The use of financial reasons to carry out the financial analysis constitutes a tool that represents the fair reality of the financial situation of any organization. Through their employment it can be determined how the firm has performed and evaluate its management.
All the people who are surrounded by a changing socio-economic environment, in which the uncertainty of what can happen with their companies is a constant, they need to have methods or tools to evaluate their functioning in any of the Periods of its existence, in the past to appreciate the true situation that corresponds to its activities, in the present to make changes in the good of the administration and in the future to make projections for the growth of the organization.
It shows that the survival of these entities is closely linked to the management and behavior of all agents involved in the processes of exchange (both internal and external) of their daily operation, for this have been implemented a Series of techniques to judge all these aspects that can provide at any moment useful and accurate information of the company that will help to make quick and effective decisions at a certain time.
The fundamental pillar of the financial analysis is contemplated in the information provided by the financial statements of the company, taking into account the characteristics of the users to whom they are directed and the specific objectives that originate them, between The most known and used are the Balance Sheet and the Statement of Results (also called Profit and Loss), which are prepared, almost always, at the end of the period of operations by the administrators and in which the capacity of the entity is evaluated to generate Favorable flows according to the collection of the accounting data derived from the economic facts.
There are Also other financial statements that sometimes are not very taken into account and that provide useful and important information about the operation of the company, among these are: the state of Changes in the Heritage, the Changes in the Situation Financial and Cash Flow.
One of the most used tools to carry out financial analysis are the Financial Reasons because they allow to measure, in a high degree, the efficiency and behavior of the company. These present a broad perspective of the financial situation, allow to specify the degree of liquidity, profitability, financial leverage, coverage and everything that has to do with their activity.
The Financial Reasons are compared with those of the competition and lead to the analysis and reflection of the operation of the companies in front of their rivals. The following explains the basics of application and calculation of each one of them.
The liquidity of an organization is judged by the ability to repay the short-term obligations that have been acquired as they expire. They refer not only to the company’s total finances, but to their ability to convert certain current assets and liabilities into cash.
NET WORKING CAPITAL (CNT): This reason is obtained by decounting the current obligations of the company all its current rights.
CNT = Current Current-Active Passive
SOLVENCY INDEX (IS): This considers the true magnitude of the company in any instance of the time and is comparable with different entities of the same activity.
IS = Current Current/Passive Active
ACID TEST INDEX (ACID): This test is similar to the Solvency index, but within the current asset, the inventory of products is not considered, since this is the lowest-liquidity asset.
ACID = Current Active-Inventory/Current Liabilities
ROTATION OF INVENTORY (RI): This measures the liquidity of the inventory by means of its movement during the period.
RI = Cost of the sold/average Inventory
AVERAGE INVENTORY TERM (PPI): Represents The average number of days an item remains in the company’s inventory.
PPI = 360/Inventory Rotation
TURNOVER OF ACCOUNTS RECEIVABLE (RCC): Measures The liquidity of accounts receivable by means of their turnover.
RCC = annual Sales on credit/Average Accounts Receivable
AVERAGE PERIOD OF ACCOUNTS RECEIVABLE (PPCC): This Is a reason for evaluating the company’s credit and collections policy.
PPCC = 360/Turnover of Accounts Receivable
ACCOUNTS payable ROTATION (CPR): This is Used to calculate the number of times the accounts payable become cash over the course of the year.
RCP = annual Purchases on credit/Average Accounts Payable
AVERAGE PERIOD OF ACCOUNTS PAYABLE (PPCP): It Allows to glimpse the rules of payment of the company.
PPCP = 360/Turnover of Accounts Payable.
These reasons indicate the amount of money of third parties that are used to generate profits, these are of great importance since these debts commit to the company in the course of the time.
DEBT ratio (RE): Measures The proportion of total assets contributed by the company’s creditors.
RE = Total Liabilities/Total Assets
PASSIVE-CAPITAL ratio (RPC): Indicates The relationship between the long-term funds provided by creditors and those provided by business owners.
RPC = long-term Liabilities/stockholders ‘ Equity
PASSIVE RATIO To TOTAL CAPITALIZATION (RPCT): It Has the same goal of the previous reason, but also serves to calculate the percentage of the long-term funds that creditors provide, including long-term debts such as stockholders ‘ equity.
RPCT = long-term Debt/Total Capitalization.
These reasons allow analyzing and evaluating the profits of the company with respect to a given level of sales, of assets or the investment of the owners.
GROSS PROFIT MARGIN (MB): Indicates The percentage remaining on sales after the company has paid its stock.
MB = Sales – Cost of selling/Sales
OPERATING PROFIT MARGIN (MO): Represents The net profits that the company gains in the value of each sale. These should be taken into account back up the financial or government charges and determine only the utility of the operation of the company.
NET PROFIT MARGIN (MN): Determines The percentage remaining in each sale after deducting all expenses including taxes.
TOTAL ASSET ROTATION (RAT) — Indicates the efficiency with which the company can use its assets to generate sales.
RAT = Annual Sales/Total Assets
ROI — Determines The total effectiveness of the administration to produce utilities with the available assets.
REI = Net Earnings after total taxes/Assets
COMMON CAPITAL YIELD (CC): Indicates the performance obtained on the book value of the stockholders ‘ equity.
CC = Net income after taxes – preferred Dividends/stockholders ‘ equity – preferential Capital
Earnings PER SHARE (UA): Represents The total of earnings obtained for each current ordinary stock.
UA = Utilities available for ordinary shares/Number of ordinary shares in circulation
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 in force
These reasons evaluate the company’s ability to cover certain fixed charges. These are more frequently related to the fixed charges that result from the company’s debts.
TIMES THAT INTEREST HAS BEEN EARNED (VGI): It Calculates the company’s ability to make contractual interest payments.
VGI = Utility before interest and taxes/annual interest Expenditure
TOTAL LIABILITY COVERAGE (CTP): This reason considers the ability of the company to fulfil its interest obligations and the ability to repay the principal of the loans or to make payments to the amortization funds.
CTP = Earnings before interest and taxes/Interests plus credits to the main liability
TOTAL COVERAGE RATIO (CT): This reason includes all types of obligations, both fixed and temporary, determines the company’s ability to cover all of its financial positions.
CT = Utilities before lease payments, interest and taxes/Interest + credits to the main liability + lease payments.
At the end of the analysis of financial reasons, we must have the necessary criteria and bases to make the decisions that best suits the company, those that help to maintain the resources obtained previously and to acquire new ones that guarantee the Future economic benefit, also to verify and fulfill the obligations with third parties in order to reach the primary objective of the administrative management, to position itself in the market obtaining wide profit margins with a permanent and solid validity In front of the competitors, giving a degree of satisfaction to all the managing bodies of this collectivity.