Mastering Financial Statement Analysis in CRE - Blooma

The art of financial statement analysis in commercial real estate helps investors understand the financial health and viability of a potential investment. 

Careful study of a company’s income statement, balance sheet, and statement of cash flows equips CRE professionals with powerful tools to evaluate performance, identify trends, and make optimal investment choices. Brokers, lenders, and debt-equity participants depend on accurate and insightful financial statement analysis to inform their strategic choices and minimize risk.

This post covers the elements of financial statement analysis such as ratio, horizontal and vertical, and trend analyses, as well as metrics and techniques widely used in the industry to assess liquidity, solvency, and profitability in CRE.

Key Components of Financial Statement Analysis

The analysis of financial statements is the process of examining a company’s financial information to evaluate its financial health and activity. 

In commercial real estate (CRE), financial statement analysis plays an important role in informed investment decision-making and sustainable growth and operation. The main elements of the analysis of financial statements are the following:

Income Statement

An income statement (sometimes referred to as a profit and loss or P&L statement) is a summary of the revenues and expenses of a company for a given period of time. The main line items are:

• Gross Profit: Total revenue minus cost of goods sold (COGS)
• Operating Profit Margin: Operating income, divided by total revenue, shows how well the company is operating.
• Net Income: The overall profit after subtracting all expenses, taxes, and costs from total revenue.

Balance Sheet

A balance sheet is a summary of what the company owns and owes at a given point in time. The main line items are:

• Total Assets: Resources the company has, such as real estate property.
• Liabilities: Obligations or debts owed by the company.
• Shareholders’ Equity: The residual interest in assets after subtracting liabilities.

Statement of Cash Flows

A statement of cash flows is a summary of cash received and spent from operating, investing, and financing activities. The statement of cash flows measures the liquidity and overall cash management of the company:

• Operating Activities: Cash generated or used from regular business operations.
• Investing Activities: Cash paid or received for investments in assets, such as real estate property.
• Financing Activities: Cash received or paid for borrowing and repaying debt, as well as equity interests.

Challenges in Effective Financial Analysis

Commercial real estate professionals all recognize the necessity of financial statement analysis, yet it presents challenges. Recognizing these challenges improves decision-making for lenders and investors alike. 

Some of the most common challenges include the following. 

Non-traditional Structures

Many CRE investments feature non-traditional structures with multiple tiers of debt and equity and/or SPVs, which can cloud the picture of true investment health, making it hard to answer the following questions:

• Debt to Equity: How much of the funds used to acquire an asset were borrowed versus owned? This can be difficult to determine with complex financing.
• Liquidity: Cross-ownership of assets and liabilities between entities can impact the accuracy of current ratio and quick ratio calculations.

Non-standard Reporting

Lack of uniformity between companies and jurisdictions can create hurdles in comparing statements. Differences in accounting treatments, such as revenue recognition and asset valuation, can also muddy financial pictures.

For example, property and asset valuation methods may differ, resulting in significant discrepancies between reporting entities.

Differences in depreciation methods can also impact net income as well as total asset figures.

Fragmented Data

Many CRE professionals are used to working with fragmented data, where investment and portfolio data are stored in various systems and formats. Fragmented data can slow down analysis and delay timely decision-making:

• Timely Data: Current financial data is key to accurate analysis, but it can be delayed due to fragmented data systems.
• Statement Reporting: Pulling together statements from various reporting entities can be laborious and error-prone.

Decision Impact

The above challenges can have a significant effect on the accuracy of financial analysis and, ultimately, decision-making. 

Poor risk assessment due to incomplete or inaccurate data can expose lenders and investors to hidden liabilities. This can lead to analyses that miss the mark and less-than-optimal investment strategies, which can impact portfolio performance. Incomplete and non-standard reporting can hide the borrower’s true credit risk and lead to defaults.

Blooma: Enhancing Accuracy and Efficiency in Analysis

Blooma applies technology that streamlines and automates thorough financial statement analysis. Here are the various ways you can leverage the platform’s features for this purpose. 

AI-Powered Data Extraction

Using artificial intelligence (AI), Blooma’s data extraction algorithms automatically parse financial statements, improving the speed and quality of financial analysis. AI is used to automate the data extraction process from different financial statement types (i.e. balance sheet, income statement, and cash flow statement). 

By eliminating manual parsing, data is kept perpetually up-to-date so CRE professionals always have the latest numbers for thorough financial analysis.

Solving Traditional Issues

Financial data is standardized allowing for uniform, cross-comparable analysis of companies and markets across regions, enabling accurate valuation and risk assessment.

Also, since financial data is oftentimes fragmented and scattered across different sources. Blooma aggregates financial statement data into a single source, creating a more complete picture so analysts can conduct more accurate and in-depth analysis.

Supercharged Analytics

Deep AI-powered analytics sift through financial data to highlight trends, anomalies, and potential risks that are often missed with traditional analysis methods. Time-consuming financial reports can be generated in minutes ensuring accuracy every time. Reports contain valuable metrics like financial ratios, liquidity ratios, and profitability ratios.

Informed Decision Making

Precise financial data, in an easy-to-read format, provides an accurate assessment of risk in real-time, reducing potential risk in lending and investment decisions. The ability to conduct improved financial analysis leads to better investment choices, increasing performance and portfolio yield.

Plus, the time and effort to analyze financial statements is greatly reduced through automation so professionals can spend more time planning and advising clients.

Best Practices for Financial Statement Analysis in CRE

Here are some of the best practice guidelines to assist CRE practitioners in navigating data, interpreting ratios, and understanding real estate relevant metrics.

1. Know the Major Financial Statements

Successful financial statement analysis starts with knowing and understanding the three major financial statements. 

• Balance Sheet: A historical statement of financial position showing assets, liabilities and equity at a specific date. The balance sheet provides information about a company’s financial health.
• Income Statement: A historical statement of a company’s financial performance showing revenues, expenses, and net income for a specified period.
• Cash Flow Statement: A historical summary of cash flows from operating, investing and financing activities.
  

2. Perform Ratio Analysis to Generate Meaningful Metrics

Financial ratios help interpret financial statement information and evaluate performance. A selection of the most important and illustrative CRE ratios.

Liquidity ratios assess the ability of a company to pay its short-term debts.

• Current Ratio: Current Assets / Current Liabilities. Desirably greater than 1.0.
• Quick Ratio: (Current Assets – Inventory) / Current Liabilities. Similar to the current ratio but excludes inventory for a more conservative measure of liquidity.

Profitability ratios measure the capacity of a business to earn a profit.

• Operating Profit Margin: Operating Income / Revenue. An indicator of operational efficiency.
• Net Profit Margin: Net Income / Revenue. An indicator of overall profitability after accounting for all expenses.

Solvency ratios measure long-term financial health.

• Debt to Equity Ratio: Total Liabilities / Shareholders Equity. A leverage ratio indicates financial risk.
• Interest Coverage Ratio: Operating Income / Interest Expense. A measure of a company’s ability to pay interest.

Efficiency Ratios generally indicate the use of assets and how well they’re being optimized.

• Inventory Turnover: Cost of Goods Sold / Average Inventory. Measures the speed of inventory movement.
• Accounts Receivable Turnover: Net Credit Sales / Average Accounts Receivable. A measure of how efficiently a company collects its receivables.
  

3. Perform Horizontal and Vertical Analysis

Horizontal analysis is a type of analysis that compares items of the financial statements for successive periods to show changes and reveal trends. For instance, revenue growth, when compared over the past five years, can demonstrate the overall trend of the market.

Vertical analysis, on the other hand, treats each item on the financial statements as a percentage of some base item. It reveals cost structures and margin trends. For example, operating expenses as a percent of revenue demonstrate the efficiency of cost containment measures.

4. Apply Progressive Tools and Technology

Applying the right technological tools, such as Blooma, can enhance the efficiency and effectiveness of financial statement analysis. 

• Automated Extraction and Analysis: Eliminates human error and improves accuracy.
• Always Up-to-date Data: Provides real-time insights for time-sensitive decision-making.
• AI-Powered Insights: Provides enhanced analysis and forecasting to anticipate market trends and mitigate potential threats.

Integrating Financial Analysis with Overall CRE Strategy

When effectively integrated, financial statement analysis can support your strategic planning and optimize portfolio management. 

A good financial statement analysis should be linked to your overall investment objectives for your CRE portfolio. To do this, identify your investment goals and then set the right objectives. Identify financial ratios and other metrics that speak to each of your objectives. If income production is most important, then focus on ratios such as NOI and Cap Rate.

Linking financial analysis to other forms of analysis and evaluation will also give you a more complete picture of any potential investment:

• Market Analysis: To help judge the overall viability of investing in a particular area or sector.
• Property Valuation: To estimate the value of any given property.
• Risk Assessment: To help evaluate how the property’s financial situation will stand up under different economic outcomes. Stress testing and scenario analysis are critical here.

From here, you can feed the output of financial analysis into the strategic planning process, which will help ensure that capital is allocated appropriately.

You can employ historical financial performance to develop accurate budgeting and forecasting models. This will help you to anticipate future capital requirements and establish realistic financial targets.

Identify optimal uses for capital by comparing financial performance between properties. Invest in assets with strong financial performance. Identify underperforming assets and explore opportunities for divestment.

Last but not least, continuously analyzing and interpreting the company’s financial statements is crucial for effective portfolio management:

• Performance Measurement: Track relevant financial performance metrics over time, such as Return on Equity (ROE), operating profit margin, liquidity ratios, etc.
• Benchmarking: Compare portfolio financial performance with industry norms and peer portfolios to help identify areas for improvement.
• Strategy Adjustment: Employ financial analysis to evaluate investment performance data and adjust strategy accordingly. For example, if certain property types or sectors are underperforming, consider changing asset mix or debt funding. Reposition, refinance or sell underperforming properties.

Leveraging Technology for Enhanced Financial Reporting

The key to doing all this the right way?

To use the right technology tools. 

Making good use of an advanced technology tool like Blooma can go a long way toward integrating financial analysis into your overall CRE strategy. 

Blooma provides solutions to automate and optimize financial reporting. Some of the major advantages of using Blooma include:

• Accuracy: Data is automatically extracted and processed from various systems removing human error.
• Compliance: Blooma has built-in compliance features to ensure your organization meets regulatory requirements and avoid expensive penalties.
• Up to date: Financial data and reports can be viewed in real time allowing fast responses and informed decision making.

You also unlock amazing features such as: 

• Automated reporting: Instead of spending hours preparing and formatting financial reports, Blooma’s platform can automate this entire process.
• Real time data integration: Integrates with your existing systems to deliver current and accurate financial data.
• In depth analytics: Provides CRE professionals with detailed financial analysis to identify trends and opportunities.

Elevate Your CRE Financial Analysis with Blooma

Make Blooma a part of your financial statement analysis toolkit today. 

Blooma’s commercial real estate software can be a game changer in your CRE financial statement analysis. It uses advanced features to ensure accurate, efficient and informed financial analysis and reporting. 

Don’t miss out! 

Upgrade your financial statement analysis today for more successful CRE investments.

Demo Blooma now.