Financial Analyzing

The economic and financial analysis is an important tool for valuating companies in which it would be convenient to invest in.

The annual accounts must only be analyzed when the information is trustworthy, and when you dispose of favorable audit report without any exceptions. When the audit reports contain important exceptions or when the opinion is unfavorable, the accounts are not trustworthy.

When examining the annual accounts, it is convenient to basically observe the liquidity, the indebtedness, the management of the assets, the collection and payment terms, the sales, the expenses, the earnings, the leverage and self-funding.

To wrap-up the idea, you could say that it is convenient to invest in those companies that:

  • have a correct liquidity situation. In this way you will reduce the risk of the company suspending its payments. They are companies that usually have favorable ratings. A rating is a class elaborated by specialized institutions (Moody?s, Standard & Poors, etc) that informs about the charity of a company to attend its obligations related to its debts. The most solvent companies are those with an Aaa class (Moody?s) or AAA (Standard & Poors).
  • Have an equilibrated indebtedness. For it you precise of an adequate proportion between debts and own resources.
  • Are efficient in the use of their assets. One of the ways to valuate the efficiency consists in the analysis of the ratios of assets rotations. The management of the assets will be more efficient if rotations are greater
  • Have a good relation between the terms of collection from its clients and the payments to their suppliers. The best situation is when the company obtains for its collecting terms to be lower than its payment terms. In this way, you get your suppliers to finance a significant part of the financial needs of the company.
  • Increase their sales with respect to the inflation and to do better than its competitors. If he achieves this, its market quotation will rise.
  • Obtain to control its expenses in a way that it will allow to achieve their earnings to grow
  • Augment their earnings in relation with their sales with own resources and assets  
  • Have a favorable leverage. That is , they have a debt that increases profitability of their own resources
  • Obtain a level of earnings that will allow self-funding of the company, but at the same time, to reattribute better to shareholders through distribution of dividends.

Along the section we have proposed some ideal values for specific ratios. These ideal values must be understood as generalities that might not be valid for determined companies, in function of the sector in which they operate and the definite characteristics of each case. So you must remember that the ideal values that we have proposed have to be questioned in every case. For example, we have indicated that the ideal value for the ratio of liquidity must be higher than 1. However, in companies that collect quickly from their clients and that pay very late to their suppliers could have a normal value for the ratio that is lower than 1 without producing any tension on the liquidity. This could be the case of the big chains of hypermarkets or of supermarkets, for example.

Besides considerations studied in the section there are other elements to take into account. So you must give certain importance to the qualitative aspects that you cannot see on the annual accounts, but that condition the present and future of a company. Its about the strong and weak points of a company in what is referred to as:

  • management team (studies, experience, cohesion, age, etc.)
  • marketing (sales channels, prices, products, publicity, distribution, etc)
  • production and technology (automation, use of the production capacity, etc)
  • research and development (new products, …)
  • human resources (motivation, working climate, incentives, cohesion, formation, etc.)
  • administration (punctual and trustworthy, information, fulfillment of fiscal obligations, seriousness towards financial agreements, etc)

Finally, it is convenient to remember that for your security portfolio to be sufficiently diversified, you have to invest in a number of companies that will avoid “putting all the eggs in the same basket.” In this way, you reduce the risk of suffering important losses due to unexpected negative situations from the companies whose shares you have purchased.

Beginner Money Investing Economical and Financial Analysis of a Company Statement of source and application of funds Balance Ratios Analysis of the Operating Account Profitability Analysis Financial Analyzing