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Competitive Advantage Definition with Types and Examples

What Is a Competitive Advantage?

Competitive advantage refers to factors that allow a company to produce goods or services better or more cheaply than its rivals. These factors allow the productive entity to generate more sales or superior margins compared to its market rivals. Competitive advantages are attributed to a variety of factors including cost structure, branding, the quality of product offerings, the distribution network, intellectual property, and customer service.

Key Takeaways

  • Competitive advantage is what makes an entity’s products or services more desirable to customers than that of any other rival.
  • Competitive advantages can be broken down into comparative advantages and differential advantages.
  • Comparative advantage is a company’s ability to produce something more efficiently than a rival, which leads to greater profit margins.
  • A differential advantage is when a company’s products are seen as both unique and of higher quality, relative to those of a competitor.

Understanding Competitive Advantage

Competitive advantages generate greater value for a firm and its shareholders because of certain strengths or conditions. The more sustainable the competitive advantage, the more difficult it is for competitors to neutralize the advantage. The two main types of competitive advantages are comparative advantage and differential advantage.

The term “competitive advantage” traditionally refers to the business world, but can also be applied to a country, organization, or even a person who is competing for something.

Competitive Advantage vs. Comparative Advantage

A firm’s ability to produce a good or service more efficiently than its competitors, which leads to greater profit margins, creates a comparative advantage. Rational consumers will choose the cheaper of any two perfect substitutes offered. For example, a car owner will buy gasoline from a gas station that is 5 cents cheaper than other stations in the area. For imperfect substitutes, like Pepsi versus Coke, higher margins for the lowest-cost producers can eventually bring superior returns.

Economies of scale, efficient internal systems, and geographic location can also create a comparative advantage. Comparative advantage does not imply a better product or service, though. It only shows the firm can offer a product or service of the same value at a lower price.

For example, a firm that manufactures a product in China may have lower labor costs than a company that manufactures in the U.S., so it can offer an equal product at a lower price. In the context of international trade economics, opportunity cost determines comparative advantages. 

Amazon (AMZN) is an example of a company focused on building and maintaining a comparative advantage. The e-commerce platform has a level of scale and efficiency that is difficult for retail competitors to replicate, allowing it to rise to prominence largely through price competition.

Competitive Advantage vs. Differential Advantage

A differential advantage is when a firm’s products or services differ from its competitors’ offerings and are seen as superior. Advanced technology, patent-protected products or processes, superior personnel, and strong brand identity are all drivers of differential advantage. These factors support wide margins and large market shares.

Apple is famous for creating innovative products, such as the iPhone, and supporting its market leadership with savvy marketing campaigns to build an elite brand. Major drug companies can also market branded drugs at high price points because they are protected by patents.

How Do I Know If a Company Has a Competitive Advantage?

If a business can increase its market share through increased efficiency or productivity, it would have a competitive advantage over its competitors.

How Can a Company Increase Its Competitive Advantage?

Lasting competitive advantages tend to be things competitors cannot easily replicate or imitate. Warren Buffet calls sustainable competitive advantages economic moats, which businesses can figuratively dig around themselves to entrench competitive advantages. This can include strengthening one’s brand, raising barriers to new entrants (such as through regulations), and the defense of intellectual property.

Why Do Larger Companies Often Have Competitive Advantages?

Competitive advantages that accrue from economies of scale typically refer to supply-side advantages, such as the purchasing power of a large restaurant or retail chain. But advantages of scale also exist on the demand side—they are commonly referred to as network effects. This happens when a service becomes more valuable to all of its users as the service adds more users. The result can often be a winner-take-all dynamic in the industry.

How Is Competitive Advantage Different From Comparative Advantage?

Comparative advantage mostly refers to international trade. It posits that a country should focus on what it can produce and export relatively the cheapest—thus if one country has a competitive advantage in producing both products A & B, it should only produce product A if it can do it better than B and import B from some other country.

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Corporate Finance Definition and Activities
Corporate Finance Definition and Activities

Corporate Finance Definition and Activities

What Is Corporate Finance?

Corporate finance is a subfield of finance that deals with how corporations address funding sources, capital structuring, accounting, and investment decisions.

Corporate finance is often concerned with maximizing shareholder value through long- and short-term financial planning and the implementation of various strategies. Corporate finance activities range from capital investment to tax considerations.

Key Takeaways

  • Corporate finance is concerned with how businesses fund their operations in order to maximize profits and minimize costs.
  • It deals with the day-to-day demands on business cash flows as well as with long-term financing goals (e.g., issuing bonds).
  • Corporate finance also deals with monitoring cash flows, accounting, preparing financial statements, and taxation.
  • Determining whether or not to issue a dividend is another corporate finance activity.
  • Corporate finance jobs can pay attractive salaries.

Understanding Corporate Finance

Corporate finance departments are charged with managing their firms’ financial activities and capital investment decisions. Such decisions include whether to pursue a proposed investment and whether to pay for the investment with equity, debt, or both.

They also include whether shareholders should receive dividends, and if so, at what dividend yield. Additionally, the finance department manages current assets, current liabilities, and inventory control.

A company’s corporate finance activities are often overseen by its chief financial officer (CFO).

Corporate Finance Activities

Capital Investments

Corporate finance tasks include making capital investments and deploying a company’s long-term capital. The capital investment decision process is primarily concerned with capital budgeting.

Through capital budgeting, a company identifies capital expenditures, estimates future cash flows from proposed capital projects, compares planned investments with potential proceeds, and decides which projects to include in its capital budget.

Making capital investments is perhaps the most important corporate finance task and can have serious business implications. Poor capital budgeting (e.g., excessive investing or under-funded investments) can compromise a company’s financial position, either because of increased financing costs or inadequate operating capacity.

How to Successfully Handle Your Company’s Finances

Corporate financing includes the activities involved with a corporation’s financing, investment, and capital budgeting decisions.

Capital Financing

Corporate finance also involves sourcing capital in the form of debt or equity. A company may borrow from commercial banks and other financial intermediaries or may issue debt securities in the capital markets through investment banks. A company may also choose to sell stocks to equity investors, especially when it needs large amounts of capital for business expansions.

Capital financing is a balancing act involving decisions about the necessary amounts of debt and equity. Having too much debt may increase default risk, and relying heavily on equity can dilute earnings and value for early investors. In the end, though, capital financing must provide the capital needed to implement capital investments.

Short-Term Liquidity

A corporate finance department is also tasked with short-term financial management. The goal is to ensure that there is enough liquidity to carry out continuing operations. Short-term financial management concerns current assets and current liabilities, or working capital and operating cash flows.

A company must be able to meet all its current obligations when they are due. This involves having enough current liquid assets to avoid disrupting a company’s operations. Short-term financial management may also involve getting additional credit lines or issuing commercial paper as liquidity backup.

Working in Corporate Finance

Positions in the area of corporate finance attract many job seekers. In fact, there’s typically great competition for many of these types of jobs. Some of the many corporate finance job titles include:

  • Chief financial officer
  • Financial planning and analysis manager
  • Cost analyst
  • Financial analyst
  • Treasurer
  • Corporate accountant

Corporate finance salaries can vary among companies. However, according to top job site, Indeed, the national average annual salaries for the positions noted above are:

  • Chief financial officer: $133,898
  • Financial planning and analysis manager: $113,770
  • Cost analyst: $83,304
  • Financial analyst: $71,556
  • Treasurer: $80,428
  • Corporate accountant: $66,515

What Does Corporate Finance Do?

Corporate finance departments in companies focus on solid decision-making for profitable financial results. Thus, corporate finance involves activities that relate to the budgeting of capital, the debt and equity used to finance operations, management of working capital, and shareholder dividends.

What Is Corporate Finance vs. Finance?

Corporate finance is one of the subfields of the overall finance category. The others include public (or government) finance and personal finance.

What Are the 3 Main Areas of Corporate Finance?

The main areas of corporate finance are capital budgeting (e.g., for investing in company projects), capital financing (deciding how to fund projects/operations), and working capital management (managing assets and liabilities to operate efficiently).

The Bottom Line

Corporate finance is a subset of the field of finance. It concerns proper budgeting, raising capital to meet company needs and objectives with debt and/or equity, and the efficient management of a company’s current assets and liabilities. The various jobs in corporate finance can pay well.

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How to Successfully Handle Your Companys Finance Efficiently

In business, finance management is the practice of handling a company’s finances in a way that allows it to be successful and compliant with regulations. That takes both a high-level plan and boots-on-the-ground execution.

What Is Financial Management?

At its core, financial management is the practice of making a business plan and then ensuring all departments stay on track. Solid financial management enables the CFO or VP of finance to provide data that supports creation of a long-range vision, informs decisions on where to invest, and yields insights on how to fund those investments, liquidity, profitability, cash runway and more.

ERP software can help finance teams achieve these goals: A financial management system combines several financial functions, such as accounting, fixed-asset management, revenue recognition and payment processing. By integrating these key components, a financial management system ensures real-time visibility into the financial state of a company while facilitating day-to-day operations, like period-end close processes.

Objectives of Financial Management

Building on those pillars, financial managers help their companies in a variety of ways, including but not limited to:

Maximizing profits

Provide insights on, for example, rising costs of raw materials that might trigger an increase in the cost of goods sold.

Tracking liquidity and cash flow

Ensure the company has enough money on hand to meet its obligations.

Ensuring compliance

Keep up with state, federal and industry-specific regulations.

Developing financial scenarios

These are based on the business’ current state and forecasts that assume a wide range of outcomes based on possible market conditions.

Manage relationships

Dealing effectively with investors and the boards of directors.

Ultimately, it’s about applying effective management principles to the company’s financial structure.

Scope of Financial Management

Financial management encompasses four major areas:

  1. Planning

    The financial manager projects how much money the company will need in order to maintain positive cash flow, allocate funds to grow or add new products or services and cope with unexpected events, and shares that information with business colleagues.

    Planning may be broken down into categories including capital expenses, T&E and workforce and indirect and operational expenses.

  2. Budgeting

    The financial manager allocates the company’s available funds to meet costs, such as mortgages or rents, salaries, raw materials, employee T&E and other obligations. Ideally there will be some left to put aside for emergencies and to fund new business opportunities.

    Companies generally have a master budget and may have separate sub documents covering, for example, cash flow and operations; budgets may be static or flexible.

    Static vs. Flexible Budgeting

    StaticFlexible
    Remains the same even if there are significant changes from the assumptions made during planning.Adjusts based on changes in the assumptions used in the planning process.
  3. Managing and assessing risk

    Line-of-business executives look to their financial managers to assess and provide compensating controls for a variety of risks, including:

    • Market riskAffects the business’ investments as well as, for public companies, reporting and stock performance. May also reflect financial risk particular to the industry, such as a pandemic affecting restaurants or the shift of retail to a direct-to-consumer model.
    • Credit riskThe effects of, for example, customers not paying their invoices on time and thus the business not having funds to meet obligations, which may adversely affect creditworthiness and valuation, which dictates ability to borrow at favorable rates.
    • Liquidity riskFinance teams must track current cash flow, estimate future cash needs and be prepared to free up working capital as needed.
    • Operational riskThis is a catch-all category, and one new to some finance teams. It may include, for example, the risk of a cyber-attack and whether to purchase cybersecurity insurance, what disaster recovery and business continuity plans are in place and what crisis management practices are triggered if a senior executive is accused of fraud or misconduct.
  4. Procedures

    The financial manager sets procedures regarding how the finance team will process and distribute financial data, like invoices, payments and reports, with security and accuracy. These written procedures also outline who is responsible for making financial decisions at the company — and who signs off on those decisions.

    Companies don’t need to start from scratch; there are policy and procedure templates available for a variety of organization types, such as this one for nonprofits.

Functions of Financial Management

More practically, a financial manager’s activities in the above areas revolve around planning and forecasting and controlling expenditures.

The FP&A function includes issuing P&L statements, analyzing which product lines or services have the highest profit margin or contribute the most to net profitability, maintaining the budget and forecasting the company’s future financial performance and scenario planning.

Managing cash flow is also key. The financial manager must make sure there’s enough cash on hand for day-to-day operations, like paying workers and purchasing raw materials for production. This involves overseeing cash as it flows both in and out of the business, a practice called cash management.

Along with cash management, financial management includes revenue recognition, or reporting the company’s revenue according to standard accounting principles. Balancing accounts receivable turnover ratios is a key part of strategic cash conservation and management. This may sound simple, but it isn’t always: At some companies, customers might pay months after receiving your service. At what point do you consider that money “yours” — and report the good news to investors?

5 Tips to Improve Your Accounts Receivable Turnover Ratio

  1. Invoice regularly and accurately. If invoices don’t go out on time, money will not come in on time.
  1. Always state payment terms. You can’t enforce policies that you haven’t communicated to clients. If you make changes, call them out.
  1. Offer multiple ways to pay. New B2B options are coming online. Have you considered a payment gateway?
  1. Set follow-up reminders. Don’t wait until customers are in arrears to start collection procedures. Be proactive, but not annoying, with reminders.
  1. Consider offering discounts for cash and prepayments. Cash(less) is king in retail, and you can reduce AR costs by encouraging customers to pay ahead rather than on your normal customer credit terms.
Learn more about maximizing your AR turnover ratios.

Finally, managing financial controls involves analyzing how the company is performing financially compared with its plans and budgets. Methods for doing this include financial ratio analysis, in which the financial manager compares line items on the company’s financial statements.

Strategic vs. Tactical Financial Management

On a tactical level, financial management procedures govern how you process daily transactions, perform the monthly financial close, compare actual spending to what’s budgeted and ensure you meet auditor and tax requirements.

On a more strategic level, financial management feeds into vital FP&A (financial planning and analysis) and visioning activities, where finance leaders use data to help line-of-business colleagues plan future investments, spot opportunities and build resilient companies.

The 6 Ways to Grow a Company

 

Importance of Financial Management

Solid financial management provides the foundation for three pillars of sound fiscal governance:

  1. Strategizing

    Identifying what needs to happen financially for the company to achieve its short- and long-term goals. Leaders need insights into current performance for scenario planning, for example.

  2. Decision-making

    Helping business leaders decide the best way to execute on plans by providing up-to-date financial reports and data on relevant KPIs.

  3. Controlling

    Ensuring each department is contributing to the vision and operating within budget and in alignment with strategy.

With effective financial management, all employees know where the company is headed, and they have visibility into progress.

What Are the Three Types of Financial Management?

The functions above can be grouped into three broader types of financial management:

  1. Capital budgeting

    Relates to identifying what needs to happen financially for the company to achieve its short- and long-term goals. Where should capital funds be expended to support growth?

  2. Capital structure

    Determine how to pay for operations and/or growth. If interest rates are low, taking on debt might be the best answer. A company might also seek funding from a private equity firm, consider selling assets like real estate or, where applicable, selling equity.

  3. Working capital management

    As discussed above, is making sure there’s enough cash on hand for day-to-day operations, like paying workers and purchasing raw materials for production.

What Is an Example of Financial Management?

We’ve covered some examples of financial management in the “functions” section above. Now, let’s cover how they all work together:

Say the CEO of a toothpaste company wants to introduce a new product: toothbrushes. She’ll call on her team to estimate the cost of producing the toothbrushes and the financial manager to determine where those funds should come from — for example, a bank loan.

The financial manager will acquire those funds and ensure they’re allocated to manufacture toothbrushes in the most cost-effective way possible. Assuming the toothbrushes sell well, the financial manager will gather data to help the management team decide whether to put the profits toward producing more toothbrushes, start a line of mouthwashes, pay a dividend to shareholders or take some other action.

Throughout the process, the financial manager will ensure the company has enough cash on hand to pay the new workers producing the toothbrushes. She’ll also analyze whether the company is spending and generating as much money as she estimated when she budgeted for the project.

Financial Management for Startups

At the outset, financial management responsibilities within a startup include making and sticking to a budget that aligns with the business plan, evaluating what to do with profits and making sure your bills get paid and that customers pay you.

As the company grows and adds finance and accounting contractors or staffers, financial management gets more complicated. You need to make sure your employees get paid, with accurate deductions; properly file taxes and financial statements; and watch for errors and fraud.

This all circles back to our opening discussion of balancing strategic and tactical. By building a plan, you can answer the big questions: Are our goods and services profitable? Can we afford to launch a new product or make that hire? What might the coming 12 to 18 months bring for the business?

Solid financial management provides the systems and processes to answer those questions.

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Understand Cost Accounting: Defined with Real-World Examples

Understanding Cost Accounting: Definitions, Types, and Real-World Examples

What Is Cost Accounting ?

Cost accounting is a form of managerial accounting that aims to capture a company’s total cost of production by assessing the variable costs of each step of production as well as fixed costs, such as a lease expense.

Cost accounting is not GAAP-compliant, and can only be used for internal purposes.

Key Takeaways

  • Cost accounting is used internally by management in order to make fully informed business decisions.
  • Unlike financial accounting, which provides information to external financial statement users, cost accounting is not required to adhere to set standards and can be flexible to meet the particular needs of management.
  • As such, cost accounting cannot be used on official financial statements and is not GAAP-compliant.
  • Cost accounting considers all input costs associated with production, including both variable and fixed costs.
  • Types of cost accounting include standard costing, activity-based costing, lean accounting, and marginal costing.

Understanding Cost Accounting

Cost accounting is used by a company’s internal management team to identify all variable and fixed costs associated with the production process. It will first measure and record these costs individually, then compare input costs to output results to aid in measuring financial performance and making future business decisions. There are many types of costs involved in cost accounting, which are defined below.

Types of Costs

  • Fixed costs are costs that don’t vary depending on the level of production. These are usually things like the mortgage or lease payment on a building or a piece of equipment that is depreciated at a fixed monthly rate. An increase or decrease in production levels would cause no change in these costs.
  • Variable costs are costs tied to a company’s level of production. For example, a floral shop ramping up its floral arrangement inventory for Valentine’s Day will incur higher costs when it purchases an increased number of flowers from the local nursery or garden center.
  • Operating costs are costs associated with the day-to-day operations of a business. These costs can be either fixed or variable depending on the unique situation.
  • Direct costs are costs specifically related to producing a product. If a coffee roaster spends five hours roasting coffee, the direct costs of the finished product include the labor hours of the roaster and the cost of the coffee beans.
  • Indirect costs are costs that cannot be directly linked to a product. In the coffee roaster example, the energy cost to heat the roaster would be indirect because it is inexact and difficult to trace to individual products.

Cost Accounting vs. Financial Accounting

While cost accounting is often used by management within a company to aid in decision-making, financial accounting is what outside investors or creditors typically see. Financial accounting presents a company’s financial position and performance to external sources through financial statements, which include information about its revenues, expenses, assets, and liabilities. Cost accounting can be most beneficial as a tool for management in budgeting and in setting up cost-control programs, which can improve net margins for the company in the future.

One key difference between cost accounting and financial accounting is that, while in financial accounting the cost is classified depending on the type of transaction, cost accounting classifies costs according to the information needs of the management. Cost accounting, because it is used as an internal tool by management, does not have to meet any specific standard such as generally accepted accounting principles (GAAP) and, as a result, varies in use from company to company or department to department.

Cost-accounting methods are typically not useful for figuring out tax liabilities, which means that cost accounting cannot provide a complete analysis of a company’s true costs.

Types of Cost Accounting

Standard Costing

Standard costing assigns “standard” costs, rather than actual costs, to its cost of goods sold (COGS) and inventory. The standard costs are based on the efficient use of labor and materials to produce the good or service under standard operating conditions, and they are essentially the budgeted amount. Even though standard costs are assigned to the goods, the company still has to pay actual costs. Assessing the difference between the standard (efficient) cost and the actual cost incurred is called variance analysis.

If the variance analysis determines that actual costs are higher than expected, the variance is unfavorable. If it determines the actual costs are lower than expected, the variance is favorable. Two factors can contribute to a favorable or unfavorable variance. There is the cost of the input, such as the cost of labor and materials. This is considered to be a rate variance.

Additionally, there is the efficiency or quantity of the input used. This is considered to be a volume variance. If, for example, XYZ company expected to produce 400 widgets in a period but ended up producing 500 widgets, the cost of materials would be higher due to the total quantity produced.

Activity-Based Costing

Activity-based costing (ABC) identifies overhead costs from each department and assigns them to specific cost objects, such as goods or services. The ABC system of cost accounting is based on activities, which refer to any event, unit of work, or task with a specific goal, such as setting up machines for production, designing products, distributing finished goods, or operating machines. These activities are also considered to be cost drivers, and they are the measures used as the basis for allocating overhead costs.

Traditionally, overhead costs are assigned based on one generic measure, such as machine hours. Under ABC, an activity analysis is performed where appropriate measures are identified as the cost drivers. As a result, ABC tends to be much more accurate and helpful when it comes to managers reviewing the cost and profitability of their company’s specific services or products.

For example, cost accountants using ABC might pass out a survey to production-line employees who will then account for the amount of time they spend on different tasks. The costs of these specific activities are only assigned to the goods or services that used the activity. This gives management a better idea of where exactly the time and money are being spent.

To illustrate this, assume a company produces both trinkets and widgets. The trinkets are very labor-intensive and require quite a bit of hands-on effort from the production staff. The production of widgets is automated, and it mostly consists of putting the raw material in a machine and waiting many hours for the finished good. It would not make sense to use machine hours to allocate overhead to both items because the trinkets hardly used any machine hours. Under ABC, the trinkets are assigned more overhead related to labor and the widgets are assigned more overhead related to machine use.

Lean Accounting

The main goal of lean accounting is to improve financial management practices within an organization. Lean accounting is an extension of the philosophy of lean manufacturing and production, which has the stated intention of minimizing waste while optimizing productivity. For example, if an accounting department is able to cut down on wasted time, employees can focus that saved time more productively on value-added tasks.

When using lean accounting, traditional costing methods are replaced by value-based pricing and lean-focused performance measurements. Financial decision-making is based on the impact on the company’s total value stream profitability. Value streams are the profit centers of a company, which is any branch or division that directly adds to its bottom-line profitability.

Marginal Costing

Marginal costing (sometimes called cost-volume-profit analysis) is the impact on the cost of a product by adding one additional unit into production. It is useful for short-term economic decisions. Marginal costing can help management identify the impact of varying levels of costs and volume on operating profit. This type of analysis can be used by management to gain insight into potentially profitable new products, sales prices to establish for existing products, and the impact of marketing campaigns.

The break-even point—which is the production level where total revenue for a product equals total expense—is calculated as the total fixed costs of a company divided by its contribution margin. The contribution margin, calculated as the sales revenue minus variable costs, can also be calculated on a per-unit basis in order to determine the extent to which a specific product contributes to the overall profit of the company.

History of Cost Accounting

Scholars believe that cost accounting was first developed during the industrial revolution when the emerging economics of industrial supply and demand forced manufacturers to start tracking their fixed and variable expenses in order to optimize their production processes.

Cost accounting allowed railroad and steel companies to control costs and become more efficient. By the beginning of the 20th century, cost accounting had become a widely covered topic in the literature on business management.

How Does Cost Accounting Differ From Traditional Accounting Methods?

In contrast to general accounting or financial accounting, the cost-accounting method is an internally focused, firm-specific system used to implement cost controls. Cost accounting can be much more flexible and specific, particularly when it comes to the subdivision of costs and inventory valuation. Cost-accounting methods and techniques will vary from firm to firm and can become quite complex.

Why Is Cost Accounting Used?

Cost accounting is helpful because it can identify where a company is spending its money, how much it earns, and where money is being lost. Cost accounting aims to report, analyze, and lead to the improvement of internal cost controls and efficiency. Even though companies cannot use cost-accounting figures in their financial statements or for tax purposes, they are crucial for internal controls.

Which Types of Costs Go Into Cost Accounting?

These will vary from industry to industry and firm to firm, however certain cost categories will typically be included (some of which may overlap), such as direct costs, indirect costs, variable costs, fixed costs, and operating costs.

What Are Some Advantages of Cost Accounting?

Since cost-accounting methods are developed by and tailored to a specific firm, they are highly customizable and adaptable. Managers appreciate cost accounting because it can be adapted, tinkered with, and implemented according to the changing needs of the business. Unlike the Financial Accounting Standards Board (FASB)-driven financial accounting, cost accounting need only concern itself with insider eyes and internal purposes. Management can analyze information based on criteria that it specifically values, which guides how prices are set, resources are distributed, capital is raised, and risks are assumed.

What Are Some Drawbacks of Cost Accounting?

Cost-accounting systems ,and the techniques that are used with them, can have a high start-up cost to develop and implement. Training accounting staff and managers on esoteric and often complex systems takes time and effort, and mistakes may be made early on. Higher-skilled accountants and auditors are likely to charge more for their services when evaluating a cost-accounting system than a standardized one like GAAP.

Financial Statements Defined : Accounting Tools’ Perspective

The Bottom Line

Cost accounting is an informal set of flexible tools that a company’s managers can use to estimate how well the business is running. Cost accounting looks to assess the different costs of a business and how they impact operations, costs, efficiency, and profits. Individually assessing a company’s cost structure allows management to improve the way it runs its business and therefore improve the value of the firm. These are meant to be internal metrics and figures only. Since they are not GAAP-compliant, cost accounting cannot be used for a company’s audited financial statements released to the public.

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Crafting a Strong Financial Plan: Key to Business Success

Crafting a Strong Financial Plan: Key to Business Viability and Financing Success

The financial plan plays a crucial role in determining the viability of your business idea and securing financing. It provides a clear overview of costs and funding requirements, making it an essential tool for convincing financiers to invest in your venture.

Creating a financial plan doesn’t have to be complex; you can base it on your business plan and keep it simple. Market research and a well-thought-out marketing plan should be integral parts of your business plan, providing a solid foundation for your financial projections.

While seeking input from an expert like an accountant is valuable, it’s important to work out as much of your financial plan as possible on your own. This preparation will help you when approaching financiers or investors for funding.

A comprehensive financial plan typically includes five budgets that outline the minimum requirements for starting your business, the necessary investments, and how you plan to finance them. These budgets enable you to assess the viability of your business idea, estimate your projected turnover, evaluate profitability, and examine cash flow to ensure you have sufficient funds each month. Addressing these key aspects in your business plan is crucial for success.

1. Investment budget: This budget should list the investments required to launch your business, differentiating between immediate and delayed investments. It provides an indication of the minimum funding needed to get started.

2. Financial budget: The financial budget outlines how you plan to finance your investment budget, including options such as personal capital (equity capital), loans (borrowed capital) from a bank, or a combination of both.

3. Operating budget: The operating budget demonstrates the profitability of your business. It helps estimate your expected turnover and analyze the costs associated with running your business. By combining these factors, you can determine whether your business will generate a profit or incur a loss.

4. Cash flow budget: Income and expenditure can fluctuate throughout the year. Creating a cash flow forecast allows you to track all inflows and outflows over a specific period, such as monthly or quarterly. This helps identify periods of surplus cash and potential shortfalls, enabling better financial management.

5. Personal expense budget: This option involves assessing your personal financial situation and determining the amount of personal capital available. Calculate your personal expenses, including taxes and operational costs, to establish the minimum turnover required to meet your financial needs.

Financial Statement Analysis: How It’s Done, by Statement Type

When evaluating a credit application, financiers consider both “hard” factors related to your business and its foundation, as well as “soft” factors associated with you as a business owner. To increase your chances of success, prepare a well-structured presentation that showcases your familiarity with the financier’s requirements and language.

Financiers typically evaluate:

– Business owner assessment, including qualities and experience.
– Quality and financial basis of the business plan.
– Company history, such as turnover, gross profit, and cash flow.
– Industry trends and developments.
– Loan type, size, and duration.
– Purpose of the loan.
– Clear budget and understanding of financial obligations.
– Comprehensive understanding of the business’s cost structure.
– Repayment capacity without jeopardizing the business.
– Potential for future business growth.
– Financial structure and personal expenditure.
– Market analysis conducted by an independent body.
– Market research and industry information.
– Offered security to ensure repayment.

When writing your financial plan to secure investment, it is important to make a positive first impression. Create a compelling presentation that demonstrates your understanding of the financier’s requirements and uses appropriate language and visual aids. Incorporate an introduction, tables, visuals, and consider graphic design elements to enhance readability.

Additional tips to improve your financial plan and increase your chances of success include using your own equity to finance the business, negotiating favorable financing terms and conditions, supporting your application with a pitch, and exploring various financing options available to you.

 

For More you can check: Financial Statement Analysis: How It’s Done, by Statement Type

Financial Planning
Art of Financial Planning: A Comprehensive Guide for Success

The Art of Financial Planning: A Comprehensive Guide for Success

Financial Planning includes all the activities that apply general management standards to the financial resources of a firm such as planning, directing, organizing, procurement of funds, investment, and return of the funds. In this article, students will learn about the meaning, objectives, and features of financial planning. 

Financial Planning

Financial Planning

Financial Planning is one of the major planning that is required to be conducted by the management. Financial Planning includes all the activities which are related to the procurement of funds, investing those funds, and the return expected from the investment done. Financial Planning also ranges from tax planning which is an important activity. This planning is very important for a business to function, in this regard we have initiated the discussion on this topic ‘Financial Planning’ which is to be studied in greater detail. The scope of this topic is vast hence for a conceptualized study this is to be referred to. 

Definition and Meaning

Financial planning is defined as a document that has records of a business owner or firm’s financial situation along with planning on the spending of money to achieve a certain goal by working by a well-devised plan. Financial planning may be made independently or by an experienced planner.

It is basically a financial budget plan, which helps organize the business and includes a set of goals that are supposed to be followed by the firm or business owner to save and spend accordingly. It helps distribute various monetary expenses such as rent, while at the same time saving some amount of money as short-term or long-term savings. 

Financial Planning is the process of estimating the capital requirement and also determining the competitive elements required for financial planning. This is a plan which has been defined as a document that contains a person’s current money situation with the long-term monetary goals, the strategies to achieve those goals on the basis of the current fund. A financial plan may be devised and drafted independently or with the assistance of a financial planner. The first step in the creation of a financial plan is to involve collecting the numbers from the web-based accounts into a document or a spreadsheet. 

This type of planning is also known as an investment plan as it manages various types of liquid and other assets that involve risk and uncertainty. Financial planning done by individuals is not as risky as they do not involve huge investment or undertaking, such as funds kept separate for college or university, estates, healthcare, or retirement.

Financial Planning in Financial Management

A financial plan is an overall evaluation of an individual’s current pay and future financial state by using the current known variables to predict the future income, asset values, and withdrawal plans. Financial Planning includes the budget which organizes the business and the individual finances and at times includes a series of steps or specific goals for spending and saving for the future. This plan distributes the future income to various types of expenses such as rent or utilities and also reserves some income for the short-term and long-term savings as well. A financial plan is sometimes referred to as an investment plan, while personal financing focuses on specific areas like risk management, estates, colleges, or retirement. 

Objectives

There two main objectives of financial planning which are given below:

  • Ensuring Availability of Funds When Required: The foremost and most important objective of financial planning is to keep in check that funds are available in cases of emergency or whenever it is required for use. Sufficient funds should be available with the firms for various purposes.
  • Check Unnecessary Fundraising by the Firms: Insufficient funds are just as bad as surplus funds. Idle money will only result in a loss for a firm as against investment. Therefore, proper allocation of funds is a very important part of financial planning.

Different Approaches to Financial Analysis

The Objectives of Financial Planning are Enumerated as Follows – 

The foremost objective of financial planning is assuring that sufficient fund is available with the company for different purposes. 

Excess funding is as bad as inadequate funds. If there is a surplus amount of money, then the financial planning is to invest it in the best possible manner as keeping financial resources idle is a great loss for an organization as it will be in vain.

Features

There are a number of features of financial planning that are important for firms and individuals. These are listed below:

  • Foresight: A plan made without foresight will only result in a disaster. Foresight is needed in planning for estimating risks and the need for liquid and other assets. It may not be 100% accurate but it should be able to give an estimate of the future risks.
  • Flexibility: A plan made should be flexible as it will help in the future to make adjustments according to the needs. 
  • Optimal Usage of Funds: A financial plan should be able to utilize idle money and assets so that they can prove to be fruitful in the future. It does not involve funds kept aside for unforeseen circumstances but the assets that could be otherwise utilized.
  • Simplicity: Financial planning should be simple in terms of structure and should be able to provide a sound allocation of resources that can be easily understood even by a layman.
  • Liquidity: It is also a very important aspect of financial planning which involves keeping current assets in the form of money. This will help in easy allocation and payment of various kinds like salary, fees, and other kinds.

Features of Financial Planning is Enumerated as below – 

  • Simplicity: A sound financial structure must provide a simple financial structure that could be managed easily and understandable even to a layman.
  • Foresight: Foresight must be used in planning to know the estimate and the need for capital which may be estimated as accurately as possible. A plan visualized without any foresight will outcast disaster for the company.
  • Flexibility: Repeating the financial adjustments becomes necessary hence its flexibility is required so that it is easily adaptable
  • Optimum use of Funds: Capital should not only be adequate but should also employ productive effects. A financial plan should prevent wasteful use of the capital, thus avoiding idle capacity to ensure proper utilization of funds to earn the capacity in an enterprise.
  • Liquidity: Current assets are to be kept in the form of liquid cash. Cash is also required to finance purchases, to pay the daily needs like paying salaries, wages, and other incidental expenses.

Conclusion:

Financial Planning is an important aspect of the individual as well as business life. This article gives you an insight into what financial planning comprises and what are its key aspects.

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Complete Financial Plan: Importance, Purpose & Core Elements

Financial Plan: Meaning, Purpose & Key Components

What Is a Financial Plan?

A financial plan is a document that details a person’s current financial circumstances and their short- and long-term monetary goals. It includes strategies to achieve those goals.

A financial plan can help you to establish and plan for fundamental needs, such as managing life’s risks (e.g., those involving health or disability), income and spending, and debt reduction.

It can provide financial guidance so that you’re prepared to meet your obligations and objectives. It can also help you track your progress throughout the years toward financial well-being.

Financial planning involves a thorough evaluation of one’s money situation (income, spending, debt, and saving) and expectations for the future. It can be created independently or with the help of a certified financial planner.

Key Takeaways

  • A financial plan documents an individual’s short- and long-term financial goals and includes a strategy to achieve them.
  • The plan should be comprehensive and highly customized.
  • It should reflect an individual’s personal and family financial needs, investment risk tolerance, and plan for saving and investing.
  • Planning in finance starts with a calculation of one’s current net worth and cash flow.
  • A solid financial plan provides guidance over time and serves as a way to track progress toward your goals.

The Fundamentals of Financial Plans

Understanding a Financial Plan

Whether you’re going it alone or with a financial planner, the first step in creating a financial plan is to understand how important it can be to your financial future. It can provide the guidance that assures your financial success.

Start your planning effort by gathering information from your various financial accounts into a document or spreadsheet.

Then make some basic calculations that establish where you stand financially.

You may complete the following steps as an individual or a couple:

Calculate Net Worth

To calculate your current net worth, subtract the total for your liabilities from the total for your assets. Begin by listing and adding up all of the following:

  • Your assets: An asset is property of value that you own. Assets may include a home, a car, cash in the bank, money invested in a 401(k) plan, and other investments accounts.
  • Your liabilities: A liability is something you owe. Liabilities may include outstanding bills, credit card debt, student debt, a mortgage, and a car loan.

Determine Cash Flow

Cash flow is the money you take in measured against the money you spend. To create a financial plan, you must know your income as well as how and when your money is spent.

Documenting your personal cash flow will help you determine how much you need every month for necessities, how much is available for saving and investing, and where you can cut back on spending.

One way to get this done is to review your checking account and credit card statements. Collectively, they should provide a fairly complete history of your income and spending in a wide range of spending categories.

For example, document how much you’ve paid during the year for housing expenses like rent or mortgage payments, utilities, and credit card interest.

Other categories include food, household (including clothing), transportation, medical insurance, and non-covered medical expenses. Still others can include your spending on miscellaneous entertainment, dining out, and vacation travel.

Once you add up all these numbers for a year and divide by 12, you’ll know what your monthly cash flow has been (and where you can improve it).

 

When establishing your cash flow history, don’t overlook cash withdrawals that may have been used on sundries, from take-out, to shampoo, to sodas. ATM withdrawals can also highlight where you might cut unnecessary spending.

Establish Your Goals

A major part of a financial plan is a person’s clearly defined goals. These may include funding a college education for the children, buying a larger home, starting a business, retiring on time, or leaving a legacy.

No one can tell you how to prioritize these goals. However, a professional financial planner should be able to help finalize a detailed savings plan and specific investing that can help you reach them one by one.

 

The main elements of a financial plan include a retirement strategy, a risk management plan, a long-term investment plan, a tax reduction strategy, and an estate plan.

Benefits of a Financial Plan

  • A financial plan involves a thorough examination of your income and spending.
  • It can improve your understanding of your financial circumstances at all times.
  • It establishes important short- and long-term financial goals.
  • It clarifies the actions required of you to achieve your various financial goals.
  • A financial plan can focus your attention on important immediate steps, such as reducing debt and building your savings for emergencies.
  • It enhances the probability that you’ll achieve financial milestones and overall financial success (however you define it).
  • It can guide your efforts over time and provide a means to monitor your progress.
  • It can keep you out of financial trouble and reduce the stress and worry you may have experienced in the past.

Reasons for a Financial Plan

Financial planning is a smart way to keep your financial house in order. It’s a money tool for everyone, regardless of age, earnings, net worth, or financial dreams. It offers individuals a way to document their personal goals and corresponding financial goals. It can keep people on track to meet ongoing financial needs and major financial goals.

When to Create a Financial Plan

A financial plan is always an advantage for those who want to make sure that they manage their finances in ways that are best-suited for them. You can create one at any time, whether you’ve just joined the workforce or have been working for years.

Beyond that, here are some particular instances that call for the creation and use of a financial plan. They can also serve as signals to adjust existing plans.

  • A new job that results in added income, new expenses, or new opportunities
  • An income change that can affect your ability to pay expenses, pay off debt, or save
  • Major life events such as marriage, children, or divorce that can change financial objectives and spending needs
  • Health adversities that result in re-directing income and spending away from existing goals
  • An income windfall, such as an inheritance or insurance payment, that can affect efforts to reach your financial goals (such as providing more money for investing and debt reduction)

How to Create a Financial Plan

Certain steps are needed to create a financial plan. In addition to calculating your net worth, determining your cash flow, and establishing financial goals, as outlined above, here are additional plan elements/steps to include.

Do It Yourself or Get Professional Help

Decide whether you’ll create your financial plan on your own or with the help of a licensed financial planner. While you can certainly build a financial plan, a financial pro can help ensure that your plan covers all the essentials.

Build an Emergency Cash Fund

Based on what your cash flow allows, start setting aside enough money in a liquid account to cover all your expenses for at least 6 months (preferably, for twelve) if you find yourself without income due to unexpected events.

Plan to Reduce Debt and Manage Expenses

If you have debt, the faster and more effectively that you can eliminate it, the better for the growth of your savings, your standard of living, and the achievement of specific financial objectives.

Make it a habit to cut expenses whenever possible so that you can add to your savings. In addition, stay on top of expenses that you know you’ll have, such as taxes, so you always meet those obligations on time.

Manage Potential Risks

Your financial well-being can be affected when accidents, health problems, or the death of loved ones strike. Plan to put into place the appropriate insurance coverage that will protect your financial security at such times. This coverage can include home, property, health, auto, disability, personal liability, and life insurance.

Plan to Invest

Take part in a retirement plan at work that automatically deducts contributions from your paycheck. And plan to maximize your tax-advantaged investing with a personal IRA if and when your income allows.

Also, consider how you might allocate any other available income to a taxable investment account that can add to your net worth over time. Your plan for investing should take into account your investment risk tolerance and future income needs.

Include a Tax Strategy

Address the goal of reducing your income taxes with tax deductions, tax credits, tax loss harvesting, and any other opportunities that are legally available to taxpayers.

Consider an Estate Plan

It’s important to make arrangements for the benefit and protection of your heirs with an estate plan. The details will depend on your stage in life and whether you’re married, have children, or have other legacy goals.

Monitor and Adjust Your Financial Plan

Revisit your plan at least yearly (on your own or with a financial professional) and more often if a change in circumstances affects your financial situation. Keep it working efficiently and effectively by adjusting it as needed.

What Is the Purpose of a Financial Plan?

A financial plan should help you make the best use of your money and achieve long-term financial goals, such as sending your children to college, buying a bigger home, leaving a legacy, or enjoying a comfortable retirement.

How to Successfully Handle Your Company’s Finances

How Do I Write a Financial Plan?

You can write a financial plan yourself or enlist the help of a professional financial planner. The first step is to calculate your net worth and identify your spending habits. Once this has been documented, you need to consider longer-term objectives and decide on the ways to achieve them.

What Are the Key Components of a Financial Plan?

Financial plans aren’t one-size-fits-all, although the good ones tend to focus on the same things. After calculating your net worth and spending habits, you’ll explore your financial goals and ways to achieve them. Usually, this involves some form of budgeting, saving, and investing each month. To ensure that you live comfortably and financially stress-free for the rest of your life, the areas to focus on include an emergency savings plan, a retirement plan, risk management, a long-term investment strategy, and a tax minimization plan.

The Bottom Line

A financial plan is an essential planning tool for your financial well-being, now and into the future. It involves setting down the current state of your finances, your various financial goals, and methods that can help you achieve them.

It’s never too early or late to create a financial plan. And no matter the amount of money that you have, a financial plan can help you to determine the best way to put it to work so that you can meet your financial needs through all of your life stages.

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How to Master Finance Management Importance & Key Principles

Finance Management: Understanding the Importance and Key Principles

Finance management is the strategic planning and managing of an individual or organization’s finances to better align their financial status to their goals and objectives. Depending on the size of a company, finance management seeks to optimize shareholder value, generate profit, mitigate risk, and safeguard the company’s financial health in the short and long term. When working with individuals, finance management may entail planning for retirement, college savings, and other personal investments.

Purpose of financial management

The purpose of financial management is to guide businesses or individuals on financial decisions that affect financial stability both now and in the future. To provide good guidance, financial management professionals will analyze finances and investments along with many other forms of financial data to help clients make decisions that align with goals.

Financial management can also offer clients increased financial stability and profitability when there’s a strategic plan for where, why, and how finances are allocated and used. How financial management professionals help clients reach goals will depend on whether the client is a company or an individual.

Types of financial management

Finance management professionals handle three main types of financial management for companies. These types involve various aspects of the internal decisions a company will likely need to make about cash flow, profits, investments, and holding debt. Many of these decisions will depend significantly on factors like company size, industry, and financial goals. Financial management professionals help companies reach financial goals by guiding in these areas of financing, investment, and dividends.

Financial management

Financial management professionals assist companies in major decisions that involve acquiring funds, managing debt, and assessing risk when borrowing money for purchases or to build the company. Financing is also required when raising capital. Companies can make better, more strategic financing decisions to raise capital or obtain funds when they have information on cash flow, market trends, and other financial stats on the health of a company.

Investment

Financial management professionals can help companies choose where to invest, what to invest in, and how to invest. The financial professional’s job is to determine the number of assets (both fixed and long term) a company will need to hold and where cash flow goes based on current working capital. In essence, this type of financial management is about assessing assets for risk and return ratios. Financial managers will consider a company’s profits, rate of return, cash flow, and other criteria to assist companies in making investment decisions.

Dividend

Companies should have a dividend disbursement plan and policy in place, with guidance from a financial management professional who can create and implement that plan, suggest modifications when needed, and monitor payouts if and when they occur. Any time a financial decision is made, it’s essential to consider dividend payments since you may hold dividends to fund certain financial decisions within the company.

It’s also important to have a flexible long-term plan that can grow with the company. Some more mature companies may pay out dividends at certain times or once a year; the payout schedule depends on many factors. Other companies may retain or reinvest dividend payments back into the company if the company is in a growth phase.

What is the financial management cycle?

The financial management cycle is a financial planning process critical to a company’s growth and development. It includes:

Effective financial management aligned with an organization’s goals and objectives can lead to greater efficiency and stability. These parts of the financial management cycle must work together to be the most effective.

1. Planning and budgeting

During this analytical phase in the financial management cycle, a company uses past and current financial data to set financial targets, modify objectives, and make changes to the current budget. This phase will typically involve detailed planning as well as a big picture one, meaning a company will look at day-to-day operations, long-term financial plans, and try to link financial targets to these activities.

The goal is to create a strategic financial plan for the company that aligns with objectives for the next three to five years. When setting specific budgets, a company may budget for one fiscal year at a time. A big reason for this is that a budget involves many moving parts that are subject to change by market fluctuations.

2. Resource allocation

Financial managers assign value to capital resources ( anything a company uses to manufacture/produce goods/services) and offer advice on allocating these resources based on criteria like projected company growth and financial goals. Resource allocation is important because it allows a company to have a long-term financial plan focused on its business objectives. Financial management professionals help companies by providing a framework for using capital resources and creating a portfolio that will generate the most revenue, given the company’s financial status.

3. Operations and monitoring

This phase is critical to protect against fraudulent activity, errors, compliance issues, or other variances in the allocation of funds, etc. Financial management professionals should run regular financial reviews of business operations and cash flow. These periodic reviews can help mitigate fraud and identify other issues. It is a preventative step that ensures the continuity of business operations by securing the validity and accuracy of a company’s financial processes.

4. Evaluation and reporting

Financial management professionals should evaluate a company’s current financial management system and propose changes when necessary. Financial reports and financial data can be helpful when assessing the efficiency and success of an existing system.

Some criteria a financial management professional may consider when evaluating a financial management system include security, compliance, company data needs, and level of support needed. These criteria vary by the company’s size, industry, current financial situation, and long-term goals.

Financial management professionals should be able to offer research-based suggestions that can help a company securely store and manage financial data in compliance with relevant laws and harness that data when needed.

How to work in finance management

To work in finance management, you’ll need a bachelor’s degree in business, economics, finance, or a related field. While there’s no mandatory licensure for careers in financial management, certification is highly recommended. In many cases, employers like to see at least five years of professional experience before hiring into a financial management position. Typical jobs that individuals may pursue as an entry point to finance management may include loan officer, junior tax accountant, personal finance advisor, or accountant.

How to Successfully Handle Your Companys Finance Efficiently

Educational requirements

A bachelor’s degree in finance, business management, or a related field is the minimum requirement to work in finance management. A master’s degree may be required for senior-level positions. Typical coursework for bachelor’s degree programs in finance or business management may include accounting, economics, finance, and human resources. Many master’s programs will offer internships, along with some bachelor’s programs. Internships are highly recommended.

Read more: Personal Money Management Insights:10 Essential Finance Tips

Certifications

Certification is optional but suggested if you plan on a long-term career in finance management. Professional trade organizations typically offer certification. The type of certification you earn can be specialized to your job title or role. Common certifications that financial management professionals hold include:

  • Certified Management Account (CMA) certification is offered by the Institute of Management Accountants (IMA) and is ideal for anyone wanting to work in financial management. Requirements include at least two years of professional experience and a bachelor’s degree.
  • Chartered Financial Analyst (CFA) certification offered by the CFA institute focuses on investment analysis. This certification is for financial management professionals who want to work in senior-level positions like CFO. Educational and experiential requirements are also necessary to enroll in the CFA program.
  • Certified Government Financial Manager (CGFM) certification offered by the Association of Government Accountants (AGA) is for professionals who work in government financial management specifically. You’ll need at least two years of professional experience in government financial management to earn certification.
  • Certified Treasury Professional (CTP) certification offered by the Association of Financial Professionals (AFP) can benefit anyone who wants to work in corporate treasury. This certification focuses on risk management, corporate liquidity, and ethics. You’ll need to meet educational and experiential requirements for this certification, with several options available for admittance into the CTP program.

Skills

Careers in finance management require a mix of financial skills and business skills. It’s essential to understand business operations, but proficiency in accounting, financial, and data analytics is equally important. Finance management merges management and finance. You may find success working in the field of finance management if you hold these skills:

Workplace skills

  • Good communication
  • Problem-solving skills
  • Organized
  • Quality leader
  • Proficiency in public speaking and presentation
  • Ability to manage a group of people
  • Detail-oriented
  • Analytical skills
  • Strong decision-making skills
  • Ethical

Technical skills

  • Basic and advanced math skills (algebra, statistics, basic computing)
  • Computer skills
  • Proficiency in financial management systems
  • Understanding of statistical modeling software and spreadsheets
  • Industry-specific knowledge
  • Proficiency in accounting principles and techniques
  • Understanding investment principles

Experience

Professional experience in finance or business management is key if you want to advance into upper-level finance management positions. Expect to work at least five years in an entry to mid-level finance position before being eligible to work in finance management. Remember, finance management careers are managerial positions, so requirements like experience and education matter. It’s not just the quantity of experience but also the quality that matters. Try to find jobs in finance or accounting. It’s also helpful to find jobs that can help you move into the specific industry that you want to work in.

Careers in finance management

The scope of careers in the finance management field is vast. From entry-level positions in bookkeeping to management positions like a financial manager or management accountant, you’ll have many career pathway choices.

The career you choose will depend on factors like education, certifications, professional experience, industry, employer, and location. Salaries among finance management jobs will also differ based on these factors. Individuals in senior-level positions like CFO and vice president of financial planning and analysis will be among the top-tier earners in finance management.

*All annual salary data is sourced from Glassdoor as of August 2022

Financial manager

Average annual salary (US): $133,190

Job outlook (2020 to 2030): +17% [1]

Financial managers oversee a financial department and may assist in creating strategic financial plans for an organization. Their duties include preparing financial reports and statements, forecasting, setting budgets, analyzing financial markets for trends and investment opportunities for an organization, and seeking ways to mitigate costs.

Financial advisor

Average annual salary (US): $106,012

Job outlook (2020 to 2030):  +5% [2]

Personal financial advisors assist individuals in planning for their future by helping them manage money and seek out investments based on individual situations. A personal financial advisor meets with individuals to set financial goals with short and long-term plans to achieve those objectives. Some financial aspects an advisor may handle include taxes, retirement, college savings, insurance, estate planning, and more. Financial advisors may work for an investment firm or on their own.

Financial analyst

Average annual salary (US): $93,605

Job outlook (2020 to 2030): +6% [3]

Financial analysts may work within a large corporation or with individuals. Their job is to analyze their client’s financial situation and make financial suggestions based on goals and financial status. A financial suggestion may include finding investment opportunities. The goal of an analyst is to evaluate market trends and position a client in a secure financial standing based on the analysis of trends and related data.

Management accountant

Average annual salary (US): $106,058 [4]

Management accountants work for corporations or government agencies. Their goal is to provide an in-depth financial analysis of an organization’s internal financial processes for strategic financial decision-making. Key decision makers in an organization use the information gathered by management accountants to aid in decision-making in the long and short term.

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bookkeeping
What is bookkeeping ? Definition, types, and best practices

3 key benefits of bookkeeping

If you’re new to business, you may be wondering about the importance of bookkeeping. Whether you outsource the work to a professional bookkeeper or do it yourself, you’ll be able to reap a variety of benefits.

bookkeeping
bookkeeping

1. Access to detailed records of all transactions

By logging and keeping track of all financial transactions, you will have easy access to any financial information you might need. To make it even easier, bookkeepers often group transactions into categories.

Common transaction categories include:

When it’s finally time to audit all of your transactions, bookkeepers can produce accurate reports that give an inside look into how your company delegated its capital. The two key reports that bookkeepers provide are the balance sheet and the income statement. The goal of both reports is to be easy to comprehend so that all readers can grasp how well the business is doing.

2. Ability to make informed decisions

Because bookkeeping involves the creation of financial reports, you will have access to information that provides accurate indicators of measurable success. By having access to this data, businesses of all sizes and ages can make strategic plans and develop realistic objectives.

Examples of financial statements that can help with decision-making include:

  • Balance sheets
  • Income statements
  • Cash flow statements

Not only can this help you set goals, but it can also help you identify problems in your business. With an accurate record of all transactions, you can easily discover any discrepancies between financial statements and what’s been recorded. This will allow you to quickly catch any errors that could become an issue down the road.

A Deep Dive into Financial Analysis: Definition, Importance, and Practical Applications

3. Better tax preparation

When it’s time to file your taxes, you’ll need to comply with the Internal Revenue Service’s (IRS) legal regulations and systems that govern their finances. Some of the most common documentation businesses must provide to the federal government include:

  • Financial transactions
  • Financial statements
  • Tax compliance
  • Cash flow reports

By staying up to date with your bookkeeping throughout the year, you can help alleviate some of the stress that comes with filing your taxes.

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A Deep Dive into Financial Analysis: Definition, Importance, and Practical Applications

What Is Financial Analysis?

Financial analysis is the process of evaluating businesses, projects, budgets, and other finance-related transactions to determine their performance and suitability. Typically, financial analysis is used to analyze whether an entity is stable, solvent, liquid, or profitable enough to warrant a monetary investment.

Key Takeaways

  • If conducted internally, financial analysis can help fund managers make future business decisions or review historical trends for past successes.
  • If conducted externally, financial analysis can help investors choose the best possible investment opportunities.
  • Fundamental analysis and technical analysis are the two main types of financial analysis.
  • Fundamental analysis uses ratios and financial statement data to determine the intrinsic value of a security.
  • Technical analysis assumes a security’s value is already determined by its price, and it focuses instead on trends in value over time.

Understanding Financial Analysis

Financial analysis is used to evaluate economic trends, set financial policy, build long-term plans for business activity, and identify projects or companies for investment. This is done through the synthesis of financial numbers and data. A financial analyst will thoroughly examine a company’s financial statements—the income statement, balance sheet, and cash flow statement. Financial analysis can be conducted in both corporate finance and investment finance settings.

One of the most common ways to analyze financial data is to calculate ratios from the data in the financial statements to compare against those of other companies or against the company’s own historical performance.

For example, return on assets (ROA) is a common ratio used to determine how efficient a company is at using its assets and as a measure of profitability. This ratio could be calculated for several companies in the same industry and compared to one another as part of a larger analysis.

 

There is no single best financial analytic ratio or calculation. Most often, analysts use a combination of data to arrive at their conclusion.

Corporate Financial Analysis

In corporate finance, the analysis is conducted internally by the accounting department and shared with management in order to improve business decision making. This type of internal analysis may include ratios such as net present value (NPV) and internal rate of return (IRR) to find projects worth executing.

Many companies extend credit to their customers. As a result, the cash receipt from sales may be delayed for a period of time. For companies with large receivable balances, it is useful to track days sales outstanding (DSO), which helps the company identify the length of time it takes to turn a credit sale into cash. The average collection period is an important aspect of a company’s overall cash conversion cycle.

A key area of corporate financial analysis involves extrapolating a company’s past performance, such as net earnings or profit margin, into an estimate of the company’s future performance. This type of historical trend analysis is beneficial to identify seasonal trends.

For example, retailers may see a drastic upswing in sales in the few months leading up to Christmas. This allows the business to forecast budgets and make decisions, such as necessary minimum inventory levels, based on past trends.

Investment Financial Analysis

In investment finance, an analyst external to the company conducts an analysis for investment purposes. Analysts can either conduct a top-down or bottom-up investment approach. A top-down approach first looks for macroeconomic opportunities, such as high-performing sectors, and then drills down to find the best companies within that sector. From this point, they further analyze the stocks of specific companies to choose potentially successful ones as investments by looking last at a particular company’s fundamentals.

A bottom-up approach, on the other hand, looks at a specific company and conducts a similar ratio analysis to the ones used in corporate financial analysis, looking at past performance and expected future performance as investment indicators. Bottom-up investing forces investors to consider microeconomic factors first and foremost. These factors include a company’s overall financial health, analysis of financial statements, the products and services offered, supply and demand, and other individual indicators of corporate performance over time.

 

Financial analysis is only useful as a comparative tool. Calculating a single instance of data is usually worthless; comparing that data against prior periods, other general ledger accounts, or competitor financial information yields useful information.

Types of Financial Analysis

There are two types of financial analysis: fundamental analysis and technical analysis.

Fundamental Analysis

Fundamental analysis uses ratios gathered from data within the financial statements, such as a company’s earnings per share (EPS), in order to determine the business’s value. Using ratio analysis in addition to a thorough review of economic and financial situations surrounding the company, the analyst is able to arrive at an intrinsic value for the security. The end goal is to arrive at a number that an investor can compare with a security’s current price in order to see whether the security is undervalued or overvalued.

Technical Analysis

Technical analysis uses statistical trends gathered from trading activity, such as moving averages (MA). Essentially, technical analysis assumes that a security’s price already reflects all publicly available information and instead focuses on the statistical analysis of price movements. Technical analysis attempts to understand the market sentiment behind price trends by looking for patterns and trends rather than analyzing a security’s fundamental attributes.

Horizontal vs. Vertical Analysis

When reviewing a company’s financial statements, two common types of financial analysis are horizontal analysis and vertical analysis. Both use the same set of data, though each analytical approach is different.

Horizontal analysis entails selecting several years of comparable financial data. One year is selected as the baseline, often the oldest. Then, each account for each subsequent year is compared to this baseline, creating a percentage that easily identifies which accounts are growing (hopefully revenue) and which accounts are shrinking (hopefully expenses).

Vertical analysis entails choosing a specific line item benchmark, then seeing how every other component on a financial statement compares to that benchmark. Most often, net sales is used as the benchmark. A company would then compare cost of goods sold, gross profit, operating profit, or net income as a percentage to this benchmark. Companies can then track how the percent changes over time.

Examples of Financial Analysis

In the nine-month period ending Sept. 30, 2022, Amazon.com reported a net loss of $3 billion. This was a substantial decline from one year ago where the company reported net income of over $19 billion.

Amazon.com, Q3 2022 Statement of Operations.

Financial analysis shows some interesting facets of the company’s earnings per share (shown above. On one hand, the company’s EPS through the first three quarters was -$0.29; compared to the prior year, Amazon earned $1.88 per share. This dramatic difference was not present looking only at the third quarter of 2022 compared to 2021. Though EPS did decline from one year to the next, the company’s EPS for each third quarter was comparable ($0.31 per share vs. $0.28 per share).

Analysts can also use the information above to perform corporate financial analysis. For example, consider Amazon’s operating profit margins below.

  • 2022: $9,511 / $364,779 = 2.6%
  • 2021: $21,419 / $332,410 = 6.4%

From Q3 2021 to Q3 2022, the company experienced a decline in operating margin, allowing for financial analysis to reveal that the company simply earns less operating income for every dollar of sales.

Why Is Financial Analysis Useful?

The financial analysis aims to analyze whether an entity is stable, liquid, solvent, or profitable enough to warrant a monetary investment. It is used to evaluate economic trends, set financial policies, build long-term plans for business activity, and identify projects or companies for investment.

How Is Financial Analysis Done?

Financial analysis can be conducted in both corporate finance and investment finance settings. A financial analyst will thoroughly examine a company’s financial statements—the income statement, balance sheet, and cash flow statement.

One of the most common ways to analyze financial data is to calculate ratios from the data in the financial statements to compare against those of other companies or against the company’s own historical performance. A key area of corporate financial analysis involves extrapolating a company’s past performance, such as net earnings or profit margin, into an estimate of the company’s future performance.

What Techniques Are Used in Conducting Financial Analysis?

Analysts can use vertical analysis to compare each component of a financial statement as a percentage of a baseline (such as each component as a percentage of total sales). Alternatively, analysts can perform horizontal analysis by comparing one baseline year’s financial results to other years.

Many financial analysis techniques involve analyzing growth rates including regression analysis, year-over-year growth, top-down analysis such as market share percentage, or bottom-up analysis such as revenue driver analysis.

Last, financial analysis often entails the use of financial metrics and ratios. These techniques include quotients relating to the liquidity, solvency, profitability, or efficiency (turnover of resources) of a company.

What Is Fundamental Analysis?

Fundamental analysis uses ratios gathered from data within the financial statements, such as a company’s earnings per share (EPS), in order to determine the business’s value. Using ratio analysis in addition to a thorough review of economic and financial situations surrounding the company, the analyst is able to arrive at an intrinsic value for the security. The end goal is to arrive at a number that an investor can compare with a security’s current price in order to see whether the security is undervalued or overvalued.

What Is Technical Analysis?

Technical analysis uses statistical trends gathered from market activity, such as moving averages (MA). Essentially, technical analysis assumes that a security’s price already reflects all publicly available information and instead focuses on the statistical analysis of price movements. Technical analysis attempts to understand the market sentiment behind price trends by looking for patterns and trends rather than analyzing a security’s fundamental attributes.

The Bottom Line

Financial analysis is a cornerstone of making smarter, more strategic decisions based on the underlying financial data of a company. Whether corporate, investment, or technical analysis, analysts use data to explore trends, understand growth, seek areas of risk, and support decision-making. Financial analysis may include investigating financial statement changes, calculating financial ratios, or exploring operating variances.

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