Analysis: it is the decomposition of a whole into parts to know each of the elements that make it up and then study the effects that each one performs.
Financial statement analysis is the critical process aimed at evaluating a company's current and past financial position and results of operations, with the primary objective of establishing the best possible estimates and predictions about future conditions and results.
The analysis of financial statements rests on 2 main bases of knowledge: in-depth knowledge of the accounting model and mastery of financial analysis tools that allow identifying and analyzing financial and operating relationships and factors.
The most important quantitative data used by analysts is the financial data obtained from the companies' accounting system, which helps decision-making. Their importance lies in that they are objective and concrete and have an attribute of measurability.
Interpretation: is the transformation of the information in the financial statements into a form that allows it to be used to know the financial and economic situation of a company to facilitate decision-making.
For a better understanding, the concept of accounting is defined, which is the only viable system for the systematic classification, classification and recording of commercial activities.
Among the limitations of the accounting data we can mention: monetary expression, simplifications and rigies inherent in the accounting structure, use of personal criteria, nature and need for estimation, balances at acquisition price, instability in the monetary unit.
Relative importance of the analysis of financial statements in the total effort of decision
They are an indispensable component of most decisions about loans, investments and other upcoming issues.
The importance of financial statement analysis lies in that it facilitates decision making for investors or third parties who are interested in the economic and financial situation of the company.
It is the main element of the entire set of decisions that interests the person responsible for the loan or the investor in bonds. Its relative importance in the set of investment decisions depends on the circumstances and the market moment.
The types of financial analysis are internal and external, and the types of comparisons are cross-section analysis and time series analysis.
The main environments regarding the financial evaluation of the company:
- Profitability Debt Solvency Rotation Immediate liquidity Productive capacity
His acting techniques are 2:
Analysis and comparison.
Objective of the financial statements
- It is to provide useful information to investors and credit grantors to predict, compare and evaluate cash flows. To provide users with information to predict, compare and evaluate the profit generating capacity of a company.
The conceptual structure of the FASB (Financial Accounting Standards Board) believes that the measures provided by accounting and financial reporting are essentially a matter of personal judgment and opinion.
Likewise, it defines that relevance and reliability are two primary qualities that make accounting information a useful instrument for decision-making. Timeliness is an important aspect, as well as productive value and feedback, comparability, cost-effectiveness. benefit.
SFAC 3 defines 10 elements of the financial statements of commercial companies:
- Assets Liabilities Own funds Investment of owners Distributions to owners The comprehensive result.
Financial statements
They must contain in a clear and understandable way everything necessary to judge the results of operation, the financial situation of the entity, changes in its financial situation and changes in its stockholders' equity, as well as all those important and significant data for management and Other users in order that the readers can properly judge what the financial statements show, it is convenient that they be presented in a comparative way.
The final product of the accounting process is to present financial information so that the various users of the financial statements can make decisions, now the financial information that these users require is focused primarily on:
- Assessment of the financial situation Assessment of profitability and Assessment of liquidity
Accounting considers 3 basic reports that every business must present. The statement of financial position or Balance Sheet whose purpose is to present the financial situation of a business; the Income Statement that aims to report in relation to the accounting of the same business and the cash flow statement whose objective is to provide information about the liquidity of the business.
Balance sheet
The statement of financial position also known as Balance Sheet presents in a single report the information to make decisions in the areas of investment and financing.
Balance sheet: is the financial report that shows the amount of assets, liabilities and capital, on a specific date. The state shows what the business owns, what it owes and the capital that has been invested.
The balance of a company presents the following structure:
Assets Liabilities
Current assets Current liabilities
Fixed Assets Fixed Liabilities
Other assets Other liabilities
Stockholders' equity
Total assets Total liabilities and capital
Asset: resources available to an entity for the realization of its purposes, for which we say that the asset is made up of all the resources that an entity uses to achieve the purposes for which it was created.
Asset is the quantifiable set or segment of the future economic benefits fundamentally expected and controlled by an entity, represented by cash, rights, goods or services, as a consequence of past transactions or other identifiable and quantifiable events occurred in monetary units.
The liability represents the resources available to an entity for the realization of its purposes, which have been contributed by the entity's external sources (creditors), derived from transactions or economic events carried out, which give rise to a present obligation to transfer cash, goods or services; Virtually inescapable in the future, meeting the requirements of being identifiable and quantifiable, reasonably in monetary units.
Stockholders' equity is the owners' right to the net assets that arises from the owners' contributions, from transactions and other events or circumstances that affect an entity and which is exercised through reimbursement or distribution.
The order in which the accounts are presented is:
Assets: the ones collected from highest to lowest liquidity
Passive: the order is from highest to lowest degree of demand.
Balance sheet format:
- Header (business name, financial statement title, date, currency) Title for asset Sub-classifications for assets Total assets Title for liabilities Sub-classification for liabilities Total liabilities Title for capital Details of changes in capital Total liabilities and capital
Statement of income.
It tries to determine the amount by which the accounting income exceeds the accounting expenses, the remainder is called the result, which can be positive or negative.
If it is positive it is called profit and if it is negative it is called loss.
The income statement format consists of
- Header Income section Expense section Net profit balance or net loss.
If the income is greater than the expenses the difference is called net profit, the net profit increases the capital, but if the expenses are greater than the income, the company would have incurred a net loss consequently there will be a decrease in the capital account.
Cash flow statement
It is a report that includes the inflows and outflows of cash to determine the final balance or the net cash flow, a decisive factor in evaluating the liquidity of a business.
The cash flow statement is a basic financial statement that together with the balance sheet and the income statement provide information about the financial situation of a business.
Simplified illustration of cash flow statement
Initial balance
(+) Cash inflows
(-) Cash outflows
(=) Final cash balance (surplus or lack)
The financial statements should reflect financial information that helps the user to evaluate, value, predict or confirm the performance of an investment and the perceived level of implicit risk.
USE OF FINANCIAL REASONS
The ratio analysis evaluates the performance of the company using calculation methods and interpretation of financial ratios. The basic information for the ratio analysis is obtained from the income statement and the company's balance sheet.
The analysis of ratios of the financial statements of a company is important for its shareholders, its creditors and for management itself.
TYPES OF REASONS COMPARISONS
Ratio analysis is not just applying a formula to financial information to calculate a given ratio; interpretation of the value of reason is more important.
There are two types of ratio comparisons:
- Cross section analysis
It involves comparing the financial ratios of different companies at the same time. This type of analysis, called benchmarking, compares the values of the company's ratios with those of a major competitor or group of competitors, especially to identify areas with opportunities for improvement. Another important type of comparison is the one made with the industrial averages. It is important for the analyst to investigate significant deviations to either side of the industry standard.
The ratio analysis directs attention only to potential areas of interest; it does not provide conclusive evidence of a problem.
- Time series analysis
Evaluates the financial performance of the company over time, by analyzing financial ratios, allows the company to determine if it is progressing as planned. Growth trends are observed when comparing several years, and knowing them helps the company to foresee future operations. As in cross-sectional analysis, any significant change from one year to the next needs to be evaluated to see if it is the symptom of a serious problem.
- Combined analysis
It is the analysis strategy that offers the most information, combining cross-section analysis and time series analysis. It allows evaluating the trend behavior of a ratio in relation to the industry trend.
CATEGORIES OF FINANCIAL REASONS
Financial ratios are divided for convenience into four basic categories:
- Liquidity ratios Activity ratios Debt ratios Profitability ratios
Comparative table of the main liquidity ratios
| REASONS | MEASURE | SHORT TERM IMPORTANCE | LONG TERM IMPORTANCE |
| LIQUIDITY | xxx | ||
| EXERCISE | RISK | xxx | |
| DEBT | xxx | ||
| COST EFFECTIVENESS | PERFORMANCE | xxx |
Important fact is that debt ratios are useful mainly when the analyst is confident that the company will survive the short term successfully.
LIQUIDITY ANALYSIS
It reflects the ability of a company to meet its short-term obligations as they become due. Liquidity refers to the solvency of the company's general financial position, that is, the ease with which it pays its bills.
Net working capital.
It's not really a reason, it's a common measure of a company's liquidity. It is calculated as follows:
Net working capital = Current assets - Current liabilities
Circulating reason.
It determines the ability of the company to meet its short-term obligations, expressed as follows:
Current ratio = Current Assets
Current Liabilities
Important: Sow that the current ratio of a company is 1, the net working capital will be 0.
Quick reason (acid test)
It is similar to the current ratio, except that it excludes inventory, which is generally the least liquid of the current Assets, due to two factors:
- Many types of inventory do not sell easily. Inventory is normally sold on credit, which means that it translates into an account. receivable before it becomes money.
It is calculated as follows:
Quick Ratio = Current Assets - Inventory
Current Liabilities
The quick ratio provides a better measure of liquidation, generally only when a company's inventory cannot easily be converted into cash. If you inventory the liquid, the Current Ratio is an acceptable measure of overall liquidity.
ACTIVITY ANALYSIS
They measure the speed with which various accounts are converted into sales or cash. With respect to current accounts, liquidity measures are generally inadequate, because differences in the composition of a company's current accounts significantly affect its true liquidity.
Inventory rotation
It measures the activity, or liquidity, of a company's inventory.
It is calculated as follows:
Inventory turnover = Cost of sales
Inventory
The resulting turnover is only significant when compared to that of other companies in the same industry or to a previous inventory turnover of the company.
Inventory turnover can easily be converted to average inventory duration by dividing 360 (the number of days in a year) by inventory turnover. This value is also considered as the average number of days inventory is sold.
Average collection period
It is defined as the average amount of time required to recover accounts receivable.
It is calculated as follows:
Average collection period = Accounts receivable.
Average sales per day
= Accounts receivable
Annual sales
360
The average collection period is significant only in relation to the credit conditions of the company.
Average payment period
It is the average amount of time required to settle accounts payable. It is calculated similarly to the average collection period:
Average payment period = Accounts receivable.
Average purchases per day
= Accounts receivable
Annual Purchases
360
The difficulty in calculating this ratio stems from the need to know annual purchases (a value that does not appear in the published financial statements). Normally, purchases are calculated as a certain percentage of the cost of the products sold.
This figure is significant only in relation to the average credit conditions granted to the company. Lenders and potential trade credit providers are primarily interested in the average payment period because it allows them to learn about the company's bill payment patterns.
Rotation of total assets
Indicates the efficiency with which the company uses its assets to generate sales. In general, the higher the total asset turnover of a company, the greater the efficiency of utilization of its assets. This measure is perhaps the most important for management because it indicates whether the company's operations have been financially efficient. It is calculated as follows:
Total asset turnover = Sales
Total assets
A caveat regarding the use of this ratio stems from the fact that a large portion of total assets includes the historical costs of fixed assets. Since some companies own assets that are older or newer than others, comparing the turnover of that company's total assets can be misleading. Due to inflation and historical asset book values, companies with newer assets will have lower rotations than companies with older assets. Differences in these turnover measures could be the result of more expensive assets and not operating efficiencies. Therefore the finance manager must be cautious when using this cross-sectional ratio.
DEBT ANALYSIS
A company's debt level indicates the amount of money borrowed by others that is used to try to make a profit. The greater the debt that the company uses in relation to its total assets, the greater its financial leverage.
Debt ratio
It measures the proportion of the total assets financed by the company's creditors, the higher this ratio, the greater the amount of money lent by third parties that is used to try to generate profits.
| Debt ratio | = | Total liabilities |
| Total assets |
Reason for the ability to pay interest
It measures the company's ability to make contractual interest payments, that is, to pay its debt. The lower the ratio, the greater the risk to both lenders and homeowners.
| Reason for the ability to pay interest | = | Earnings before interest and taxes |
| Interests | ||
PROFITABILITY ANALYSIS
There are many measures of profitability, which relates the company's returns to its sales, assets or stockholders' equity.
Common format income statements
They are those in which each game is expressed as a percentage of sales, they are especially useful to compare performance over time.
Gross profit margin
It measures the percentage of every dollar of sales left after the company paid for its products.
| Gross profit margin | = | Sales - Cost of sales | = | Gross profit |
| Sales | Sales |
Operating profit margin
Calculate the percentage of each dollar of sales left after deducting all costs and expenses, including interest and taxes. It is commonly used to measure the success of the company in relation to profits on sales. The older the better.
| Net profit margin | = | Net income after tax |
| Sales |
Return on assets
Determines the effectiveness of management in making profits from its available assets; also known as return on investment. The higher the better.
| Return on assets | = | Net income after tax |
| Total Assets |
Return on stockholders' equity
Estimate the return obtained from the owners' investment in the company. The higher the performance the better for owners.
| Return on stockholders' equity | = | Net income after tax |
| Stockholders' equity |
DUPONT ANALYSIS SYSTEM
The DuPont system merges the income statement and balance sheet into two summary measures of profitability: return on assets (RSA) and return on equity (RSC).
This system brings together the net profit margin, which measures the profitability of the company in sales, with its total asset turnover, which indicates the efficiency with which the company used its assets to generate sales.
| RSA | = | Net income after tax | x | Sales | = | Net income after tax |
| Sales | Total assets | Total assets |
| CSR | = | Net income after tax | x | Total assets | = | Net income after tax |
| Total assets | Stockholders' equity | Stockholders' equity |
