Demystifying the differences between financial analysis and financial reporting. Yes, they are different.

The Difference Between Financial Analysis and Financial Reporting

Financial reporting and financial analysis are often assumed to be synonymous. Many times, I see bookkeepers send financial statements supplemented with sales reports to their management teams under the assumption that these reports include “analysis.” And maybe these reports do include some percentage of revenue calculations within the financial statements to show how the account balances changed each of the prior months. Either way, this only tells management “What happened.” Or perhaps your staff accountant creates a graph showing trending weekly cash balances and collections over the past three months so you can see the ebbs and flows of cash. As useful as this is, this does not tell you what balances or projected collections are going to be three months from now based on current customer contracts or the potential inflows from new deals you plan to close.

Usually, I’ll see management teams just accept the reports, skim them, and move on. I find that companies that never had a financial analytics function usually do not understand what the function does, the value it can provide, or problems it can solve. These companies usually hire outside financial analysts for a one-time project to build a model to prepare for a capital raise or lender covenant.

When interviewing management teams, I always ask what their pain points are. Usually, they respond reactively: “accounting is a mess, I’m in a cash crunch, and I need to get reports out to my board. I need my accounting fixed, not analytics.” They do not understand that both are required to avoid corporate implosions.

Good data creation processes on the front end (accounting) mixed with profitability and cash flow forecasting on the backend (analytics) will proactively help them see a cash crunch before it happens.

Certainly, accountants are needed to fix immediate errors and bookkeeping nightmares, but once that is cleaned up, you will need to figure out if your data is telling you if you are going to run out of cash. A financial statement might be prepared perfectly, but it does not help you understand future financial outcomes that could transpire due to current decision making.

I had a few clients claim they only needed to have financial statements quickly provided after month-end and nothing more. They had board reporting requirements and understood the need to review their financial results swiftly. However, because their businesses were historically stable (in their opinion), the management teams settled for lower-cost, simple financial statement reporting. There was no imperative to further invest in the finance function. Unsurprisingly, this eventually ran its course. They ran into profitability and unexpected cash flow constraints and then called me to help them get some better visibility.

Remember the finance and accounting department is split into two camps. The first camp includes the “what happened” functions (accounting and reporting). The second camp includes the “what is going to happen” functions (analytics and forecasting).

Financial reporting and only knowing “what happened.”

“What happened” functions are primarily composed of the month-end close process and basic financial reporting.

The month-end close process is the universal accounting practice of performing reconciliations, reviews, and other accounting procedures after a fiscal month ends to produce financial statements. This process usually takes the form of a checklist that accountants use to perform activities such as bank reconciliations, sales validations, or billing and receivables reviews.

It is also known as “closing the books,” and traditionally takes place the first two weeks of every month.

The formal month-end close process gives the accounting team time to sort through every bill, sale, and bank transaction in the previous month to make sure it is accounted for in the proper period. The goal is to review this data and adjust anything out of place so that properly stated financial statements can be published to management and the board.

The month-end close process is the point of origin for financial data creation. As such, it is critical to complete timely in order to receive accurate insights on the back end. When done manually, the process is tedious and requires detailed management, with redundancy to ensure numbers line up. Automation drastically helps speed things up and enhance accuracy, but it still requires experienced hands on the wheel to review the data creation process.

Without accounting for every transaction running through the company (or verifying the accuracy of any automated data flows that handle simultaneous, large volumes of transactions), the financial statements most likely will not be accurate. Any financial analysis on those financial statements will not be useful or representative of reality either.

Once accounting data is verified for accuracy and completeness, the financial reporting function can get to work putting charts and graphs together to show “what happened.” Maybe management wants weekly reports illustrating certain product sales winners and losers, perhaps they want monthly trend reports of profitability over the past twelve months. Regardless of what kinds of information the report might show, it is traditionally a rearview mirror of past performance.

When I work with clients, one of the first things I review is their monthly financial package (if they have one). I want to understand where they have been. If they cannot produce a monthly financial package, accurate financial statements, or even accounting data, I cannot fully diagnose or locate the root of their financial woes, opine on potential future performance, or help them manage cash flow. Bad accounting data used in predictive modeling yields inaccurate forecasts and blind management recommendations.

Financial analysis and knowing “what is going to happen.”

“What is going to happen” functions like FP&A can only begin productive work once the “what happened” function is stable.

The “what is going to happen” function includes the personnel and software involved in interpreting and using past financial performance to inform future outcomes and make recommendations to management. Formally known as the FP&A team, the financial analysis function excels at playing “devil’s advocate” and anticipating management needs. They tend to be proficient at financial modeling and presenting scenarios of what could happen if certain management decisions are made. Any analyst can put financial reports together and build PowerPoint decks on past performance, but the best analysts excel at predictive models and forecasting.

Predicting the future is never easy or 100% accurate, but mature companies and volatile startups alike need to manage to a budget to maintain profitability and implement cash flow forecasting techniques to sustain ongoing operations and liquidity for future growth initiatives.

Throughout this blog, I’ll try to highlight the value of budgeting and cash flow forecasting and how to build these tools yourself. These two models in my opinion are the most important tools used by the finance function. I would argue they are more important than any accounting software or automation tools since they help you make decisions by looking forward into the future (though of course, it’s important to remember that they are only as good as quality of their input data).

Budgets are cool.

Budgets require you to think at least a year ahead about what your sales initiatives might yield and the expenses that might be needed to achieve those objectives. They also provide a financial scorecard that you can benchmark your actual performance against to essentially grade yourself on how well you achieve your financial goals as time goes by.

Honestly, if you don’t have a cash forecast model, then what are you even paying your finance team for?

A cash flow forecast is a tool that projects and details the drivers of company cash inflows and outflows, forecasts ending bank balances, and calculates projected burn rates. Standard cash flow forecast models should project cash flow 13 weeks into the future. However, I prefer going a step further to model out the next 52 weeks of cash flow to capture a year’s worth of seasonality.

Want to kill it at your next board meeting?

Management teams can build a lot of rapport with their board and investor groups if they can communicate projected cash shortfalls well ahead of time. This not only allows ample time to prepare for a capital raise or secure debt financing, but it also gives leadership time to pivot corporate objectives and communicate the financial impact of those decisions.

Over time, I found that the clients that dismiss more in-depth financial analytics functions are ill-equipped for market downturns, capital management, or new product/service expansions.