Units 5 & 6. Annual reports.

Interpretation and analysis

1
 Units 5 & 6. Economic and financial
analysis of annual reports.

Index:

1. Economic and financial analysis

2. Analysis methods
3. Balance sheet analysis
4. Profit and loss account analysis
5. Profitability analysis
2
OBJECTIVES

• Analyze the economic-financial situation of a

company based on the information provided in
the balance sheet and the profit and loss account
in order to be able to make the appropriate
decisions.

3
 1. Economic and financial analysis

Concept:
- It is carried out through accounting information.
- It is used to diagnose the situation and perspectives of the
company
- It complements organizational, marketing, and commercial,
industrial and technological and human analyses.
- It focuses on the equilibrium conditions of the company’s assets,
liabilities and equity structures, and of its financial flows.
- It provides the concepts and techniques necessary to formulate
consistent judgments about the company from a double
perspective:
-internal: analysis of weaknesses and strengths. 4

-External: interested in the company’s situation and evolution.

 1. Economic and financial analysis
Utility of the economic and financial analysis
Through the diagnosis of the balance sheet and the profit and loss
account  Detect problems and fix them on time ensure the
company’s viability

Example of problems that come to light with this analysis… the company has:

 Insufficient financial structure Insufficient capital Excessive debt few benefits

 owners should provide more capital

 Very unbalanced balance sheet due to excess in short-term debt it has to be solved
because it can end in bankruptcy

 Insufficient profitability produced by

Low sales
Low sale prices  If not solved, there will be losses
Excessive expenses
 1. Economic and financial analysis

Features of a succesful analysis:

 It is performed with reliable, complete information and all

relevant data

 It is performed in time for decision making

 It obtains the right conclusions that allow the right decisions to

be taken.

13
 1. Economic and financial analysis
The focus of the analysis varies according to
• the analyst’s interest :
•Economic structure analysis
•Financial structure analysis
• and the users of the information:

• Managers: more information and higher frequency. Aim: keep

control over the company’s performance.
• Owners: valuation of their securities.
• Creditors: company’s liquidity, capacity to generate earnings
and cash.
• Auditors: ensure the reliability of accounting information.
7

•Others: investment analysts, fiscal management, trade unions…

 1. Economic and financial analysis

Financial structure:
- sources of funding for the company to achieve the stated goals
- use of different sources of funding in a given time.

Economic structure
- investment made by the company to carry out its operating
activities:
a) Permanent capital
- investments on fixed assets than are intended to be made,
- depending on the productive sector, size, intensification of
the use of machinery…
b) Minimum (stable) level of circulating elements
- Resources invested in raw materials, products… 8
 1. Economic and financial analysis

This analysis permits to:

- identify successe and failures that policies developed by the
company have originated and
- take appropriate actions to improve future performances.
Limitations to the analysis:
• Based on historical data: lack of perspective.
• Referred to the close of the fiscal year.
• Possible manipulations of accounting data in the company
• Financial information does not include the effects of inflation.
• Difficulty in obtaining sectoral data: comparability.
 2. Analysis methods
A) Comparison between patrimonial masses
It can be expressed in absolute terms or relative ones (horizontal
analysis).
Comparison and analysis of the temporal evolution of the
patrimonial masses or items of income, expenses, profits, taking the
first year under reference.

B) Method of the vertical percentages (vertical analysis):

Percentage for each asset or concept of the balance sheet or profit
or loss account in relation to a given magnitude (total asset, total
turnover).

C) Method of the ratios:

Relationship between items of the financial statements
 2. Analysis methods

Analysis methods:
A) Static/dynamic
• Static: analysis of the situation of the company at a particular
time.
• Dynamic: analysis of the situation of the company over time,
comparing the situation in different periods.
B) Intracompany/Intercompanies
• Intracompany: comparison to the past situations or even
forecast of the company. The analysis can be performed as time
series and appreciate the evoluction of the company. Or
compare with what was forecasted and identified possible
causes of deviations.
• Intercompanies: the comparison is made with companies of
the same sector or their average value.
 3. Balance sheet analysis

3.1. Objectives
It is a first step in the analysis of financial statements and permits to
evaluate:

• Liquidity and solvency.

• Debt.
• Financial independence.
• Guarantee against third parties.
• Capitalization.
• Asset management.
• Financial balance. 12
 3. Balance sheet analysis
3.1. Objectives of the analysis
Aspects to take into account before analysis:
• Reliability of the data.
• Valuation standards used
• Composition and quality of the assets and liabilities.
• Effect of inflation
• Accounting criteria of the company's country
• Company groups
• Average values
• Interim financial statements
• Industry differences
• Company size
13

• Geographic area
 3. Balance sheet analysis
3.2 Definitions
Preliminary considerations about assets:
• Non-current assets (Activos no corrientes, ANC). Those goods that remain in the
company over an operating cycle, intended for the activity of the company; they are
amortized over the life of the asset.
• Current assets (Activo corriente, AC). Those assets and rights that remain in the
company not more than one year (operating cycle).
• Inventory (Existencias, E): Assets to be sold in normal operating cycle (eg
goods, finished products) in production or in the form of materials or
supplies to be consumed in the production process or services (eg raw
materials).
• Trade receivables (Realizable, R). Assets of a company which may be liquid
in the short term. Most commonly, this term refers to those debts from
customer and debtors of the company.
• Cash (Disponible, D). Liquid components of a business asset. Equals to cash
and other liquid assets equivalents.
•Total Assets (Activo total, AT) = Non-current assets (NCA) + Current Assets (CA)
 3. Balance sheet analysis
3.2 Definitions
Preliminary considerations about liabilities:
• Non-current liabilities (Pasivo no Corriente): Obligations of long term
maturity
• Current liabilities (Pasivo Corriente): Obligations of short term
maturity.

• Total liabilities (Pasivo total): Non-current liabilities + Current

liabilities.

Permanent resources of the company= Non-current liabilities + Equity

Equity
Permanent resources
Assets Non current liabilities
Total liabilities
Current liabilities
 3. Balance sheet analysis
3.3. Horizontal analysis
Permits to check for the same company, the evolution of different
economic groups over time.
Comparison in relative and absolute terms.

Non-current Equity
Non-current assets Equity
assets
Inventories
Inventories Non-Current
Non-Current Liabilities
Current Trade Trade Liabilities
assets receivables receivables
+ + Current
Current
Cash Cash Liabilities
Liabilities
ASSETS ASSETS E+L E+L
31/12/N-1 31/12/N 31/12/N-1 31/12/N
 3. Balance sheet analysis

3.4. Working capital

Known in Spanish as Fondo de maniobra, Capital Circulante,

Capital de Trabajo o Fondo Neto de Rotación.

W. C.= CURRENT ASSETS – CURRENT LIABILITIES=

= Permanent Resources – Non Current Assets

It represents:
• Capacity of the company to cope with their immediate debts (short
term debts) with the liquidity of its current assets.
• Part of current assets that is being financed with permanent
resources (equity+ long term liabilities). 17
 3. Balance sheet analysis

3.4. Working capital

Non Current Equity

Assets
Permanent
resources
Non-Current
Working
Current Liabilities capital
Assets

Current
Liabilities 18
 3. Balance sheet analysis
3.4. Working capital
Hypothesis of the financial balance:
Permanent resources of the company should sufficient to cover
the financing of non current assets and a reasonable part of
current assets:
WORKING CAPITAL > 0
The company in this case, has sufficient current assets to meet its
short-term debt (current liabilities).

While if:
FM < 0  economic-financial imbalance
 Has a short-term due higher than current assets  it might not be 19

able to meet the coming payments.

 3. Balance sheet analysis
3.5. Vertical analysis and balance graph
Vertical analysis:
• Consists in calculating the percentage for each group in relation
to the total assets or total liabilities.
• Allows greater relativity and objectivity in the analysis
• Analises the capital structure of the company and its evolution.

Balance graph:

• It is made from the calculated percentages

• Allows a better view of the problems.
• Allows analysis of the degree of equilibrium in which the
company is located at a given time.
 3. Balance sheet analysis

3.5. Vertical analysis and balance graph

The graph of the balance sheet allows to analyze the economic
and financial equilibrium of the company.
Situations:
• Maximum stability: assets are financed by equity

Non Current Equity

Assets

Current
Assets
21
 3. Balance sheet analysis

3.5. Vertical analysis and balance graph

• Equilibrium: Equity + Non current liabilities amount enough to
finance non current assets and also a part of current assets

Non- Equity
Current Permanent
Resources
Assets

Non Current Working

Current Liabilities capital
Assets
Current
Liabilities WORKING CAPITAL> 0
 3. Balance sheet analysis

3.5. Vertical analysis and balance graph

• Inestabilidad: Permanent resources are not enough to finance
non current assets.

Non- Equity
Current Permanent
Resources
Assets Non Current
ANC
Liabilities

Current Current WORKING CAPITAL< 0

Assets Liabilities
AC
23
 3. Balance sheet analysis
3.6. Analysis using percentages (Amat, 2008)
1. Current assets (CA) should be higher, and if possible twice
the current liabilities (short-term obligations), in order to
avoid liquidity problems in the company. It is advisable
therefore that:
CA ≈ 1,5 – 2 CL

a) If CA < CL → Caution→ Liquidity problems, the company won’t be able to

afford in the short term its debts becauseit has insufficient resources.

b) If CA >>> CL → Attention → Underutilization of the CA→ If instead , CA

are much higher than CL, it is possible that circulating resources might be
being underutilized and a low return is obtained thereof.

c) If CA <<< CL → Caution→ Important liquidity problems→ In this case 24

the Working Capital of the company is negative, so it is entering into what is
known as technical insolvency.
 3. Balance sheet analysis
3.6. Analysis using percentages (Amat, 2008)

2. Trade receivables (realizable, R) plus cash (disponible, D)

should be close to current liabilities. R+D ≈ CL

R+D ≈ CL → Correct.

Caution → There might be problems to meet

payments as, though the company higher CA to CL,
R+D < CL → this would be materialised in the form of stocks so it
may not have cash to meet payments in the short
term.

R+D > CL → Attention. Eventual under-investment in R and D

 3. Balance sheet analysis

Non Equity Non Equity

Current Current
Assets Assets

Non-Current Non-Current
Liabilities Inventories Liabilities
Current
T. Receivabl
Assets Current Current
Liabilities Cash Liabilities

Trade receivables +
CA ≈ 1,5 - 2 CL
Cash ≈ CL 26
 3. Balance sheet analysis
3.6. Analysis using percentages (Amat, 2008)

3. Equity (E) should represent 40-50% of equity plus total

liabilities (TL). E ≈ 40-50% o/E+TL

Decapitalization of the company (excessive

E< 40-50% o/E+TL Caution
debt)

It could be that the company had an excess of

own funds, and probably an excessive capital.
The company could have achieved similar
E > 40-50% o/E+TL Attention
business objectives asking their partners to hold
less capital (we should also see what return are
they getting) and a higher debt.
 Non Equity
Current
Assets

Non-Current
Inventories Liabilities

T. Receivabl
Current
Cash Liabilities

E≈ 40-50% E+L

28
 Non Equity
Current Ideal balance for an
Assets industrial company

Inventories
Non Current
Liabilities
Trade
receivables Current
Cash Liabilities

• High level of investment in non current assets

• Current Assests almost doubles Current Liabilities
• Trade receivables + Cash ≈ Current Liabilities
29

• E ≈ 40% - 50% Total liabilities

 Non Current Equity
Assets
Inventories
Ideal balance for a
commercial company
Trade
Receivables
Current
Cash Liabilities

• Non current Assets of less importance

• Non Current Liabilities not important
• Current Assets almost doubles Current Liabilities
• Trade receivables + Cash ≈ Current Liabilities 30

• E ≈ 40% - 50% Total liabilities

 3. Balance sheet analysis
3.7. Analysis through ratios
RATIO:
- It is the quotient between magnitudes that have some relationship
and for that reason are compared.
- Its value is considered more significant than that of each of them
individually or provides information complementary to that of
previous.

Its effectiveness lies in the possibility of comparison with others that

may be:

• company’s own historical register.

• similar companies: sector data.
• from competitors.
• budgeted ratio: subjective information and of an internal nature. 31
 3. Balance sheet analysis
3.7. Analysis through ratios

a) Solvency:
Indicates the capacity of the company to face its debts. The
higher the ratio, the stronger the financial position of the
company, it is more solvent.
𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠
𝑆𝑜𝑙𝑣𝑒𝑛𝑐𝑦 =
𝑇𝑜𝑡𝑎𝑙 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
A ratio below 1 forecasts a default situation: even selling godos
and rights of the company they cannot face the debts.

This ratio should be around 1.5

 3. Balance sheet analysis
3.7. Analysis through ratios
b) Liquidity:
Evaluate the capacity of the company to meet its current liabilities
with its most liquid assets.
CurrentAssets Advisable for current assets is 1.5
LiquidityRatio(Current _ ratio)  to 2 times current liabilities,
CurrentLiabilities therefore Liquidity ratio = 1.5 to 2

𝑇𝑟𝑎𝑑𝑒 𝑟𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠 + 𝐶𝑎𝑠ℎ Advisable for trade receivables plus cash is

𝐴𝑐𝑖𝑑 𝑡𝑒𝑠𝑡 𝑟𝑎𝑡𝑖𝑜 = equal to current liabilities, acid test therefore
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
=1
𝐶𝑎𝑠ℎ Advisable = 0.3
𝐶𝑎𝑠ℎ 𝑟𝑎𝑡𝑖𝑜 =
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠

Allow to diagnose a situation of technical or theorical insolvency

(bankruptcy in which the company can not pay all the debts to its creditors due to lack of
liquidity)
 3. Balance sheet analysis
3.7. Analysis through ratios
c) Debt
Analyze the company’s financial structure (amount and type of debt)
and evaluate the impact of the financial burden on the outcome.
.
TotalLiabilities Analysis of the
DebtRatio 
TotalAssets amount of debt

In order to avoid an excessive debt situation, it is advisable that debt s do

not exceed 50-60% of E+TL, so Debt ratio = 0,5-0,6

Financial Expenses Debt cost analysis

Cost of debt 
Total Liabilities
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 *The cost of debt must be less than the
𝑄𝑢𝑎𝑙𝑖𝑡𝑦 𝑜𝑓 𝑡ℎ𝑒 𝑑𝑒𝑏𝑡 =
𝑇𝑜𝑡𝑎𝑙 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 return on assets: Positive financial
leverage
 3. Balance sheet analysis
3.7. Analysis through ratios
d) Asset turnover:
Study the performance achieved from the assets, taking as reference
turnover.
Sales
Asset turnover 
Total assets

Sales
Non current assets turnover 
Non current assets
Sales
Current assets turnover 
Current assets
Asset turnover ratios:
- evaluate their ease to become liquid
- measure their ability to generate income (earnings)
- assess the efficiency and profitability
Their value must be the greatest possible
 3. Balance sheet analysis
3.7. Analysis through ratios

e) Collections and payments:

They allow to check the evolution of the collection policy in the company
and thethe payments to suppliers..
𝐶𝑙𝑖𝑒𝑛𝑡𝑠
𝐶𝑜𝑙𝑙𝑒𝑐𝑡𝑖𝑜𝑛 𝑝𝑜𝑙𝑖𝑐𝑦 =
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑑𝑎𝑖𝑙𝑦 𝑠𝑎𝑙𝑒𝑠

𝑆𝑢𝑝𝑝𝑙𝑖𝑒𝑟𝑠
𝑃𝑎𝑦𝑚𝑒𝑛𝑡 𝑝𝑜𝑙𝑖𝑐𝑦 =
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑑𝑎𝑖𝑙𝑦 𝑝𝑢𝑟𝑐ℎ𝑎𝑠𝑒
- We must homogenize the numerator and denominate in terms of VAT.
- The higher the value of the payment term ratio, the longer it takes us to
collect from our customers and the worse it is for the company.
- The lower the value of the payment term ratio, the sooner we are paying
our suppliers and the less they are financing us.
 3. Balance sheet analysis
3.8. Statement of Source and Application of Funds:
EOAF:

It is a useful instrument because it shows the variations that have

occurred in the balance sheet during a certain period of time. It serves
to see what the company has invested in and how it has financed it.

The EOAF makes it possible to determine:

- What investments have been made.
- What financing has been used.
- How the financing is distributed among shareholders, retained
earnings and debt.
- What part of the financing is short term and long term.
- Is there a balance between the investments made and the
financing used?
37
 3. Balance sheet analysis

3.8. Statement of Source and Application of Funds

Balances of two different financial years:
We start from the balance sheet of two
consecutive years, once the results have
been distributed.

Variations (increases and decreases) are

calculated. Changes in assets must always
be equal to changes in liabilities and
equity..
38

=
* Análisis de estados financieros, Oriol Amat 2008
 3. Balance sheet analysis

3.8. Statement of Source and Application of Funds

Increases and reductions

What is considered as
application and what as a
source?

In the example it would be:

The company has invested
mainly in non-current assets
and has basically financed them
with current liabilities. In
general, it would be optimal to
finance it with permanent 39
resources.

* Análisis de estados financieros, Oriol Amat 2008

 4. Income statement

4.1. Objectives
Income statement objectives:

- Determine how the company generates results and how they can improve.
- Historical accounts and previsional ones can be used.
The analysis of the ordinary results allows to evaluate:
- Evolution of the turnover
- Gross margin evolution.
- Evolution of the structure costs and financing ones.
- Calculation of accurate sales to cover expenses and check the viability
of the company (breakeven point)
- When analyzing previsional profit and loss accounts, it is possible to
40

optimize the evolution of future results.

 4. Income statement
4.2. Analytical income statement
Net sales
- Proportional manufacturing costs
- Proportional marketing costs
= Gross margin
- Structural costs (external services, taxes, other expenses…)
+ other income (including financial ones; rent, commissions, cantinas, transport….)
- Personnel costs
= EBITDA
- Amortization
- Impairment
Resuls from
operating
= EBIT (Earning Before Interest and Taxes) activities
- Financial expenses

+/- Other financial

= PBT Profit Before Taxes
- Taxes
Profit from continuing operations 41
Result from discontinued operations
= Net profit
 4. Income statement

4.2. La cuenta de pérdidas y ganancias analítica

Margen bruto:
Es la diferencia entre los ingresos por ventas y el consumo de
mercaderías y materias primas, teniendo en cuenta la variación de
existencias.
EBITDA:
Si al margen bruto se le descuentan los gastos necesarios para la
explotación, se obtiene el EBITDA. Es una referencia que puede ser útil
para valorar la gestión de una sección o departamento de la empresa,
puesto que no tiene en cuenta el coste de la financiación (intereses) ni
la infraestructura (amortizaciones).
BAIT:
Es el resultado habiendo incluido los gastos de explotación y las
amortizaciones.
BAT:
42
Es el resultado del ejercicio antes del pago del impuesto de sociedades
o de beneficios.
 4. Income statement

4.3. Vertical analysis of the income statement

In the vertical analysis, the items of the P&L account are
expressed in relation to another magnitude, normally the Net
Turnover, although it can also be the result for the year. In this
way it is possible to check the weight of each one of them.
calcularía de forma análoga. No se muestran aquí para
Extracto de una cuenta de resultados donde figura el

1. Set revenue as
análisis vertical, en el resto de filas de la cuenta se

100%

2. Calculate of
mejorar la visualización de los datos.

values according
to revenue
4,705/45,286

43
 4. Income statement

4.4. Horizontal analysis for the income statement

The horizontal analysis compares the values of the items of the
P&L account in relation to those of the previous year. It serves to
determine the evolution and to be able to identify the causes of
variations.
CUENTA DE PÉRDIDAS Y GANANCIAS
2.014 2.013 Tasa var
Importe neto de la cifra de negocios ( Nota 23 ) 1.337.280 870.459 53,6% 1. The result for the year has
Variación de existencias de productos terminados y en curso de fabricación
increased with respect to the
Trabajos realizados por la empresa para su activo 742.783 638.389 16,4%
previous year.
Aprovisionamientos ( Nota 23 ) -219.496 -188.545 16,4%
Otros ingresos de explotación (Nota 16 ) 59.035 60.740 -2,8%
2. Despite the increase in sales
Gastos de personal (Nota 23 ) -703.477 -587.672 19,7%
(INCN), operating income has
Otros gastos de explotación -758.017 -236.247 220,9%
decreased due to increases in
Amortización del inmovilizado (Notas 6 y 7 ) -535.429 -502.887 6,5%
Imputación de subvenciones de inmovilizado no financiero y otras Nota 16 105.457 178.993 -41,1%
personnel and other operating
Otros resultados 1.628 -14.608 -111,1% expenses.
Resultado de explotación 29.764 218.623 -86,4%
Ingresos financieros 44.644 96.783 -53,9%
3. The financial result has
Gastos financieros -237.932 -159.729 49,0%
improved significantly, allowing
Variación del valor razonable en instrumentos financieros
Diferencias de cambio -676 -33 1948,5%
the company to have a net profit
Deterioro y resultado por enajenaciones de instrumentos financieros 620117
in this fiscal year higher than in
Resultado financiero 426.153 -62.979 -776,7% the previous year, despite the
decrease in the operating result. 44
Resultado antes de impuestos 455.917 155.643 192,9%
Impuesto sobre beneficios (Nota 20) 437.152 317.414 37,7%
Resultado del ejercicio 893.068 473.058 88,8%
 4. Income statement
4.2. Analysis through ratios

Sales and their evolution are a key variable for economic diagnosis
of a company.

Sales year N
Sales exp ansion 
Sales year ( N  1)

- The effect of inflation should be considered in the sector (since much

of the increase in sales is due to the effect of inflation)
- Calculation by products, markets or market segments.
 5. Profitability analysis
5.1. Economic profitability

Economic profitability= Economic performance=ROI

Allows to know the evolution and factors affecting the productivity of
assets.
EBIT
Wealth generated by the
Economic profitability 
investment
Total Assets

- EBIT is used to evaluate the profit generated by assets regardless of how it is

financed. (financial expenses are not taken into account)
- Also called: ROI (Return on Investments), ROA (Return on Assets).
- Higher value  more productivity of assets.

- Return on Assets > Average cost of liabilities (financing: debt interest +

shareholders’ dividends)  the profit of the company is sufficient to cover
the cost of financing.
 5. Profitability analysis
5.1. Economic profitability: ROI or ROA

Allows to know the evolution and factors affecting the productivity of

assets.
EBIT
ROA 
Total Assets

EBIT is taken to evaluate the profit generated by assets regardless of

how it is financed. It is the Result from operating activities

ROI (Return on Investments), ROA (Return on Assets).

Higher value  more productivity of assets.

Return on Assets> Average cost of liabilities (financing: debt interest +

shareholders’ dividends)  the profit of the company is sufficient to
cover the cost of financing.
 5. Profitability analysis
5.1. Economic profitability

Breakdown of the ratio in order to optimize two components:

Sales EBIT
Return  
Total assets Sales

Nº of times that sales reach asset

Asset Gross
value turnover margin Wealth generated by each um
sold

Sources of profitability are:

-Margin applied by monetary unit sold
- volume of sales per monetary unit involved in the production
process

To increase the return:

- Increase gross margin  rise sale price, reduce costs
- Increase turnover  more sales, reduce assets.
 5. Profitability analysis
5.2. Financial profitability= ROE

ROE (Return on equity) profitability of the owned capital.

It measures the net profit generated by the company in relation to

investment of owners.

Net Income
ROE 
Shareholder ' s Equity

It should be at least positive and equal (or exceedind) the

expectations of shareholders (opportunity cost).
 5. Profitability analysis

5.2. Financial profitability

Breakdown of financial profitability:

Revenue EBIT Assets Profit before taxes Profit

Profitability     
Assets Revenue Equity EBIT Profit before taxes

Assets Gross margin Financial Fiscal effect

turnover Leverage

The financial leverage relates debt to the financial expenses it causes.

The product of both ratios must be >1.
The fiscal effect measures the impact that has the tax benefit in the
financial profitability.
 5. Profitability analysis
6.2. Financial profitability

Financial leverage:
-It is to use debt to finance an operation provided that the investment
generates greater benefits than the financial cost (interest)

Assets Profit before taxes

Leverage  
Equity EBIT

If the product of the two ratios is >1 debt increases profitability

If the product of the two ratios is <1 debt reduces profitability
If the product of the two ratios is =1 debt doesn’t affect to profitability
Positive leverage: if the performance of the assets in which the company invests is higher than the cost of
the needed funds for the investment  helps to increase the profitability of the equity.
Eg.: a company applies for a bank loan at a rate of 8%, and invests those funds in a project that offers a
return of 10%.

Negative leverage: if the performance of the assets in which the company invests is lower than the cost of
the needed funds for the investment  reduces the profits of the company, has no sense to invest
Eg.: a company applies for a bank loan at a rate of 8%, and invests those funds in a project that offers a
return of 5%.
 5. Profitability analysis

5.2. Self-financing
Self-financing capacity:

- Resources invested in the company by the company itself.

𝐶𝑎𝑝𝑎𝑐𝑖𝑑𝑎𝑑 𝑑𝑒 𝑎𝑢𝑡𝑜𝑓𝑖𝑛𝑎𝑛𝑐𝑖𝑎𝑐𝑖ó𝑛 =
𝐹𝑙𝑢𝑗𝑜 𝑑𝑒 𝐶𝑎𝑗𝑎 𝐵º𝑁𝑒𝑡𝑜 + 𝐴𝑚𝑜𝑟𝑡𝑖𝑧𝑎𝑐𝑖𝑜𝑛𝑒𝑠 − 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑜𝑠

- The greater the self-financing, the greater the financial

independence vis-à-vis third parties.

- The higher the self-financing, the lower the profitability for

shareholders in the short term and the more likely it is to
be opposed by them.