Analysis and interpretation of financial statements

The Accounting is the science that controls the activities and economic facts in the companies, entities and units, in order to present records, to offer accurate and reliable information regarding the results of a period and the financial situation of the entity.
These observations are of great importance since they allow to evaluate alternatives that facilitate the decision making by means of the application of techniques, methods, procedures of the planning, registers, calculations, analysis, verification and presentation of the Economic-financial situation of the company.

Conceptual Bases for Financial Economic Analysis

Analyze: Decompose into constituent elements or parts, separate or discriminate the parts of something in relation to a whole. Analyzing is the primary technique applicable to understand and understand what is meant in the financial Statements.

Financial Analysis: It Is The study of the financial reality of the company through the financial Statements, the financial analysis aims to interpret the facts on the basis of a set of techniques that lead to decision making.

The Analysis of financial statements, also known as economic-financial analysis, balance analysis or accounting analysis, is a set of techniques used to diagnose the situation and perspectives of the company in order to make decisions Appropriate. Oriol Amat.

Economic Analysis: It is the breakdown of economic phenomena in its parts and the study of each one in particular. In the analysis of the Financial Statements, the economic analysis consists mainly in determining the percentage of the profitability of capital invested in the business.

Interpreting: Relative appreciation of concepts and figures of the content of the Financial Statements based on analysis and comparison.

Techniques for interpreting: analyzing and comparing.

To Analyze: To decompose the whole in each one of its parts in order to study each one of its elements.

To Compare: secondary technique applicable by the analyst to understand the meaning of the contents of the Financial Statements and thus to be able to issue judgments. It Is The simultaneous study of two figures or aspects to determine their points of equality or inequality.

The Financial Statements constitute a structured representation of the financial situation and the financial performance of the entity; They aim to provide information about the financial situation, performance and changes in the financial position of the entity that is useful to a wide range of users when making economic decisions, as well as to show the results of the activity Carried out by the administration, or account of the responsibility in the management of the resources entrusted to it.

The analysis of Financial Statements, also known as Economic Financial Analysis, is to use a set of techniques that aims to diagnose the situation and perspective of the company, in order to be able to make appropriate decisions.

From An internal perspective, the management of the company can make decisions that correct the points the weak points that can threaten their future and at the same time take advantage of the strengths so that the company reaches its objectives.

From an external perspective, these techniques are also very useful for all those people interested in knowing the situation and foreseeable evaluation of the company.

Balance Sheet: Relates all assets, liabilities and capital of an entity to a given date, usually at the end of a month or a year, which is why it is considered a static Financial State. The balance sheet is like a photograph of the entity so it is also known as a State of Situation.

Result State: Presents a summary of the income or expenses of an entity during a specific period, it may be a month or a year, which is why it is considered a dynamic Financial State. The Result State, also called State of Operations, is like a movie of the entity’s operations during the period. This state has what may be the most important individual information about a business: its Net Income (less Expense).

Capital State: Presents a summary of changes occurring in the entity’s capital for a specific period (one month or one year). Just as the Result State is considered a dynamic Financial State.

Ratios as an essential part of Financial Economic Analysis are a vital tool for decision making, facilitating analysis, but never substituting good analytical judgment.

The financial ratios or reasons allow to relate elements that alone are not able to reflect the information that can be obtained once they are linked with other elements, either from the accounting state itself or from other states that are related to each other, either In a direct or indirect way, thus showing the development of a particular activity.

The ratios are used to analyze the contents of the Financial Statements and are very useful to indicate:

¨ weak Points of a company.
¨ Problems and anomalies.
¨ In Certain cases as a basis for formulating a personal judgement.

There are a wide range of financial reasons that are used in our entities when conducting an economic financial analysis, in our case, to analyze the financial situation of the entity subject to analysis, we will use the following ratios:

¨ Reasons for liquidity.
¨ Reasons for activity.
¨ Reasons for debt.
¨ Reasons for profitability.

Liquidity Reasons:

They Measure the ability of the company to meet its short-term obligations, they refer to the amount and composition of the current liabilities and their relationship with the current asset, which is the source of resources that the company has to satisfy its obligations Contracted more urgently.

For analysis It will be determined:

1. NET working Capital.
2. Solvency Index.
3. Immediate liquidity Index or acid test.

1. NET working Capital:

It Is defined as the funds or resources with which a company operates in the short term, after covering the debts and obligations that expire in that short term, that is to say, it expresses the financial means that has an entity to pay the obligations (debts) in the short term; This ratio should always be positive, because not knowing when the company will have income and thus support the most urgent operations, always their current assets must be greater than their current liabilities.

Calculation Form:
Working Capital = Circulating Assets – circulating Liabilities
Express:
The maneuvering bottom of an entity.

2. Solvency Index:

Determines the possibility that an entity has to cope with its short-term payments, indicating its ability to cover its short-term obligations from its current assets, which the company expects to become cash in a more or Less short.

Calculation Form:

Solvency Index = Circulating Assets/circulating Liabilities
Express:
The amount of current assets that an entity has to cover each weight of short-term debts.
Optimal:
Two pesos of circulating assets for each weight of debt in the short term.

3. Immediate liquidity Index or acid test:

It Indicates the capacity of payment of an entity, discounting the less liquid items of the circulating asset, that is to say, the inventories.
Calculation Form:
Immediate liquidity Index = Circulating Assets – inventories/circulating Liabilities
Express:
With how much current asset weights an entity has to cope with each weight of its most urgent debts, without the inventories.

Activity Reasons:
They Measure how efficiently the company uses the resources with incidence in the sales, the inventories, the accounts receivable as well as the accounts payable.

Of these reasons the following are calculated:

1. Turnover of accounts receivable.
2. Turnover of accounts payable.
3. Inventory Rotation.

Turnover of Accounts receivable (R. C x C)
Determines every few days and how many times are collected in a given period, the faster we are charging, the faster you enter cash to perform your operations.

Calculation Form:
R. C x C = Net Sales/Average Accounts receivable = Times
Express:
The times that have been charged to the clients in a certain period.
In order to know how many cash recovery is made, the accounts receivable must be calculated the average term or collection cycle.

Calculation Form:

Collection Cycle = Number of days of the period/R C x C = Days
Express:
Every How many days the collections are made to the clients.

Noval In Our country is legislated by the Ministry of finance and Prices that the collection of the obligations is every 30 days, except the cases in which an agreement is made between the participating entities.

Turnover of Accounts payable (R. C x P)
They Reflect how many days the payments are made to suppliers, that is, short-term debts are cancelled.

Noval In Our country It is legislated by the Ministry of finance and Prices that the payment of the obligations is every 30 days, except the cases in which an agreement is made between the participating entities.

Calculation Form:

R. C x P = Net Purchases/Average Accounts payable = Times.
Express:
The times that the debts have been paid to the suppliers in a certain period.

Payment Cycle:

Calculation Form:
Pay Cycle = Number of days of period/R C x P = Days
Express:
Every few days the payments are made to the suppliers.

Inventory Rotation (R. I)
It tells Us how efficient the inventories have been consumed, we can analyze the rotation of raw material inventories, production in process and finished products.
Calculation Form:

R. I = Merchandise Cost/Average Inventory

Express:

The times that inventories have been consumed during the period, that is to say that a slow rotation would cause storage expenses, idle products in the warehouses as well as unnecessary expenses in purchases.

Average inventory Period.
Calculation Form:

Average inventory Term = Number of days of period/R. I = Days
Express:

Every How many days the inventories rotate.

Reasons for indebtedness:
They Measure the relation of the funds provided by the company with respect to the creditors, to the extent that this indicator increases, in greater financial difficulties the company will be.

Calculation Form:

Debt Ratio = Total Liabilities/Total Assets

Express:

With how many pesos, or with what percentage of debts, an entity, it finances the total of its assets.

Leverage Reasons
These reasons are used to diagnose on the structure, quantity and quality of the debt that the company has, as well as to verify to what extent the sufficient profit is obtained to support the financial cost of the debt.

Reasons for Profitability.
It Allows to relate what is generated through the State of Result, with what is required of assets and sale to develop the business activity, relating the profit or utility to tax and interest with the total of assets, with the purpose of evaluating the Utility that the entity has.

Conclusions

The analysis and interpretation of the Financial Statements constitutes a useful tool for decision making in the company; Which is constituted by the valuation of several reasons and indicators that measure the effectiveness of the economic management of any entity, but it should be taken into account that for a correct interpretation one must analyse the interaction of several indicators, since One in itself does not allow to determine the financial situation of the same.