In one of our credit assessment training courses we start with a financial exercise in which we ask our learners to analyse a business – but all that we give them is the financial statements.
Being obedient and enthusiastic individuals, they set about the task with gusto, calculating profitability margins and gearing ratios, debating the growth in revenue and whether it was good or indifferent.
But, at some point, they come to a grinding halt because they realize they can’t interpret the financial information without knowing a lot more about the business itself. They start to ask questions like, “what industry does the business operate in?”, “what does the business sell?”, “who are the competitors?” and so on.
And that’s the point of the exercise. It takes a while but eventually they understand that an analyst has to understand the business and its environments before looking at the financial performance because the analysis requires context before it becomes meaningful.
There are three key environments that should be considered;
- The macro-environment; this is the big, wide world and everything that goes on in it that may affect the business either positively or negatively. These are the things that the business can’t control and so management has to be aware of what’s happening and be able to anticipate the change in the environment and adapt the business’ operations to suit.
- The market environment; this is the marketplace in which the business operates and, obviously, has a direct bearing on its future sustainability. Here the analyst should consider issues such as products, target market, competition, suppliers etc.
- The micro-environment; this is the internal environment of the business and includes an analysis of the experience and quality of management, corporate governance, available resources, labour, and so on.
With an understanding of these three environments, the analyst is in a much better position to interpret the financial results and make judgment on the strength or otherwise of its financial position.
In our e-book, Business Lending Essentials Part 1; Assessing Business Risks, we set out some background to this analysis and provide some tools and techniques to enable analysts to apply a logical approach to the assessment of a business. The ebook is free and can be downloaded from www.businessbankingcoach.com by clicking here.