Looking at how your business finances have changed over time can reveal valuable insights into how internal and external factors may be impacting your financial performance. In this article, you'll learn everything you need to know about how to use a flux analysis to unlock these insights to improve your strategic planning.
A thorough understanding of your SaaS business's historical changes provides valuable insights into performance. When done right, flux analysis can enhance data integrity and support proactive planning.
It's an essential tool for financial analysts to improve company financial planning and analysis (FP&A), to specific vendor expenses.
Regularly analyzing financial statements to identify the differences between flux yields valuable decision-making insights, especially in terms of identifying potential areas for improvement.
What is flux analysis?
Flux analysis, also called fluctuation variation analysis, is a method of analyzing financial statements. This type of accounting compares balances across two different periods to identify and examine the increase or decrease in each account. To identify historical variations, the flux is determined for the current period by subtracting from it the prior period's ending balance.
Flux analysis in accounting is also called "horizontal analysis" because it compares comparable items from two eras "across the horizon of time" or "horizontally" – which is usually shown next to each other, either monthly or annually. Flux analysis is a way to measure or quantify changes over time, which can help companies better understand how internal and external factors may be impacting their performance.
Flux analysis vs. variance analysis
The terms "flux analysis" and "variance analysis" are often used interchangeably. However, they are actually two different types of analysis.
A flux analysis compares the actual performance against expected or past performance to spot significant variations. Meanwhile, CFOs and finance teams will do a budget variance analysis by comparing expected sales to actual sales to find budgeting and prediction errors.
A flux analysis and a variance analysis are both accounting activities. However, a variance analysis is used to determine where variances occur between what was budgeted in the previous period and what was actually spent to evaluate financial performance. Although a variance analysis is commonly considered an accounting tool, it can also be applied to SaaS metrics or KPIs to evaluate operational performance.
Flux analysis results are typically shown in dollars or percentages. With variance analysis, variances would be likewise reported in dollar amounts or percentages. However, for SaaS metrics or KPIs, results would be reported as both an absolute number in whatever their units of measure are and as a percentage.
How flux analysis accounting improves business performance
Accounting flux analysis helps businesses ensure that their accounting and reporting data is complete and accurate. Flux analysis helps management monitor and evaluate financial data and offer insights for future budget forecasting. It’s most often applied to gain insights from a company’s financial statements:
- Flux analysis can be used to examine profit and loss (P&L) statements to find patterns in earnings and spending that could indicate opportunities for improving profitability.
- Cash flow statements: Flux analysis shows trends and areas for liquidity improvement in a company's cash flow statement.
- Balance sheet flux analysis helps find trends in a company's solvency status and where the company's financial stability can be improved.
Other ways to use fluctuation analysis
After month-end close processes, flux analysis can be used to validate data precision and also identify accounting errors. Businesses can use it to compare their performance against competitors or industry averages, identifying competitive standing and areas for improvement.
Companies can immediately use flux analysis to optimize resource allocation and ROI. Plus, using flux analysis to perform periodic financial account reviews help businesses refine strategic long-term goals and target new areas of investment.
How to do a flux analysis in 5 steps
In this section, we’ll walk you through the following five steps required to do a flux analysis.
Step 1. Define the parameters of your analysis
Start by selecting a year or period to compare against the current statement.
You’ll also need to select the comparison interval (monthly, quarterly or annually) and decide how many intervals to include in your analysis. For example: do you want to look at the monthly flux over the last year or the quarterly flux over the last three years?
Your choice of this will determine the amount of data you need to pull together for your analysis.
Step 2. Calculate the period-to-period flux
Flux analysis accounting can be expressed as absolute numbers or percentages.
The formula for calculating flux as an absolute number is simple:
The percent flux can be calculated in two ways. Both offer the same result.
The first method is user-friendly and easy to understand but longer to write out:
The second method is mathematically simpler but less intuitive unless you're familiar with the concept:
Depending on the number of periods under review, this calculation may need to be repeated numerous times. For example, if analyzing five years of year-to-year flux, you'll calculate it four times, starting with Year 1 as the base.
Step 3. Note any significant fluctuations
The accounts you're looking at change over time. So you need to determine which fluctuations are significant.
Because there’s no rule determining a materiality standard, you’ll need to use your best judgment to determine which fluctuations represent material changes -- serious discrepancies that warrant investigation. Factors to consider might include your organization's total revenue and expenses and the potential financial impact the discrepancy could have on the company's profit margins if not resolved.
Step 4. Identify the drivers behind the flux
Fluctuations can happen due to multiple factors, not just the most apparent one, so investigating all contributing elements is important. There may be many interrelated factors driving the fluctuations you’re seeing. So, this part of the process could take quite a bit of time depending on how deeply you need to dig into it.
Step 5. Provide an explanation for the flux
When explaining the sources of flux, you should always avoid reporting changes without referencing their root causes. It's also important to clearly describe the reasons for differences using simple language so anyone can understand the changes. Be sure to include sufficient information in flux explanations so business leaders and investors don’t feel the need to review the source data to understand what happened.
At minimum, you’ll need to explain which accounts changed, when they changed, and by how much. Then, to the degree possible or warranted, you’ll want to include an explanation of why the change occurred.
Because numerous accounts in your company are interconnected, it's possible that the percentage change you see are the result of different drivers each impacting the account in different ways. Depending on the complexity of the line item in question, the number of interrelated drivers, it’s possible that you may not be able to fully explain all causes for a given fluctuation. If you can identify causes that explain a portion of the fluctuation, it may be sufficient to detail those causes in your flux analysis report along with their respective impact on your result.
A flux analysis example: SaaS cloud hosting costs
Let’s say we’re a fast-growing SaaS company interested in optimizing our cloud hosting costs. In order to inform our thinking about how to do that, we need to understand our past usage patterns over our first five years in business.
To calculate the period to period flux across the first five years, you need to apply the same calculation to the actual costs for Years 3-5 too:
Looking at these results, you notice a major increase in cloud hosting costs in your second year and another substantial rise in Year 4.
We need to identify what's causing the changes in our cloud hosting costs to better inform our cost-saving strategies.
Were the increases in Years 2 and 4 the result of growth in your customer base? Or were there other reasons, like unfavorable cloud hosting fee structures with one or more of the providers you were using then? And what happened to bring those costs down in Years 3 and 5?
Answering these questions requires digging into your data. While the actual analysis may take quite a bit of time, this example fluctuation analysis clearly demonstrates how it can provide insights that help in making important decisions.
Cloud hosting is a big expense for a SaaS business. So, by understanding these fluctuations you can potentially save your company tons of money.
How to use flux analysis to make your financial planning more effective
Flux analysis of accounting reports is essential for SaaS companies to enhance financial performance and make more informed decisions. It lets you measure and compare performance over time, identify trends, and ideally, to learn what is driving them. This type of analysis can provide business leaders the insights they need to quickly make necessary adjustments to improve performance or cash position.
Collecting and analyzing data can be time-consuming when using a spreadsheet. In contrast, a platform like Drivetrain, which is purpose-built for FP&A, makes it significantly faster for finance teams to aggregate their data from multiple sources to make flux analysis fast and easy. With the ability to drill down into your data in any way you need, understanding the underlying reasons for fluctuations is easier, too, even if they’re the result of multiple interrelated factors.
Contact our team for a demo so you can see firsthand how Drivetrain can help you use flux analysis to quickly and easily uncover new insights that you can leverage to improve your strategic financial planning.