Anyone working in the financial planning and analysis (FP&A) department should be very familiar with the three financial statements in FP&A – Income Statement, Balance Sheet, and Cash Flow Statement. Each of the financial statements provides important financial figures, during certain time periods, for the internal and external stakeholders of a company.
The income statement reveals the profitability of a company by displaying the revenue, cost of goods sold, net income, and various expenses. A balance sheet states a company’s assets, liabilities, and shareholders’ equity at a particular point in time. The cash flow statement displays cash flows from operations, financing, and investing activities both into and outside of the business.
Why Should an FP&A Analyst Know About the Three Financial Statements?
While it is not necessary that an FP&A analyst be capable of producing and maintaining the three financial statements in FP&A, he/she should understand the basic components of these statements and the meaning behind each of the figures. It is especially critical for FP&A analysts who are responsible for financial modeling, financial analysis, and forecasting a business’s future profitability, which requires the extraction of historical data.
1. The statements help an FP&A analyst understand the financial structure and past performance.
It is an essential first step for an FP&A analyst to learn about a company’s financial status and structure before beginning any analysis. The three financial statements summarize all the significant numbers an analyst needs to know, ranging from the revenue streams from which a business generates its earnings, to the composition of its cost structures and methods of allocating costs.
The FP&A analyst would also want to find out how the company performed over the past years in order to understand growth or decline in its operating efficiency. With this information, an analyst can already get a sense of earnings and cost trends ahead of performing analyses.
2. The statements provide necessary information for financial modeling.
Information found on the three financial statements is constantly used in different kinds of financial analysis and forecasting processes. For example, an FP&A analyst has to extract information such as the revenue and expenses of the entire business and each individual department from the income statement to build a consolidation model.
For large companies, their financial statements can be very comprehensive yet long to search through. An FP&A analyst should be able to pick from the statements the right numbers to use in their calculations and quickly realize variances in these data.
3. Constant updates on financial data are needed for the forecasting process.
Forecasting is the process of looking at historical data and analyzing patterns to predict a business’ short-term performance going forward, on a weekly or monthly basis. Maintaining a forecasting model requires frequent monitoring and revising by an FP&A analyst, and therefore, he/she should continually collect data from monthly financial statements and refine the forecasting model with the latest information to produce an accurate prediction.
The financial statements also help an FP&A analyst realize the opportunities and risks the company is facing. For example, a leverage risk to a company may be signaled when it raises a large amount of capital through short-term and long-term debt.
An FP&A analyst should factor this into their forecast since higher interest expense and larger cash outflows to service debt are expected as the company repays its principal and interest. A good analysis can help company management exercise proper caution when planning to take on large projects or invest in developing new product lines.
4. Business planning requires the collection of long-term financial results from past statements.
A long-range business plan (LRBP) outlines a company’s long-term plan and prediction on future performance for a period of between five to ten years. To come up with a reliable long-range plan, an FP&A analyst must gather historical data from the financial statements for at least the past five years to comprehend long-term trends in the company’s operations.
Factors such as the revenue growth rate and return on invested capital should be taken into consideration when an FP&A analyst budgets project expenses and maps out long-term resource allocation.
5. The three financial statements act as a source for validation in financial models.
After constructing a financial model and placing all the data in the right places, an FP&A analyst should always validate the data to ensure the accuracy of the calculations. The three financial statements then become the optimal sources for data reconciliations because they are the formal records of the financial performance of the business.
When inconsistencies are found between a number in a model and in the financial statement, an FP&A analyst should revise the model to match the financial statement before proceeding. It is common practice in financial modeling to insert a column of numbers, such as the total revenue and total allocation costs, directly linked to the financial statement at the end of a financial model for prompt comparisons.