A Complete Guide on Fluctuation (Flux) Analysis in Accounting

Introduction

Have your business’s finances changed over time? How have these changes impacted your overall financial performance? To find out these answers and make data-driven decisions, a business needs to conduct fluctuation analysis, or flux analysis. 

Often used interchangeably with horizontal variance analysis, flux analysis is a method that helps businesses track and manage financial performance by comparing the balances of two accounting periods. It helps spot variations in trends swiftly and efficiently, giving deep insights about business performance. 

This blog dives deep into understanding the intricacies of flux analysis: what it is, flux analysis calculation with examples, why it is important, and how automation can enhance the scalability and efficiency of flux analysis.

What is Flux Analysis in Accounting?

Flux analysis refers to measuring deviations in account balances between two reporting periods. Utilizing financial statements such as the balance sheet, income statement, and cash flow statement, it compares and identifies the significant discrepancies between ending balances as well as key financial indicators over different accounting periods. 

To understand the flux analysis meaning, note that it goes beyond identifying numerical differences. Businesses can truly leverage variance analysis data only when they can extract strategic foresight into why those fluctuations have occurred in those periods. A good flux analysis provides a nuanced assessment of material differences. Additionally, if done accurately, flux analysis can boost business performance by driving proactive planning powered by data integrity.

Types of Flux Analysis

Fluctuations can happen for any element of the business. A company can focus on fluctuations in expenses or sales and find out if any external factors or internal issues are responsible for the differences. . Or, it can analyze fluctuations in balance sheet elements like inventory, accounts payable, or accounts receivables and analyze their impact on cash flows. The purpose of fluctuation analysis will determine the type of flux analysis that organizations select.

• Horizontal flux analysis

  Horizontal flux analysis compares the ending balances of different financial indicators over two accounting periods to spot changes in trends and patterns. It is known as horizontal analysis as it compares similar elements across the time horizon. For example, a company comparing its accounts receivables balance at the end of 2023 accounting period with that of 2022 accounting period is an example of horizontal flux analysis. By overseeing how the same line items have changed across the time period, horizontal analysis helps to gauge the financial performance.

• Vertical flux analysis

  Vertical flux analysis involves analyzing the components of a financial statement in the same period by comparing them with a base figure. Here, we denote the particular component as a percentage of the base figure. For example, a company analyzing its balance sheet considers total assets as the base figure, and the component it wants to examine is accounts receivables. So in this case, it will see express accounts receivables as a percentage of total assets. Using vertical analysis, businesses can detect critical changes in performance trends.

Why Is Flux Analysis in Accounting Important?

With the increase in financial data complexity and volume, tracking and managing it is becoming difficult for businesses more than ever before. Here, fluctuation analysis helps CFOs and finance teams measure and compare business performance over a period of time, discover trends and patterns, and implement corrective actions by identifying the factors driving those changes. 

Here are a few more reasons why flux accounting is important: 

• End-to-end visibility of financial data 

  Fluctuation analysis helps businesses analyze revenues, expenses, cash transactions, bank balances, etc., at a granular level. It further provides key insights about the catalysts driving financial performance. By conducting flux analysis, businesses can find out:

  • What is driving their growth trajectory, and what has changed over time? 
  • The anomalies causing a sudden spike or drop in numbers
  • Growth opportunities and a data-backed analysis of where they should spend more and where they need to cut costs
  • What are the potential risks, and how can they be mitigated? 

  For instance, a company can analyze its assets on the balance sheet and identify the amounts tied up in accounts receivable or working capital blocked by inventory. They can also analyze which banks saw a decrease in reserves, and with this know-how they can then improve their bank balance management. 

• Detect warning signs early on 

  Conducting flux analysis for financial statements can help companies get a holistic view of their financial health and gain insights into expenses, assets, liabilities, revenues, cash flows, etc. This, in turn, can help identify patterns and troubleshoot early warning signs. 

  For example, if the liquidity ratios of a company are declining over two consecutive years, it means the business might face difficulties in paying short-term debts and they do not have enough cash reserves. In this case, they would recognize the need to improve their liquidity ratio with highly accurate cash forecasting. 

• Set benchmarks for financial performance

  Flux analysis helps benchmark a business’ performance and take active measures to surpass industry standards. By delving deeply into the insights provided, businesses can identify areas for improvement. For instance, diversifying product lines can help a business streamline growth if it is falling behind the industry average. 

• Implement long-term strategy

  Flux analysis enables businesses to make high-impact decisions to increase ROI and optimize resource allocation. They involve redefining business processes and objectives to tap into market potential and drive business growth. CFOs, finance managers, and business heads can design long-term strategies and set realistic targets based on critical indicators identified via flux analysis 

Steps to Conduct Flux Analysis

Flux analysis in accounting is a four-step process. It starts with gathering financial data from different sources, analyzing the changes in financial statements and calculating variances using flux analysis. Here are the steps to conduct flux analysis:

1. Identify and gather relevant data from financial statements 
2. Analyze the financial data 
3. Calculate the flux analysis ratio by reducing the prior year’s balance from the current year’s balance
4. Interpret the results and identify the reasons behind the change

Step 1: Identify relevant data from the financial statements 

This step involves screening the financial statements and identifying the relevant financial data. Once identified, businesses will use this data to calculate variances and conduct flux analysis. Lastly, they will identify the balances that need to be compared and analyzed. 

Step 2: Analyze the financial data 

Businesses will now analyze the differences in financial indicators over the two reporting periods. These changes could be pertaining to increased revenues, surged profits, lower liquidity ratios, etc.

Step 3: Calculate the flux analysis ratio 

To determine the flux analysis ratio, identify the ending balance for the current year or , the base year you want to choose, and the prior year balances. Find the difference between the two and divide the result by the prior year’s value to get the flux analysis percentage or ratio. 

Step 4: Interpret the results 

Analyze the flux analysis results to find out the drivers behind the change. This will help to proactively alleviate roadblocks and boost margins. Based on the insights derived, businesses can implement strategies to boost profit, streamline cash flows, negotiate contracts for better payment terms, and so on.

Flux Analysis Formula

You can calculate flux analysis in percentages or as absolute numbers. To calculate the variance as absolute numbers, deduct the value shown in the previous reporting period from the value shown in the current reporting period. 

To get the variance in percentage, deduct the value of the previous period from that of the current year. Divide the resultant by the value of the previous year and multiply by 100. 

Understanding Flux Analysis Calculation

Businesses can conduct fluctuation analysis at the end of the reporting period. This can be done annually, quarterly. or, in some cases, monthly. Flux analysis usually includes: 

• Balance sheet variance 

  This refers to the changes or discrepancies in the components of a balance sheet over a specific period. Balance sheet variances help businesses understand how assets, liabilities, and equity have evolved from one period to another, highlighting shifts in financial position. By comparing balance sheets over time, businesses can identify trends, assess the impact of operational decisions, and evaluate their financial health and plan accordingly to fortify liquidity and solvency position. 

• Profit and loss (P&L) Variance 

  This refers to the differences between the figures of income and expenses recorded in a company’s financial statements over a specific period of time. Analyzing P&L variances help businesses identify deviations in revenue and operating expenditures, enabling them to understand the reasons behind fluctuations in profitability and enhance strategies to maximize margins. 

• Cash flow variance

  A cash flow variance refers to the disparity between cash inflows and outflows in a company’s financial statements over a given period of time. It helps pinpoint discrepancies in cash management, identify operational inefficiencies, and adjust strategies to improve liquidity of the business through robust cash forecasting. 

An Example of Flux Analysis

Let’s take an example of a manufacturing company, JKL Manufacturing, that has been in business for five years. The company now wants to optimize its production costs. 

Step 1

First, the company will gather the production costs from previous profit and loss statements and arrange them for further analysis. The production costs for the last five years look like this. 

Step 2

The company will now identify the values that are different from the previous year. Here, the costs are seen increasing each year.

Step 3

To perform the flux analysis, the company will calculate the change in costs from one year to the next. They will reduce the year 1 cost from year 2 to get the flux number. Then divide it by the year 1 cost and multiply it by 100 to get the flux analysis percentage. 

So, the Year 2 flux was $15,000 or 50%.

The company will repeat this process for the subsequent years, which will look like: 

Year 3: 10,000 or 22% 

Year 4: 15,000 or 27%

Year 5: 10,000 or 14% 

Step 4

The company will now analyze the flux numbers and percentages to understand the changes in production costs. For instance, the rising costs in years 2 and 4 could be due to an increase in production volume, which led to higher production costs. On the other hand, the cost increase in years 3 and 5 was proportionately smaller. It could be due to the cost optimization strategies the company had implemented.

By diving deep into these fluctuations and their causes, JKL Manufacturing will then make informed decisions based on the variances to streamline its production strategies in an attempt to save a significant amount of money in the long run. 

Challenges in Flux Analysis in Accounting

Businesses face numerous challenges when performing fluctuation analysis using traditional methods.. Traditional flux analysis relies on manual methods to collect data and organize it into innumerable linked spreadsheets. Further,it demands efforts to integrate plugins to compute variances and detect discrepancies in outputs, which makes it challenging for organizations. Some of the key challenges businesses may face in flux analysis are:

• Manual data entry 

  Entering data manually into spreadsheets and accounting is not only a grueling, time-consuming process but also leads to errors and inconsistencies. Further, it requires sustained efforts from a large accounting team to manually organize and record data.

• Limited scalability 

  Lack of automation means the business will have to enter data manually. With larger datasets and complex financial structures like consolidation or amalgamation scenarios, it becomes difficult to scale, limiting the depth and accuracy of flux accounting. It also becomes hard to identify meaningful patterns or anomalies when the data is too large to handle. 

• Lack of real-time insights 

  Businesses may find it difficult to track real-time changes in financial data, thereby impacting decision-making. Up-to-date financial information is crucial to building useful variance explanations that, in turn, are significant to winning stakeholders’ trust. 

Automation To The Rescue: Why Is Automation Important in Flux Analysis

While flux analysis in accounting helps businesses understand changes in financial performance, adoption of automation significantly enhances the accuracy, efficiency, and scalability of the process. Embracing automation is a must for business to keep up with business complexities and make informed decisions.

• Automation helps businesses gather data from multiple sources, including ERP systems, spreadsheets, and databases, and arrange them chronologically and accurately. 
• Automation helps reconcile large volumes of transactions instantly and detect and report anomalies. It makes flux analysis a seamless process for large businesses that have to deal with huge amounts of data, thereby boosting scalability. 
• Automation helps to calculate variances for large volumes of data and interpret flux analysis results with minimal manual intervention. It gathers real-time insights, thereby improving efficiency and the quality of decision-making. 
• By automating manual variance analysis, the team can ensure consistency, compliance with regulatory requirements, and accuracy in flux accounting by eliminating the risk of errors. 

How Does HighRadius Level Up Automated Fluctuation Analysis For Businesses?

Processing flux analysis manually for huge amounts of financial data is a real challenge for businesses. They need automation to maintain the effectiveness and accuracy of calculating variances based on historical trends for any cash flow category with minimum efforts and time. 

Keeping this in mind, HighRadius brings state-of-the-art Variance Analysis for Cash Forecasting Software. This AI-powered software uses various methods to compare variances for flux analysis, like previous year to current year or year-to-date analysis. 

This cutting-edge, automated tool in our Treasury Suite helps CFOs make informed investment, funding, and borrowing decisions by: 

• Skimming projected trends over time for any category or entity. 
• Configuring customized, user-defined views by bank, entity, or region dimensions. 
• In-depth assessment and drilling down to find out the underlying causes of fluctuations in forecasts and actuals. 

Additionally, HighRadius’ Account Reconciliation solution that helps businesses get a holistic and controlled overview of reconciliations with variances. The Reconciliation Control Tower feature gives a consolidated view of General Ledger (GL) balance status, drawn straight from ERP systems, and helps identify discrepancies that may exist with the current Supporting Balance in an external system of records. 

The results? 95% forecast accuracy in global inflows and outflows, 98% cash flow category tagging, along with 100% accounts coverage. 

FAQs

1) What is balance sheet flux analysis? 

Balance sheet flux analysis involves examining the changes in the components of a company’s balance sheet over a period of time. It helps businesses understand the reason behind fluctuations in assets, liabilities, and equity and interpret their impact on the company’s financial health. 

2) What is P&L variance analysis?

Profit and loss flux analysis involves examining changes in income and expenses over a period of time. It helps businesses understand fluctuations in revenues and costs and assess their impact on profitability. The analysis helps pinpoint trends and optimize strategies to maximize profits. 

3) How to perform a flux analysis in Excel?

To perform flux analysis in Excel, gather data from ERP and databases into spreadsheets and organize it. Then calculate variances and format them to represent changes clearly. Next, look for patterns and trends behind fluctuations to implement strategies and record them as summary tables or charts. 

4) Flux Analysis vs Variance Analysis?

Flux analysis and variance analysis, while often used interchangeably, differ in focus and applications. Flux analysis helps understand financial data fluctuations over time to spot trends and drivers of performance changes. Variance analysis compares actual to budgeted figures to evaluate budgeting strategies.