The Financial indicators, They are tools designed based on the financial information of a company. In addition, they are essential to measure stability, debt capacity, to generate liquidity, among others.
For this reason, in this article we are dedicated to explaining: what are financial indicators, their types, what they are for, we will develop some definitions necessary for a better understanding of: financial indicators of liquidity, indebtedness, profitability and efficiency.
What are Financial Indicators?
Well, as we mentioned at the beginning, the financial indicators They are instruments that are designed making use of the financial information of a particular company. And, it should be noted that they are necessary to measure:
- Debt capacity.
- Ability to generate liquidity.
- Returns and profits of the entity (through the interpretation of the amounts).
- Results and information in general.
Likewise, we must emphasize that financial indicators authorize the study of financial reality, individually. And, in turn, they facilitate the comparison of said study with the competition and organization or entity that leads the market.
On the other hand, it is convenient to mention a relevant aspect about these financial reasons. And, there are different types of financial indicators, which comprise different functions. Among the most used are:
- Liquidity indicators.
- Indebtedness indicators (capital structure).
- Of profitability.
- Coverage indicators.
Now, we cannot end this point of the article without first clarifying to all readers that the detailed explanation of each of these indicators will be found in the following title. So we invite you to continue reading.
Types of Financial Indicators
After completing the detailed explanation of the financial reasons, we continue with the development of the different types that exist. It is important to mention that each of them has a different purpose. Pay attention to the following texts!
Let’s start by clarifying that this type of financial reason is intended to identify the capacity of the company to meet your short-term financial responsibilities and obligations as they become due.
The objective of this indicator is to determine the level of indebtedness in which a particular company is in order to interpret the financing that creditors have with respect to said company. This results in the level of risk.
In the same way, we must mention that, within the indebtedness indicators, the following can be found: debt ratio and liability-equity ratio. Next, we will develop each one of them in detail. Attentive!
Well, this indicator aims to determine the degree of profitability that the company has compared to its: sales, assets or capital addressed. In addition, it is up to us to mention that, within their profitability reasons are:
- Gross profit margin.
- Operating profit margin.
- Long-term total asset turnover.
- Return on investment or return on assets or ROA.
- Return on common capital.
- Earnings per share.
- Dividends per share.
Finally, it is up to us to clarify that this index is intended to determine the ability of the company to pay fixed charges resulting from debts acquired by it. And, within the coverage reasons are:
- Total liability coverage.
- Total coverage ratio.
What are Financial Indicators for?
With all this, it is convenient that you know the function and purpose of financial reasons. Since on many occasions it is not usually given the importance it deserves. For this reason, we will explain to you in detail what this indicator is for.
Well, in a nutshell, we can say that the financial ratios or indicators serve to show the relationship between the different accounts of the financial statements. They also aim to analyze certain important aspects such as:
- Your liquidity.
- Your profitability.
- And, the operational efficiency of an entity.
Definitions Necessary for a Better Understanding of Financial Indicators of Liquidity and Indebtedness
In another vein, it is essential to emphasize certain relevant aspects regarding the settlement indicators. And it is very important that every reader has knowledge about some concepts in order to better understand the formulas.
- Current active: are those that are expected to be converted into cash or that can be
sold or used in less than one year.
- An example of current assets can be: cash and banks, money that customers
owed to the company, accounts receivable, other debtors, inventory (raw material).
- Current liabilities: they are taxes, accounts payable, electricity, water. Obligations or
debts that the company has with a maturity of less than one year.
- An example of current liabilities can be: suppliers or short-term credits.
Now, within the liquidity indicators you can find: working capital, solvency ratio or current ratio, acid test, inventory turnover, portfolio turnover or accounts receivable turnover and short-term accounts payable turnover.
Settlement financial indicators: Working Capital
Net working capital (CNT) = Current assets – Current liabilities
If the result obtained after applying the formula is positive, the company has the required assets to be able to cover its short-term debts. In short, when the positive result is higher, it means that it is a good indicator for the company.
Solvency Index or Current Ratio
Solvency ratio = Current assets / Current liabilities
In this case, the higher the result, the greater the ability of the company to pay all its responsibilities and obligations. Likewise, it is important to mention that the optimal level of solvency is 1.5 and above.
However, there are several companies in the country that consider that the optimal level of solvency is 1. This, in order not to have an excess in terms of liquidity, which translates into a loss of profitability for the company in question.
Acid Test = (Current Assets – Inventories) / Current Liabilities
It is worth mentioning that this index is intended to determine solvency, but not including inventories. For service companies, the result between this indicator and that of solvency includes a low difference due to the small amount of inventories they handle.
Inventory Turnover = Cost of Goods Sold / Average Inventories
Now, the result of this type of indicator in particular, allows knowing or knowing how long inventories take to be sold on average. If the result of such a formula increases, a good administration can be presumed.
Likewise, we must emphasize a specific aspect. And it is that, when the calculation is made with financial statements of one year, the result obtained from the formula must be divided by 12 in order to determine the months in which the inventory rotated.
Portfolio Rotation or Accounts Receivable Rotation
Portfolio turnover = Sales on credit / Average accounts receivable
Well, this indicator in particular has the objective or purpose of calculating the amount of time it takes for accounts receivable to become cash. In short, it takes care of calculating how long it takes for customers to pay.
Now, it is convenient to clarify that, in order to obtain this particular data in months, it is necessary to divide 360 by the result of the formula. This, assuming that financial ratios are being used on financial statements for a specific year.
Short Term Accounts Payable Turnover
Turnover of accounts payable = Purchases on credit / Average accounts payable
Now, this indicator allows calculate the time it takes the company to pay its debts. We must mention that, in order to obtain this data in months, it corresponds to divide 360 by the result of said formula.
On the other hand, it is up to us to define two important points about the indebtedness indicator. As we have mentioned previously, it is comprised and divided into: debt ratio and liability-equity ratio.
Financial Indicators of Indebtedness: Indebtedness Ratio
Debt ratio = Total liabilities / Total assets
This type of indicator is responsible for measuring the proportion of assets that are financed by suppliers or by creditors. It should be noted that, while this financial risk indicator is high, the greater the possibility of bankruptcy.
Liability-equity ratio = Long-term liability / Equity
This type of indicator is responsible for reflecting the existing proportion between the assets that have been financed by the partners, and those that have been financed by third parties. However, when the result obtained is greater than 1, it is presumed that the financing comes to a greater extent from third parties.
Definitions Needed for a Better Understanding of Financial Profitability and Efficiency Indicators
To conclude this article, it is up to us to define certain important and necessary points about the financial indicators of profitability and those of efficiency reasons. We invite you to pay attention to the following points to develop.
Gross profit margin
Gross profit margin = (Sales – Cost of sales) / Sales
Operating profit margin
This indicator reflects all the net profits that the company obtains in each sale it makes. However, you must take the value of the sale and subtract direct and indirect expenses and costs incurred. We must mention that this formula may change depending on the company.
Long-term total asset turnover
Accounts Payable Turnover = Sales / Total Assets
Return on investment or return on assets or ROA
Return on investment = Net income after taxes / Total assets
Return on common equity
Return on Common Equity = (Net Earnings After Tax – Preferred Dividends) / Stockholders’ Equity – Preferred Equity
Earnings per share
(Earnings per ordinary shares / number of ordinary shares)
Dividends per share
Dividends per share = Dividends paid / Number of ordinary shares outstanding
Total liability coverage.
Total coverage of the liability = Earnings before interest and taxes / Interest plus payments to the principal liability
Total coverage ratio.
Total coverage ratio = Earnings before lease, interest and tax payments / Interest + Credit to principal liability + Lease payment
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