The financial integrity of a company is vitally important for all new and established businesses. Without healthy financial performance, a business cannot fund new projects and grow its revenues. Nor, can a company fund the research, production, marketing, and sales activities in support of those activities. The start-up business fits the general model of a new product introduction in an established company with the exception of having a mature process to follow. A company's financial history is often used to gauge the liquidity, efficiency, and profitability of business operations. Analyzing the balance sheet and profit and loss statements over time are methods commonly used to set financial policy, and ultimately, this information provides management with factual data that helps direct company operations. However, in a start-up company, historical data may not be available, so it is vitally important to double check all financial projections to ensure a company's second and third year financial ratios are not distorted and management is using reliable information from which to make their business decisions.
Comparative Ratio Analysis
The use of comparative ratios can provide insight into regional and national performance trends in market specific industries. By scoring your company's ratios relative to those of your industry competitors, you can gauge your company's performance and determine the correct course of action to take in order to improve your business. We recommend a simple comparison with financial benchmarks that are easy to apply. Monitoring metrics over time is a necessary practice for tracking trends and improving process operations. A simple benchmarking process provides management valuable data that can be communicated to company employees garnering the necessary support for implementing change.
Excess Cash Flow Valuation Method
Using comparative ratio analysis with the excess cash flow method to determine a company's value, allows management to verify how fiscal policy impacts the company. The excess cash flow method takes the appraised value of assets (not book value) together with pre-tax cash flow from operations and multiplies this number by a factor that is derived from rating the company in 4 key areas: (1) the experience of the management; (2) the competitive environment; (3) the business risk; and (4) the quality of customer accounts. This method is used to determine how financial targets and actions by management impact a company's value.
Valuation Methods As A Management Tool
Our research interest is in teaching senior management the use of comparative ratios and valuation methods to manage company operations and set fiscal policy. We further combine the financial tools and analysis with a business management flow diagram ensuring that all functional areas of the organization are observed on an ongoing basis. Use of several other holistic valuation tools such as discounted cash flow, price earnings, and liquidation methods allow us to compare small and middle market companies to their key competitors and also publicly traded companies.