POLITECHNIKA SWIETOKRZYSKA

Analysis of a
company’s financial
standing. The role of
ratio analysis in
financial planning

Financial Planning

Leonardo Leiro Vidal

01/2022
Index
What Is Financial Analysis? ........................................................................................................... 3
Understanding an Analysis of a Company's Financial Position ..................................................... 3
Ratio Analysis ................................................................................................................................ 5
 Liquidity and solvency. ...................................................................................................... 5
 Versatility and Usefullness ................................................................................................ 7
 Turnover and Efficiency..................................................................................................... 7
 Common Size Comparison Ratios ..................................................................................... 7
What Is Financial Analysis?

To understand and value a company, investors examine its financial position by studying its
financial statements and calculating certain ratios. Fortunately, it is not as difficult as it sounds
to perform a financial analysis of a company. The process is often a part of any program
evaluation review technique (PERT), a project management tool that provides a graphical
representation of a project's timeline.

Understanding an Analysis of a Company's Financial Position

If you borrow money from a bank, you have to list the value of all of your significant assets, as
well as all of your significant liabilities. Your bank uses this information to assess the strength
of your financial position; it looks at the quality of the assets, such as your car and your house,
and places a conservative valuation upon them. The bank also ensures that all liabilities, such
as mortgage and credit card debt, are appropriately disclosed and fully valued. The total value
of all assets less the total value of all liabilities gives your net worth or equity.

Due to the great and rapid changes in the business environment, managers face the need to
have high-level knowledge that allows them to make quick and timely decisions, which
requires the application of useful tools to efficiently manage their companies and achieve the
established objectives.

Generally in organizations there are financial problems that are difficult to handle; face
financial costs, risk, low profitability, conflicts to finance themselves with their own and
permanent resources, making ineffective investment decisions, control of operations,
distribution of dividends, among others.
A company facing a difficult and convulsive environment with the drawbacks described above,
must implement measures that allow it to be more competitive and efficient from an
economic and financial perspective, in such a way that it makes better use of its resources to
obtain greater productivity and better results. with lower costs; reason that implies the need
to carry out an exhaustive analysis of the economic and financial situation of the activity that it
carries out.

Financial analysis is an instrument available to management, which serves to predict the effect
that some strategic decisions may have on the company's future performance; decisions such
as the sale of a dependency, variations in credit policies, in collection or inventory policies, as
well as an expansion of the company to other geographical areas (Brigham and Houston,
2006).

Indeed, financial analysis is a key tool for the management of any organization, since it
includes a set of principles and procedures used in the transformation of accounting, economic
and financial information that, once processed, is useful for decision-making. of investment,
financing, planning and control decisions with greater ease and relevance, in addition to
allowing the results obtained by a company during a given period of time to be compared with
the results of other similar businesses.

Some people, focuse on financial analysis as a process that consists of the application of a set
of analytical techniques and instruments to financial statements, to generate a series of
measures and relationships that are significant and useful for decision making; since the
information recorded in the financial statements alone is not sufficient to carry out relevant
financial planning or analyze and interpret the results obtained to know the financial situation
of the company.

The analysis of financial statements is characterized by being an operation based on the

reclassification, compilation, obtaining and comparison of accounting, operational and
financial data of an organization, which through the use of appropriate techniques and tools
seeks to evaluate the financial position, development and the results of business activity in the
present and past to obtain the best estimates for the future.
Ratio Analysis

Effective planning and financial management are the keys to running a financially
successful small business. Ratio analysis is critical for helping you understand financial
statements, for identifying trends over time and for measuring the overall financial
state of your business. In addition, lenders and potential investors often rely on ratio
analysis when making lending and investing decisions.

Some indicators of the financial situation by the ratio analysis are:

 Liquidity and solvency.

Many economist refer to liquidity, few to solvency, but some refer to the concept of
liquidity with the term solvency; which is why it is necessary to distinguish between
these definitions; Therefore, liquidity implies maintaining the cash necessary to fulfill
or pay the commitments contracted previously; while solvency is focused on
maintaining the assets and resources required to safeguard the debts acquired, even
when these assets are not referred to as cash.

For a company, having liquidity means meeting its commitments and having solvency
reflects its availability to pay those commitments; this indicates that for a company to
present liquidity it is necessary that it be solvent in advance.

However, for Gitman (2003), liquidity is measured by the ability of a company to pay
its short-term obligations as they come due. This author considers that liquidity refers
to the solvency of the general financial position of the organization, which translates
into the facility that the company has to pay its debts.
However, liquidity is the immediate ability to pay with which a company can respond
to its creditors; meanwhile, solvency is the ability of a company to respond in the short
term; whose capacity is reflected in the possession of goods that the company can
dispose of to cancel the commitments contracted in a short time.

For a company to be solvent, it must be willing to settle the liabilities contracted at

maturity; In addition, it must demonstrate that it is able to continue with a normal
path that allows it to maintain an adequate financial environment in the future.

In this way, solvency is reflected in the possession of quantities of goods that a

company has to settle its debts, but if it is not easy for that company to convert those
goods into cash to make its cancellations, then there is no liquidity; therefore, it is
important to note that a company with liquidity is solvent, but a solvent company does
not always have liquidity.

From the economic point of view, liquidity is given by the ease or difficulty of
converting an asset into cash immediately and without suffering a significant loss of its
value, this indicates that the easier it is to convert an asset into cash, the more liquid it
is. will be that asset.

A company that needs to cancel contracted commitments can obtain financial

resources more quickly by converting its inventories and accounts receivable into cash;
since, a company is considered liquid to the extent that it has a greater proportion of
its total assets under the modality of current assets; the latter constitute all the money
that is available in cash at the time of preparing the company's balance sheet, such as
money in banks and petty cash, accounts receivable in the short term and placements
close to maturity.

Anyway, when we focus on ratio analysis, we also need to speak about:

 Versatility and Usefullness

The information a trend analysis provides allows to you to make and

implement ongoing financial plans and, when necessary, make course
corrections to short-term financial plans.

Ratio analysis also provides ways for you to compare the financial state of
your business against other businesses within your industry or between your
business and businesses in other industries.

 Turnover and Efficiency

Operating expense and turnover ratios are critical for helping you assess how
efficiently your business is utilizing assets and managing liabilities. An
operating expense ratio compares operating expenses such as rent, inventory
purchases and advertising to sales revenue.

 Common Size Comparison Ratios

Balance sheet common size ratios are important for making comparisons of
assets and liabilities. These financial ratios focus on calculating each asset on
the balance sheet as a percentage of total assets and each liability as a
percentage of total liabilities plus owner’s equity. Financial planning goals
might then include strengthening your accounts receivable collection policy
and tightening credit-granting guidelines.
Bibliography

https://repository.unilibre.edu.co/bitstream/handle/10901/18758/TRABAJO%2
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https://www.demonstratingvalue.org/resources/financial-ratio-analysis

https://corporatefinanceinstitute.com/resources/knowledge/finance/ratio-
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