Financial Statement Analysis: A Comprehensive Guide
Financial Statements
Balance Sheet
A company’s financial position in a given period.
Accounting Equation: Assets = Liabilities + Capital
Double Entry Method: Balance accounts
Risk Factors and Liquidity of the Company
Debt (Alien Capital)
If there are problems, creditors and lenders can file a lawsuit to recover money from the company. However, shareholders recover money only after the debt has been paid.
Equity
Solvency ratio.
Income Statement
Summarizes the profits of an enterprise in a given period. The result is a determinant of the cash flows of a company.
Result: Revenue – Expenses
Statement of Cash Flows
- Determines the profitability of the company
- Determines the profitability of own resources
- Determines the ability to pay for all amounts owed in a given period
Accounting Irregularities
Everything should be accurate and truthful within the company. The account must be declared if these numbers are rigorous or estimates, discuss the nature of the liabilities (debts, among others), and how debts are settled. All strictly verified.
Analysis of Financial Statements
Financial Measures:
- Profitability
- Liquidity
- Financial Structure and Leverage
- Asset Management
- Sustainability of the company
Analysis of Ratios
These Evaluate:
- The current operations of the company
- Evaluate the effectiveness of the company
- Risk of operations
- Compare current performance with past performance
- Standardize financial information to follow the comparisons between periods of time or other companies
Types of Ratios
- These are extracted from the financial statements:
- Financial ratios measuring liquidity and leverage
- Operating ratios measuring activity and profitability
- Valuation ratios, which are the exchange rate of actions with respect to the assets or earnings
For a Company to be Successful
Analysis of Profitability
These can be analyzed knowing if:
Income over Expenses = Profit
The company may generate negative benefits but accumulated losses if the time step is greater than the profits.
DuPont Model
The DuPont analysis system acts as a research technique designed to localize the areas responsible for the company’s financial performance. The DuPont analysis system is the system used by management as a framework for analyzing financial statements and determining the financial condition of the company.
The DuPont system meets, in principle, the net profit margin, which measures the profitability of the company relative to sales, and total asset turnover, which indicates how efficiently it has disposed of the assets to generate sales.
Liquidity Analysis
The balance sheet and cash flow statement help evaluate the cash or the lack of it within the company.
Balance Sheet: Measures the vision of the relationship between current assets (cash) and current liabilities.
Cash Flow: Measures and identifies the sources and use of cash.
Financial Structure
Another factor in the success of the organization is the financial structure of the company, whether it is funded by own capital, debt, or other joint ventures.
Sustainability
- Measuring the capacity of the company to get enough to hold business in the future
- Is measured by a report by an auditor that regulates if the company has properly applied GAAP in the presentation of the financial statements
These reports were good or more will declare the auditors to the company if you think it will or will not be running in the future.
Other Financial Statements
- State Distribution of Results
- State of Rules of Valuation
- Status of Stocks
- State of Final Status
- Statement of Revenue and Expenses
- State Funding Table (Movement of Funds)
- Statement of Changes in Equity
Statement of Changes in Net Worth
Records the changes that have occurred in the equity of a company during the last two years.
Defined as a result of the state of equity evidenced in:
- Result of Profit and Loss
- Income and Expenses
- Transfers
- Statement of Changes in Total Equity:
Showing changes in it.
- Variations
- Adjustments
What is Accounting?
Information system that identifies, measures, and communicates economic information to facilitate users of the same in decision-making.
External Accounting
Financial information relating to the company abroad. Can the business repay their debts? Do you offer a sufficient return to shareholders? Do you manage your assets properly?
Internal Accounting
Provides relevant information for decision-making. One of its parts is cost accounting, which helps the efficiency of production factors. What products are profitable? What does it cost to produce?
Treasury
It is the cash that the company has, also adding those investments which are convertible into cash immediately.
Types of Activities that Generate Cash Movements
Regular Activities: Giro business / sale
Investing Activities: Acquisition of fixed assets
Financing Activities: Ratio of acquisition or repayment of money requested for funding
Extraordinary Activities: Sporadic, not related to the economic activity
Status of Cash Flow
| = Initial cash balance (a) |
| + Collection of ordinary activities |
| – Payment of ordinary activities |
| = Change in cash ordinary activities (B) |
| + Other charges |
|
| = Change in cash other activities (C) |
| Closing balance of cash = (a + b + c) |
This is a financial report to help assess the capacity of the company to generate cash. Also to assess the chances of business success or survival of the same.
Financial Cash Flow
Cash flow is the money generated by the company through its normal work. The computation of this flow for the company represents the company’s ability to repay its debts.
| Ordinary Recoveries – | (Regular payments) | Financial Cash Flow = |
Balance Sheet
Is a statement reflecting the assets of the company. In a way, it is a document equivalent to a person’s assets, comprising assets minus debt.
| Assets – | Debts (Liabilities) | = Equity |
The Result of Adjustments
| Result = | Income |
|
Expenditure
One concept related to the procurement of goods and services for consumption, whether in the production process or to third parties.
Payment
It is out of cash. Are not only costs but also, in the case of some concepts, depreciation is considered.
Investment
That part of expenditure that is incorporated into the production process of a product, such as machinery, vehicles, etc.
Management Accounts Result
STRUCTURE | |
| NET SALES | |
| Proportion of manufacturing costs | |
| Proportional marketing costs | |
| = | Gross Margin |
| Depreciation | |
| Overheads | |
| Other income and expenses | |
| = | Profit before imptos and interest (EBIT) |
| Financial income and expenses | |
| = | Profit before tax (EBT) |
| Impto. Societies | |
| = | NET PROFIT OR NET LOSS |
Economic Cash Flow
Is obtained by adding net income + amortization period as it is an expense that is not paid. It is also often added to provisions. In this sense, the financial movements are based only on incoming and outgoing cash (billing and payment), and the economic change in the principle of accrual (revenue and expenses payable).
Analysis and Financial Assets
It is basically identical to a vertical analysis of a consolidated statement.
Once you have determined the composition in percentage terms, it is important to consider the following principles:
- Assets must be greater than short-term liabilities, because otherwise we run the risk of illiquidity.
Measures to address this situation:
- Larger capital
- Increase cash flow and reduce dividends
- Convert debt from short to long term
- Accounts receivable x receivable
- Sell fixed assets
- The most available feasible have to match the liabilities. This is basically the same as above but more refined since it only considers liquid assets
- Equity should be between 35% to 50% of total liabilities. It is precious to the company if it is capitalized and the debt is not excessive
Measures to address this situation:
- Increase in capital to reduce debt
- Improving the relationship between current assets and circulating liabilities to solve liquidity problems
Status of Sources and Uses of Funds
It is a useful tool for assessing the balance sheets, as it reveals changes that have occurred in the same over a given period of time. It can answer the following questions:
What investments have been made?
What funding has been used?
What is the balance between investments and the financing used?
Ratios
Is a ratio between two quantities that have some relationship and for that reason are compared.
Liquidity Ratios
Liquidity Ratios: Current Assets / Liabilities
Greater than 1 means it is capable of meeting their obligations, but more than 2 means that the company is inefficient in managing their funds and therefore loses profit.
Cash Ratios: Realizable Available / Short-Term Liabilities
It is more accurate than the previous one and basically the same. +1 indicates positive, -1 indicates negative.
Availability Ratio (Acid Test)
= Available / Short-Term Liabilities
Debt Ratios
They are used to diagnose the amount and quality of debt to the company, as well as to assess to what extent the benefit is obtained sufficient to bear the financial burden of debt.
Reti debt:
Total Liabilities / Total Liabilities
Optimum value (0.5 – 0.65). More than this means that the debt is excessive, and less means that there is excess capital.