Company Investment

Analysis
Dr. GINE DAS PPRENA,SE,MSI,AK,CA,CMA,CPA,CSRA,CAPM,CFMA,CERA
 Analysis of Economic and Financial Dynamics
The analytical schemes showed in the previous chapter focus on the definition of the Operating and Net Income,
Capital Invested and Capital Structure, and Free Cash-flow from Operations and Free Cash-flow to Equity.

The analysis can start from each of them. In this context, it may be useful to start the analysis from the sources of
capital and their investment in company’s activities and to measure their returns in terms of earnings and dividends.

Equity and debt are the two sources of capital to finance company activities. Equity refers to the shareholders
source of capital. It can be increased through new capital or self-financing.

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 Analysis of Economic and Financial Dynamics
Equity must be repaid by dividends. Therefore, the equity remuneration is residual because it is achieved after the repayment
of all production factors only in the case of specific conditions.

Debt in capital structure refers to the financial debt only. Usually, more specifically it refers to the Net Financial Position (NFP)
that it is equal to the difference between financial debts (both long and short) and liquidity (equal to the sum between financial
credits, marketable securities and cash.

Financial debt generates financial costs mainly in terms of interest on debt. It represents the debt holders’ remuneration and
then the cost of debt. It is located between EBIT and EBT by reducing it. It also generates a cash-out with negative effects
on the Free Cash-flow to Equity (FCFE)

The sum between equity and financial debt defines the Capital Structure of the company. Capital sources are invested in
assets, both operating and non-operating, Net Working Capital and Liquidity in order to achieve company activities.

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 Investments in Operating Assets
Investments in Operating Capital Expenditure (Capex) refer to investments
in operating assets strictly such as operating tangible, intangible, financial
assets, and inventory stable over time.

The main aim of these investments is to increase the EBITDA over

time. It can be achieved by increasing operating revenues (through
the increase of production capacity) and by decreasing operating
costs (through the increase of technology efficiency) over time

Investments in Net Working Capital (NWC) refer to the

investments in operating receivables and payables and inventory.
The operating receivables and payables refer to the operating
revenues and costs that they do not generate cash-in and cash-out
yet. The inventory refers to the products created but not yet sold.

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Investments in Non-operating Assets

They refer to the investments in Surplus Assets. It is possible to distinguish between investments in tangible,
intangible and financial Surplus Assets, and investments in non-operating and non-current operating receivables
and payables.

The investments in Surplus Assets are not considered in Net Operating Capital Invested (NOCI). Therefore,
they increase the amount of Capital Invested (CI) only

Investments in tangible and intangible and financial Surplus Assets refer to the investments in non-core
business activities. The amortization and depreciation of intangible and tangible Surplus Asset are located
between EBT-Operating and EBT. The main reasoning for this positioning is not to damage the EBIT. In
this way, the EBIT can be considered strictly operating. Investments in tangible and intangible Surplus
Assets can affect the non-operating revenues and costs that they affect the EBT.

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 Investment in Liquidity

Specific reasoning must be reserved to investments in Liquidity. It refers to the amount of cash, cash equivalent, financial credits
and marketable securities that a company decides to maintain in the company. Therefore, it is not a capital source but capital
invested because it is an investment decision. Indeed, liquidity is positioned in the Net Financial Position by reducing its value

It is necessary to distinguish between: (i) the temporary movements of Liquidity, that they are due to the effect of cash-in and
cash-out used to balance the movements of other items; (ii) the investment in Liquidity that defines the level of liquidity that
company wants to maintain over time. Only the second type can be considered as a proper investment.

Liquidity can generate operating and non-operating financial revenues with positive effects on EBT and Free Cash-flow to
Equity (FCFE)

In cash-flow terms, it can be considered as a cash-out. Therefore, the increase in Liquidity reduces the Free Cash-flow to
Equity (FCFE)

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Provisions

Finally, it is necessary to consider Provisions for risk and

charges, taxes and employees. They reduce the Capital Invested
(CI). Accruals for provisions (employees, taxes, risk and
charges) are located in the operating costs (non-cash).
Therefore, they have direct effects on EBIT. In cash-flow terms,
they only have effects if they are really used with consequent
cash-out by reducing the Free Cash-flow from Operations
(FCFO).
Financial Ratios Analysis
An analysis of the relationships between Operating Revenues, Capital Invested and Structure, and Free Cash-
flows from Operations and Free Cash-flow to Equity, it can be achieved on the basis of several main ratios:

Capex on Operating Revenues (COR):

COR = Capex / Operating Revenues (OR)

*The COR ratio measures the return of capital invested in Capex on the basis of Operating Revenues. Specifically a low
value of ratio means a high return of capital invested in Capex in terms of Operating Revenues. In this case, the investments
in Capex are able to push-up the Operating Revenues.

*On the contrary, a high value of ratio means a low return of capital invested in Capex in terms of Operating Revenues. In
this case, the investments in Capex are not able to push-up the Operating Revenues.

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 Financial Debt on Operating Revenues (FDOR)

FDOR = Financial Debt (FD) / Operating Revenues (OR)

NFDOR = Net Financial Position (NFP) / Operating Revenues (OR)

*The FDOR and NFDOR ratios measure the capability of the Operating
Revenues to face Financial Debt and Net Financial Position in Capital Structure.
In both cases the meaning is the same. Specifically a high value of ratio means a
low level of ability of Operating Revenues to face Financial Debt (FD) and Net
Financial Position (NFP).
*On the contrary, a low value of ratio means a high capability of Operating
Revenues to face Financial Debt (FD) and Net Financial Position (NFP).

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Cash-flow on Operating Revenues (CFOR):

CFOR = Cash-flow (CF) / Operating Revenues (OR)

*The CFOR ratio measures the relationship between Cash-flow and Operating
Revenues. It can be considered as an indirect and approximate measure of the
company’s ability to transform Operating Revenues into Cash-flows. Specifically a
low value of ratio means a bad relationship between Operating Revenues and Cash-
flows.

*On the contrary, a high value of ratio means a good relationship between
Operating Revenues and Cash-flows.

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 Return on Operating Capital Invested (ROIC):

ROIC = Operating Income (OI) / Capital Invested in Operating Assets (CI)

The ROIC ratio defines the relationship between Operating Income (OI) and Capital Invested in Operating Assets
(CI) only. It is also called Return on Investment (ROI) if all company’s investments are in core-business

Financial Debt on Operating Income (FDOI):

FDOI = Financial Debt (FD) / Operating Income (OI)

The FDOI ratio measures the company’s ability to face Financial Debt (FD) through the Operating Income (OI).
Generally, the greater the distance between the amount of Operating Income and the amount of Financial Debt, the
lower the financial risk.

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Cost of Financial Debt on Cash-flows (CDCF)

CDCF = Cost of Financial Debt (CD )/ Cash flows (CF )

Despite the fact that the cost of financial debt has both economic (it is a cost) and financial dynamics (it is a cash-out), in
this context an analysis of its impact on financial dynamics is preferred. Indeed, the effects of cost of debt on cash-flows is
very relevant because if the company cannot face the relative cash-out, it is in a default condition

Cash-flows on Operating Income (CFOI)

CFOI = Cash flows (CF) / Operating Income (OI)

The CFOI ratio measures the relationship between Operating Income and Cash-flows. It can be considered as an indirect and
approximate measure of the company’s ability to transform Operating Income in Cash-flows. Specifically, a high value of ratio
means a good relationship between Operating Income and Cash-flows; otherwise, a low value

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 Return on Equity (ROE):

ROE = Net Income (NI) / Equity (E)

The ROE ratio is one of the most popular and most commonly used. It measures the return on Capital
Invested in equity on the basis of Net Income. In the financial approach the return of shareholders’
investment is the aim of the company and thus the ROE is the true bottom-line measure of company
performance.

Financial Debt on Net Income (FDNI)

FDNI= Financial Debt FD / Net Income (NI)

The ratio FDNI can be applied by considering the Financial Debt (FD) or the Net Financial Position (NFPD). In both case,
it measures the relationship between Net Income and Financial Debt. Generally the higher the ratio, the lower the
company’s ability to face Financial Debt.

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Net Income on Capital Invested (NICI)

NICI = Net Income (NI) / Capital Invested (CI)

It is worth noting that in all cases, the increase of ratio is not necessarily good news. Net Income being equal, the increase
of the ratio is due to a reduction in the capital invested. The decrease of investments implies the reduction of future
company abilities to compete in the business and, therefore a future reduction in Operating and Net Income.

Cash-flows on Net Income (CFNI):

CFNI = Cash flows (CF) / Net Income ( NI)

The CFNI ratio measures the relationship between Net Income and Cash-flows. It can be considered as an indirect and
approximate measure of the company’s ability to transform Net Income in Cash-flows. Indeed a high value of ratio
means a good relationship between Net Income and Cash-flows; otherwise, a low value of ratio means a bad
relationship between Net Income and Cash-flows

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 Equity on Cash-flows (ECF):

ECF = Equity (E ) / Cash flows (CF)

The ratio ECF defines the relationship between Equity (E) and the Cash-flows (CF). Considering two types of cash-
flows, Free Cash-flow from Operations (FCFO) and the Free Cash-flow to Equity (FCFE)
Financial Debt on Cash-flows (FDCF):
FDCF = Financial Debt (FD) / Cash flows (CF)

Capex on Cash-flows (CCF)

CCF = Capex (C) / Cash flows (CF)

The ratio CCF defines the relationship between Capex (C) and the Cash-flows (CF). Considering two types of cash-
flows, Free Cash-flow from Operations (FCFO) and the Free Cash-flow to Equity (FCFE

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thank you
Gine Das Prena
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