more equity can dilute existing shareholders' value.
• Equity implications: Increasing equity affects control, depending on its structure.

Industries typically have norms for acceptable levels of debt and equity, so it's beneficial to research these standards to gain insight into your organisation's position. This is often measured by calculating the debt-to-equity ratio.

When considering debt, it's essential to be informed about its purpose and your current levels. Questions to explore include:

• Can you increase or decrease your debt levels?
• Are there covenants associated with current or new debt?
• What are the restrictions on using lines of credit, particularly concerning operating expenses?

Lines of credit, in general, can only be used for operating expenses, and it’s necessary to determine whether the assets you are purchasing require long-term debt.

On the equity side, assess the capacity for raising additional equity. Sources of equity may include:

• Friends and family (often private funding)
• Venture capital
• Initial Public Offerings (IPOs) and other marketplaces

Keep in mind that IPOs can be costly. By carefully analysing all these factors, you’ll gain a clearer picture of your organisation’s financial standing and prospects.

When students evaluate the path forward, they often overlook the costs associated with conducting an IPO, which can be substantial. Additionally, the way equity is structured can have significant implications for control. Equity instruments include various types of common shares and their different classes. It’s important to remember the distinction between voting and non-voting shares, as this can vary between public and private companies. Typically, public companies offer fewer classes of shares, while private companies can have a more diverse range.

Furthermore, one must consider preferred shares and their terms, such as whether they can be repurchased or if there are any restrictions. Other factors to examine include retained earnings and shareholder loans, as these elements can affect the ability to raise equity.

When making comparisons, it’s critical to assess the balance sheet, flexibility, and risk tolerance of the company's owners. This is especially relevant for small and family-owned businesses, where tax and estate planning, as well as succession planning, are vital considerations.