This document discusses liquidity analysis and financial statement analysis of a company's short-term financial health and ability to meet its near-term obligations. It covers analyzing liquidity through cash flow analysis using EBITDA and liquidity reserves, operating working capital analysis of current assets and liabilities, coverage ratios of current assets to liabilities, and the operating cycle which measures the time between acquiring inventory and collecting cash from sales. The goal is to determine if the company can satisfy its short-term debt obligations from its normal business operations.

1. Financial Statement Analysis Chapter 7 Liquidity Bonsón, E., Cortijo, V., Flores, F. Content on this file is licensed under a Creative Commons Attribution Non-Commercial No Derivatives Works 3.0

2. Index Introduction Cash flow analysis Operating working capital analysis Coverage ratios Operating cycle

3. Index Introduction Cash flow analysis Operating working capital analysis Coverage ratios Operating cycle

4. Introduction Liquidity refers to the capacity of the company to satisfy its short-term liabilities From an internal perspective, liquidity analysis can be conducted thanks to the cash flow budget or similar plan From an external perspective, liquidity analysis can be performed using two different methodologies: based on the cash flows : in this case, we analyse if the company can meet its short-term liabilities using its operating cash flow, net , and its liquidity reserves . based on the operating working capital , or the capacity of the current assets related to the company’s operating activities to generate enough cash so as to satisfy the related current liabilities

5. Short-term debt to be satisfied Operating Working Capital and Operating cycle Cash flow and Liquidity reserves Trade and other payables Current tax liabilities Current liabilities (operating) Current provisions for employee benefits Other short-period provisions Other current financial liabilities Other current non-financial liabilities Liabilities included in disposal groups classified as held for sale Current liabilities (non-operating)

6. Index Introduction Cash flow analysis Operating working capital analysis Coverage ratios Operating cycle

7. Cash flow analysis The objective is to state if the company can satisfy its short-term debts using its operating cash flow, net EBITDA – interests – taxes EBITDA calculation depends on the chromosome of presentation for the company (8 possibilities) and its liquidity reserves Non-functional assets that can be easily converted into cash

8. The special case of EBITDA

9. The special case of EBITDA EBITDA (cash approach)

10. Liquidity reserves Under IFRS, assets are classified into current and non-current assets. In addition, in both categories, it is possible to differentiate between functional and non-functional assets –also called liquidity reserves because they can be sold and converted into cash if the company has liquidity problems, without risking the company’s operative capacity Investment property Other non-current financial assets Non-current assets classified as held for sale Other current financial assets Liquidity reserves

11. Index Introduction Cash flow analysis Operating working capital analysis Coverage ratios Operating cycle

12. Operating working capital analysis Working capital, defined as the excess of current assets over current liabilities Operating working capital (excess of operating current assets over operating current liabilities) + Inventories + Trade and other receivables - Trade and other payables - Current tax liabilities Operating Working Capital

13. Operating working capital analysis The sign, positive or negative of the OWC can not be used a priori as a pertinent indicator It is necessary to calculate turnovers and coverage ratios in order to analyze in depth the capacity of the operations to satisfy the related debt

14. Index Introduction Cash flow analysis Operating working capital analysis Coverage ratios Operating cycle

15. Coverage ratios Coverage ratios are used to measure relationships between different components of the OWC. The most meaningful are Operating Current Ratio = Operating Current Assets Operating Current Liabilities Quick Ratio = Trade and other receivables Operating Current Liabilities It is expected to find positive values, better as higher , and it will be necessary to compare with an appropriate benchmark

16. Index Introduction Cash flow analysis Operating working capital analysis Coverage ratios Operating cycle

17. Operating cycle Also known as Cash Conversion Cycle , is the time period in which a company converts its resources into cash It can also be defined as the total time needed to collect cash from sales after having paid for the raw materials and resources acquired Operating Cycle = SP + RPP – PPP ( days ) SP = Stockholding period RPP = Receivables processing period PPP = Payables processing period

18. Operating cycle SP = Inventories*365 Revenue RPP = Receivables*365 Revenue PPP = Operating current liabilities*365 Revenue If SP + RPP < PPP, the company can have a negative OWC without having liquidity problems because its payables processing periods are longer that the time needed to sell its inventories and collects its receivables. On the other hand, if SP + RPP > PPP, the company must have a positive OWC