Economic & Financial Analysis: A Comprehensive Guide
Economic and Financial Analysis: Definitions
Information System Functions
Any information system performs three functions: selecting relevant economic processes, processing the selected information, and reporting.
Analytical Techniques
Analytical techniques or tools are means that allow us to discuss the company, bearing in mind factors such as the sector it belongs to, company size, or comparison with data from other companies. The most used are:
- Static Analysis: This is done through data related to a specific time.
- Dynamic Analysis: This analyzes the company throughout its life through several accounting statements.
- System of Accounting Ratios or Ratios: The ratio is obtained by the ratio of two or more groups.
- Vertical Analysis: This performs analysis by comparing factors with other elements of the active and passive.
- Horizontal Analysis: Pools of assets are related to successive balance sheets.
Types of Analysis
- Heritage Analysis: This determines the structure of a company. It studies the current situation, changes, and future trends.
- Financial Analysis: This looks at whether the company has sufficient funds for its normal functioning and if the activity is adequately distributed. It aims to find out if the company can generate the necessary cash flows to meet its obligations.
- Economic Analysis: This addresses the company’s profitability, i.e., results from a relative perspective, not absolute figures.
Economic and Financial Structure
- Economic Structure: This refers to the means acquired for the reliable functioning of the company’s activity. The economic structure is the company’s assets.
- Financial Structure: This is established by the company’s funding sources, including own and others. It identifies all the Net Worth + Liabilities.
- Top Financial Balance: This provides a balanced relationship that should exist between the economic and financial structure of the company.
Coefficients of Structure
- Structure of Non-Current Assets: Non-current assets / total assets. This ratio is higher for industrial enterprises.
- Structure of Current Assets: Current Assets / Total Assets. Service companies have a high debt ratio.
- Structure of Net Worth: Net Worth / Net Worth + Liabilities. If it is high, the company has a solid financing structure.
- Structure of Non-Current Liabilities: Non-Current Liabilities / Net Worth + Liabilities. This ratio should be high.
- Structure of Current Liabilities: Current Liabilities / Net Worth + Liabilities. This ratio should be low.
Fixed Capital
Economic grouping of elements that are solid financing, i.e., the net worth. It is called core funding.
Working Capital
Share of assets funded by resources (fixed liabilities). It is called working capital or rotation fund. It may vary for each company but must cover at least half of the company’s ripening period. It’s the difference between Current Assets and Current Liabilities. It can be positive, negative, or zero. The bigger it is, the greater the company’s capacity to meet debts. If it is negative, the company cannot generate sufficient liquidity to meet debts.
Fixed Capital – Working Capital = Non-Current Assets. Working Capital = Current Assets – Current Liabilities
The consequences of a high working capital are:
- It’s a security fund that can cope with any imbalances.
- It can keep up with the current activity.
- It serves to measure the financial situation of the company.
- It sets the amount of permanent capital the company has used to finance current assets.
- It offers stability to reach an operating margin of the company.
- Ideally, the period should cover at least half of the company’s ripening.
The higher the Working Capital, the better prepared the enterprise will be for addressing debt.
Assets
- Total Balance: Where fixed assets and current assets are fully financed with equity, which is the maximum term for financial stability.
- Normal Balance: Or financial stability, is the full funding of fixed liabilities to fixed assets plus the circulating part. In this situation, it marks the first stage of financial stability, and working capital is positive.
- Suspension of Payments: A situation of financial imbalance that is maintained over time, i.e., the working capital is negative, which means that some fixed asset is financed by liabilities. It is a legal situation in which a company must pay its creditors, who want to charge. It is declared by a judge and may be requested voluntarily by the company. It is normally associated with the development of moratoriums to overcome structural problems and avoid bankruptcy.
- Bankruptcy: This figure applies to commercial companies that cannot pay all their debts because current liabilities are greater than the actual business activity. It is declared by a judge and may be of three types: random (there is no blame, just mismanagement), guilty (poor management, and the employer also incurs irresponsible acts), or fraudulent (voluntary mismanagement to defraud).
- Leverage Effect: Resorting to borrowing when the cost exceeds the economic cost of funding.
- Profitability: A relationship established between what has been invested in a certain operation and the economic performance obtained.
Accounting Books
The obligation to keep organized records requires the use of books, some mandatory, which must be legalized. One must know how to keep and retain them.
Required Books
Entrepreneurs must keep a book of Inventories and Annual Accounts and another Journal. Trading companies also need a book of Proceedings.
The books are legalized in the Commercial Register where the company is domiciled. Each page of each book should bear the seal of the Registry. They must be kept clearly, in order of dates, without spaces or deletions. They must show a true and fair view of the company’s assets, financial position, and results. They must be kept for six years from the last entry made.
- General Journal: The main accounting book, where all the financial transactions involving the company are recorded daily. The notation of joint operations cannot exceed a period of one month.
- Book of Inventories and Annual Accounts: This is the main and binding book. It should be legalized and stamped at the Commercial Register. It opens with the initial balance detailing the company. At least quarterly, the balances are checked and rewritten. This book will also collect the financial statements reflected in the annual accounts, showing the year-end balance, the Profit and Loss Account, changes in Net Worth, cash flows, and Memory.
- Ledger: This is no longer compulsory. It groups operations by accounts.
- Book of Acts: Only for Corporations. It contains all the agreements reached in the general meetings.