Finance is an important tool for analysis and decision-making in today's economy, financial policies and measures capture the attention of businessmen, investors, rulers and even the working people.
Economic globalization has turned the world into a sensitive problem, in fact all economies, even the most powerful are affected by any change that may occur in terms of prices or speculation of the New York, London or Japan stock market.
It is vitally important that professionals in this field have the necessary knowledge to face the challenges and transformations that future life imposes, and know how to defend our interests both nationally and internationally, in this material offers information regarding financing to long-term, financial analysis techniques, use of ratios, valuation of balance sheet items, as well as definitions and concepts that will help to understand the different contemporary financial trends.
The work consists of an introduction, development, and analyzed bibliography.
Introduction
The study of finance is an important tool for the development of the economy and decision-making, by analyzing the necessary data and figures that will make it possible to choose the best alternative courses of action, with a view to increasing income and profitability of investments and businesses efficiently and effectively.
Accounting as science and art does not take the form of a simple recording of economic events, but its scope of action is diversifying every day more, the accountant must be a professional who knows how to value and understand each figure, each indicator, must be able to running a business with a spirit of exchange and motivation, making financial analysis techniques and tools your daily companion. Our country needs to train capable professionals, upright and above all with a high scientific, ethical and moral level.
It is for this reason that the following work aims to serve as support material for teaching in the discipline of Finance with a view to facilitating our students the daily study and constant improvement in financial topics of greater use and application, as well as being able be used as reference material by our graduates once their working life has begun, allowing them to obtain elementary knowledge in such an important tool for decision-making and future projections of companies..
1. Short-Term Financial Planning
Short-term financial planning deals directly with short-term or current assets and liabilities in a company.
The most important current assets are: accounts receivable, stocks or inventories, treasury and negotiable instruments. The most important liabilities are accounts payable and short-term bank loans.
These short-term assets and liabilities are the components of the working capital or net working capital, which is nothing more than the difference between them (AC-PC).
For a company to function efficiently, it must have capital invested in facilities, machinery, inventories, etc. The total cost of these assets are the so-called accumulated capital needs of the company. These can be covered with long or short-term financing according to the variations that it presents in the period. In order to obtain a better level of long-term financing in relation to accumulated needs, the following are taken into account: maturity adjustments, permanent working capital needs and the comfort of cash surpluses.
In general, the sources imply: increase in liabilities and equity and decrease in company assets.
The jobs involve: increase in assets and decrease in liabilities and equity of the company.
The problem of the financial manager is to foresee the future sources and jobs of treasury that give him two guidelines: they alert him to the needs of treasury and provide him with a standard with respect to which he can judge the evolution of the decisions made.
The treasury budget starts with a forecast of the company's sales that are converted into accounts receivable and thus the main source of the company's treasury. As for the outflows, they will be given by accounts payable, personnel, administrative and other expenses, capital and interest investments, taxes and dividend payments.
The next step is to develop a short-term financing plan that can be given via bank debt (with or without guarantees) or via deferral of accounts payable.
Short-term financial plans are drawn up by trial and error procedures, that is, the plan is drawn up, its development is observed, and then adjusted as many times as possible until they cannot be further improved.
2. Definitions and Basic Concepts
Short-term liabilities
They are the short-term obligations that the entity has with the exterior. Within this category are the credits granted for foreign trade operations that are paid through central banks, contributions payable to international organizations, overdrafts that may originate with foreign banks, obligations for the acquisition of products, merchandise, services, among others.
What is liquidity?
It is the ability of the company to meet its short-term commitments with its short-term assets.
How is liquidity measured ?: Dividing short-term assets by short-term liabilities: Short-term assets / short-term liabilities.
Working Capital: Short Term Assets - Short Term Liabilities
Why should liquidity be greater than 1 ?: Because assets are not always worth what they claim to be (bad accounts and obsolete inventories), while liabilities must always be paid 100%.
The Business Cycle
They are the commercial terms that are required for the normal operation of the business.
Customer Credit:
Need for Funds
Inventory:
Need for Funds
Supplier Credit:
Funding Source
Determine the basic working capital necessary to develop the business.
3. What is debt?
They are the funds that third parties have put into the company and that finance part of the total assets that the company needs to operate normally.
3.1. How is Debt measured?
Dividing the total liabilities by the equity of the company and indicates the times that third parties have placed the equivalent of the capital of the company.
Indebtedness: Short-Term Liabilities / Short-Term Assets
3.2. Why does indebtedness vary from one industry to another?
Because it is assumed that the more liquid the assets, the greater the ability to pay (banks can borrow up to 20 times their capital by law).
The indebtedness depends on the perception that the creditors have of the value of the assets and the capacity of the company to generate funds.
3.3. Example of Indebtedness
Current Liabilities
Long Term Liabilities
Total Liabilities: $ 1,200
Equity: $ 800
Indebtedness: $ 1200 / $ 800 = 1.5
4. What is profitability?
It is the result of the company expressed as a percentage of:
- Sales, Assets, Equity.
4.1. Profitability Example
Result for the Period: $ 300
Period Sales: $ 3,000
Heritage: 800
Total Assets: 2,000
Cost effectiveness:
- On sales: 300 / $ 3,000 = 10% On Equity: $ 300 / $ 800 = 38% On Assets: $ 300 / $ 2,000 = 15%
4.2. What is the Result made up of?
The result consists of:
Operating Income + NON-Operating Income
The Operating Result
Corresponds to the difference between sales less the direct cost of making those sales.
Sales: $ 3,000 - 100%
Production Cost: $ 1,500 - 50%
Adm. Cost and Sales: $ 600 - 20%
Operating Result: $ 900 - 30%
Non-Operating Result
Are those income and expenses that are incorporated into the result of the company but do not correspond to production, administration or sales costs.
Financial Expenses - Expenditure
Depreciation - Exit
Monetary Correction - Can be Income or Exit
4.3. Example Result
Sales: $ 3,000 - 100%
Production Cost: $ 1,500 - 50%
Adm. Cost and Sales: $ 600 - 20%
Operating Result: $ 900 - 30%
Financial Cost: $ 300 - 10%
Stockholders' equity or equity (also known as reserve)
It is the "net value" of an organization, and is obtained by subtracting the value of its liabilities, less the value of its assets.
Balance of funds (also known as stockholders' equity)
In a nonprofit organization, this represents the value of income less expenses.
5. The Balance: The criteria of the financial structure
We examine the balance. We will adopt a certain presentation, knowing that each country has its own rules and that we will have to adapt this standard presentation to the specific requirements of each country.
Standard balance
The Balance consists of 5 blocks:
Active:
Current Assets: Assets that are supposed to be renewed during the operating cycle.
The operating cycle describes what happens between the purchase of raw materials and the raising of money generated by sales.
O Fixed Assets, or long-term assets, are assets that are not supposed to be renewed throughout the operating cycle. When we speak of net fixed assets, we refer to the value of the fixed asset after taking depreciation into account.
The liquidity criteria for ordering these assets is theoretically true but in reality many companies can dispose of some fixed assets without any problem (a well-located building or land) while some current assets (inventories) cannot always be easily and quickly converted in money.
Passive:
- Current Liabilities: all liabilities whose payment period is less than one year; this includes Accounts Payable, taxes payable, accumulated expenses not due, etc. and short-term debts with banks and financial institutions. Long-term debts, includes all the debts that the company has maturing in excess of one year. Own resources, also called Equity or Net Equity: represents the value of the investment of the shareholders in the company. Permanent Resources: it is the sum of the Net Equity and the Long-Term Debts.
From this new vision of Balance, we will derive the following two fundamental concepts:
- Working Capital (ct) Working Capital Requirement (rct)
1- Working Capital (CT) (Rotation or Maneuver Fund).
Working Capital is defined as the difference between Permanent Resources and Net Fixed Assets.
Working capital = Permanent resources - net fixed assets
This measures the excess of the Company's long-term financial resources over its long-term use. Represents the funds, or capital, available, in long-term terms to operate in the company's operating cycle.
It is important to realize that it is the only definition of Working Capital. Obviously, CT could be calculated as the difference between Current Assets and Liabilities, but this is not a definition, because defining CT using short-term assets and liabilities would give the impression that it is affected by daily transactions, while it is crucial to recognize that CT is the net financial impact of the company's long-term policy. CT does not change every day; it just depends on the company's strategy regarding its long-term decisions.
Working capital
2. Working Capital Requirement (RCT) (Need for F.de R. or F.de M.)
A company's Working Capital Requirement (RCT) is defined as the difference between cyclical needs (needs arising from the company's operating cycle) and cyclical resources (resources provided by the operating cycle). In other words, it is the net balance of Current Assets and Liabilities, which are directly and exclusively associated with the operating cycle: purchase-storage-production-storage-sales-collection.
The RCT represents the resources necessary to maintain daily operations, that is, the resources required by the operating cycle.
In fact, a company needs to finance the goods it produces, that is, inventories. It needs to finance the goods that have been produced and sold, but not yet collected (remember, sales are a gift until they are collected), that is, accounts receivable. On the other hand, the company obtains raw materials without immediately paying for them and buying on credit reduces the net amount invested in the operating cycle through accounts payable. In addition to these accounts, the company can be financed through other non-financial debts related to its operating cycle such as taxes (VAT, Personal Income Tax, etc.), contributions to Social Security and other creditors.Advance payments and other debtors are shown in Current Assets and represent the advance payment associated with the company's operations such as Advance taxes, certain insurance premiums paid in advance, etc. The difference between various creditors and debtors provides what we will call various net.
Therefore, the Working Capital Requirement is given by:
RCT = (Inventories + Accounts receivable) - (Accounts payable + Miscellaneous net)
Working Capital Requirement
Working Capital Requirement
A. Comment 1: Although RCT is often positive (meaning a net need for funds), it can be negative in certain economic sectors such as retail, where the collection of the sale normally goes into cash before paying to providers. Selling fast, to get cash, something we'll pay for later means that our operating cycle, instead of requiring cash, will generate cash that, if invested, will produce financial income.
B. Comment 2: RCT increases with the company's sales even if the operating cycle policy does not change (same inventory turnover, same collection period, same terms of payment to suppliers). Thus, a growing company should expect an increase in its RCT. As a consequence, the investment caused should be considered an integral part of the company's disbursement plan in any investment project in new production. Finally, RCT changes with the possible seasonal activities of the company.
6. Fundamental Equation of Balance
If the Working Capital represents the funds available after having financed the long-term assets to operate in the company's operating cycle and if the Working Capital Requirement measures the funds necessary to finance its operating cycle, the Balance can be considered as a dialogue between CT and RCT. CT expresses how much money it provides to the operating cycle and RCT how much it needs. Obviously, the difference between the two provides us with the company's Net Cash:
Net Cash = Working Capital - Working Capital Requirement
If the Working Capital is greater than the Working Capital Requirement, we will have a positive Net Cash.
On the other hand, if the Working Capital is less than the Working Capital Requirement, we will obtain a negative Net Cash (that is, the need for short-term loans, short credits, etc.).
Of the fundamental accounting equality:
Total assets = Total debts + Own resources
We can deduce that the Net Treasury is equal to the Liquid Assets (cash, marketable securities, and short-term investments) less callable Financial Liabilities (short-term loans, short credits, and any other short-term financial debt).
Therefore, we can now completely rebuild the balance structure:
Fundamental Equation of Balance
The fundamental equation of Balance:
Net Cash = Working Capital - Working capital requirement leads us to three important comments:
- It is clearly demonstrated that a company's liquidity position is the result of strategic (long-term) and operational (short-term) policies. If information from the present or the past is used, it is of limited interest, since we do not need to go through the entire analysis to measure the company's Treasury situation (we can obtain it simply and directly by looking at liquid assets and financial liabilities callable from the company). But it is an essential relationship to plan and foresee future situations. If we can predict the working capital of the company, (and for this we need an investment plan showing the expected variations in fixed assets,and a financing plan showing the expected variations in permanent resources) and if we can foresee the Working Capital Requirement (relating it for example to the level of sales), we can obtain a good prediction of the expected liquidity position for the company. It is shown that what matters is not the level of Working Capital itself, but its relationship to the Working Capital Requirement. A company with a high level of Working Capital could be in financial difficulties if its Working Capital Requirement were even higher. On the other hand,a company with a poor level of Working Capital (or even negative as in the case of supermarkets) could be in a good financial position if the Working Capital Requirement was even smaller (or more negative) than its Working Capital Finally, the previous relation will be used more frequently in its dynamic version, where variations will be considered instead of absolute numbers:
Variation in TN = Variation in CT - Variation in RCT
Liquidity is therefore, once again, a direct consequence of decisions that affect Working Capital (strategic decisions such as investment or divestment decisions, issuance of shares or repurchase of shares, issuance or cancellation of long-term debt, decisions on dividends, which have an impact on the level of retained earnings) and decisions that affect the Working Capital Requirement (operational decisions such as changing the level of inventories, accounts receivable, accounts payable or various net). Operating directors, in the productive area, in commercial activities or in purchasing functions, influence the liquidity of the company daily. Therefore, the concept of RCT is essential;the control of its level and its fluctuations over time is of vital importance for the liquidity of the company. RCT represents the meeting point of various functions within the company, which have different objectives and obligations but all will have, at the end of the day, a crucial impact on the company's liquidity.
Marketing people must understand the basic techniques and methods of financial analysis, if we want to make good decisions, control and adjust the execution of plans, explain and defend our decisions before our peers and hierarchical superiors. Financial ratios are one of those techniques that we must know in addition to others, for example, financial budgeting, capital budgeting, asset management, working capital management, risk analysis, cost of capital, activity-based costing and added economic value.
7. The Financial Reasons
It is the number that results from dividing one number by another. It is used to evaluate aspects of profitability, liquidity, leverage and efficiency. The generally accepted financial reasons are of two kinds:
- Those that summarize some aspects of the operation during a given period of time. Those that summarize some aspects of the financial position during a given period of time.
7.1. Analysis of Financial Ratios
It uses the information obtained from the Financial Statements and presents a broader perspective of the financial situation of the company. You can, for example, specify the profitability of the company, its ability to meet its short-term debts, establish the extent to which the company is being financed with liabilities and whether management is using its assets effectively. The company's financial ratios are compared with those of the industry, with those of our main competitors, and with trend analysis.
Liquidity Ratios
They measure the company's ability to pay its short-term obligations
Current Ratio (Current Assets) / (Current Liabilities)
Acid Test (Cash + Short-term Stock Market Values + Net Accounts Receivable) / (Current Liabilities)
Net Working Capital
Current Assets - Current Liabilities
Accounts Receivable Rotation (Credit Sales) / (Accounts Receivable from Customers)
Inventory days in stock (Inventory, at cost) / (Daily average of the Cost of Goods Sold)
Sales to Accounts Receivable (Total Sales) / (Accounts Receivable to Clients)
Cash Sales (Sales) / (Cash)
Leverage Ratios
They measure the extent to which the company is being financed with external liabilities.
Debt Ratio (Total Liabilities) / (Total Assets)
Financial Leverage (Total Assets) / (Net Equity)
Interest Coverage (Earnings before Interest and Taxes) / (Interest Expense)
Ratio Debt to Equity (Total Long-Term Debt) / (Net Equity)
Efficiency reasons
It measures the effectiveness of management in the use of company assets.
Rotation of Total Assets (Total Sales) / (Total Assets)
Capital Rotation (Total Sales) / (Net Equity + Long-term Liabilities)
Rotation of Inventories (Cost of Sold) / (Raw Materials + Production in Process + Finished Product + Supplies)
Average Days of Non-Due Portfolio (Total Accounts Receivable from Customers) / (Average Daily Sales)
Rotation of Fixed Assets (Sales) / (Fixed Assets)
Profitability Reasons
It measures the effectiveness of management in generating accounting profits on sales and investment.
Gross Margin (Sales minus Cost of Sold) / Sales
Return on Assets (Net Income) / (Total Assets) or (Return on Sales) X (Rotation of Assets)
Return on Capital (Return on Sales) X (Rotation of Capital)
Return on Equity (Net Income) / (Net Equity) or (Return on Assets) X (Financial Leverage)
Return on Sales (Net Income) / (Sales)
DuPont system
It has been very popular since the late 70's. Combine efficiency ratios with profitability ratios.
Return on Investment (ROI) (Return on Sales) X (Total Asset Rotation)
Rate of return on Equity (Return on Investment) / (Percentage of Assets financed with Equity)
Alternatively: (Return on Investment) / (1.0 - Debt Ratio)
Bibliography
- Brealey, Richard and myers, Steward: Fundamentals of Business Financing, publishing house Mac Graw Hill / interamericana de España SA 1993.Fernández, Cepero. Modern Accounting I. Bookkeeping and Accounting Principles. Editorial Uteha.Gitman, Lawrence: Fundamentals of Financial Administration Volume I. Editorial Mes.Meigs and Meigs. Accounting. The basis for managerial decision making: Weston, Fred and Copeland. Fundamentals of Financial Administration Volume I. Editorial Mes.Weston, J, F and Brigham, E, F: Administration Finance. Editorial Interamericana SA 1987. Encarta Encyclopedia.
