In today's turbulent world, it is not enough to know the results that are achieved, it is necessary to know the causes of those results. This paper demonstrates the relationship between performance, profitability, margin on sales, asset turnover and leverage, and provides a tool to deepen the analysis of causes.
Introduction
The economic-financial analysis has become a transcendental and necessary element for the success of administrative procedures, which despite its limitations is essential to master regardless of the type of business. The method used, in addition to demonstrating the relationship between performance, profitability, margin on sales, asset turnover and leverage, providing a tool to deepen the analysis of causes, shows an example of how to perform the analysis of the Performance and Profitability applying the integral method supported by the cause-effect diagram.
Development
The economic position of an entity can be determined from the Yield and Profitability ratios. Knowing the value of these indicators is good, but knowing the causes that gave rise to those values is better. Yield can be expressed as the ratio of Net Profit to Total Assets. The economic performance or profitability index can be divided into two ratios that will better express the causes of its evolution. According to Amat Salas (1997), if we multiply the Yield ratio by the Sales / Sales ratio and alter the order of the factors, then Yield can be expressed through the Total Asset Turnover and Margin over Sales ratios.
To increase the Yield, you must increase the turnover, that is, sell more or reduce the asset, and / or increase the margin, that is, sell more expensive or reduce costs.
The difference between yield and profitability reflects the use of debt financing or financial leverage. Therefore, if we multiply the profitability ratio expressed by the relationship between Net Income and Capital. In accordance with Amat Salas (1997), if we multiply this ratio by that of Assets / Assets and by Sales \ Sales and alter the factors, then Profitability can be expressed from the ratios of Total Asset Turnover, Margin on Sales and Leverage.
Profitability = Performance * Leverage
Profitability can be calculated and the causes of its variation identified and, at the same time, the influence of different factors on it can be determined, once the integral method and the cause-effect diagram have been applied (see figure 2). If you want to increase profitability, you can increase Turnover by selling more, increase Margin by reducing costs or increase leverage. If the analyst prefers, he or she could calculate the debt ratios, quality of the debt, yield, leverage and profitability, and later carry out the analysis without actually making the graph, but taking into account the cause-effect relationships.
As a result of the analysis of this point, we will know if the entity is capable of generating the benefits that guarantee it to continue in the market.
The integral method consists of comparing the quantities that are taken as a basis with the quantities to be analyzed, for this it is necessary to determine half of the variation of the first factor and multiply it by the sum of the second factor and add the result to half of the variation of the second factor by the sum of the first factor. Resulting in the joint influence of the two factors on the investigated indicator.
IF1 = ½ΔF1 * (F20 + F21)
IF2 = ½ΔF2 * (F10 + F11)
IC = IF1 + IF2
Where:
CI - Joint influence of the investigated Indicator
IF1 - Influence of the first factor
IF2 - Influence of the second factor
The cause-effect diagram, also known as the Ishikawa diagram (for the name of its author) or the fishbone diagram (for its graphic appearance) is one of the 7 basic tools of quality management. Its purpose is to graphically express the set of causal factors involved in a certain quality characteristic. Developed by Dr. Kaouru Ishikawa in 1960 by understanding that the result or effect of a process was not predictable without understanding the causal interrelationships of the factors that influence it. Soto (2008)
By identifying all the variables or causes that intervene in the process and the interaction of said causes, it is possible to understand the effect that results from any change that occurs in any of the causes. The relationships are expressed through a graph made up of two sections (see figure 3)
- The first section is made up of a main arrow towards which other arrows converge, considered as branches of the main trunk, and on which smaller arrows, the sub-branches, again impinge. In this first section the causal factors are organized. The second section is made up of the name of the characteristic (effect). The main arrow in the first section points precisely to this name, thus indicating the causal relationship that exists between the set of factors (causes) with respect to the characteristic.
Therefore, the principle of Causality is applied in which, it is known that an effect corresponds to every cause.
The effect will give indications to be able to study what the cause is and look for an alternative solution, concrete, that eliminates it. Logically, it should be visible to everyone and everyone should have the ability to access it. Thus this diagram will show the causes on one side and the effects on the other.
The problems must be important enough to be reflected in the diagram, otherwise, it would make it endless and even fill it with insignificance that would only lead to deviating the main ones that really need to be addressed.
Cause-effect diagrams (like any schematic representation) should only be used as a visual aid or as the first stage of more complete documentation. (Soto, 2008)
Practical example.
As previously stated, the Yield is closely linked to the Total Asset Turnover and the Margin on Sales; therefore any variation in these indicators will cause variations in the Yield. Table 1 shows the Margin over Sales ratios
Table 1. Profitability analysis
Similarly, any variation in Yield and Leverage will have a negative or positive impact on Profitability, as shown in table 1.
Variations can be explained using the integral method, which will quantify the influence of Margin and Turnover on Yield, as shown in table 2, and the influence of Yield and Leverage on Financial Profitability, as shown in Table 2. table 3.
Table 2. Joint influence of margin and turnover.
Table 1 shows that, from 2009 to 2010, the Margin on Sales and the Total Asset Turnover decreased by 0.145 and 0.019, respectively. Table 2 shows that the influence of Margin on Yield caused the latter to decrease by 0.042 and the influence of Total Assets Turnover caused a decrease in Yield of 0.006. The joint influence of Margin and Turnover on performance caused this indicator to decrease by 0.048. From 2010 to 2011, the Yield increased by 0.348 and this increase was caused by the growth of the Margin over Sales by 0.200 that stimulated the Yield to grow by 0.125 and the increase in the Asset Turnover by 0.685 which had an impact on an increase in the Yield of 0.224. From 2009 to 2011, the Margin on Sales grew 0.055 and brought with it an increase in Yield of 0.083, for its part, Asset Turnover grew by 0.666 and had an impact on Yield growing by 0.218, the joint influence of Margin and Turnover caused an increase in yield from 2009 to 2011 of 0.300.
From all of the above, it can be inferred that Yield increased as a consequence of the increase, both in Total Asset Turnover, and in Margin on Sales.
Asset Turnover grows as a consequence of increasing the value of sales and the cancellation of deferred assets. Margin on Sales increases due to the increase in Net Profit as a result of increasing the sale prices of sugar cane. Then the Yield grows due to the increase in the sales price of sugarcane and the cancellation of deferred assets.
Table 3. Joint influence of Yield and Leverage
During the period from 2009 to 2011, Financial Leverage has maintained a parabolic trend, having a negative influence on Profitability. For its part, Yield has maintained an inverse trend to Leverage, until reaching very positive values in 2011. Profitability has maintained a similar trend to Yield.
Applying the integral method to the profitability analysis (table 3), the following can be proposed:
1. From 2009 to 2010
Financial Leverage increases by 0.636 and Yield decreases by 0.048.
The decrease in Yield caused a decrease in Profitability by 0.190.
The increase in Financial Leverage caused an increase in Profitability of 0.056.
The joint influence of the decrease in Yield and the increase in Financial Leverage on Profitability caused a decrease in the latter by 0.134.
2. From 2010 to 2011;
Financial Leverage decreased by 2,963 and Yield increased by 0.348.
The decrease in Financial Leverage caused a decrease in Profitability by 0.706
The increase in Yield caused an increase in Profitability of 0.977.
The joint influence of the increase in Yield and the decrease in Financial Leverage on Profitability caused an increase in the latter by 0.271.
During the period from 2009 to 2011, Profitability increased by 0.138 (-0.134 + 0.271) as a result of variations in Financial Leverage and Yield.
Conclusions
The application of the integral method to the analysis of profitability based on the cause-effect diagram, allows to quantify the influence that the variables associated with it exert on the profitability of the company and to determine in a simple way the causes of these variations.
Bibliography
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