Financial Indicators

A. Liquidity indicators
OBJECTIVE

To measure the extend to which the companies can meet short-term obligations

A.1. Current Rate

Formula

Current Assets : Short-Term Debt

Interpretation

It measures the extend to which short term debt are covered by current assets. Interpretation:
Subunit values (below one) indicate short term liquidity problems, because of the negative working capital. This means
that: (i) short-term financial resources (borrowed from banks through working capital credit lines, or from suppliers
through invoices with future payment term) were allocated to long term investments (fixed assets); (ii) when receivables
and inventories were collected / sold, the cash inflow received wasnt used to pay suppliers or shor-term credits
borrowed from banks, but instead was used to to pay dividends, pay long-term credits to banks or affiliated entities or
just cover losses from current or previous financial exercises
Values above par ( > 1) indicate a positive working capital. This means that when all balance reicevables are collected
and inventories are sold, together with the current available cash, the consolidated amount should be enough to cover
the balance value of the entire short term debt. Theoretically, the company has positive working capital to finance its
short term capital needs. Nevertheless, very high values might indicate problems, because too much capital is invested
in receivables and inventories. In any case, positive working capital is not equivalent to immediate, effective or tangible
liquidity. In fact, positive working capital actually indicates the potentiation of future likely positive net cash flow, as
receivables are collected and inventories are sold. Nevertheless, in real business practices there are several reasons that
hamper (prevent, stop) the potentiation of positive working capital to materialize into positive net cash flow: (i)
defaulted receivables because customers go bankrupt; (ii) inventory obsolescence or their perishable nature, which
lowers the realizable value (market price).
Conclusion:
values above one are preferables and indicates a likely good liquidity standing, but this is not guaranteed
values below one indicate negative working capital and very likely poor short-term liquidity position. This is not
preferable and usually not found among low risk companies

A.2. Quick rate

Formula

(Current Assets Inventories) : Short-Term Debt

Interpretation

Similar to the current rate, only that inventories are excluded from the current asset based. Financial analysis norms recommend
this indicator value to exceed 0,8 , with similar interpretation as the current rate.
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A.3. Cash rate

Formula

(Current Assets Inventories -Receivables) : Short-Term Debt

Interpretation

Similar to the current rate, only that both inventories and receivables are excluded from the current asset base, therefore leaving
for the numerator only the treasury (cash and bank account). Financial analysis norms recommend this indicator value to
exceed 0,2.

B. Short term rotation indicators

OBJECTIVE

To measure the correlation between the length of short-term debt, receivables and inventories rotation. Basically, this
will indicate if the subject company / sector is paying the suppliers faster or lengthier as compared to the cumulated
period of receivables collection and inventories sale.

The understanding of the operating cycle is important, as it indicates:

The cash generation process on the short-term operating level
The necessary capital to finance short-term needs / the surpus capital generated by the company on short-term
The rational of every business is to generate more cash at the end of the day, as compared to the initial invested cash into the company through the
added value production and/or distribution process. Nevertheless, if the raw material price, production costs and final product market price
changes amid uncorrelated pattern, this cycle can generate losses. Likewise, is one company doesnt manage properly the cash conversion cycle
phases, by supplying with surplus raw materials, allowing extended payment terms to customers or accepting very short payment terms toward
suppliers, the cash conversion cycle can generate negative cashflow.
B.1. DSO (Days of Sales Outstanding)
Formula

(Receivables / Turnover) * 365

Interpretation

This indicator measures the average duration of receivables collection, being expressed in numbers of days. Increasing values
might indicate non-performing receivables. This is acceptable only if:
The turnover increases faster as compared to receivables advance
The capital invested in receivables does not report surplus value above the equilibrium level (the CCR analysis)
The company / sector does not record large sensitivity following the stress test scenario results

B.2. DIH (Days of Inventories on Hand)

Formula

(Inventories / Turnover) * 365

Interpretation

This indicator measures the average duration of invetories rotation, being expressed in numbers of days. Increasing values
indicate that more and more capital is invested in inventories, lengthening the cash conversion cycle.
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B.3. DPO (Days of Payables Outstanding)

Formula

(Short-term Debt / Turnover) * 360

Interpretation

This indicator measures the average duration of short term debt rotation, being expressed in numbers of days. Increasing values
indicate that average payment terms of short-term debt (credits from banks, affiliated institutions, suppliers, state) is
lengthening. This situation is acceptable only if the subject company / sector reports positive and good quality working capital
(with strong cash rate).

B.4. CCC (Cash Conversion Cycle)

Formula

DSO + DIH DPO

Interpretation

The indicator is expressed in number of days and measures the time span the company / sector needs in average to turn 1 EUR
invested into the production and / or distribution activity into 1 EUR collected from the business activity.
This indicator can have positive or negative values, each situation highlighting a different context and analysis.
1 EUR + X OUT

1 EUR IN

Positive cash conversion cycle since the company / sector is paying suppliers faster as compared to the necessary time to
collect receivables and sell inventories, we must closely check the capital (debt and equity) structure, in other words to
understand if the financing structure of the company is sustainable.

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Negative cash conversion cycle since the the company / sector is paying suppliers lengthier as compared to the necessary
time to collect receivables and sell inventories, we must closely check the capital allocation (investments) directions and
productivity.

Liquidity and short-term rotation indicators provide valuable information related to the evolution of balance sheet structure in
time and by maturities (equity, debt and assets on short and logn term).
The maturities horizon principle states that long term investments (fixed assets) must be financed through long term
financing resources (permanent capital = equity and long term debt) and short term investments (current assets) must be
financed through short-term debt.
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C. Profitability indicators
OBJECTIVE

To measure the overall performance of the company / sector.

General
interpretation

When computing every profit margin on sectorial level, the challenge we must consider is related to the offset effect between
the negative and positive results recorded by multiple companies active in the respective sector. Due to this effect, the overall
sectorial margin converges towards the breakeven point (0%). Therefore, for the financial indicators in general, as well as for
the profitability indicators in special, the breakdown by profit margin ranges is of critical importance. All profits margin are
computed on sectorial overall level for both 2012 and 2013 financial exercises, whereas for every profitability indicator the
dispersion of companies based on profit margins is illustrated through pie charts (ie. Showing how many companies have
profits between zero 10%, or losses between -10% and zero). By correlating the distribution of companies by profit ranges
together with the overall sectorial result, one can observe the profitability performance of small-size and large-size companies.
For example, if 30% of the companies have positive net profits but the overall sectorial net profit is 2%, this means that the
absolute value of the profits is larger as compared to the obsolute value of losses, making more likely for the large-sized
companies (the 30%) to report larger profits (in absolute value) as compared to the absolute losses reported by small-sized
companies.
It is abvious that financial analysis norms would indicated the fact that the higher the profits, the more stable and more
efficient the company is. Nevertheless, profits must not be confused with good liquidity position, likewise losses must not be
correlated necessarilty with poor liquidity position (unless both profits or losses are very large in value and reported for
consecutive financial exercises). This is because net positive profits indicate that revenues are above the expenses recognized in
the same financial exercise, which does not necessarily imply that cash inflows are above the cash outflows for the same
finance exercise, because:
Except the situation of cash payment, the revenue recognized in P&L and the actual cash inflow are done in different
moments (and maybe in different financial exercises). Examples:
o sales on credit (or technically accrued revenue), the firm provides goods or services before it receives cash
payment, with revenue recognized when invoice is issued, but with cash inflow recognized when receivable is
collected (ie. A DSO of 90 days means that, in average, all sales done in 4th quarter this year generate cash
inflows in 1st quarter next year);
o (ii) unearned revenue - the firm receives cash before it provides the good or service, the cash increases now in
equal amount with unearned revenue (a liability). When the firm ultimately provides the good or service,
revenue increases (we recognize the revenue in the P&L) and the liability decreases. For example, the firm can
recognized cash increases during December this year from some advance or subscription payments from
customers, and recognize the revenue together with the corresponding expense during January next year.
Technically speaking, actual revenue recognition will always imply asset increases or liabilities decreases, whereas
actual expense recognition will always imply asset decreases or liabilities increases
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Time span between the transformation of revenue in cash inflows, and expenses if cash outflows is very important to
determine the liquidity position. If the latter is faster (ie. Expenses impact cash outflows faster than revenues generate
cash inflows), the cash drag out of the company is larger, fueling pressure on the liquidity position. This is tipically
found for companies / sectors where the DPO (the average payment of suppliers) < DSO + DIH (the operating cycle, the
cumulated period necessary to collect receivables and sell inventories), with negative CCC (cash conversion cycle)

Some expenses are non-monetary for the current financial exercise perspective. The most known non-monetary expense
is amortization (the multiannual recognition of expenses done in the past with fixed assets investments). Basic example
(we eliminate complications related to asset disposal and G/L impact, salvage value, transportation and maintenance
costs or different amortization methods, just for the sake of simplicity):
o acquisition of productive fixed asset is done in T0, with lifespan usage of 5 years, and upfront payment of 100 K
EUR
o since the fixed asset is expected to generate revenue during the 5 years usage time, the expenses related to this
machine must also be recognized during its timelife (this is because of a very important accounting principle that
states the revenues must be reported in the same financial exercises with the expenses done to generate the
corresponding revenue);
o if linear amortization is used, the annual expense recognized would be 20 K EUR / year;
o this actually means that we would report in T0 a cash outflow of 100 K EUR (cash decreases a lot in TO), with
no expense (accounting profit will not be affected), wherease we will report no cash outflows during T1 T5
(treasury is not affected) but with annual amortization expenses of 20 K EUR (accounting profit will be
impacted negatively). Therefore, we might have good accounting profits in T0 but with poor liquidity, whereas
in T1 T5 we might have low accounting profits (or even losses) but with good liquidity.

C.1. Net result Margin

Formula

Net Result : Turnover

Interpretation

Measures the firm ability to transform sales into profits, by reporting revenue above expenses

C.2. Operating Result Margin

Formula

= EBIT : Turnover = (Operating Revenue Operating Expense) : Turnover

Interpretation

The most important component of net result, the operating margin represents the firm capacity to generate profits from its
principal activity
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C.3. ROE Return on Equity

Formula

Net Result : Equity

Interpretation

The return that shareholders receive for the capital they invest and maintain into the company.

C.4. ROA Return on Asset

Formula

Net Result: Total Assets

Interpretation

Economic rate of return provides information on the effectiveness of using company assets in its business and generating
profits.

C.5. OROA Operating Return on Asset

Formula

EBIT : (Assets Cash)

Interpretation

Similar to ROA, but measuring more the operating return of the operating assets (by excluding the monetary positions, or the so
called cash drag)

D. Capital Structure and Investment indicators

OBJECTIVE

To measure the extend to which the companies / sector can meet long-term obligations, to illustrate the capital structure
(the proportion of debt and equity used to finance assets) and proxy for the Going concern (the theoreticall
assumption that companies are to exist forever, which is not necessarily the case for companies with distressed debt, ie
large amount of debt and very poor capitalization rate)

General
interpretation

Depending on the operating cycle (DSO + DIH) duration, the financial analysis norms recommend the following balance sheet
weight:

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Long operating cycle (ie. production)

45%

55%

Fixed assets

Current
Assets

Permanent
Capital

Short operating cycle (ie. Services, distribution)

10%
50%
90%

Short Term
Debt

Fixed assets

50%

Current
Assets

Permanent
Capital

15%

Short Term
Debt

85%

D.1. Debt Ratio

Formula

Total Debt : Total Assets

Interpretation

Safety theoretical financial analysis norms state that debt ratio should not exceed 66%, but we must also consider the sectorial
specificity depending on the operating cycle length (as illustrated above in the mirrored balance sheet structure)

D.2. Short Term Debt Ratio

Formula

Short Term Debt: Total Debt

Interpretation

Follow the above ilustration in the mirrored balance sheet structure

D.3. Capex Ratio

Formula

CAPEX : Tangible Assets, where CAPEX = capital expenditure, and represents the amount of capital invested in fixed tangibe
assets, with the most basic formula for CAPEX = (Tangible Assets) + Amortization (we exclude gain or loss from assets
disposal or impairment impact, just for the sake of simplicity)

Interpretation

This indicator measures the extend to which tangible and productive assets are being renewed.

D.4. Depreciation Ratio

Formula

Amortization : Tangible Assets

Interpretation

This indicator measures the expense recognition rhythm caused by previous tangible assets investments. It is seen as a proxy to
indicate the rhythm that assets are becoming obsolete.

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