How to Use Financial Gap Analysis
A gap analysis is a tool that companies use to compare their current financial performance with their target performance. Business owners and managers can use this information to not only identify any financial gaps but to better understand how to overcome them and find the best course of action towards the company’s financial goals. The “gap” in a gap analysis is the space between where an organization is and where it wants to be in the future. Not to be confused with GAAP (Generally Accepted Accounting Principles) reporting, a gap analysis is a measure of where a business has gaps in finance, operational efficiency or other blind spots.
The main questions a gap analysis aims to answer are:
- Where are we now?
- Where do we wish we were?
- How are we going to close the gap?
In this article, we will outline the purpose and process of a gap analysis and answer some frequently asked questions.Talk to An Expert
Understanding Gap Analysis
A gap analysis is a method of assessing the financial performance of a business to determine whether requirements or objectives are being met and, if not, what steps should be taken to meet them. By defining these gaps, management teams can create plans to address any underperforming areas and work towards the goals of the organization.
Performance gaps can be measured across multiple areas of the business, such as revenue generation, sales processes, technology adoption, internal communication or operations processes. Gap analysis can also be used to assess the difference between liabilities and rate-sensitive assets including bank assets, bonds, loans and leases.
There are typically five basic steps to a gap analysis, which include:
- Benchmarking the current state
- Defining financial goals
- Analyzing the gap data
- Compiling a gap report and making a plan
- Monitoring progress
When Is a Gap Analysis Necessary?
Whenever fluctuations in profitability, changes in operational efficiency or rapid growth occurs, performing the process of a gap analysis, and specifically a financial gap analysis, can bring essential insights into how a business operates to light. This information can help a company navigate a scope of financial situations, ranging from long-term strategic planning to short-term budget issues.
However, companies do not need to be underperforming to perform a gap analysis. Since these analyses are strategic in nature, business owners and managers can use them to understand aspects such as market positioning and labor needs. Further, company leaders can use this information to scale the business and/or set the organization up for long-term financial success.
Types of Gap Analyses
Gap analyses can generally be split into two categories: strategic and operational.
Strategic gap analysis assesses gaps in business planning and the overall organization.
Operational gap analysis, on the other hand, examines a specific project, process or day-to-day work of a team or department.
Types of gap analysis include:
- Financial/Accounting gap analysis
- Product or market gap analysis
- Strategic gap analysis
- Skill gap analysis
- Compliance gap analysis
- Product development gap analysis
- And more
Gap Analysis Examples
Many businesses use the gap analysis process. Let’s take a look at some examples of gap analysis uses.
Gap analysis is most useful when an organization needs to:
- Develop a change management strategy but leadership needs to first identify the gap between the current and desired state
- Create a new strategy for the team and want to understand where the organization currently sits
- Prepare for an audit and showcase how the company is proactively addressing any gaps
- Find out why the organization isn’t meeting important key performance indicators (KPIs) and strategic objectives
- Identify opportunities to improve existing processes
- Prepare a strategic plan and prioritize resources
How To Perform a Financial Gap Analysis
A gap analysis template can be used and typically contains five basic steps to evaluate the gaps. Let’s take a look.
Benchmark Current Financial State
A gap analysis starts by defining the state which an organization is operating at. The current situation represents an objective reality which can be measured using currently available financial data. This data serves as a baseline against which future growth potential can be measured.
For instance, if an organization wants to perform a gap analysis of profits, then the current situation would be based on the most recent annual, quarterly or monthly profits. Financial key performance indicators are gross profit margin and operating profit margin.
Define Financial Goals
Management can use this step to define what is important to the success of the organization and their future financial goals.
The desired financial situation is the company’s goal for the key financial metrics performance. It should be based on the same measures as the current situation; for example, if the current situation is a measure of profits, then the desired situation should also be based on profits.
Analyze the Financial Gap Data
In a financial gap analysis, the gap is measured between the current financial situation and the desired financial situation. The gap is, quite simply, the difference between the current financial situation and the desired financial situation. To evaluate a company’s financial performance start with the P&L statement and to evaluate the gross profit margin and net profit margin. This step provides an opportunity to not only identify a gap and determine its size, but also to figure out why there is a gap.
This step can help management identify the roots of any issues or underperforming areas. Business leaders can successfully analyze the financial data by:
- Being specific about the gap.
- Asking questions to determine why the gap is occurring in order to determine the root of the problem. For instance: what is holding back our team from meeting the sales goals?
- Looking through the company’s financial statements:, income statement, balance sheet, and cash flow statement to determine financial position.
Establish a Plan
After leadership identifies the gap and determines why it is occurring, they can create a plan to address the issues to improve the company’s financial health. In some cases, there may be a single solution for bridging the gap; in others, leadership may utilize several strategies in order to address any issues revealed by the analysis. These plans often include a detailed set of processes set at a specific cadence.
Gap analysis should be a continuous process where after changes have been made, the company re-evaluates its current position, progress, and goals.
Gap Analysis FAQs
A gap analysis is a powerful tool in strategic planning. However, many business leaders may not be sure where to start. Let’s answer some frequently asked questions.
How Do You Do Gap Analysis for your Business’ Finance and Accounting Department?
A gap analysis of your business’ finances is the same as gap analyses in other departments; the only differences are the goals and objectives assessed during the analysis. For example, in a financial gap analysis, a team might look at the company’s performance in terms of sales or revenue.
What Are the Three Fundamental Components of a Gap Analysis?
The three fundamental components of a gap analysis include: assessing the current situation, determining the goal state, and highlighting the gap between the two. Then, the organization leaders can create an action plan to bridge said gaps.
What Should a Financial Gap Analysis Include?
A financial gap analysis typically focuses on a few key elements. These elements can include, for example:
- Cost of Goods Sold
- Gross Margin
- Gross Profit
- SG&A Expenses
- Net Income
- Net Income Margin
- Cash or Liquid Assets
- Debt or Liabilities
- Equity / Equity Structure
- Free Cash Flow
- And more
What Happens After the Gap Analysis?
Following the analysis, the leaders of an organization will have a clear picture of where the gaps in the organization are, how big the gaps are, and how management may begin to address them.
Forward progress relies on consistent work over a period of time. We recommend taking concrete measures to manage progress, such as implementing key performance indicators (KPIs).Start the Conversation
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