Financial analysis is a technique for evaluating the operational behavior of a company, diagnosing the current situation and predicting future events and which, consequently, is oriented towards obtaining previously defined objectives. Therefore, the first step in a process of this nature is to define the objectives in order to formulate, then, the questions and criteria that will be satisfied with the results of the analysis -which is the third step- through various techniques..
Financial analysis tools can be limited to the following: a) comparative analysis, b) trend analysis; c) proportional financial statements; d) financial indicators and e) specialized analysis, among which the statement of changes in financial position and the statement of cash flows stand out.
Financial indicators
Financial indicators group a series of formulations and relationships that allow standardizing and properly interpreting the operating behavior of a company, according to different circumstances. Thus, the short-term liquidity, its capital structure and solvency, the efficiency of the activity and the profitability produced with the available resources can be analyzed.
Consequently, the indicators are classified as follows:
Liquidity ratios
Capital structure reasons
Activity reasons
Profitability reasons
Once the selected indicators have been calculated to answer the questions posed, they proceed to their interpretation, which is perhaps the most delicate part in a financial analysis process, because it no longer involves a quantitative part, but a great load of subjectivity and inherent limitations. to the handling of information that could, among other things, have been manipulated or simply poorly presented. There are also a series of external factors that affect the results obtained, mainly due to the effect of inflation.
For this reason, all the operations carried out by a company, in a given period of time, must be subjected to a process of adjustments for inflation, in order that the figures produced by said operations are expressed in constant pesos or the same purchasing power. In addition, for comparative purposes, the financial statements should be updated from one year to the next, after having been adjusted for inflation.
This situation means that certain financial ratios cannot be calculated with the figures issued in the financial statements, but must be subjected to an additional purification or "correction", which advocates because the interpretation of such results is not distorted and leads to erroneous judgments and making wrong decisions.
Classification of financial ratios
Financial ratios have been classified, for better interpretation and analysis, in multiple ways. Some authors prefer to give greater importance to the profitability of the company and begin their study by the components that make up this variable, continuing, for example, with the explanation of the solvency, liquidity and efficiency indicators. Other texts raise solvency first and then profitability and stability, defining the latter in the same category of efficiency. In the same way, there are hundreds of ratios or indices that can be calculated based on the financial statements of an economic entity, but not all of them are important when diagnosing a situation or evaluating a result.
For these reasons, in this text the various indicators have been classified into four groups and only those most commonly used and that are of real importance for the purposes foreseen in the work and its users will be explained. These groups are:
- Liquidity ratios, which assess the ability of the company to meet its short-term obligations. Therefore, it implies the ability to convert assets into cash. Capital structure and solvency ratios, which measure the degree to which the company has been financed by debt. Activity ratios, which establish the effectiveness with which they are being used. the resources of the company Profitability reasons, which measure the efficiency of the administration through the returns generated on sales and on investment.
In turn, each of these groups incorporates a series of ratios or indices that will be studied independently. However, before entering into the proposed study of financial indicators, attention should be drawn to a fact that, strangely, goes unnoticed in most of the texts on analysis of financial statements published for students in our country. This fact refers to the inflation that is recurrent in our environment and that, in addition, its effect must be calculated and accounted for. These circumstances (inflation and accounting records) lead to a new way of interpreting the results obtained,inasmuch as the presence of the inflationary phenomenon in financial figures can produce serious distortions compared to the standards used up to now as a measure of evaluation and behavior.
Income from exposure to inflation
Tax and accounting standards define profit or loss from exposure to inflation as the credit or debit balance recorded in the monetary correction account, respectively. In turn, the monetary correction account is made up of the inflation adjustments made to the non-monetary accounts of the balance sheet and to all the accounts of the income statement, as summarized in the following table:
| Investments in shares and contributions | Credit | |
| Property, plant and equipment (cost) | Credit | |
| Accumulated depreciation and depletion | Debit | |
| Intangible assets (cost) | Credit | |
| Deferred assets (cost) | Credit | |
| Accumulated amortization | Debit | |
| Heritage | Debit |
According to the definition given, regarding the adjustments that affect the monetary correction account, it can be clearly seen that said account is made up of a) adjustments to balance sheet accounts and b) adjustments to income accounts. The former, whose net balance will henceforth be generically called "profit from asset holding", increase or decrease profit because they are accounted for in crossed balance sheet and income accounts; On the other hand, the latter do not alter the accounting profit, since their recording affects, as a debit and as a credit - simultaneously - only the income statement accounts. Likewise, a part of the inflation adjustments to assets is transferred to the income statement, either as a higher value of the cost of the merchandise sold (adjustment to inventories), or as a higher depreciation expense,depletion or amortization (Fixed, intangible and deferred assets) or as a lower profit on sale (investments in shares and contributions). Therefore, the traditional accounting profit is being affected by three factors, diametrically different in their effect on the final profit or loss:
1. Adjustment to income accounts: they do not alter the final profit, because they are recorded as a higher value of the respective income or expense against the monetary correction account. However, inflation adjustments to the two basic components of the income statement, income and expenses, have completely different connotations for the purposes of calculating financial indicators that indicate or diagnose the situation of an economic entity, although their adjustment is justified in the sense that they express in homogeneous terms (weights of the last day of the period under study) all the operations carried out during the year.
Under these circumstances, the adjustment for inflation to costs and general expenses is defined as the highest value that the company would have to disburse to incur the same costs and expenses but on the last day of the year or period, when the prices of said items are They have increased as a result of inflation. In other words, if the company wanted to continue operating in at least the same dimensions and magnitudes as the previous year, it should have sufficient resources to meet its costs and expenses, but at the new prices. In this sense, the adjustment for inflation to costs and expenses must be subtracted from profits because it represents the largest disbursement that will have to be made and, therefore, the money to meet that greater outflow of money must come from profits.If you do not want to deteriorate the assets of the company. Therefore, for the purposes of the analysis, for reasons, costs and expenses must be adjusted for inflation.
On the other hand, the inflation adjustment to income is only useful for purposes of comparison between one year and another, but not for the estimation of financial indicators, because said adjustment, contrary to what was explained in the case of costs and expenses In general, economically, it does not mean, for any reason, that due to the fact that inflation has occurred, income will grow automatically.
2. Adjustment to balance sheet accounts: One hundred percent increase or decrease the final profits recorded by an economic entity, because its counterpart always affects the monetary correction account, which belongs to the income statement. However, as can be easily observed, this kind of profit has not been realized and does not come from the company's operations, which is why it could be wrongly incorporated into the indicators that use reported profits or losses as a parameter and that include, By legal obligation, this type of profit. On the other hand, with some reservations, the adjustments that directly affect the balance sheet accounts, as they are the counterpart of the monetary correction account, if they are taken into account in the design of financial indicators.
3. Adjustments to balance sheet accounts that are transferred to the income statement: part of the inflation adjustments to the balance sheet accounts -at one time or another- must be transferred as a higher value of cost or general expenses. A typical case of this situation is observed in inventories, which are restated for inflation, but at the time of being consumed or sold, they should affect profits not because of the historical acquisition cost but because of their adjusted cost until the moment of being consumed. or sold. In the same way, but in longer terms, it occurs with depreciation, depletion and amortization, which must be calculated on the acquisition cost, but duly adjusted for inflation, which causes the expense for these concepts to be greater than that which is would be recorded if there were no obligation to make adjustments for inflation.
In summary, it is neither prudent nor technical to take the figures reflected in the financial statements - neither at historical values, nor with figures adjusted for inflation - without first understanding with some degree of depth the philosophy of the integral system of adjustments for inflation and the implications that They involve their accounting procedures, with the aim of correcting some of the bases that serve as a parameter for the calculation of financial indicators. The foregoing means that, in some cases, the components of a ratio or index must be taken over their original or historical acquisition values, in others according to figures adjusted for inflation and in others, the balances must be corrected to eliminate adjustments. partial or total due to inflation,as it is explained at length in the study of each of the indicators incorporated in this chapter.
Interpretation of financial ratios
For the reasons stated, financial indicators should be interpreted with caution since the factors that affect any of their components -number or denominator- can also directly and proportionally affect the other, distorting the financial reality of the entity. For example, classifying a short-term obligation within long-term liabilities can improve the current ratio, in a misleading way.
Due to this circumstance, when studying the change that occurred in an indicator, it is desirable to analyze the change presented, both in the numerator and in the denominator in order to better understand the variation detected in the indicator.
Due to the above considerations, a careful analysis of the notes to the financial statements is recommended, since it is there that the accounting policies and the valuation criteria used are disclosed.
Likewise, the results of the analysis by financial indicators must be compared with those presented by similar companies or, better, of the same activity, to give validity to the conclusions obtained. Because it can reflect, for example, an increase in sales of 25 percent that would seem to be very good - looked at individually - but that, however, if other companies in the sector have increased their sales by 40 percent, such An increase of 25 percent is not really a favorable trend, when studied as a whole and comparatively.
Liquidity ratios
The liquidity analysis allows estimating the capacity of the company to meet its obligations in the short term. As a general rule, short-term obligations are recorded on the balance sheet, within the group called "Current liabilities" and includes, among other items, obligations with suppliers and workers, bank loans with a maturity of less than one year, taxes payable, dividends and participations payable to shareholders and partners and unpaid expenses incurred.
Such liabilities must be covered with current assets, as their nature makes them potentially liquid in the short term. For this reason, fundamentally the liquidity analysis is based on current assets and liabilities, since it seeks to identify the ease or difficulty of a company to pay its current liabilities with the product of converting its current assets to cash.
For the explanation of each of the financial reasons, the figures of the financial statements incorporated in the appendix of this text will be used as a model.
Current ratio
This indicator measures the current availability of the company to meet the existing obligations on the date of issuance of the financial statements that are being analyzed. By itself, therefore, it does not reflect the ability to meet future obligations, since this also depends on the quality and nature of current assets and liabilities, as well as their turnover rate.
Current Assets / Current Liabilities
| Historical | Tight | ||
| 1,058,535 | 1,639,870 | 1,058,703 | 1,639,969 |
| 667,445 | 1,586,299 | 667,445 | 1,586,298 |
| 1.59 | 1.03 | 1.59 | 1.03 |
In this case, the updating of inventories (an important component of current assets) at current prices is not significantly influencing the performance of the indicator, a fact that may indicate a good inventory turnover. If the inventories were very old, then the indicator would tend to be higher after applying the integral system of adjustments for inflation, although this does not necessarily indicate a better possibility to meet short-term obligations, since there may be obsolete inventories whose realization in the market is not easy to carry out.
The interpretation of this financial ratio must be carried out together with other behavioral results, such as the turnover indices and acid test, although everything seems to indicate that the estimated ratios on historical values can more efficiently indicate the situation of the companies, in the short term term, against your obligations.
The current ratio indicator presents some kind of limitations in the interpretation of its results, the main one being the fact that this ratio is measured statically, at a given moment of time and, consequently, it cannot be guaranteed that in the future the resources that were available will continue to be so. Furthermore, when decomposing the various factors of ordinary reason, serious arguments are found about the reasonableness of their function. For example, cash balances or securities deposited in temporary investments represent only a margin of safety in the event of atypical business situations and, for no reason, reserves for the payment of current operations of the company;assuming otherwise would be like discarding the principle of continuity and thinking that the company is going to be liquidated in the near future.
In the same way, accounts receivable and inventory are accounts of permanent movement and for this reason, it is not safe to assume that a high balance should remain that way, especially when it is required to meet current obligations. The two variables are closely interrelated with concepts such as level of sales or profit margin, these concepts being, in reality, the true parameters in determining future cash inflows.
This can be summarized by stating that the liquidity of a company depends more on the expected future cash flows than on the balances, of the same nature, recorded in the accounting at the time of analysis. In addition, the efficiency in the rotation of accounts receivable and inventories, aims to achieve maximum profitability in the use of assets and not necessarily obtain greater liquidity.
Another limitation of the common reason is that its result can be easily manipulated in order to obtain figures that are required for some special purpose. For example, on the last day of the year an important liability could be canceled and taken again on the first day of the following year, with which the ratio improves by simultaneously decreasing both the assets (from whose funds the resources are taken) and the current liabilities.. Significant items that have to do with inventories in transit may also be deliberately discontinued; By not recording neither assets nor liabilities, the current ratio improves. Likewise, the decision to make new purchases could be postponed, given the proximity of the accounting closing, reducing both current assets and liabilities, but increasing the indicator.
There are standards on this indicator that, sometimes, are taken automatically as measurement parameters, when in reality each particular case must be evaluated in its own dimensions. This is how it is stated that a 2: 1 ratio, that is, having current assets that duplicate short-term obligations, is ideal; however, there may be situations in which there are minimum levels of inventories and optimal turnover of accounts receivable, with which there will be sufficient liquidity to meet current liabilities, even though the indicator does not seem to be the best.
On the other hand, it might be thought that the higher the current ratio, the better the financial management of resources. But, if you look at this case objectively, a very high indicator, although it is stimulating for suppliers and financial institutions, because it practically ensures the return of debts, it is also a sign of mismanagement of cash and an excess in own investment, coming from of partners and shareholders, who will be affected by the rate of return associated with said investment.
Acid test
By not including the value of inventories owned by the company, this indicator indicates with greater precision the immediate availability for the payment of short-term debts. The numerator, consequently, will be made up of cash (cash and banks) plus temporary investments (Cdt's and other immediately realizable values), known today as "cash equivalents", and plus "accounts receivable".
(Current Assets - Inventories) / Current Liabilities
| Historical | Tight | ||
| 2.0X1 | 2.0X2 | 2.0X1 | 2.0X2 |
| 800,974 | 1,121,825 | 801,142 | 1,121,924 |
| 667,445 | 1,586,299 | 667,445 | 1,586,298 |
| 1.20 | 0.71 | 1.20 | 0.71 |
As in the case of the current ratio, the acid test indicator is not affected by inflation because its components are monetary items, expressed in nominal original values, that is, they do not change as a result of variations in the general level of prices, although they are strongly affected in terms of purchasing power.
In the example, for the year 20X2 there was a noticeable deterioration in the index, possibly due to the acquisition of new liabilities (see comparative balance sheet and trend analysis) whose destination was not working capital but investment in fixed assets. It is worth asking here if the expansion of the physical structure through short-term loans will allow an increase in sales, capable of generating sufficient resources to meet these obligations. Quite possibly, this company will have to restructure its liabilities or sell part of its fixed assets, failing to face financial problems.
The same limitations set forth when the current reason was studied apply to this reason, since it is also a static test that does not take into account the principle of continuity and is based on the assumption that the company will enter into the liquidation process and, consequently, will not it will generate any kind of operations that generate cash flows, such as new sales of products or services specific to its activity.
Likewise, eliminating the inventory account from the numerator does not guarantee better liquidity since the quality of the accounts receivable must be taken into account, a concept that will be studied later, and the ease of carrying out the inventory, since it is sometimes easier sell the stock of merchandise or products to recover the portfolio. If accounts receivable have a slow turnover, it is recommended to eliminate this item for the calculation of the acid test, including in the numerator, therefore, only cash and temporary investments or cash equivalents. When this filtering is carried out, the indicator thus calculated is called the «extreme liquidity ratio».
Working capital
Although this result is not properly an indicator, since it is not expressed as a ratio, it complements the interpretation of the «current ratio» by expressing in pesos what it represents as a ratio.
Current Assets - Current Liabilities
| Historical | Tight | ||
| 391,090 | 53,571 | 391,258 | 53,571 |
Here again, it can be seen that the slight variations that occur between the results, before and after inflation adjustments, are not relevant, which indicates -as already indicated- an optimal inventory turnover.
This result indicates the excess or deficit of the company, represented in current assets, that would appear after canceling all current liabilities. As can be seen, working capital presents the same limitations found for the current ratio, since it corresponds to the absolute expression of a relative result.
Defensive basic interval
It is a general liquidity measure, implemented to calculate the number of days during which a company could operate with its current liquid assets, without any kind of income from sales or other sources.
Although it is not an indicator of widespread use, in times of inflation its result can be extremely useful in certain business circumstances, such as labor negotiations (possibility of strikes or indefinite stoppages) or contracting general insurance (especially loss of earnings).
(Cash + Temporary investments + Accounts receivable) / (Cost of sales + General expenses) / 365
| Historical | Tight | ||
| 786,707 | 1,121,825 | 786,875 | 1,121,924 |
| 1,297,311 ÷ 365 | 2,701,706 ÷ 365 | 1,326,437 ÷ 365 | 2,888,398 ÷ 365 |
| 221 | 152 | 217 | 142 |
The result indicates that the company could continue to meet its obligations for 217 days, with the results of 20X1 adjusted for inflation and for 142 days with those of 20X2, in exchange for the number of days shown for the same years, but without having eliminated the effect. of inflation, which is why this indicator should be taken including adjustments for inflation.
The capital structure of a company can be defined as the sum of funds from own contributions and those acquired through long-term debt; while the financial structure corresponds to all the debts -both current and non-current- added to equity or internal liabilities. The sources of acquisition of funds, together with the class of assets that are owned, determine the greater or lesser degree of solvency and financial stability of the economic entity. The relative magnitude of each of these components is also important to assess the financial position at a given time.
The solvency indicators reflect the ability of the company to meet the obligations represented in fixed charges for interest and other financial expenses, as a result of its short and long-term contractual obligations, as well as the timely repayment of the amount owed. This means that the proportion of debt and the magnitude of the fixed costs derived from it are indicators of the probabilities of bankruptcy of a company due to insolvency and of the risk assumed by investors, given the variability of expected profits and that constitute your performance.
Businesses go into debt for many reasons. The main one is that borrowing can be cheaper than own financing because, as a general rule, investors demand a higher remuneration (otherwise, they would prefer to be creditors and not investors), since within said remuneration the cost of financing. In other words, the yield that is paid to the creditors is fixed, whereas it is variable in the case of the partners or shareholders. With a simple example, the above statement can be better understood. Suppose a company with total assets equivalent to one million pesos, which can be financed with its own resources, through external financing or with a combination of both sources.If we also assume a profit before interest of 400 thousand pesos, an interest rate of 30 percent and, to simplify, the non-existence of income tax, we would have:
| CAPITAL | DEBT | UAII | INTEREST | UAI | RETURN |
| 1,000,000 | 0 | 400,000 | 0 | 400,000 | 40.00% |
| 800,000 | 200,000 | 400,000 | 60,000 | 340,000 | 42.50% |
| 600,000 | 400,000 | 400,000 | 120,000 | 280,000 | 46.67% |
| 500,000 | 500,000 | 400,000 | 150,000 | 250,000 | 50.00% |
| 300,000 | 700,000 | 400,000 | 210,000 | 190,000 | 63.33% |
| 100,000 | 900,000 | 400,000 | 270,000 | 130,000 | 130.00% |
From which it can be seen that to the extent that the debt is higher, the profitability of investors will also be higher in relation to the capital contributed. Due to this circumstance, it is stated that the cost of financing through debt is less than the cost of own resources, given its variability in the latter case.
Another reason for indebtedness is the deductibility of interest, which can produce, through the lower tax paid in use of said prerogative, a significant generation of internal resources for future financing of its operations; provided that said lower tax, caused by the use of the deduction from financial expenses, is withheld from net profits, to avoid that the resources thus generated are implicitly distributed to shareholders. For example, if a company finances itself 100 percent with its own resources (company X) and another company does it in equal parts (company Y), we would have:
| CAPITAL | DEBT | UAII |
| Earnings before interest and taxes | 400,000 | 400,000 |
| Taxes (30% on $ 500,000) | 150,000 | 0 |
| Profit before tax | 250,000 | 400,000 |
| Income tax (35%) | 87,500 | 140,000 |
| Net profit | 162,500 | 260,000 |
Situation that indicates a lower tax of $ 52,500, product of applying the tax rate (35 percent) to the amount of interest accrued ($ 150,000), which means that the state subsidizes -in a certain way- the cost of external financing obtained by economic entities.
From a strategic planning perspective, the company should not distribute this lower tax ($ 52,500), but retain it under the figure of a voluntary reserve, to be accumulated and, later, used in new investment plans.
However, this advantage has been lost in Colombia with the implementation of the comprehensive inflation adjustment system that taxes, precisely, the indebtedness in nominal pesos, that is, it taxes the profit obtained when registering debts that will be paid, in the future, in pesos with lower purchasing power.
Capital structure and solvency ratios
In order to assess the risks explained above and the possibilities of meeting long-term liabilities, there are some financial indicators, such as those studied below:
Total leverage
It measures to what extent the equity of the owners of the company is compromised with respect to their creditors. They are also called leverage ratios, as they compare the financing from third parties with the resources provided by the shareholders or owners of the company, to identify who bears the greatest risk.
Liabilities / Equity
| DEBT | UAII | ||
| 1,029,660 | 1916,691 | 1,029,660 | 1,916,691 |
| 505,826 | 913,750 | 576,844 | 1,008,133 |
| 2.04 | 2.10 | 1.78 | 1.90 |
For this example, the results can be interpreted as follows: for each peso of equity there are debts of 2.04 and 2.10, for each of the years studied, before inflation adjustments; and 1.78 and 1.90, after applying the integral system. It is also usually interpreted as a relationship between the two variables that intervene in the design of the indicator; that is, it could be said that, after adjusting for inflation, the owners are 178 and 190 percent committed, respectively.
In nations with low inflation rates, some variants of the previous formulation have been designed to improve and clarify the results. One of these variations is the «Liabilities-Capital» ratio, which differs from the one previously studied in that it does not include all the items that make up the equity, but only the capital stock:
Liabilities / Capital
That, in our country, it would have to be modified to add the equity revaluation account, whose philosophy is, precisely, to estimate the loss of purchasing power of the initial capital to know what would be the amount of the contributions required if one wanted to start a new one. company with the operational and market characteristics of the entity that is currently operating:
Liabilities / (Capital + Equity Revaluation)
The indicators related to the concept of «leverage» and that, therefore, involve the company's equity in their analysis are, as already defined, analysis of the financial and capital structure and risk measures, because In situations in which this indicator is high, the interest payments and disbursements to meet the obligation will be higher, and the risks of insolvency will also be higher, in times of economic slowdown or due to particular problems of the entity.
It should be remembered that a company is considered commercially insolvent when it incurs inability to comply, at maturity, with the obligations acquired and that they are represented in debts and liabilities with third parties, mainly due to the fact that the cash flows, generated by the economic entity, are insufficient.
There are also other useful indicators for the purposes of evaluating the solvency of a company, which have already been studied previously, mainly in the part corresponding to proportional financial statements, such as the relations «Long-term Liabilities-Capital», «Long-term liabilities term-Equity »or the one presented below.
LONG-TERM CAPITALIZATION
Measure that indicates the relative importance of long-term debts within the capital structure of the company, as already defined:
Long-term liabilities / Total capitalization
| Historical | Tight | ||
| 362,215 / 868,041 | 330,392 / 1,244,142 | 362,215 / 939,059 | 330,392 / 1,338,525 |
| 0.4173 | 0.2656 | 0.3857 | 0.2468 |
The higher this indicator, the greater the risk that the economic entity runs, since an unforeseen situation that affects the company's operating income, reducing them, could lead to a situation of illiquidity and insolvency, as a consequence of the high financial burden that long-term debts would cause. The denominator of this indicator is made up of the sum of long-term debts and the company's equity, which is why it seems valid that the interpretation of results is made on figures adjusted for inflation.
Debt level
This indicator indicates the proportion in which creditors participate on the total value of the company. Likewise, it serves to identify the risk assumed by said creditors, the risk of the owners of the economic entity and the convenience or inconvenience of the level of debt presented. High debt ratios can only be admitted when the rate of return on total assets is higher than the average cost of financing.
The rate of return on total assets is calculated as the product of comparing profit with the amount of assets owned by the company, as explained in the chapter on profitability indicators. For its part, the average cost of financing will be given by the rate represented by the interest accrued in a period, with respect to the average of financial obligations maintained during the same period of time; The income tax rate is deducted from the result thus obtained, when the tax legislation allows the deductibility of the financial expenses incurred.
Passive active
| Historical | Tight | ||
| 1,029,660 / 1,535,486 | 1,916,691 / 2,830,441 | 1,029,660 / 1,606,504 | 1,916,691 / 2,924,824 |
| 0.4173 | 0.2656 | 0.3857 | 0.2468 |
It can be seen in the results adjusted for inflation how the share of creditors "falls" from sixty-seven percent to sixty-five percent. This is due, of course, to the part of the inflation adjustments that are recorded as a higher value of their respective items and that in the income statement generated an “unrealized” profit. Consequently, this indicator must be analyzed without adjustments for inflation, because -otherwise- the erroneous conclusion of an improvement in debt ratios could be reached when, in reality, what is being done is to increase the value of total assets, up to an amount equal to its replacement cost.
For the same reason above, the valuations should be subtracted from the total assets, as well as the liability accounts called "customer advances" and "deferred income", since their nature is not strictly a credit but they are temporarily recorded there, while the association of its costs and expenses with the realization of the income occurs, that is, while its causation occurs in time.
Number of times interest is earned
This indicator indicates the relationship that exists between the profits generated by the company and the financial costs and expenses incurred as a result of short and long-term liabilities. It measures the impact of financial costs and expenses on the profits generated in a given period, with the purpose of evaluating the company's ability to generate sufficient liquidity to cover this kind of expenses.
Earnings before interest and taxes / Interest and financial expenses
| Historical | Tight | ||
| 405,472 / 276,952 | 734,852 / 244,692 | 366,445 / 276,953 | 697,726 / 244,682 |
| 1.46 | 3.00 | 1.32 | 2.85 |
The value corresponding to the concept of "Earnings before interest and taxes" (numerator) of this indicator was calculated as follows:
| Historical | Tight | |||
| 20X1 | 20X2 | 20X1 | 20X2 | |
| Net profit | 85,913 | 361,317 | 46,886 | 324,191 |
| More: printing supply | 42,607 | 128,842 | 42,607 | 128,843 |
| Interests | 276,952 | 244,692 | 276,952 | 244,692 |
| Earnings Before Interest and Taxes | 405,472 | 734,852 | 366,445 | 697,726 |
The lowest value determined between the numerators (before and after inflation adjustments) amounting to $ 39,027 and $ 37,126, corresponds to the net result of the inflation adjustments, as follows:
| 20X1 | 20X2 | |
| Cost of sales adjustment | 25,576 | 29,004 |
| Deferred amortization adjustment (expense) | 989 | 11,252 |
| Depreciation adjustment (expense) | 2,562 | 8,416 |
| Net balance debit (credit) | 9,900 | 11,546- |
| Monetary correction | 39,027 | 37,126 |
For the calculation of the indicator "Number of times interest is earned", the value of the gain or loss due to "exposure to inflation" registered in the monetary correction account must be eliminated, since said result has not been realized by the company. The gain or loss from exposure to inflation is defined as the net balance (debit or credit) recorded in the monetary correction account as a result of applying the comprehensive inflation adjustment system to the non-monetary items of the balance sheet:
| corrected | ||
| "Real" profit before interest and taxes | 376,346 | 686,180 |
| "real" interest payment | 276,953 | 244,682 |
| 1.36 | 2.80 |
From which it can be concluded that, in reality, this company would have thirty-six cents in 20X1 and one eighty in 20X2 to cover operating expenses, after fulfilling its contractual obligations, derived from previously acquired financial liabilities. Figures that are very different from those shown before eliminating the effect of inflation and "correcting" the error of accounting for the gain or loss from exposure to inflation.
Note that within the refined profit for the calculation of this indicator, the item "other income" or "non-operating income" is included, which, by their very nature, should be excluded, since their magnitudes will hardly be realized or repeated. in the future.
Despite the corrections introduced in this indicator, before its final evaluation some other factors that affect its calculation must be considered, such as:
- Interest and other capitalized financial expenses, since they come from financing fixed assets and may not be affecting the income statement for accounting purposes. They should be added to the interest recorded as an expense for the period (denominator); The average interest rate must correspond (after including capitalized financial expenses) with the average market rate, registered in the year being analyzed. If this is not the case, the cause will have to be sought, which may be determined by development credits (whose rate is lower than the commercial rate on the market) or by an incorrect accounting of liabilities or the undue deferral of interest or other financial expenses;On some occasions it is pertinent -and in fact some analysts recommend it- to add to the denominator the amount of the disbursements that, for capital payments, have been made during the year under analysis, as well as the rental fees for Leasing contracts in force during the period As it is a matter of measuring the capacity to generate resources that allow timely compliance with the fixed charges that, for financing, have been assumed, some authors recommend reconciling the profit by adding the "virtual" expenses that have affected the income statement, but that do not involve cash outlays, such as deferred depreciation and amortization.A similar purge is done when preparing the statement of changes in financial position or the statement of cash flows, as explained in the next chapter.
Summarizing, this indicator indicates the number of times that the profits cover the immediate financial obligations of the company and, therefore, can determine its borrowing capacity. The higher the indicator result, the better your future credit position.
Activity reasons
This class of ratios, also called turnover indicators, measure the degree of efficiency with which a company uses the different categories of assets that it owns or uses in its operations, taking into account their speed of recovery, expressing the result through indices or numbers. times.
Purse rotation
It establishes the number of times that accounts receivable return, on average, in a given period. Normally, the "sales" factor should correspond to credit sales, but since this value is not always available to the analyst, it is acceptable to take the company's total sales, regardless of whether they have been cash or credit. For its part, the denominator of this ratio is the average registered in accounts receivable from customers or debtors for merchandise, which is obtained by adding the initial balance to the final balance and dividing this total by two or -for greater precision- the average of the last twelve months.
Sales / Accounts Receivable
| Historical | |
| 1,620,003 / 304,637 | 3,102,816 / 227,094 |
| 5.32 | 13.66 |
These results would be interpreted as follows: 20X1 accounts receivable, amounting to $ 304,637, were converted into cash 5.32 times during that period and 13.66 times during 20X2.
As these are items that do not suffer adjustments for inflation, it is irrelevant for the analyst to evaluate the turnover of accounts receivable, before or after the application of said comprehensive system of adjustments for inflation.
The portfolio rotation indicator allows to know the speed of collection but it is not useful to assess whether said rotation is in accordance with the credit policies set by the company. For the latter comparison, it is necessary to calculate the number of days of turnover of accounts receivable.
Portfolio collection period
Once the number of rotation times of the accounts receivable is known, it is possible to calculate the days required to collect the accounts and documents receivable from customers. To do this, it is enough to divide the number of days considered for the analysis (30 days if it is a month or 365 if it is a year) by the turnover indicator, previously calculated:
Days / Rotation
| Historical | |
| 365 / 5.32 | 365 / 13.66 |
| 69 | 27 |
As it has been explained that it is indifferent to calculate this ratio on historical or inflation-adjusted values, it will be said, then, that the company in the example took an average of 69 days to recover sales on credit, during 20X1 and 27 days in 20X2, which It seems to show either that the company's credit policy varied substantially from one period to another, or that there was a high degree of inefficiency in the area responsible for the portfolio.
The portfolio rotation indicator and the number of days of recovery of accounts receivable are used to be compared with averages of the sector to which the company being analyzed belongs or, as already mentioned, with the policies set by the senior management of the economic entity. However, on this last point, it should be taken into account that a number of days of portfolio recovery that exceeds the established goals does not necessarily imply deficiencies in the corresponding area, as happened with the example taken in this text, because there could be some few clients, whose balances are proportionally higher than the common client portfolio, are registering a delay in the fulfillment of their obligations or enjoy any special prerogative,which will cause the general average to deviate a bit.
To avoid the previous problem, it is useful to classify accounts receivable according to their age, identifying the expired periods in each case, more or less under the parameters allowed to establish the provisions for accounts of difficult or doubtful collection, incorporated in the tax regulations. and accountants.
Inventory turnover
It indicates the number of times that the different classes of inventories rotate during a given period of time, or, in other words, the number of times that these inventories are converted into cash or accounts receivable.
Cost / Inventory
| Historical | Tight | ||
| 986,266 / 257,561 | 2,066,098 / 518,045 | 1,011,842 / 257,561 | 2,095,102 / 518,045 |
| 3.83 | 3.99 | 3.93 | 3.95 |
In this case, it is correct that, for a better interpretation of results, the value of the average inventories (denominator) remains at historical values but, on the other hand, the cost value does incorporate the respective adjustments for inflation, since said figure expresses the amount that the company should reserve in order to operate normally, in inflationary conditions, or at least in the same volume of transactions registered in the immediately preceding period. Therefore, in addition to the inflation adjustment from calculating depreciation from fixed assets and amortization of deferred, intangible and exhaustible assets, it should reflect the update of the other factors that make up the cost of production -such as inventory purchases,labor and indirect expenses- applying the procedures that were repealed by Law 488 of 1998:
| corrected | ||
| Cost / Inventory | 1,075,871 / 257,561 | 2,175,317 / 518,045 |
| 4.18 | 4.20 |
However, taking into account the previous correction, the interpretation cannot be made in the sense that the inventory turnover improved with inflation (with respect to historical values), but in the direction of pointing out that this company has had to rotate 4.18 times its inventory, at 3.83 times in 20X1; and 4.20 times in exchange for 3.99 times in 20X2, if the intention was to maintain a certain stability in the purchasing power of the currency.
This "inventory turnover" indicator can - and should - be calculated for each class of inventory: raw material, products in process, finished products, merchandise for sale, spare parts and materials, among the most common, in which case the The «cost» factor must be adapted to the circumstances (raw material consumed, cost of production, cost of sales or consumption, depending on whether it is one type of inventory or another); and the average inventory should be as representative as possible, hopefully obtained with a long series of data (for example, the twelve months of the year), although the average of adding initial inventory with final inventory, does not invalidate its result.
Inventory days
It is another way of measuring the efficiency in the use of inventories, only now the result is expressed not as a number of times, but through the number of days of rotation.
Days / Rotation
| Historical | Tight | ||
| 365 / 3.83 | 365 / 3.99 | 365 / 3.93 | 365 / 3.95 |
| 95 | 91 | 93 | 92 |
These results would indicate that the company converted its inventories into cash or accounts receivable (through sales) every 95 days and every 91 days, during 20X1 and 20X2, viewed from the point of view of figures not corrected for inflation and every 92 and 87 days, during the same periods, after eliminating the effect of price changes in the calculation of depreciation.
Is this true? Apparently not. A change in the numerator of the ratio must first be introduced (a change that was studied in the chapter on "inventory turnover") and then its interpretation re-evaluated:
| corrected | ||
| Days / Rotation | 365 / 4.18 | 365 / 4.20 |
| 87 | 87 |
Figures that must be read and interpreted in the light of "what should be." In other words, so that this company is not affected in terms of purchasing power, its inventory should return (converted into cash or accounts receivable) every 87 days and not every 95 or 91 days, during the two years under study.
Supplier rotation
It expresses the number of times that accounts payable to suppliers rotate during a given period of time or, in other words, the number of times that such accounts payable are canceled using liquid resources of the company.
As the amount of purchases made during the year is not known in the exercise that has been carried out, these can be estimated through the known information: beginning and ending inventories and cost of sales. However, it must be emphasized that the reason would be more complete if the volumes of inventory purchases made from suppliers were known exactly.
| Tight | corrected | |||
| Sales cost | 986,266 | 2,066,098 | 1,011,842 | 2,095,102 |
| More: ending inventory | 257,561 | 518,045 | 257,561 | 518,045 |
| Merchandise available | 1,243,827 | 2,584,183 | 1,269,403 | 2,613,147 |
| Less: ending inventory | 239,987 | 257,561 | 239,987 | 257,561 |
| Total purchases | 1,003,840 | 2,326,582 | 1,029,416 | 2,355,586 |
Purchasing / Suppliers
| Historical | Tight | ||
| 1,003,840 / 45,681 | 2,326,582 / 110,826 | 1,029,416 / 45,681 | 2,355,586 / 110,826 |
| 21.97 | 20.99 | 22.53 | 21.25 |
These results would be interpreted as follows: Accounts payable to suppliers in 20X1, which amounted to $ 45,681, caused cash outflows 21.97 times in said period and 20.99 times during 20X2. However, by partially practicing the integral system of inflation adjustments, the value of purchases is also partially expressed in terms of the currency of December 31 of each period, which is why purchases should also be duly updated for inflation. In order to obtain the amount it would cost to acquire the same volume of inventories, in order to continue operating normally, but at the new prices affected by inflation:
| corrected | ||
| Purchasing / Suppliers | 1,090,865 / 45,681 | 2,424,458 / 110,826 |
| 23.84 | 21.88 |
Consequently, the indicator of turnover of accounts payable to suppliers must be calculated based on figures adjusted for inflation, since it relates a non-monetary item (purchases) with a monetary item (suppliers).
Purchase days in accounts payable
It is another way of measuring the outflow of resources to meet obligations acquired with suppliers for inventory purchases, but expressing the result not as the number of times, but through the number of days of rotation.
Days / Rotation
| Historical | Tight | ||
| 365 / 21.97 | 365 / 20.99 | 365 / 22.53 | 365 / 21.25 |
| 17 | 17 | 16 | 17 |
These results would indicate that the company canceled its debts with suppliers every 17 days, during 20X1 and 20X2, seen from the point of view of figures not corrected for inflation and every 16 and 17 days, during the same periods, after eliminating the effect of the price variation. When taking corrected figures, these rotation days would change to 15 in 20X1, but would remain at 17 in 20X2.
Net marketing cycle
This indicator, which is calculated as a number of days, is useful to identify the magnitude of the investment required as working capital, because it relates the turnover of the three variables that directly intervene in the operational activity of a company: accounts receivable to customers, inventories and accounts payable to suppliers. For its estimation, the results, in number of days, of the rotations corresponding to each of the mentioned concepts are taken:
| Real | ||
| Number of portfolio days | 69 | 27 |
| Number of days of inventory | 87 | 87 |
| Subtotal | 156 | 114 |
| Less: number of days of supplier rotation | fifteen | 17 |
| Net marketing cycle | 141 | 97 |
Whose interpretation is none other than the estimate of the working capital requirements, which were 139 and 97 days, for each of the years analyzed. To the extent that this indicator is higher, it will mean that the company must also obtain greater amounts of money to meet its obligations with suppliers, which can be achieved, either through improving its collection or efficiency in the rotation of inventories, or through new loans, a solution that is not the best, since it will involve additional financial costs, to the detriment of profitability rates.
Asset turnover
This class of indicators establishes the efficiency in the use of assets, by the administration, in its task of generating sales. There are as many kinds of relationships as there are asset accounts in an accounting catalog. However, the most used asset rotation reasons are the following
- Sales to cash and equivalents: The ratio between sales and cash balances indicates the causal relationship arising from the normal operations of the company and its availability to cover daily needs and have a prudent reserve for eventualities. The higher the ratio, the greater the probability of a cash shortage; which will cause having to resort to other sources of financing Portfolio sales: It is a parameter that relates the entity's commercial operations with the holding of unproductive resources in the portfolio. A result that is too low can indicate too broad credit policies or inefficiency in the collection of accounts receivable. It could also be an indication of payment problems, on the part of one or more clients.Sales to inventories: As in the previous relationship,a low indicator could be a sign of excess stock, slow moving goods or outdated inventories. On the contrary, a rotation above the average for the sector would indicate insufficient investment in inventories, which could lead to market losses due to not being able to attend new orders in a timely manner Sales of fixed assets: The relationship between these two variables refers to the total invested in property, plant and equipment and its ability to produce and generate sales. Therefore, a low indicator, with respect to the sector average, would be diagnosing potential excesses in installed capacity, or inefficiencies in the use of machinery or its technical obsolescence.a rotation above the average for the sector would indicate insufficient investment in inventories, which could lead to market losses due to not being able to attend new orders in a timely manner Sales to fixed assets: The relationship between these two variables refers to the total invested in properties, plant and equipment and its ability to produce and generate sales. Therefore, a low indicator, with respect to the sector average, would be diagnosing potential excesses in installed capacity, or inefficiencies in the use of machinery or its technical obsolescence.a rotation above the average for the sector would indicate insufficient investment in inventories, which could lead to market losses due to not being able to attend new orders in a timely manner Sales to fixed assets: The relationship between these two variables refers to the total invested in properties, plant and equipment and its ability to produce and generate sales. Therefore, a low indicator, with respect to the sector average, would be diagnosing potential excesses in installed capacity, or inefficiencies in the use of machinery or its technical obsolescence.The relationship between these two variables refers to the total invested in property, plant and equipment and its ability to produce and generate sales. Therefore, a low indicator, with respect to the sector average, would be diagnosing potential excesses in installed capacity, or inefficiencies in the use of machinery or its technical obsolescence.The relationship between these two variables refers to the total invested in property, plant and equipment and its ability to produce and generate sales. Therefore, a low indicator, with respect to the sector average, would be diagnosing potential excesses in installed capacity, or inefficiencies in the use of machinery or its technical obsolescence.
As can be seen, the intensity in the use of assets is always measured with reference to sales because, normally, they are the ones that provide the opportunity to generate own resources. For the same reason, the sales to total assets ratio, as will be seen later, is essential for the calculation of performance indicators.
To illustrate the procedure and the interpretation of this class of indicators, the development of the relationship "sales to fixed assets" will be taken as an example.
Gross Fixed Assets / Sales
| Historical | Tight | ||
| 1,620,003 / 574,661 | 3,102,816 / 1,384,524 | 1,620,003 / 702,486 | 3,102,816 / 1,566,740 |
| 2.82 | 2.24 | 2.31 | 1.98 |
The results of this indicator indicate that, for each peso invested in fixed assets, 2.82 pesos were generated in 20X1 and 2.24 in 20X2, in sales. Taking the figures after adjusting for inflation, the results change to 2.31 and 1.98, respectively.
It should be taken into account that the turnover is calculated in pesos and, consequently, the real productivity of the company is not analyzed, for which it would be necessary to know, among other things, the quantity of articles manufactured, the installed capacity and the sales and purchases of fixed assets during the period under analysis
There are some parameters of general application when estimating asset turnover ratios that must be taken into account for a better interpretation of the results. First, if the level of assets changes considerably during the period analyzed, it is advisable to take the simple average, dividing by two the sum of the initial and final balances. On the other hand, a constant performance or with a growing trend over time indicates an efficient management of assets and prevents a temporary expansion from being confused with a sustained growth of the company's operations
Profitability reasons
Profitability ratios, also called performance ratios, are used to measure the efficiency of the company's administration to control the costs and expenses that it must incur and thus convert sales into profits or profits.
Traditionally, the profitability of companies is calculated by using ratios such as asset turnover and profit margin. The combination of these two indicators, explained below, yields the financial ratio called "Return on Investment" (ROI) and measures the overall profitability of the company. Known as the Dupont method, it is a way of integrating a profitability indicator with another of activity to establish where the return on investment comes from: or the efficiency in the use of resources to produce sales or the net profit margin generated for such sales.
This indicator indicates to the investor how the return on the investment made in the company occurs, through the profitability of the equity and total assets.
Return on investment
Profit / Assets
| Historical | Tight | ||
| 85,913 / 1,535,486 | 361,317 / 2,830,441 | 46,886 / 1,606,504 | 324,191 / 2,924,824 |
| 5.59% | 12.77% | 2.92% | 11.08% |
In the example analyzed, it can be observed that, after applying the integral system of adjustments for inflation, the indicator drops notably in the two years of study, although with less intensity in 20X2. This fact is explained because the monetary correction account showed a debit balance (loss), decreasing the amount of profits (numerator of the ratio), despite also the slight increase in the value of the company's total assets (product of the adjustments to investments and property, plant and equipment).
In the author's opinion, one more correction should still be made to the design of this important indicator, in the sense of eliminating the part of the profits or losses from "asset holding", which are reflected in the monetary correction account: $ 9,900 - and $ 11,546, for 20X1 and 20X2, respectively. This correction is made under the premise that such profits are "unrealized gains" and, consequently, cannot form part of the basis for calculating the real return on investment.
Under these conditions, the indicator would be estimated as follows:
| corrected | ||
| Real profit / Assets | 56,786 / 1,606,504 | 312,645 / 2,924,824 |
| 3.53% | 10.69% |
Results that, conclusively, indicate that the estimated profitability over historical values (before eliminating the effect of inflation) over-estimates the operating efficiency of the company and its ability to generate profits.
But where does the profitability of the company in the example really come from? This information can be obtained by analyzing separately the two components of the 'Return on investment' indicator, ie 'asset turnover' and 'profit margin'.
Asset turnover
Asset turnover measures the efficiency with which the available assets have been used to generate sales; It expresses how many monetary units (pesos) of sales have been generated for each monetary unit of available assets. Consequently, it establishes the efficiency in the use of assets, since changes in this indicator also indicate changes in said efficiency. However, in the presence of inflation, the result tends to present distortions, since sales represent a flow and are recorded in currency of average purchasing power of the period analyzed. Instead, the assets will be valued at their acquisition cost, which produces an underestimation of the power to generate sales for each peso invested in assets.By eliminating the effect of inflation and correcting - accordingly - the mix of currencies of different purchasing power, this indicator will tend to increase and, what is more important, will allow a better analysis of the efficiency of the company, since it is possible to compare the results with other companies in the same sector and between different periods:
Sales / Assets
| Historical | Tight | ||
| 20X1 | 20X2 | 20X1 | 20X2 |
| 1,620,003 / 1,535,486 | 3,102,816 / 2,830,441 | 1,620,003 / 1,606,504 | 3,102,816 / 2,924,824 |
| 1,055 | 1,096 | 1,008 | 1,061 |
Profit margin
It expresses the amount of profits obtained for each monetary unit of sales. This indicator measures the operational efficiency of the company, since any increase in its result indicates the capacity of the company to increase its performance, given a stable level of sales. In periods of inflation, the volume of sales may be increased, although the physical volume remains unchanged. Consequently, the cost of the merchandise sold will also increase, but in less proportion to the increase in sales, because these costs will be valued at old prices (at their historical purchase value). Thus, the percentage increase in profits will be higher than the percentage increase in sales. As explained in the following calculation,the comprehensive inflation adjustment system corrects this distortion:
Profits / sales
| Historical | Tight | ||
| 85,913 / 1,620,003 | 361,317 / 3,102,816 | 46,886 / 1,620,003 | 324,191 / 3,102,816 |
| 0.053 | 0.116 | 0.029 | 0.1045 |
If the effect of the «asset holding profit» (taken from table No. 14 «Monetary correction») is eliminated, as already seen, we would have:
| corrected | ||
| Actual Profit / Sales | 56,786 / 1,620,003 | 312,645 / 3,102,816 |
| 0.035 | 0.1008 |
With these results adjusted for inflation and "corrected" it can be concluded that the profitability of this company comes from its efficiency in the use of physical resources (assets) to produce sales than from the net profit margin generated by said sales.
Return on equity
This indicator indicates, as its name indicates, the rate of return obtained by the owners of the company, with respect to their investment represented in the equity recorded in the accounting:
Profit / Equity
| Historical | Tight | ||
| 85,913 / 505,826 | 361,317 / 913,750 | 46,886 / 576,844 | 324,191 / 1,008,133 |
| 16.98% | 39.54% | 8.13% | 32.16% |
But if profit is purified, in the sense of eliminating the gain from asset holding:
| corrected | ||
| Real profit / Equity | 56,786 / 576,844 | 312,645 / 1,008,133 |
| 9.84% | 31.01% |
This means that after correcting for adjusted profit, true profitability "falls" to 31 percent in 20X2, while profitability increases in the prior period.
As a culmination, and to complement this text, the following financial analysis video-course is suggested in which Professor Carlos Albert Magro studies the balance sheet assets, vertical and horizontal analysis, financial ratios, income statement or profit and loss, the break-even point or neutral point and the EBITDA calculation. Good material to deepen the learning of financial analysis techniques. (6 videos - 1 hour and 32 minutes)
