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The Ten Steps Process

• María José García López

Step 1. Working Capital.

Working Capital (WC) is defined as:

Total Current Assets – Total Current Liabilities

WC should be positive, because it means that the Company has enough economic resources
in the short term to be converted in liquidity to attend the payment of its current liabilities.
Otherwise, the Company will have liquidity problems and an unstable financial position.

In any case, we should compare the total amount of WC with the sector average because in
some sectors (as hypermarkets) the WC is negative for all the companies, and it doesn’t
mean a bad financial position for the firm.
Step 1. Working Capital.

We can also calculate Adjusted Working Capital defined as:

Total Adjusted Current Assets – Total Adjusted Current Liabilities

Being:

™ Adjusted Current Assets = Current Assets – non current assets held for sale
™ Adjusted Current Liabilities = Current Liabilities – liabilities related to non current assets
held for sale

Adjusted WC eliminates the possible effect of to have non current assets held for sale
included in the current assets following the accounting classification once the Company
decides not to use it anymore. Eliminating these accounts related to non current assets held
for sale, we only consider the economic resources related to the business cycle.
Step 2. Leverage

Total Liabilities . x 100

Equity + Total Liabilities

This relationship measures the balance between third parties resources (Debt) and total
financial sources of the firm.

A good relationship is when equity represents no more than 70% of total financial resources.
Step 3. Debt With Cost

Total Debt with Cost . x 100

Total Equity + Liabilities

We must take into account long-term and short-term debt with cost

Debt with cost are:

Debt Instruments (Bonds, Debentures)

Loans and Borrowings
Financial leases payable

In this case, as lower as better for the Company.

Step 4. Sales Variation

Sales y1 – Salesy0 . x 100

Salesy0

With this ratio, we can study the sales evolution. The variation should be higher than the
inflation rate of the period, to have a real increase on sales volume.

Sales is always the first (or two first) line of the Income Statement. Another possibilities are
to find it as “Income”, “Revenue”,…..
Step 5. EBITDA Variation

EBITDA y1 – EBITDA y0 . x 100

EBITDAy0

EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortisation) is calculated as

Revenue – Operating Expenses.

EBITDA is the most important step in the Income Statement, because it is only related to the
Business Cycle.

EBITDA variation should be at least as higher as sales variation or ever higher, because the
effect of economies of scale.

If EBITDA variation is lower tan sales variation means that the Company is incurring in more
expenses and is not repercuting them to the sales
Step 6. EBIT Variation

EBIT y1 – EBIT y0 . x 100

EBITy0

EBIT (Earnings Before Interest, Taxes) is generally called “Operating Income”

We have to check if there is any important variation between EBITDA and EBIT variation,
because if it is, it only can be due to the effect/impact of Economic Structure (more/less
depreciation, more/less impairments, gains or losses from non current assets) in the Income
Statement.
Step 7. Net Income Variation

7.1. Net Income from Continuing Operations (NIcont operat)

NIcont operat y1 – NIcont operat y0 . x 100

NIcont operat y0

We have to check if there is any important variation between EBIT and Net Income from
continuing operations, because if it is, it only can be due to the effect/impact of Financial
Structure (more financial expenses, gains or losses from marketable securities, gains or
losses from derivatives) in the Income Statement.
Step 7. Net Income Variation

7.2. Net Income (including the effect of discontinuing operations if any)

Net Incomey1 – Net Incomey0 . x 100

Net Income y0

We have to check if there is any important variation between Net Income and Net Income
from continuing operations, because if it is, it only can be due to the effect/impact of
Discontinuing Operations (sale of brands, abandonment of a geographical market, climate
event of irreversible consequences) in the Income Statement. The discontinuing operations,
due to their characteristics, only can happen once upon the time.
Step 8. Net Cash Flow from Operating Activities (NCOA) Variation

NCOAy1 – NCOAy0 . x 100

NCOAy0

We have to check if there is any important variation between EBITDA Variation and Net Cash
Flow from Operating Activities, because as far as Revenues are increasing, it’s supossed
tŚaƚcash should increase at least at the same percentage.

Big differences between one variation and another can be a signal of accounting makeup
Step 9. Net Cash Flow from Investing Activities (NCIA)

This step inform us about the expansive or contractive policy of the company related to their
non current investments on assets and/or related to the financial investments both current
and non current.

In general these flows are negative because the investments require more cash resources
than the amounts collected by the sales of these ítems but we need to analyze the group
carefully to understand if cash inflows and outflows come from non current assets or
financial assets
Step 10. Net Cash Flow from Financing Activities (NCFA) Margin

10.1. Financing Cash Flows related to Debt Evolution

In the case of NCFA, more than the evolution itself, it is interesting for us to know if the
company is reimbursing its debts or is refinancing them to proceed to the payment. We
can check this, paying attention to the debt cash Flows.

10.2. Financing Cash Flows related to Equity and Dividends evolution

In this second part, we check if the company is increasing or decreasing its share capital
and if the company has paid any dividend during the period. In this sense, we can also
check if, independently of what happens to the company, the dividend paid is stable or if
it has suffer important deviations due to the net income (losses) result.