Financial Management
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RELEVANCEOFFINANCIALDIAGNOSIS.pdf
LUCRĂRI ŞTIINŢIFICE, SERIA I, VOL. XXI (3)
299
THE RELEVANCE OF THE FINANCIAL DIAGNOSIS
ON THE DECISION-MAKING PROCESS
ETZ STELIAN
1 , GOMOI BOGDAN COSMIN*
1 , PANTEA MIOARA FLORINA
1
1 ”Aurel Vlaicu” University of Arad, Faculty of Economics, Romania
*Corresponding author’s e-mail: [email protected]
Abstract: The accounting’s main objective is to offer in financial terms an accurate image
of a company’s activity, while the financial management is focused on administrating the
information delivered by the accounting in order to make the most appropriate decisions in
order to accomplish the fundamental objective of a company, namely the profit. By using a
various research methodology, such as: the data analysis, the case study or the dynamic
and comparative study, the present paper aims to emphasize how important the financial
diagnosis is, in order to improve and to optimize the decision-making process within a
company. In order to increase the relevance of the results, it was taken into consideration a
stock listed company.
Key words: financial diagnosis, indicators, relevance, decision-making process
INTRODUCTION
In order to appreciate the financial health of a company, the first step is a diagnostic
analysis aimed to outline the perimeter quite limited of the entity in the approach of
outlining and implementing of the strategies for conservation and development.
The rates system represents, in addition to the absolute indicators of financial
structures confined within the financial statements, a basic tool in diagnosing the entity's
financial state [4].
This is based on the philosophy of the flow indicators correlation (taken out from
the profit and loss account or the financing statement) with the stock indicators (taken out
from the balance sheet). While the stock indicators merely reflect the fair image of the
entity in cumulative figures, the flow indicators come to the aid of the analysts, providing
information of the „moment” on the formation of cumulative figures shown by the stock
indicators [1].
MATERIALS AND METHODS
In order to elaborate this paper, various research methods are used, such as: the
analysis, the synthesis, the induction, the deduction, the brainstorming, the dynamic study
or the case study [13].
RESEARCH RESULTS
Under this financial picture, we find that the assets of a certain stock exchange
listed entity, namely Petrom, represents a large proportion of tangible fixed assets
representing wells, infrastructure, plant and machinery for oil extraction.
The share of tangible fixed assets revolves on average around 75%, of which
approximately 65% represents wells, equipments and facilities for extraction. There cannot
be neglected the property rights of the entity or the entity's financial activity. In this regard,
we will notice that Petrom has established a diversified portfolio of financial titles, which,
in the second period analyzed, namely N-4 - N-2, while increasing purchases on the capital
market, records a growing profit at the level of financial activity. Moreover, the state
provides real support to the entity, by increasing decommissioning costs that Petrom
recovers from the state. In what follows, we present, in a schematic manner, a dynamic
analysis of the synthesis accounting information of our entity, bringing to the fore:
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structural indicators, indicators of funding, management indicators, profitability indicators,
risk indicators or cost indicators (Table 1) [14]:
Table 1.
Various indicators of a listed company for a five years time period Objective Indicator N-4 N-3 N-2 N-1 N
Investments
Fixed assets 0.598 0.676 0.777 0.796 0.834
Intangible assets 0.007 0.012 0.019 0.057 0.044
Tangible assets 0.709 0.642 0.645 0.689 0.712
Financial assets 0.284 0.346 0.336 0.254 0.244
Current assets 0.402 0.324 0.223 0.204 0.166
Stocks 0.208 0.233 0.410 0.471 0.475
Receivables 0.161 0.217 0.430 0.335 0.461
Liquidity 0.631 0.550 0.160 0.051 0.063
Funding
Global autonomy 0.826 0.844 0.835 0.733 0.688
Overall indebtedness 0.174 0.156 0.165 0.267 0.312
Financial stability 0.828 0.845 0.837 0.814 0.826
Financial indebtedness 0.997 0.998 0.998 0.900 0.833
Repayment capacity 0.960 0.734 0.906 0.848 1.284
Financial balance rate 0.521 0.538 0.737 0.862 0.753
Management
Receivables rotation 38.90 days 37.98 days 59.89 days 37.13 days 57.86 days
Stock rotation 50.34 days 40.89 days 57.12 days 52.17 days 59.63 days
Commercial credits rotation 25.66 days 33.16 days 52.32 days 48.61 days 55.51 days
Profitability
Commercial profitability 91.25% 96.44% 18.96% 8.39% 16.70%
Economic profitability 33.76% 35.39% 31.77% 33.50% 24.09%
Financial profitability 13.20% 18.54% 13.49% 7.53% 9.73%
Risk
Current liquidity 3.196 2.781 1.818 1.475 1.239
Immediate liquidity 2.531 2.132 1.073 0.781 0.650
Sight liquidity 2.017 1.529 0.292 0.286 0.079
ACID test 2.017 1.529 0.292 0.076 0.079
Economic lever - 2.20 4.82 -0.92 0.37
Financial lever - 2.85 3.66 -1.17 -1.45
Score function 2.785 2.958 2.022 1.719 1.509
Cost
The average interest rate 2.90% 0.00% 0.00% 0.13% 15.63%
Average tax rate 15.86% 10.24% 17.29% 36.32% 19.40%
Tax savings 0.46% 0.00% 0.00% 0.05% 3.03%
The cost of borrowed capital 2.44% 0.00% 000% 0.08% 12.60%
The cost of equity 1.32% 1.78% 1.92% 0.00% 0.00%
The weighted average cost 1.51% 1.50% 1.60% 0.02% 3.94%
Economic value added 32.24% 33.88% 30.17% 33.47% 20.15%
Valuation
bases
The impact of revaluation
reserves 0.00% 0.61% 0.44% 0.38% 0.58%
Source: own elaboration
In the bottom part of the balance sheet, the situation of the current assets structure
shows a little different than happens in most frequent cases, i.e. appears the anomaly of
increasing evolution of receivables and, in particular, of stocks [6].
Such a development automatically induces an acute deterioration of the entity’s
treasury that provides early information about the possibility of financial imbalances
installation [14].
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0.70 1.19 1.85 5.70 4.44
70.90 64.20 64.52
68.95 71.16
28.40 34.61 33.63
25,.35 24.40
0%
20%
40%
60%
80%
100%
N-4 N-3 N-2 N-1 N
Figure 1. The fixed assets structure of a listed company for a five years time period
Table 2.
The treasury of a listed company during a five years time period
Source: own elaboration
It is true that an excessive treasury becomes „lazy” as long as there it is not
effectively harnessed by allocating the cash placements, or, why not, by financing an
N-4 N-3 N-2 N-1 N
Profit before
tax 1.683.423.208 lei 2.546.166.973 lei 2.149.627.028 lei 1.605.563.340 lei 1.697.519.745 lei
Net treasury
generated
from
operating
activity
2.771.300.260 lei 2.954.789.370 lei 2.485.377.106 lei 4.383.615.591 lei 2.656.968.662 lei
- 183.489.110 lei -469.412.264 lei 1.898.238.485 lei -1.726.646.929 lei
- 6,62% -15,89% 76,38% -39,39%
Net treasury
used in
investing
activity
-2.170.111.346 lei -3.167.623.570 lei -3.760.781.518 lei -5.528.758.491 lei -4.058.494.992 lei
- -997.512.224 lei -593.157.948 lei -1.767.976.973 lei 1.470.263.499 lei
- 45,97% 18,73% 47,01% -26,59%
Net treasury
used in
financing
activity
-218.847.795 lei -836.100.465 lei -1.422.986.498 lei 653.946.441
lei 1.420.123.809 lei
- -617.252.670 lei -586.886.033 lei 2.076.932.939 lei 766.177.368 lei
- 182,05% -29,81% -245,96% 17,16%
Total cash
flow 382.341.119 lei -1.048.934.665 lei -2.698.390.910 lei -491.196.459 lei 18.597.479 lei
- -1.431.275.784 lei -1.649.456.245 lei 2.207.194.451 lei 509.793.938 lei
- -374,35% 157,25% -81,80% -103,79%
Cash and
cash
equivalents at
the beginning
of the year
4.117.609.227 lei 4.499.950.346 lei 3.451.015.681 lei 752.624.771 lei 261.428.312 lei
Cash and
cash
equivalents at
the end of the
year
4.499.950.346 lei 3.451.015.681 lei 752.624.771 lei 261.428.312 lei 280.025.791 lei
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investment or portfolio of profitable investments at a rate at least equal to the rate of the
risk-free interest on the capital market. In our case, it appears that the entity wants to
pursue a new direction in terms of cashing the value of production sold [7].
This can occur for various reasons; however, such a policy certainly was preceded
by an analysis of the creditworthiness of customers, which gives some safety for the
collection in the future of the debts paid. This statement is supported by the degree of
hedging, through the registration of the depreciation adjustments, which are up to the share
of 50% of the total receivable balance customers [3].
Furthermore, a slowly accumulation of inventories does nothing but to block
indefinitely a significant part of the company’s cash. There is no question in this case,
regarding the real impact of the registration of unsalable stocks.
The treasury is presented progressive in Table 2) [9].
Scenarios on the cause of this situation appearance are numerous, but the
macroeconomic conjuncture conditions have a big say, in particular by paying the current
debt policy of the state.
The elasticity of oil assets is null. But if the demand suffers decreases repeatedly,
the entity cannot afford to record sub-activity costs, given the increased share of fixed
costs within the amount of total costs [5].
When it comes to the financing policy of the entity, we refer, in other words, to the
structure of financing of specific activities. It is noticeable that, in the first phase, the
financial structure of the entity coincides in relative terms, with the share of the equity.
So, the entity opts for a funding policy on account of hiring treasury loans,
especially „cash-polling” loans. In these circumstances, the entity enjoys greater autonomy
and an enviable degree of solvency, which gives the entity the possibility of getting new
financing under extreme advantageous conditions.
Only within the recent years, it appears that the entity is also looking forward for a
long term loan. However, the entity presents a greater degree of financial security,
considering the positive development of the capacity to repay loan installments on account
of affecting the self-financing capacity.
It is quite clear that the policy of financing the entity falls within a balanced policy
boundaries aimed at ensuring continuity and financial stability:
Table 3.
The financing indicators of a listed company for a five years time period
Indicator N-4 N-3 N-2 N-1 N
Global autonomy 82.56% 84.39% 8349% 73.27% 68.77%
Overall indebtedness 17.44% 15.61% 16.51% 26.73% 31.23%
Financial stability 82.83% 84.54% 83.66% 81.39% 82.58%
Financial indebtedness 99.68% 99.82% 99.80% 90.02% 83.28%
Repayment capacity 96.01% 73.41% 90.64% 84.75% 128.40%
Financial balance rate 52.13% 53.81% 73.71% 86.24% 75.27%
Source: own elaboration
However, the variation recorded in the amount of the liquidity, due to the dilution
of the period of sales collection, correlated with an yearly consistent spore of commercial
debts increase generates significant changes within the amount of the financing flows, and
less in the size of the cash flows:
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Table 4.
The rotation indicators of a listed company for a five years time period
Indicator N-4 N-3 N-2 N-1 N
Receivables rotation 38.90 days 37.98 days 59.89 days 37.13 days 57.86 days
Stock rotation 50.34 days 40.89 days 57.12 days 52.17 days 59.63 days
Commercial credits rotation 25.66 days 33.16 days 52.32 days 48.61 days 55.51 days
Period of cash deficit 63.59 days 45.70 days 64.69 days 40.70 days 61.98 days
Source: own elaboration
Periods of high storage of up to 2 months, reflect a situation typical for large
enterprises, given the size of marketed production and distribution frequencies for major
clients of the company. However, this situation is considered quite risky, as long as the
supply process can even reach to be blocked just because of the incapacity of paying to an
important customer, such as the state [15].
This aspect was remarked also within the entity’s liquidity indicators which
describe a steep downward trend, inducing a potential risk of payment incapacity for the
future:
Table 5.
The liquidity indicators of a listed company for a five years time period
Indicator N-4 N-3 N-2 N-1 N
Current liquidity 3.196 2.781 1.818 1.475 1.239
Immediate liquidity 2.531 2.132 1.073 0.781 0.650
Sight liquidity 2.017 1.529 0.292 0.286 0.079
ACID test 2.017 1.529 0.292 0.076 0.079
Source: own elaboration
All these are due to the configuration of the profitability - risk binomial. This
binomial, in a simplified sense, requires that any marginal risk assumed by the entity must
be paid as such, so that the marginal investment involving a profitability spore is
sufficiently motivating for decision makers [2].
Such an approach calls also the total cost structure which has to be classified in
fixed costs, respectively variable costs. From this stellar graph emerge a series of correlations between different rates aiming the
solvency of the company. It is noticed quite easily that, although the entity has a capacity for debt
due repayment, liquidity size decreases from one year to another, exposing the enterprise to a
greater risk of default. However, this evolution is not a concern as long as it is confirmed an
encouraging trend of the cash flow. The leverage indicators express, in different conceptions, the
impact of the variation of the tax value in the size of the exercise’s result [4].
Thus, if economic leverage effect measures the changes in gross profit from
operations, the change with a unit of fiscal value, 0
0 Pr
P
CA
CA
ofit gross
, while the financial
leverage effect considers also the size of the financial expenses, reporting the variation of
the net profit to a unitary change of the tax value
0 Pr
Pr 0
net
net
ofit
CA
CA
ofit
to a change unit
turnover. As shown in the figures, indeed, the share of fixed costs is considerable within
the cost structure of the entity, as a variation of the tax value has really a devastating
impact on the size of profits, be it the operating profit or the net profit [1].
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Figure 2. The solvency indicators of a listed company for a five years time period
The score function is the value of the score function Băileşteanu, built for the
Romania case in 1998. This uses as an evaluation tool the linear function of the
form 414.10333.00526.0909.0444.0 4321 GGGGf , where G1 - current
liquidity ratio, G2 - solvency ratio, G3 - customer turnover rate and G4 - the profitability
rate of return costs [1].
The recitals from which started the selection of this model are that the score
function Băileşteanu reflected in greater extent the autochthonous economic environment,
given that the empirical study is based on figures regarding the Romanian companies.
Moreover, this model perceives the risk of bankruptcy in terms of solvency, liquidity and
profitability of the company, indicators that summarize in one form or another both
management policies of the operating cycle and the scope of the funding policy [8].
If the value of the function is lower than 0.5, then it is considered a bankrupt state
under imminent. Range (0.5; 1.1) is considered limited range; range (1.1; 2.0) is considered
the intermediate zone, while if the function has a higher value than 2, then it is considered
that the entity is in a favorable zone [2].
No just and maybe, we can consider that the entity Petrom has a healthy economic
and financial situation, without being exposed to the risk of bankruptcy in the near future:
Also, the balance sheet structure and mandatory annexes to the financial
statements, notes also the visible impact of the choice of the assessment base, representing
the fair value, as specified in the measurement principles of the financial statements
package. The entity operates yearly value adjustments on the net book value of assets
subjected to revaluation treatment under the law. Therefore we find also an important value
of the balance of revaluation reserve in the amount of equity. Although the percentage size
0
0.2
0.4
0.6
0.8
1
1.2
1.4 Global autonomy
Liquidity
Repayment capacity
Balance ratio
N-3 N-2 N-1 N
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of 0.40% does not say much, in absolute size, revaluation reserves present a significant
fluctuating evolution, but in relative terms, constantly [10].
Table 6.
The risk indicators of a listed company for a five years time period
Indicator N-4 N-3 N-2 N-1 N
Economic leverage - 2.20 4.82 -0.92 0.37
Financial leverage - 2.85 3.66 -1.17 -1.45
Score function 4.199 4.372 3.436 3.133 2.923
Source: own elaboration
Depreciation size fits also within a framework of evolving fairly steady, hovering
around 6% of the net assets. This significant share of depreciation brings in the income
statement of the entity tax savings of about 0.96 percent, meaning in absolute values, a not
at all negligible amount [12].
Although the entity presents a low economic and financial risk, it records relevant
profitability rates. Inelastic demand of products traded by our entity gives us a competitive
advantage, specifically to the entire sector:
Table 7.
The profitability indicators of a listed company for a five years time period
Indicator N-4 N-3 N-2 N-1 N
Commercial profitability 91.25% 96.44% 18.96% 8.39% 16.70%
Economic profitability 10.58% 14.34% 9.28% 5.25% 4.48%
Financial profitability 13.20% 18.54% 13..49% 7.53% 9.73%
Source: own elaboration
The leverage effect generates in the purse of the entity, due to the deductibility of
interests, a significant amount of tax savings, whose percentage size is given by the
difference between the economic profitability and, respectively, the financial profitability,
weighted with the parity rate of shareholders' contributions and creditors’ contributions.
The economic profitability is defined as the ratio between gross operating profit,
respectively, the size of the capital invested, while the financial profitability is the net gain
obtained by the entity by affecting a unit of the own funds [11].
CONCLUSIONS
The corporate governance principles ensure the conservation and the development
portfolio of the shareholders, meeting the efforts of the specialists in order to reduce the
adverse effects of the information asymmetry phenomenon.
Although the implementation of such a set of principles, through an organizational
structure well built, aims huge costs, the marginal gain of shareholders and of the other
external users materializes in a confidence-building in leadership and also an additional
motivation in getting significant real performance.
We will not lie on the classification of these indicators, as this section is intended
only to provide a mirror of the overall economic situation of our entity, and just to give
clues on likely future developments [6].
Embarking upon a fascinating insight of the financial management through the rate
system, we keep in mind some basic principles in the corporate finance, namely, the
financial policies of the entity must follow a well-defined direction, coupled with the
entity's strategy in the medium and long term.
This direction must, however, take into account several fundamental rules in
finance, namely:
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the minimum financial balance rule, whereby stable funding allocations should be covered only from sustainable sources, and also the financing of the need for
structural working capital should be financed at the expense of working capital;
the maximum borrowing rule, which implies that banking practice indicates to the companies that the size of borrowed funds should be fully covered by affecting
equity;
the repayment capacity rule, which implies that the yearly size of financial liabilities does not have to exceed 3-4 times the average yearly self-financing
capacity provided;
the minimum self-financing rule, translated by requiring the entity's contribution to the financing of investment projects for which the credit is requested [2].
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