Ways to Assess the Financial Condition of Enterprises

Marina Stupakova

Financial Analysis Tools

How should the financial health of an enterprise be assessed? How should its diagnostics be performed and what recovery measures should be taken? A manager of any dynamic enterprise would generally pose these questions. Several methods can be offered to handle this matter. For example, sticking to the medical terminology, one can call a doctor, i.e. an auditor. Another method involves performing a self-diagnostics based on financial statements and standard data available at any enterprise.

Accountants have become accustomed to using, primarily, absolute indicators. However, even if you «scrutinize» such indicators, it will be very difficult to make a judgment as to whether an enterprise is successful. With the advent of financial ratios based on standard reporting data, a manager can obtain a prompt (and accurate, in most cases) picture of the financial position of his or her enterprise and its counterparts. Correct management decisions can be made based on the trends in these ratios over time.

These financial analysis techniques are implemented in bespoke computerized systems that provide a tool for managers and experts in performing the financial diagnostics and analysis of their enterprises. Bespoke software does not require in-depth knowledge of financial analysis and can provide an additional source of information. Well-known financial software producers include companies such as Alt, INEK and Pro-Invest-IT. They deliver ready-made, tested and technically sound software applications that can be used to automatically compute necessary financial ratios based on understandable input data and interpret their specific values, which enables users to make useful conclusions.

Express-Diagnostics

Enterprises seek financial analysis systems to perform the express-diagnostics of their operations, which is required in monitoring liquidity, asset productivity and capacity ratios, etc. These and other ratios which provide a broad picture of an enterprise’s financial position and performance are calculated based on the balance sheet (Form #1) and income statement (Form #2). The analysis of these ratios enables financial departments to identify «weaknesses» of the enterprise so that managers can make relevant management decisions. In addition to the study of its own indicators, an enterprise can perform a benchmarking exercise. Primary data [for the benchmarking exercise] are publicly available and can be legally obtained from national statistics agencies and other sources (e.g. web-site of the Russian Federal Commission for the Securities Market or FCSM – http://www.fcsm.ru). In addition, some producers of financial analysis software take care of their users and provide them with necessary information. For example, the Pro-Invest-IT company’s web-site contains an industry-specific database (http://www.pro-invest.com/it/products/ae/industry.htm) that provides data on successful enterprises from different economic sectors using the format of the Audit Expert. The database is updated on an on-going basis with new enterprises and industries. The access is provided to everyone and not only to authorized users of software applications.

In-depth Analysis

The express analysis enables enterprises to identify their «weaknesses». However, it is necessary to use an extended set of financial data to understand the causes of these weaknesses. The in-depth analysis requires not only the balance sheet and income statement as an information source but also cash flow statements and statements of changes in equity, receivables and payables, disaggregation of gains or losses, etc. A user can generate his or her own tailor-made indicators and use them to perform the analysis. Not all software applications provide this option. However, it is available in the above Audit Expert system, where this option is implemented in such a way that its use does not require programming skills.

The analysis of an extended set of data can result in recommendations for reducing production costs and working capital requirements, improving asset productivity and solvency ratios, etc. These findings can also be used in managing production and sales functions, developing business plans of investment projects. The financial condition of an enterprise might have to be assessed when managers analyze the appropriateness of equity financing or when a creditor analyses its exposure to the enterprise’s projects.

The diagnostics involves the analysis of not only the enterprise’s current financial position but also its changes over time, i.e. the identification of relevant trends. However, the format of Russian financial statements keeps evolving all the time and a «straightforward» comparison of financial indicators for different periods does not seem possible. Therefore financial statement data must be reconciled to a single basis, which is IFRS – or US GAAP-compliant format of financial statements in the above software applications . The reason why international standards were selected as a basis is pretty straightforward: the objective of Western accounting is to obtain information for management-decision making purposes (that is why the financial diagnostics is required) rather than meet the needs of fiscal authorities.

Operating Principles of Financial Analysis Systems

The Audit Expert system will be used as an example to illustrate the solution of financial analysis problems by means of computerized systems.

Input data can be entered either manually or automatically. The system automatically imports data from the most popular accounting software such as «1C: Accountancy», «Info-Accountant», «INFIN-Accountancy». Data in the form of a text file can be retrieved from any other accounting software, including in-house software, and entered into the Audit Expert system. The Audit Expert system deals with not only Russian statutory accounts but also with the forms of financial reports produced in other CIS countries given specific accounting characteristics of Belorussia, Kazakhstan, Uzbekistan, Ukraine, Moldova and Estonia. Many other popular financial analysis software products do not provide this option.

After entering Form #1 and Form #2 of financial statements for any selected period starting from 1994, users of the Audit Expert system obtain IAS-formatted analytical balance sheets and income statements that show the changes in line items over the periods under review. At the same time, 20 major financial ratios are generated to analyze profitability, liquidity, solvency, efficiency and capital structure of the enterprise. The Audit Expert system can revalue all or part of balance sheet items in order to achieve more faithful representation. One can either use a single rate to revalue all elements of a line item (e.g. receivables) or apply individual rates to each component of the line item (e.g. each debtor).

The software enables users to browse all output data across selected periods in absolute values, changes over different periods or percentages. The system generates curves of changes in indicators for any selected line of tabulated analytical data and distribution charts – for several lines of data.

The system provides ten standard financial analysis techniques such as liquidity, break-even and ROE analyses (using Dupont formula) as well as techniques specified in regulations. Based on the analysis, the software automatically generates expert conclusions that enable the user to assess the financial condition of the enterprise and focus on critical issues (which is especially crucial for individuals who are not sophisticated financial analysts).

It is very convenient to run the Audit Expert system. A special Wizard enables the user to select a set of tailor-made analysis techniques, set a currency for output tables (in addition to a local currency, any other currency can be selected to «eliminate» the effects of inflation), choose a language, format of numbers, select a required depth of analysis and many other options.

The Audit Expert system generates Word-formatted analytical reports. Users can design the structure of the report that can include input and output tables, curves and charts, narrative expert conclusions and comments made by users when browsing the analytical tables. After performing new calculations, the software automatically recomputes output tables in the report and expert conclusions. If a user creates reports in Excel, data are also recomputed automatically. The Audit Expert report can be generated both in Russian and English given internationally recognized terminology. This makes sure that not only Russian but also foreign experts understand the analysis.

Not only for enterprises

In addition to enterprises, supervisory bodies and so-called receivers are interested in having the financial condition of companies analyzed. These types of managers focus on standard ratios such as liquidity, efficiency, capital structure ratios and others.

External financial analysis is also within the competence of banks, insurance companies and investors because no one is willing to get new exposures without prior analysis of the solvency and financial viability of their clients. Government agencies are also interested in using this software for the purpose of monitoring enterprises within their jurisdiction.

Marina Stupakova is a Pro-Invest-IT Manager. She can be contacted by e-mail: stupakova@pro-invest.com.