As an HVAC contractor, strategic financial analysis is one of the vital tools at your disposal. It allows you to make informed decisions about where to allocate your resources and how to grow your business. Moreover, an excellent financial planning strategy reveals bottlenecks and opportunities you can use to propel your business forward.
There are many benefits to implementing strategic financial analysis in your HVAC business.
The question is: How often do you review your numbers?
If it’s more frequent than monthly, you’re on the right track, and your HVAC business is likely in good shape. If not, you will want to create a system that will allow you to have a stronger understanding of where you are financially.
Sadly, few businesses check their books as frequently as they should. Worse yet, many companies don’t have their books up to date at all, meaning they are flying blind. The more a company engages in strategic financial analysis, the greater the likelihood it will enjoy financial health. Strategic financial analysis is about doubling down on what works and culling processes that don’t.
In this article, discover how HVAC contractors can implement a strategic financial analysis in their business. We’ll deeply dive into what it means, what documents you need, and the step-by-step guide to performing this.
What Does Strategic Financial Analysis Mean?
Strategic financial analysis is a finance review system that dissects and interprets your financial statements. It is used to assess your company’s performance, realign your goals, and adjust your strategy to improve your business. In other words, it helps connect the dots between your numbers and your actions during an accounting period.
Every HVAC business must use strategic financial analysis as a benchmark to make informed decisions for their company’s financial future. It identifies problems and opportunities within your financial standings. You then develop a blueprint based on the results that will be the starting point for your growth strategy.
The strategic financial analysis you implement will cover your business model. In some cases, they can also involve comparing your business to benchmarks or your projected financial forecasts.
The 3 Essential Reports in Strategic Financial Analysis
Your business’s strategic financial analysis is anchored on the elements it needs to analyze. Therefore, before anything else, you have to produce the necessary documents on which you’ll build the strategic financial analysis.
There are three essential reports necessary to creating your strategic financial analysis. These are pretty much known to every business in existence – the financial statements. These include:
- P&L Statement
- Cash flow Statement
- Balance Sheet
The P&L Statement is more commonly referred to as the income statement. This financial statement conveys the revenue and expenses of a business within a period. The P&L is a helpful document for horizontal analysis, describing economic trends over time.
It is particularly relevant in competitive markets like the residential home services industry. For instance, this would help identify whether the business is losing or gaining market share in an HVAC business.
The Cash Flow Statement is another financial statement from which your strategic financial analysis will branch. This financial statement provides a detailed look into the inflows and outflows of liquid cash within your HVAC business. It is a powerful metric to gauge your company’s ability to generate money and operate in the short term.
For example, we all know HVAC businesses are often seasonal. That said, you will want to ensure you have enough cash on hand to last through the shoulder months.
Strategic financial analysis can help determine if your company has the resources to expand, pay debts, and make investments. The Balance Sheet lists your company’s assets, liabilities, and shareholder equity. It is critical in strategic financial analysis as it provides a snapshot of your company’s net worth.
Strategic financial analysis is not a one-and-done affair. Apart from a financial comparison of the three financial statements, you must create actionable steps. It’s not necessarily easy, but it’s possible with effort and expert guidance. If you need help, Wizard of Sales® has you covered. Book a call.
Step-by-Step Guide to Strategic Financial Analysis for your HVAC Financial Statements
Strategic financial analysis is essential to the success of your HVAC business. How exactly should an HVAC contractor go about this financial planning system? If you want to make the most of your financials, conduct strategic financial analysis as often as possible.
A study from Federal Reserve revealed that businesses that are financials-motivated are more booming and growing than others. That said, you want to review and analyze your financial statements at least once a month. It will give you enough headroom to plan your actions, decisions, and strategy in the succeeding month.
Below, we’ll explain in detail the step-by-step guide to conducting strategic financial analysis.
1. Monthly comparison of your forecast vs. actuals
If you’re already doing your part in regular financial analysis and reporting, you’re already ahead of others. However, there’s more to financial analysis methods than just reading and reporting. You need to benchmark your actuals to get even more value in your strategic financial analysis. You can do this by comparing your actual business performance with your forecast.
You want to compare your forecast to what happened throughout the month during your monthly meeting with staff. The frequency of the strategic financial analysis indicates a quicker period to turn negative things around. For this reason, always having your forecast available enables you to see bottlenecks and identify areas you are on track.
In an HVAC business, strategic financial analysis is not something to outsource or leave in the hands of your accountant. As the business owner, you should be intimately involved in strategic financial analysis. After all, it’s your business, and you need to ensure that it’s running as efficiently and profitably as possible. Monthly comparisons and benchmarking accomplish just that.
2. Determine where you are falling short or surpassing expectations
Your forecasted financial plans are products of educated guesses. They are goals you’d accomplish if you implemented your business’s best practices. That also means you’ll observe variances between your forecast and actual financial performance.
- On-track with forecast
- Outperforming and exceeding expectations
- Reasonably close to set values
- A bit off-track
- Performing worse than expected
What then does comparing forecast to actual performance do for my HVAC business?
Well, if you simply look closely at what happened last month, you’ll see any progress you’ve made. Conversely, you’ll also catch red flags that could spell difficulties for your business.
During your monthly meetings, one asset you may want to look into is the company’s gross profit margin. This financial metric measures your business’s variable profitability. A low gross profit margin could indicate that your company is not pricing its products or services correctly.
If that’s the case, you could look for ways to cut back on variable expenses. One way to do this is by negotiating with your suppliers for better prices. Another way to reduce costs is to streamline your installation and service processes, making you more efficient.
Another important metric for HVAC contractors is your accounts receivables turnover which measures how quickly your customers pay their invoices. A high turnover rate means they pay quickly, which is ideal for your cash flow. It will allow you to pay operating expenses that keep your business afloat and operational each month. However, a low receivable turnover rate suggests you should address delinquent clients more intentionally.
These two are only examples of what comparing forecasted information, and actual data can do for your business.
Allowing subtle issues like these can make or break your business. Nip small issues in the bud before they escalate. By looking at your forecast and actual numbers, you’ll have more real motivations for what actions you must make. That keeps you from getting blindsided and realizing you’ve been on the wrong track by the end of the year.
3. Examine your income statement
Examine the income statement, a.k.a. P&L, which documents two of the most fundamental business elements — income and expenses. During your strategic financial analysis, interpreting your income statement is imperative. The aim is to observe if you’re meeting your sales goals and operating within budget.
Differentiating between your actual income and forecasted income will produce better strategic decisions for your business’s health and growth. Here are some steps when reviewing your P&L financial statement:
- Start with the bottom line
Your bottom line gives you an overview of how your business performed within the period (in this case, a month). Typically, you want a positive bottom line, meaning you earned more than you spent. However, a negative bottom line suggests you must make some recalibration. Dig deeper into why you’re red and strategize how to turn it around.
Remember that a net loss can be common when you’re growing. Accommodating for seasonality, such is common in HVAC businesses, will help you weather the slow times.
The point is that you don’t want consistent net losses for various accounting periods. Review your cash flow statement to ensure an adequate runway to keep your business operational during net loss seasons.
- Check every P&L category
The bottom line is only one facet of the entire story. Do a vertical analysis to see your income and expenses, and then ask the following questions:
- Is your income performance sustainable?
- Is there progress each period?
- Are there unique revenue streams during this period?
You want growth to be consistent, even if it’s gradual. One-time deals may influence a boost in profit, and you don’t want to count them as performance improvement.
As for your expenses, here are the questions to ask:
- Are the expenses logical?
- Are there costs you’re expecting to see in succeeding P&L?
- Are there specific costs linked with individual streams of revenue?
Try to uncover opportunities to increase sales and cut back on expenses. There are times when expenses exceed normalcy, and that’s fine. However, any consistent increase while having stagnant or failing revenue is a bad omen.
- Compare the numbers
After vertical analysis, it’s essential to have some horizontal comparison with previous P&L results. Calculating the percentage of change between the numbers for every accounting period is helpful. You can implement financial analysis tools when doing this.
Every drive-up in revenue or expense reduction should be brought to your team’s attention. Ask why there are significant changes. The results determine what reasonable adjustments can be made to address it.
It’s always helpful to be keen and skeptical about why your business performs the way it does over periods. For example, a dramatic uptick this month may simply be attributed to poor efficiency from techs last month.
Any subtlety not brought into light can inflate your results. They might appear more optimistic than they are, which could pose unnecessary questions if performance suddenly plateaus.
- Review the math
We’re humans, and humans commit errors, even in the most unexpected and unwanted situations like your income statement. Every number, algorithm, or cell you change can affect the bottom line if you’re working on a spreadsheet. Make sure to review everything and confirm if the data indicated are accurate.
4. Examine your cash-flow statement
When viewed from an accounting standpoint, a business may look profitable given its income statement results. However, profit isn’t necessarily the oil that keeps the engine running. Sales listed in the books are not cold-hard usable cash unless they’re inside your bank account. The cash flow analyzes your business’s short-term liquidity and health.
Reading a cash flow statement is one thing, but understanding what caused it is entirely different. That is where strategic financial analysis comes in. Examining your cash flow requires an in-depth review of your cash flow statement, and here are questions to do this:
- If my profits are increasing, why don’t I have more cash in the bank?
Profit and cash are two different things. Sales you’ve listed on the books won’t add your cash reserve unless clients physically pay you for your services. Alternatively, if you paid more bills than intended, this could reduce your liquid cash. Finally, funds used to replenish inventory will also affect your bank balance.
- Accounts receivable changed negatively. Is that a good thing?
Yes and no. A negative change may mean you increased sales, but the invoices aren’t paid yet. On the other hand, it could mean you’re not collecting what you’re owed fast and more intentional enough.
- Do I need to worry about an increase in accounts payable that is bigger than expected?
That depends. You may collect more bills than expected if your accounts payable increase. That could indicate you are growing faster than projected investments for expansion. Your strategic financial analysis will tell.
- If the “change in inventory” line in your cash flow is positive, what does that mean?
A positive number in your inventory may mean you’ve sold more units than bought from customers. At the same time, a negative number indicates that you’ve restocked more units than sold that season. For a primarily seasonal HVAC business, that can mean you’re preparing for a good peak season.
- In the event of a less-than-expected “net cash change,” what should be done?
You can revisit these four sections when you get less than anticipated net cash change. Information in the following may reconcile your queries.
- Accounts receivable (Balance Sheet)
- Accounts payable (Balance Sheet)
- Inventory (Balance Sheet)
- Sales and expenses (Income Statement)
You can find the answer to all these questions in our cash flow analysis article.
5. Examine your balance sheet
Your balance sheet provides an overview of your business’s financial position. This financial statement deals with what assets you own and how much money you owe. In addition, it also covers how much money people owe you.
While P&L explains sales and expenses and cash flow tells what moves in and out, they’re incomplete details. Your balance sheet is meant to complement your P&L and cash flow statements to grasp the entire story.
Here are questions to address when doing strategic financial analysis on your balance sheet:
- What is the balance of your business bank account?
Knowing your on-hand cash will dictate most of your financial decisions. Your bank balance is listed under the assets section of the balance sheet, specifically as a current asset. That means they can quickly turn to physical cash to settle immediate bills.
- Are you owed money?
You’ll find any money owed to you in the accounts receivable section. That is where it will go if you send out invoices for a pay-later option (which is a BAD idea). As your sales increase, this value will balloon. However, you don’t want sales to remain in accounts receivable. You want to convert them into liquid cash.
- How much inventory do you have on hand?
Inventory for an HVAC business is the units and tools used for your primary operations. The balance sheet doesn’t indicate what supplies and how much each, only the value you paid for the equipment. Therefore you need to pair this strategic financial analysis with effective inventory management for precision.
- What other assets do you have?
Aside from current assets, assets like real estate or fleets are also listed on the balance sheet under long-term assets. You don’t need to keep track of this number as much as others during your monthly meetings. Unless, of course, you have many investments in real estate or large equipment.
- What bills are outstanding?
On top of keeping track of who owes you, you need to be keen on the money you owe externally. It’s okay not to pay bills immediately. You’ll find the outstanding invoices in your accounts payable.
- How much do you owe?
You may have other debts that may show up in your current liabilities. Examples of these are the sales tax associated with every service you render. You need to pay these amounts to the government. Other current liabilities may be some short-term loans outstanding.
The Main Purpose of HVAC Strategic Financial Analysis
Strategic financial analysis is necessary for HVAC businesses to track their progress toward meeting a long-term financial goal. Having one under your arsenal of activities enables you to gauge your performance quantitatively. You then learn what areas need improvement and where potential opportunities for growth lie.
Strategic financial analysis is a powerful tool that you can use to propel the financial performance of HVAC businesses. HVAC businesses can be more effective in managing their finances and making educated decisions through this strategic tool.
Relevance of Strategic Financial Analysis in an HVAC Company’s Decision-making
HVAC is an industry booming at an exponential rate. A recent report revealed that the market value of HVAC Services is at $57.8 billion in 2020. This value is projected to reach $82.5 billion in 2026. Any HVAC service provider would want in on the increased market share.
Business owners can make decisions that are growth and expansion-oriented. With that in mind, one key benefit of strategic financial analysis is helping HVAC businesses make more informed financial decisions. Another significant relevance of strategic financial analysis is that it allows HVAC businesses to identify and manage financial risks.
You can use strategic financial analysis to mitigate the potential risks and evaluate the rewards associated with the expansion. For instance, if you consider expanding operations, analysis helps determine if the necessary investment is feasible. Another example is if an HVAC contractor plans to infiltrate a new market.
It begins with strategic financial analysis, which should be the building block of your financial decisions. This quantitative investigation will prevent your business from operating in the dark and making financial decisions you regret.
If you need expert guidance on this front, book a call with Wizard of Sales®.