Financial Analysis Metrics: AECA, DuPont, and PARES

Return on Assets (ROA) Measurement Models

AECA Model

AECA considers the employed as the base for the measurement of Return on Assets (ROA). When an entity manages its trade payables as part of its trade policy, AECA is useful for estimating the investment requirements for the business. The AECA model reveals the effect of the cash policy on the net cost of finance (high liquidity negatively impacts the cost of finance).

DuPont Model

The DuPont model is very intuitive and useful for entities with a low level of liabilities and low financial expenses. Economic profitability here is meaningless because financial results distort the ROA.

PARES Model

PARES is more precise in measuring ROA because it avoids the disadvantage of DuPont by considering operating liabilities as free of charge finance. It is useful when the level of operating liabilities is high.

Instruments in the Statement of Change in Equity

1. Comprehensive Income Statement: Shows the net income plus earnings or losses coming from the maintenance of assets and liabilities whose change in valuation is recognized in equity.
2. Total Changes in Equity: The information must match the balance sheet information. It contributes to understanding the entity's financing decisions.

Cash Flow Statement Components

1. Cash Flow from Operating Activities: Generated by the business.
2. Investment Cash Flow: Captures investment in fixed assets and the proceeds from their sale.
3. Financial Cash Flow: Describes the cash coming from the issuance of equity instruments and the cash flow derived from debt transactions.

Fundamental Accounting Definitions

Assets

Resources controlled by the entity as a consequence of past events where the entity expects to obtain future economic benefits.

Liabilities

Obligations arising as a consequence of past events whose settlement is expected to produce an outflow of resources that embodies economic benefits from the entity.

Income

Increase on equity during the exercise, as an increase of assets or decrease in liabilities that does not come from owners.

Expense

Decrease on equity during the exercise, as a loss of value in assets or recognition or increase of liabilities that does not come from owners.

Qualities of Financial Information

Financial information must be:

1. Comparable: Users can select from different options, so information must be comparable.
2. Verifiable: Several independent, properly informed observers would agree the information is faithful.
3. Timely (Opportunity).

Firm Risk and Operating Leverage

With operating leverage, the greater the risk, the greater the fixed costs. This supposes a greater proportion of the firm's results. Strategies to manage this include:

1. Improving the contribution margin.
2. Increasing selling price while maintaining units sold.
3. Increasing the level of sales while maintaining the margin.

Cash Flow Classification Notes

Receipts of investment income (interest and dividends) and payment of interest to lenders are classified as operating. However, dividends paid are classified as financing activities.

Working Capital Coefficients

Basic Coefficient (Coeficient Básico)

Considers the ratio between the assets to be financed in the long run and the operating working capital.

Financing Coefficient (Coeficient de Financiación)

Relates non-current assets with the long-run funding sources (equity and non-current liabilities).