Flux Analysis is a type of comparison technique that helps us understand the changes in a company’s financials from period to period.
It is shortened from Fluctuations Analysis and is also sometimes called Horizontal Analysis. We use the method to evaluate the fluctuations in accounts over time. We usually express such changes in both monetary units and percentages.
A useful Flux Analysis aims not only to identify the changes but also to explain the reasons causing them.
Why Prepare a Flux Analysis?
Investigating the changes in our accounts can be helpful for many reasons. In management accounting and general business management, it can help us understand and manage the operations of the company in a more effective way. The insights we get from evaluating the fluctuations in our accounts also provide us with better information to support our financial and operating decisions. Another benefit is being able to identify risks for the company and opportunities to improve.
Another process that usually requires detailed explanations of changes from period to period is the external financial audit of the company. We need to be able to provide our auditors with supporting evidence for material fluctuations in our accounts.
How to Perform a Flux Analysis
To be able to support the exercise, the company needs to keep detailed records of its operations. We can then rely on those to explain the underlying reasons for the identified fluctuations.
We start by lining two periods next to each other and calculating the deviation from period to period. After we identify the material changes, we begin to identify the causes that drive them.
Fluctuations between periods can be the result of many factors. Therefore it is essential to identify these driving forces correctly. Although we may present our analysis in different levels of aggregation for various purposes, internally, we should perform it on as a detailed level as possible. That way, we can ensure that we will be able to provide accurate information for the variances for any aggregation level that we have to. When deciding which fluctuations to investigate, we need to consider the importance of the line item to the stakeholders and how much benefit we can provide with our explanations.
We must give specific details for each for the driving factor of each change. This will ensure we have a more useful explanation for each fluctuation and the underlying reasons. Such detail is precious for the decision-making process within the entity, as it enables fine-tuning.
Linked Accounts and Line Items
Another thing to consider when preparing our Flux Analysis is the interdependence between accounts or line items. Often the change in one account becomes the driver for fluctuations in another. This an area where presenting the variances in both monetary units and percentages can prove helpful. In the following example, we might look at the Cost of Goods Sold and try to figure out why it increased by more than 14%. However, if we take a look at the Cost of Goods Sold together with Sales Revenue, it is evident that Sales is the driver behind the increase in Cost. Now we can focus on finding the underlying reasons for the increase in Sales Revenue.
Sometimes we can identify no explanations and have to consider the possibility of accounting errors. If this happens, we need to correct the error and investigate the reasons behind the erroneous data.
Full Extent of the Change
After we have reviewed the underlying reasons and drivers behind each fluctuation, we may still have some unexplained portions of the changes. In such circumstances, we must employ our professional judgment to evaluate whether the outstanding inexplicable amount is material for the company and the specific analysis exercise. If it is, we need to investigate further and explain the complete change. Doing so, we may find additional insights that may prove essential for the business.
Retaining Detailed Records
Without the appropriate level of detail in the company’s data and documentation, it will become very costly to conduct a proper Flux Analysis. Insufficient detail could also result in the analytical process yielding incorrect results. As an example, consider a retailer. They may believe that the decrease in sales for a specific region is due to a sizeable new competitor. However, they will need detailed sales data per area to be able to support this explanation.
Having a detailed fluctuations analysis with underlying reasons for the identified changes can also help the company with investor confidence. If the business faced a significant one-off expense during the period, it might seem as the increase will persist and drive down profitability from now on. Having a proper Flux Analysis can help keep shareholders adequately informed for the future.
When performing fluctuations analysis on the P&L statement, we also present the line items as a percentage of revenue, to show stakeholders the relationship between accounts.
It is best practice to perform P&L and Balance Sheet Flux Analysis as part of each month’s close process. Comparing the periods closing balances to the opening balances is a great accuracy check for accounting as large fluctuations can be the result of missing or erroneous data. Also, if management or internal audit decide to review the monthly report, the entity will have a way to summarize and present the changes in balances and the performance of the business.
The only major drawback to Flux Analysis is that it takes much time in more substantial enterprises.
I firmly believe we learn best by doing, so let us take a look at s sample Flux Analysis on the Income Statement and Balance Sheet of a company. Here we have the two statements for the last two years.
Here’s the Income Statement for FY 2019 and FY 2020:
And also the Balance Sheet for the same financial years:
Income Statement Changes
We will start our fluctuations analysis on the Income Statement.
The increase in sales is driven by the successful penetration of two new markets (Germany and France), adding €30 mil and €60 mil to sales, respectively. Also, the company signed a big new client (Markosta) for €50 mil. Three customer contracts were lost, which attributed to €35 mil last year (Genesys AST, BestBrick Ltd., and Commm AG). Other clients remained at similar levels of activity and generated comparable revenues to the previous year.
COGS follows the increase in Revenues. It grew by 3% less, which resulted in a 2% improvement as a percentage of sales. 1.5% is due to optimizations in the way production lines are placed in the workshop, while the other 0.5% is due to improved economies of scale (fewer recalibration expenses for machinery).
The increase in Gross Profit is consistent with the growth in sales and the optimizations in COGS.
Admin expenses grew with €12 mil, or 46%, amounting to 6.1% of Sales in FY 2020, compared to 5% of Sales in FY 2019. The main reason for that is a one-off GDPR-related project that costs €11.5 mil. The other €650 thousand increase is due to salary indexation. Other accounts remain at similar levels to the prior period.
Selling expenses increased in line with sales. In FY 2019, these were 2.2% of sales, which grew to 2.3% of sales in FY 2020. This is due to a slight increase in transport costs due to the global situation in FY 2020 (COVID-19 pandemic).
The increase in EBITDA is consistent with the improved Gross Profit margin, and the adverse effects of more substantial growth in Admin and Selling expenses.
Depreciation expenses increased as a percentage of Sales (2.3% in FY 2019 to 2.5% in FY 2020) due to legislation changes that required the company to adjust some of the useful lives for machines.
EBIT growth is consistent with EBITDA growth due to a small impact from the increase in Depreciation expenses.
Finance costs relate to turnover loans to cover the seasonality in the business. They increased by 4% due to an increased volume of operations, but remain at around 0.2% of Sales.
Income tax expense grew with 37.2%, which is in line with the growth in profit before income tax, as the company operates in a jurisdiction with a flat tax rate of 19% for both FY 2019 and FY 2020.
Net profit increased with €7.5 mil, or 37.2%, which is consistent with the growth in profit before income tax.
The number of sold items increased with 18.6%, which was the main reason for the 21% increase in Sales Revenue. The rest of the growth is due to a slight improvement in product mix and a 2% average increase in sales prices.
On average, prices were indexed with 2%, to reflect the market development in FY 2020.
Balance Sheet Changes
Let us now take a look at the fluctuations between FY 2019 and FY 2020 in our account balances.
The decrease of €10 mil is the net effect of the acquisition project for a new packaging line for €6 mil and the depreciation charge of €16 mil.
Inventory increased by about 30%. Due to the significant increase in Sales Revenue and expectations for growth in FY 2021, the company stocked up with more inventory to be able to match the demand of clients. Production capacity is planned in a way that will be able to cover the volume requirements in FY 2021, based on the expectations of the management.
Trade receivables show a slight increase of 1.2%, as compared to the 21% increase in sales, as the company signed a contract with a new collection agency and managed to clear around €5 mil of overdue receivables.
The main reason for the €6.5 mil drop in cash balances is the investment in the packaging line for €6 mil, which the company finalized in the last quarter of FY 2020.
The increase in Retained earnings (€9.4 mil) is due to profit realized in the period, as well as dividends for €18.3 mil paid to shareholders.
Bank debt increased slightly, which is due to another overdraft line being open for €500 thousand, which was required for the project manager of the packaging line acquisition.
There’s a significant increase in trade and other payables for 48 mil euro, or 39%, which is due to the fact the company placed large purchase orders in Q4, to support the expected growth of the business. Also, key suppliers have improved their internal credit rating for the company and are now offering an extended credit term of six months (it was three months before).
A Flux Analysis helps the company with business management, reporting, and financial audits. It looks into the underlying drivers for the fluctuations and explains the full extent of all changes. A proper fluctuations analysis provides investors and company management with valuable information and insights to support the decision-making process within the company.
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Hi! I am a finance professional with 10+ years of experience in audit, controlling, reporting, financial analysis and modeling. I am excited to delve deep into specifics of various industries, where I can identify the best solutions for clients I work with.
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