The financial analysis methods are considered as the procedures used to simplify, separate or reduce the descriptive and numerical data that make up the financial statements, in order to measure the relationships in a single period and the changes presented in various accounting years.
For the financial analysis it is important to know the meaning of the following terms:
Profitability: it is the yield generated by the assets put into operation.
Rate of return: is the percentage of profit in a given period.
Liquidity: is the ability of a company to pay its debts on time.
According to the way of analyzing the content of the financial statements, there are the following evaluation methods:
- Vertical Analysis Method It is used to analyze financial statements such as the Balance Sheet and the Income Statement, comparing the figures vertically. Horizontal Analysis Method It is a procedure that consists of comparing homogeneous financial statements in two or more consecutive periods, to determine the increases and decreases or variations of the accounts, from one period to another. This analysis is of great importance for the company, because it informs if the changes in activities and if the results have been positive or negative; It also allows defining which ones deserve more attention for being significant changes in gait.
Unlike vertical analysis, which is static because it analyzes and compares data from a single period, this procedure is dynamic because it relates the financial changes presented in increases or decreases from one period to another. It also shows the variations in absolute figures, in percentages or in ratios, which allows us to widely observe the changes presented for study, interpretation and decision-making.
VERTICAL ANALYSIS AND METHODS
There are two procedures for vertical analysis:
- Comprehensive percentage procedure: It consists of determining the percentage composition of each account of the Assets, Liabilities and Equity, taking as a base the value of the total Assets and the percentage that each element of the Income Statement represents from the Net Sales.
Integral percentage = partial value / base value X 100
Example The value of the total asset of the company is $ 1,000,000 and the value of the merchandise inventories is $ 350,000. Calculate the integral percentage.
Integral percentage = 350,000 / 1,000,000 X 100
Integral percentage = 35%
The financial analysis allows determining the convenience of investing or granting credits to the business; likewise, determine the efficiency of the administration of a company.
- Simple ratios procedure: The simple ratios procedure has great practical value, since it allows you to obtain an unlimited number of ratios and indices that serve to determine liquidity, solvency, stability, solidity and profitability, as well as the permanence of your inventories in storage., the periods of collection of clients and payment to suppliers and other factors that serve to analyze widely the economic and financial situation of a company.
Analysis procedure
Two Financial Statements (Balance Sheet or Income Statement) are taken from two consecutive periods, prepared on the same valuation basis.
The corresponding accounts of the states analyzed are presented. (Not including the valuation accounts when it is the Balance Sheet).
The values of each account are recorded in two columns, on the two dates to be compared, recording in the first column the figures for the most recent period and in the second column, the previous period. (Accounts must be recorded at their net value).
Another column is created that indicates the increases or decreases, that indicate the difference between the figures registered in the two periods, subtracting the values of the previous year from the values of the most recent year. (increases are positive values and decreases are negative values).
Increases and decreases and percentage are recorded in an additional column. (This is obtained by dividing the value of the increase or decrease by the value of the base period multiplied by 100).
Variations in terms of ratios are recorded in another column. (It is obtained when the absolute data is taken from the comparative Financial Statements and the values of the most recent year are divided by the values of the previous year). When observing the data obtained, it follows that when the ratio is less than 1, there was a decrease and when it is higher, there was an increase.
FINANCIAL REASONS:
One of the most used instruments to perform financial analysis of entities is the use of financial ratios, since they can measure to a high degree the effectiveness and behavior of the company. These present a broad perspective of the financial situation, you can specify the degree of liquidity, profitability, financial leverage, coverage and everything that has to do with your activity.
The financial ratios are comparable to those of the competition and lead to the analysis and reflection of the operation of the companies against their rivals.
LIQUIDITY REASONS:
The liquidity of an organization is judged by the ability to repay the short-term obligations that have been acquired as they mature. They refer not only to the company's total finances, but to its ability to convert certain current assets and liabilities into cash.
REASONS FOR DEBT:
These reasons indicate the amount of money from third parties that are used to generate profits, these are of great importance since these debts compromise the company over time.
PROFITABILITY REASONS:
These reasons allow to analyze and evaluate the profits of the company with respect to a given level of sales, assets or the investment of the owners.
REASONS FOR COVERAGE:
These reasons evaluate the company's ability to cover certain fixed charges. These are most frequently related to the fixed charges that result from the company's debts.
LIQUIDITY REASONS:
WORKING CAPITAL (CNT):
This reason is obtained by deducting from the obligations of the company all its rights.
CNT = Current Liabilities - Current Assets
SOLVENCY (IS):
This considers the true magnitude of the company in any instance of time and is comparable with different entities of the same activity.
IS = Total assets
Totally passive
ACID TEST (ACID):
This test is similar to the solvency index, but within the current assets the inventory of products is not taken into account, since this is the asset with the least liquidity.
ACID = Current assets - Inventory
Current liabilities
INVENTORY ROTATION (RI):
This measures the liquidity of the inventory through its movement during the period.
RI = Cost of sales
Average Inventory
AVERAGE INVENTORY DEADLINE (PPI):
Represents the average number of days an item remains in the company's inventory.
PPI = 360
Inventory Rotation
ROTATION OF ACCOUNTS RECEIVABLE (RCC):
It measures the liquidity of accounts receivable through its rotation.
RCC = Annual sales on credit
Average Accounts Receivable
AVERAGE PERIOD OF ACCOUNTS RECEIVABLE (PPCC):
It is a reason that indicates the evaluation of the credit and collection policy of the company.
PPCC = 360
Accounts Receivable Rotation
ACCOUNTS PAYABLE ROTATION (RCP):
It is used to calculate the number of times accounts payable are converted to cash during the year.
CPR = Annual credit purchases
Average Accounts Payable
AVERAGE DEADLINE OF ACCOUNTS PAYABLE (PPCP):
Gives a glimpse of the company's payment rules.
PPCP = 360
Accounts Payable Rotation
REASONS FOR DEBT:
DEBT REASON (RE):
It measures the proportion of the total assets contributed by the company's creditors.
RE = Total liabilities
Total active
PASSIVE-CAPITAL RATIO (RPC):
It indicates the relationship between the long-term funds provided by creditors and those provided by business owners.
RPC = Long-term liabilities
Stockholders' equity
PASSIVE REASON TO TOTAL CAPITALIZATION (RPCT):
It has the same objective as the previous reason, but it also serves to calculate the percentage of the long-term funds supplied by creditors, including long-term debts such as equity.
RPCT = Long-term debt
Total capitalization
PROFITABILITY REASONS:
GROSS PROFIT MARGIN (MB):
Indicates the percentage that remains on sales after the company has paid its stock.
MB = Sales - Cost of Sold
Sales
OPERATING PROFIT MARGIN (MO):
It represents the net profits that the company earns in the value of each sale. These must be taken into account by deducting the financial charges and determines only the profit from the operation of the company.
NET PROFIT MARGIN (MN):
Determine the percentage remaining in each sale after deducting all expenses including taxes.
TOTAL ASSET ROTATION (RAT):
It indicates the efficiency with which the company can use its assets to generate sales.
RAT = Annual sales
Total assets
INVESTMENT RETURN (REI):
Determines the total effectiveness of the administration to produce profits with the available assets.
REI = Net profit after tax
Total assets
YIELD OF COMMON CAPITAL (CC):
Indicates the return obtained on the book value of stockholders' equity.
CC = Net profit after tax - Preferred dividends
Stockholders' equity - Preferred capital
EARNINGS PER SHARE (UA):
Represents the total earnings obtained for each ordinary share in force.
UA = Earnings available for ordinary shares
Number of ordinary shares outstanding
DIVIDENDS PER SHARE (DA):
This represents the amount paid to each shareholder at the end of the period of operations.
DA = Dividends paid
Number of ordinary shares outstanding
REASONS FOR COVERAGE:
TIMES YOU HAVE EARNED THE INTEREST (VGI):
Calculate the company's ability to make contractual interest payments.
VGI = Earnings before interest and taxes
Annual interest expense
TOTAL LIABILITY COVERAGE (CTP):
This ratio considers the company's ability to meet its interest obligations and the ability to repay the principal of the loans or make payments to the amortization funds.
CTP = Earnings before interest and taxes
Interest plus credits to the main liability
TOTAL COVERAGE REASON (CT):
This ratio includes all types of obligations, both fixed and temporary, determines the company's ability to cover all its financial charges.
CT = Earnings before payments of leases, interest and taxes
Interest + payments to the main liability + payment of leases
CONCLUSIONS
At the end of the analysis of the previous financial reasons, you must have sufficient criteria and bases to make the decisions that best suit the company, those that help maintain the resources previously obtained and acquire new ones that guarantee future economic benefits. also verify and comply with the obligations with third parties in order to reach the primary objective of administrative management, position itself in the market, obtaining wide profit margins with a permanent and solid validity against competitors, granting a degree of satisfaction for all managing bodies of this community.
A good financial analysis of the company can provide the security of keeping our company current and with excellent profitability rates.
TITLE: CLASSIFICATION OF FINANCIAL ANALYSIS METHODS
AUTHOR: Israel González - [email protected]
To complement this document on financial analysis methods, we suggest the following series of video-lessons taught by Professor Amparo Melián Navarro, from the Miguel Hernández University of Elche. (2 videos - 57 minutes)
Download the original file
