Financial Analysis: Income, Profitability, and Returns
Economic Analysis: Results and Profitability
Analysis of Income
The income statement is the profit and loss account (P & L).
Sales: Total income from economic activity.
– Cost of Sales: Variable costs to make, buy, distribute, and sell products.
= Gross Margin
– Fixed Costs: Structural costs that do not depend on the level of activity.
= Earnings Before Interest and Taxes (EBIT)
+– Financial: Difference between income and financial expenses.
= Profit Before Tax (PBT)
– Income Tax: Corporation tax or equivalent.
= Net Profit (BN)
Operating profit (EBIT) depends on the economic structure of the company. Net profit (BN) is influenced by the same factors as EBIT, along with the composition of its liabilities. Higher interest debt leads to less benefit. A simple analysis technique is to express the results as percentages of sales.
Profitability
Profitability studies the performance of the company, linking benefits to investment. It is the relationship between investment and yield, reflecting a corporate investment’s ability to turn a profit.
Profitability = Income Earned / Capital Invested allows comparisons between companies.
Financial Returns
Financial return is the return on assets, the yield on every dollar invested in the business. Economic Performance (RE) = Earnings Before Interest and Taxes (EBIT) / Assets This ratio indicates the rate at which the company’s assets are paid off. It measures the company’s ability to compensate the funds made available, using earnings before interest and taxes. This includes dividends, capital remunerated outside, and taxes. RE = EBIT / TA
Components of Economic Efficiency
RE = EBIT / Assets x Sales / Sales = EBIT / Sales (Margin) x Sales / Assets (Rotation)
- Margin: The ratio of EBIT to sales, indicating profits per unit sold.
- Rotation: The relationship between sales and assets, showing currency units earned for each dollar invested.
The breakdown of economic returns helps decide whether to act on the margin or rotation.
Increase the margin: Increase the selling price with constant unit costs, or increase the selling price while reducing unit costs.
Increase rotation: Increase sales at a higher rate or reduce asset investment. For example, increase sales and capacity, or maintain sales while reducing inventory or accounts receivable.
Financial Performance
Financial performance measures returns obtained from equity. Return on Equity (RF) = Net Profit / Equity shows the ability to pay the capital to partners after serving financial creditors and public finances. The net profit is considered. The result shows the net pay offered to the capital. A higher ratio is better.
Components of Financial Profitability
RF = Net Profit / Net Sales x Sales / Assets x Assets / Equity = Net Profit / Sales (Margin) x Sales / Assets (Rotation) x Assets / Equity (Leverage)
- Margin: Percentage of net profit on each dollar of sales.
- Rotation: The ratio between sales and assets.
- Leverage: The ratio of total investments (assets) to the company’s equity.
The leverage effect is the increase of debt on financial performance, depending on economic profitability, the cost of equity, and debt.
- Increase the margin: Raise selling prices and/or reduce costs.
- Increase rotation: Reduce assets and/or increase sales.
- Increase leverage: Raise the capital-asset ratio. Increasing borrowings remains below the cost of resources to investment performance.