Join Rudolph Rosenberg for an in-depth discussion in this video Exceptional factors, part of Financial Analysis: Introduction to Business Performance Analysis.
An important element to take into consideration when analyzing your business is the presence of exceptional factors. Let's define what that means. When I say exceptional, it is a matter of time and magnitude. It is an event that is impacting the company financially. And it is both big and does not happen often. For example, signing a large contract that will generate significantly more revenue than your usual contract, and that does not happen very often, would qualify as an exceptional contract.
It has both the time factor, as it does not happen very often, and is significantly bigger than your usual contract. If it happens every day, it is not exceptional. And if it's the same size as your other contracts, it's not exceptional either. When it comes to business analysis, my advice is to always exclude exceptional factors. Of course, exceptional factors are part of business and count towards your overall performance. But when you analyze a company, exceptional factors can be misleading.
Lets imagine for example, a company that has a declining performance this year compared to the past, but has signed a large contract that is upsetting this declining performance. Of course, that's great. And this year, that will be very helpful in paying salaries, rent, and all the other expenses of the company. But from a business analysis standpoint, this large contract could mislead you in believing that everything is fine, the company is growing healthily, and that there is no underlying issue.
In essence, if you know for sure that every year you will be able to sign another contract as large as this one, then all the better. Maybe you're not in a dire situation, but in that case you cannot say that that contract is exceptional anymore since it's recurrent. You could have a dire business situation that is hidden by an exceptional contract that makes the numbers look good. The issue here is that if you don't exclude that exceptional element, you might not realize you have an issue until you don't have the benefits anymore of that large contract.
And when it is too late too act upon it. By excluding exceptional elements, you can determine if you have a performance issue. Even if it's not a problem for your company right at this moment. You then have more time to react and do somethings so that once you don't have the benefits of the exceptional opportunity anymore, you will already have taken the required actions to ensure your business is well on track to good performance. By the way, this is also true the other way around. When you have had large exceptional expense that is making your numbers look bad.
Let's say, for example, that you are selling food and that the large portion of your inventory turned bad. And that you had to spend large amounts of money to reproduce that inventory. This extra cost is exceptional, and could have eaten up most if not all of your profits. If you analyze your business including that element, you could conclude that your company is not profitable, but by excluding it, you could realize that it is a one-time event and that your business is still as profitable as it was.
Therefore, you would just need to make sure that it does not happen again, but would not necessarily have to change the way you work and generate profits.
This course, the first in our Financial Analysis series, introduces you to key concepts of business performance analysis. Author Rudolph Rosenberg focuses on the analysis of the profit and loss (the P&L) statement and on the key dynamics you need to understand in order to interpret the performance of your business. Understanding this data will help you make informed decisions that benefit your company in the long run.
Get started now with this quick primer. When you're ready for the next steps, check out Financial Analysis: Analyzing the Top Line with Excel and Financial Analysis: Analyzing the Bottom Line with Excel.