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Department of Finance. FINANCIAL ANALYSIS. Part 2 Professor BĂTRÂNCEA Ioan PhD. C ONTENT C h .1. Theoretical Basis of the Financial Analysis C h .2. Methodology of the Financial Analysis C h .3. Competition (External) Analysis Methods C h .4. Internal Analysis Methods
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Department of Finance FINANCIAL ANALYSIS Part 2 Professor BĂTRÂNCEA Ioan PhD
CONTENT Ch.1. Theoretical Basis of the Financial Analysis Ch.2. Methodology of the Financial Analysis Ch.3. Competition (External) Analysis Methods Ch.4. Internal Analysis Methods Ch.5. Financial Position Analysis Ch.6. Performance Analysis Ch.7. Cash Flows Analysis Ch.8. Business Risk Analysis
CHAPTER 5ANALYSIS OF THE FINANCIAL POSITION 5.1. General aspects of the financial position • The International Accounting Standards mention that, in a reportseparatefrom financial statements (balance sheet, profit and loss account, changes in owners capital, cash flow statement, changes in equityaccounting policies and notes) financial analysisdescribes and explainsthe main characteristics offinancial performance and company financial position.
Such an analysis reportmay include an analysis of the following aspects: • ►main factors and influencesdetermining performance, including the changes of the environment company; • ►reaction tothe changes and their effect; • ►the investment policy for improving performances; • ►dividend policy; • ►financing sources; • ►leverage policy and risk administration.
The Balance Sheet structure (Balance Sheet – list) highlights: • Assets, • Liabilities, and • Equity • As well as the relationbetween them, namelythe financial position.
The analysis of the financial position is based on the Balance Sheet data and includes: • analysis of the economic resources of the company, that is the analysis of assets and liabilities; • analysis of the financial structure of assets, liabilities and capital. • financial structure of capital analysis shows the way in which profit will be dividedbetween different owners as well as thecapacity of the additional financing for future increase;
analysis of theliquidity and solvability of the company, expressed by their ratios; • financial adaptability, that is the ability of the company of influencing the volume and the timewhen the cash-flows are being generated.
The financial adaptability of the companyis shownespecially during difficult periods, either when the company records losses, or when investitional opportunities occur.
Assetsare company resources as a result of past events and are expected to produce future economic benefits for the company. • Debtsrepresent the liabilities of a company as a result of past events, the discounting of which is expected to result in an output of economic benefits from the company.
Equityshows the relation between assets and liabilitiesandare mathematically calculated as the difference between the company’s assets and liabilities.
The analysis of the financial position is based on the balance sheet refers to: • – dynamic analysisorhorizontal analysisbased on indexes; • – static analysisorvertical analysisbased on ratios.
5.2. Assets Analysis • The assets of the company are grouped in: • Fixed assets; • Current assets; • Prepayments. • The horizontal analysis of the assets shows their evolution during several fiscal periods.
Fixed assetsconsist of tangiblesandintangibles, purchased from third parties or produced by the companyand which enter its patrimony through different ways (investments, donations, contributions etc.).
From the point of view of their material content, fixed assets are grouped in: • intangible assets; • tangible long term assets; • financial assets.
The horizontalassets analysis implies the detailing of the analysis on their components, that isgroups of assets and the composing elements of each group.
Current assets include the following elements: • inventory; • accounts receivable; • securities; • cash andbank accounts.
5.3. Liabilities Analysis • The liabilities of the company refer the resources for financing activity: • current liabilities; • long term liabilities; • provisions; • income in advance; • subventions corresponding to assets;
1. Current liabilitiesrepresent amounts that must be paid to third parties in a period of one year. A liability is classified as current liability when : • Is expected to be settled during the normal operation cycle; • Is exigibilein a 12 month period from the data of the balance sheet.
2. Long term liabilitiesrepresent debts to be paid during a period over one year.
2. Provisions refer to, on the one hand, provisions for pensions and other similar liabilitiesand, on the other hand,refer to other provisions.
3. Revenues/Income in advance include incomesobtained during the current fiscal period, for products, works and services, but which refer to a part of fiscal period.
4. Current liabilitiesrepresent short term liabilities that the company has to third parties and which include short term debts and advance incomes.
5.4. Equity Analysis • Equity represents the right of the shareholdersover the assets of a legal entity, after subtract liabilities. • Equity has the following elements: • shares; • share premium; • revaluation reserves; • reserves; • retained earnings; • fiscal year result.
The company sharesare structured in: subscribed shares capital and/or paid.
5.5. Financial Position Ratios • The analysis of financial positionstructureor the vertical analysisof the balance sheet refers to the following objectives: • determining and evaluating the reports between different asset elements, liabilities or capital: • showing the main qualitative changes in assets and liabilities and equity generated by internal changes and by the interaction with the economic environment; • evaluation of the financial and equity statement; • constructing the financial policy and strategy.
Structure ratios are determined either asamounts of asset groups in total assets, or as amounts of liability groupsin total liabilities, respectively the amount of capital elements in total capital.
5.5.1 Assets Structure Ratios • Structure ratios of assets are grouped in: • - assets general ratio; • - current assets general ratio, which consists of: • inventory ratio; • accounts receivables ratio; • treasury ratio consistsin: • short term financial investments ratio; • cash in hand and cash in bank ratio. • - prepayments ratio.
5.5.2. Liabilities Ratios Liabilities (external capital) structure ratiosshow the value that various liability categorieshave in total liabilities. The external capital ratios may be structured as follows: • Current liabilities ratio; • Long term liabilities ratio; • Provisions ratio; • Revenues in advance ratio;
5.5.3. Equity Structure Ratios • Structure ratios of capitalshow the way of providing own resources for the financial effort of the company. In this sense, there are taken into account both the evolution of the share capital of the company and the dimension of the reserves formed as a result ofthe revaluation of assets and the reserves formed from the net profit obtained from current activity.
5.6. Short – term Equilibrium: Liquidity Analysis • According to The International Accounting Standards, liquidity refers tonear future cashin hand, after taking into account the financial liabilities corresponding to this period.
The importance of liquidity: • liquidity indicates the cash; • liquidity is a componentof the financial diagnosis; • liquidity is a form of payment capacity; • liquidity exists only in cash; • liquidity is a component of the leverage capacity of companies.
We apreciate that financial liquidity is a component of the financial equilibrium expressing the short term payment capacityof a company, by synchronizing during the fiscal period cash inputs and outputs.
Liquidity analysis models • We consider that the forms of financial liquidity are: • Current Liquidity • Acid Ratio/ Quick Ratio • Cash Ratio
Current liquidityreflects the capacity of available current assets (inventories, bills, short term securities, advance expenses) of transforming into cash on hand, that would cover the due time debts of the company.
The current liquidity ratiohas to be between 200 % and 250 %. • According to other specialists, liquidity ratio has to be over 150 %. • In the american and UK literatureit is considered that the general liquidity ratio should be of at least 200 %. • We consider that the financial safety gap of the indicator is between 150 % and 200 %.
Acid Ratio (Quick Ratio)shows the capacity of current assets (other than inventories) to cover current debts, and has two forms: 1.Quick ratio=(Current assets-Inventories)/Current Liabilities; 2.Acid ratio=(Cash+ Securities)/Current Liabilities
The Romanian legal normsstipulate that the value of the indicator should be between 50 % and 100 %. • Terry Gaskin considers that the optimum level of the indicator is 100 %. • We consider that the financial security gap of the indicator is between 50 % and 100 %.
Cash ratio measures thedegree in which cash in hand covers due time payments.
There is a favorable liquidity when the indicator is near 100 %. • We consider that the financial safety gap is between 50 % and 100 %.
5.7. Long-term Equlibrium:Solvency Analysis • The International Accounting Standards mention the fact that solvency refers to the cash on hand for a period over one yearduring which the due time payments are to be made.
Solvency Analysis Models • Solvency is expressed with the help of several models.
We consider that the financial safety gap of the indicator is between 80 % and 180 %.
British Analysts consider that the solvency state is shown through The Debt Equity Ratio ((Short+Long term Loans - Tresaury)/Equity ).
The financial safety gap for this indicator is between 0% and 50%. • A type of the the debt equity ratio indicator is the debt equity ratioin relation with the total financing of the business((Short +Long terms loans)/Short and long term loans +Equity)):
The financial solvency may be shown with the help of the financial leverage ratiocalculated either as relation between total liabilities and total assets, or as relation between total debt and total assets: