ANALYSING AND EVALUATING CORPORATE FINANCIAL DATA Introduction As a top manager, and perhaps even a company shareholder, you need to master: + The rules of financial analysis + The main ratios used to carry out a financial analysis + The sources of information used by banks and financial markets to score or rate companies + The different models of company evaluation @ Mastering the basics of financial analysis Financial analysis uses the information avaitable about a company to evaluate its financial health. Without going into as much detail as an analyst, you need to demystify the process by mastering the basics of financial analysis. The objectives of financial analysis: + Assessing the value of a company + Evaluating a company’s ability to meet its payment deadlines + Assessing a company's real economic and financial situation There are many external stakeholders who require an overview of a company’s financial health in order to evaluate its level of debt, shareholders’ equity or cash flow. For internal stakeholders, it is a useful decision-making and management tool rather than solely a scoring system: Intemal analysts are clearly in a more favourable position as they have easier access to the detailed information they need to analyse the company’s overall performance The principles of financial analysis are valid for all companies. Although large companies and SMEs have litle in common, they remain exposed to same types of risk e.g. cash flow problems that prevent them from meeting their payment deadlines. The financial analysis process is broken down into five logical stages + Define the objective + Analyse the market + Characterise the company structure + Study the ratios + Calculate or construct the evaluationAlways start by defining the objective of the analysis. This objective will be different if the analysis is carried out by or on behalf of a banker, a shareholder or a supplier. This objective will enable you to determine which ratios to calculate and will avoid unnecessary extra analysis The market analysis provides a general overview which will enable you to evaluate the data from the company analysis more effectively. For this, you should consider the three main factors relating to a company's structure. Governance By analysing the company's memorandum and articles of association, you can ascertain how its capital and voting rights are distributed, the composition of its board of directors and how much its directors are paid (variable portion...) By studying annual reports, you can identify whether the company's accounting principles have changed, whether the auditor changes often and if the company has a dividend payment policy For public limited companies, you will find: + Key figures + Information about company governance + Anactivity report + Accompany and environmental data report + Arisk and risk management report + A financial report + Additional information (company history, financial environment, regulatory environment, etc) Financial policy This involves assessing the degree of transparency and level of liquidity. A company's liquidity is at risk if it does not have the necessary cash flow to meet its financial obligations. This risk can be caused by: + Poor management or an unexpected event (market collapse, crisis, etc) + An obligation to repay debts This information can be made more accessible by creating a financial report from the main balance sheet Accounting structure For groups, this relates to the scope of consolidation (companies within the group). It is important to ascertain the accounting method used (IFRS or other). This analysis involves assessing the effective size of the group. By analysing its accounting rules, you can gain a better understanding of how its figures are calculated and presented. In order to assess the company’s degree of transparency and level of liquidity, you need to calculate the grand totals on the balance sheet: Working Capital (WC), WorkingCapital Requirement (WGR) and cash tlow. Financial analysis is a technique for assessing a company or group's real economic and financial situation using its accounting documentation and other sources of financial information (annual reports, financial communication documents, etc). Groups who are subject to IFRS standards must publish sectoral information that provides a breakdown of key data (turnover, current operating income, assets, etc) each activity sector and geographical area. A ratio can never be analysed in isolation. It must be assessed within its environment. Market analysis can be carried out using popular strategic analysis tools such as the Porter matrix, the SWOT analysis, etc. @ Financial analysis ratios Just as there is only one business plan for all internal and external uses, so financial analysis is a common approach shared by all analysts, both internal and external. The balance sheet and income statement are the basic tools of financial analysis. Ratios act as the dynamic link between these two tools. The benefit of ratios is that they represent a summary of a company's performance and its risks. These criteria must be followed: + Assessed over a minimum period of three years + Compared with the ratios of competitors in the same sector + Enable you to monitor changes in the relative value of a key element @.g. turnover, workforce, etc) There are certain elements that may disrupt your analysis: + The historical value of the different elements of the balance sheet + The way in which the accounts are presented (window dressing): an income statement presented by destination gives no direct information about the elements by type + Group affiliation: within a group, there may be internal transfer costs that make it difficult to assess a company's profitability + Changes in accounting methods: check the appendices to see if there have been any changes The analysis of these ratios represents the factual and objective basis upon which bankers, creditors and other company finance providers assess their customer's health and ability to generate sufficient revenue to be viable in the long term Pre-tax inventory and customer credit are compared with pre-tax tumover. Supplier credit is compared with raw material and other merchandise purchases. When multiplied by 360, they provide an indication of changes in inventory rotation, the average recovery period of customer receivables and the average payment period for thecompany s suppiers. All these ratios must be compared with the ratios of other companies in the same sector. © Additional sources of information for financial markets In addition to accounting documents, the balance sheet and the income statement, analysts can also use two other types of information source: 1. Banks information + The scoring elements provided by analysts on a given day + The directors’ scoring + The central payment file + Credit insurance companies + The bank's internal customer account monitoring and surveillance system: the anomaly control system. This is a set of warning signs designed to detect problems with accounts which quickly identifies anomalies and takes suitable action The central risk management department and the bank information system provides information divided into different modules: + Administrative and legal data + Information about activity volume and bank debt levels + Payment incidents + Company assessments + Financial data: balance sheet summary, structural ratios and profitability ratios One of the links between a bank and a company is the credit that it grants. In order to make a decision about credit, a bank will carry out an analysis of the company's strengths, weaknesses, opportunities and threats. Itis in your interest to know the level of power delegated to your point of contact at your bank. This will determine how quickly you are able to obtain credit. Credit allocations are delegated personally to each branch director according to: + His risk analysis qualities + His ability to implement a risk monitoring system + His experience of the business The banker follows all account activity on a daily basis. It would be both time-consuming and unnecessary to recalculate the ratios every day. Each bank can use the central bank's database to check that its customers’ payments and commitments are consistent.Sectoral information is provided by two types of reporting segment: primary and secondary. This generally involves giving information for each activity sector (product lines or strategic segments) and by geographical area. Most groups that are subject to IFRS standards operate across different sectors and in different geographical areas. Consolidated accounts alone do not provide enough information to ascertain a group’s activity in detail and evaluate its performance. ‘Some international groups (food, distribution, etc.) have chosen to use geographical area as primary reporting segments and product families as secondary segments. The information required for the primary reporting segment: + The group's internal and external turnover. The group's intemal turnover must be calculated on the basis of transfer prices, + Operating income (EBIT) + Sectoral assets and liabilities: these are the operational assets and liabilities that can be directly attributed to a sector, i.e. tangible assets, intangible assets, WCR and provisions for risks and costs + Investments and tangible and intangible assets + Depreciation expenses and provisions The information required for secondary reporting segments: + External turnover per customer location zone, for which the turnover is greater than 10% of total consolidated turnover + The accounting value of assets for each asset location zone, for zones in which the assets are greater than 10% of total assets + The total of all investments in tangible and intangible assets for each asset location zone What does it tell you? + Changes in turnover + Invested capital + Economic profitability However, financial profitability can only be calculated on a global level because the sectoral information does not provide any indication of how the activity sectors are financed. It enables you to analyse the following in greater depth: + Activity + The profitability of capital employed + Past performanceIt also enables you to identify: + The aotivity sectors and geographical areas that have generated the group's, growth and profitability + The sectors on which the group has focused its investment + Finally, it enables you to measure the invested capital and its profitability By combining ratio analysis with other sources of information, you can gain a complete picture of a company’s profile, including its risks, and obtain more detail about the company's overall performance. Combining traditional sources of information with sectoral information will be of great use in this context. Here are some of the warning signs that banks view as risks: + Accounts constantly overdrawn for several months + Anunsettled guarantee + A poor scoring with the central bank The financial analysis and overall analysis form the main body of the summary file that a bank holds about a company. Not all companies are obliged to publish sectoral information. However, it is recommended and may become compulsory in the near future. @ Scoring and rating: the external view of banks and financial markets Based on all the data that a banker has at his disposal, he calculates a scoring for companies and directors. Scoring/rating is a tool used by financial institutions to assess whether a company or individual is eligible for finance: + Company activity + Financial structure and profitability + Payment consistency These figures are based on the company’s financial documents and require an analysis of the balance sheet and the income statement (P&L). The balance sheet provides information about the company’s financial structure and enables the analyst to calculate the payment score. The P&L (profitability) provides the information required for the credit score. The elements these scores are based on: 1. The central risk management department Each month, all credit organisations must declare any credit granted above a certain threshold to the central bank's risk management department. In addition to declared bank loans, details are also held of late payments to social welfare bodies.The total of all credit is communicated to banks for each company for which they have made a declaration This information does not include the banks that have granted the credit, but does provide details of the score allocated to each company by the central bank, based on certain criteria: + Tumover volume + Payment consistency + The company’s financial structure and income Consequences: This is a key source of information for your banker who has access to detailed information about all your company's debts and can cross-check bank loans obtained from other financial institutions. 2. The central payment file All credit establishments must declare the commercial bills relating to any overdue debts to the central payment file, including the following information: + The name the withdrawing party (defaulting company) + The rejection reason (lack of funds, legal decision, etc) Once a month, a list of payment incidents is sent to the credit establishments making the declarations. These establishments may obtain a report containing the commercial bills listed in the name of a given company. Your banker can quickly find out about any payment incidents, enabling him to get a better picture of his customer's financial situation. It is important to note that companies do not have access to this source of information. Financial information is increasingly being used to establish company scores. A company’s financial communication policy is therefore of strategic importance. Reliability and transparency must lie at the heart of your communication strategy. The trust of your employees and external financial partners depends upon you adhering to these two good practices. A company's scoring comprises the three elements: + An activity score: a letter of the alphabet that indicates the turnover sector in which the company falls + Acredit score: a number that indicates the company's financial structure and profitability + Apayment score: a number that indicates the company's payment Publish information in good time to convey an image of reliability, rigour and organisation This is also important for your staff, enabling them to focus on the new year. Your banker has reliable, up-to-date information about your company’s financial situation: be as transparent as possible to avoid damaging his trust in you ConclusionIn an increasingly complex, global and financial environment, this ‘universal’ knowledge of financial analysis will enable you to strengthen: + Your dialogue + Your contribution to your company's strategy