FINANCIAL DIAGNOSIS..

APPROACHES AND COMPLEMENTARITIES

Gdoiu Mihaela Pitesti University The financial diagnosis involves judgment upon the financial health of the company, the strengths and weaknesses of financial management through which past, present and future risks arisen from the financial situation can be estimated, following the reduction of risk and improvement of results. The finality of the financial diagnosis consists in offering financial information to people both from inside and outside the company. Key words: financial diagnosis, the diagnosis function, the financial position of the company

The significance of the financial diagnosis

The company is subject to a process of decision-making which ensures its regulation in order for it to function normally. In case a disturbance appears within the company, steps will be taken in way of adopting some regulatory decisions, starting from the causes. This is where the diagnosis analysis appears, with the role of identifying the causes that have offset the well being of the company. Even if the company functions normally, the diagnosis analysis can be used with the purpose of evaluating the performance of the company. The results of the analysis are materialized in the financial and economical diagnos is. The term diagnosis comes from the Greek diagnostikos which means able to know. The term is borrowed from medicine, meaning an activity envisaging the recognition of certain diseases, based on their symptoms, in order to discover the causes and apply therapy necessary for the healing process. Similarly to the activity of the company as a social organism, the diagnosis involves the identification of a companys disfunctionalities, the research and analysis of facts and responsibilities, the identifi cation of the causes of the disfunctionalities, as well as the elaboration of a forecast and the recommendation of a certain therapy; Performing a company diagnosis is done not only when the company is facing problems, but also when the evaluation of its performance is considered or when the company is in good health, but improvement is desired.1 The financial and economical diagnosis is a complex research with a view to evaluating the activity of the company, in order to elaborate some decisions allowing the improvement or the restoration of the companys performance. The diagnosis and regulatory function is explained by the fact the economical and financial diagnosis addresses and prevents the apparition of negative variations from the level of established goals. Also, the economical and financial diagnosis guides the investment, financing and dividend distributing decisions, elaborates financial forecasts, evaluates the expected yield, helps in continuing or initiating activities with various partners. The diagnosis is not limited to an identification of the phenomena and their interpretation, representing an objective of strategic management or of forecast management. Management specialist Peter Drucker said that an efficient leader must allocate 50% of his time for diagnosis. The financial diagnosis represents a part of the companys global diagnosis, of the comprehensive evaluation of the situation and performances of the company. Consequently, the financial diagnosis can only offer a partial and specialized look at the companys financial situation and performance, its goal being oriented on studying: the companys capacity to ensure immediate and long -term solvency, i.e. avoiding the risk of bankruptcy; the company ability of maintaining a satisfactory level of performance, considering the resources engaged in the activity, the ability to refinance the activity, to own enough resources to avoid financial risk. The financial diagnosis can arise in various situations, taking on various traits: It becomes a strategic diagnosis when it follows the companys strengths and weaknesses, both in using its economical potential and in relation to the external business environment; It is elaborated as a stock-market diagnosis when it considers the relationship of the company with the stock market, if the company is quoted on the market. The indicators supplied by the diagnosis are an important element in guiding the purchase or sale of stock, both for the company and for the other investors in the stock market;; It is a valuation diagnosis when it contributes to clarifying some necessary elements for establishing the value of a company, in case of investment, mergers, etc. The financial diagnosis can determine directly the patrimony value of the company or can supply the indicators necessary for establishing its yield value, because it allows the evaluation of the companys durable beneficiary capacity;
1 J.P.Thibaut,

Le diagnostic d'entreprise, SEDIFOR, 1989, pag.15

351 When it intervenes in order to determine the difficulties a company is facing and follows its stabilization, it is a crisis diagnosis. In this case, the priority of the diagnosis is to determine if the company is capable to maintain or to regain its short-term solvency. The diagnosis appeared out of objective needs of various users of its results, in the situation of making a decision regarding the management of the company, purchase and sale of stock, granting or refusing a loan, investments, liquidation decisions. The financial diagnosis ultimately tends to evaluate the way a company can overcome constraints regarding

performance, solvency, autonomy, financial flexibility. Financial balance, which represents the companys ability to honor obligations as they reach their maturity, is o f great importance in the evolution of financial analysis. The exact measurement of the results obtained and the anticipation of the companys evolution trend is a preoccupation of the financial diagnosis. If the study of performance and the analysis of the balance represent fundamental themes of the financial diagnosis, it also considers highlighting other important financial traits, such as: financial independence and financial flexibility. The financial diagnosis mainly envisages the finance and accounting function of the company, being especially oriented towards yield and risks. The financial diagnosis involves judgement upon the financial health of the company, the strengths and weaknesses of financial management through which past, present and future risks arisen from the financial situation can be estimated, following the reduction of risk and improvement of results. The financial diagnosis can be a model usable by financial consultants, but also for the internal analysis of the companys financial performance. The diagnosis must indicate the companys strengths, weaknesses and potential. The diagnosis must describe the key environment variables, which have an influence on the companys activity (demographics, economy, technology, cultural, legislation). All these factors interact. All these key variables must be analyzed upon any financial diagnosis. The general conclusions regarding the companys financial diagnosis will form a SWOT matrix.

The objectives of the financial diagnosis

Generally, the objectives of financial diagnosis are oriented based on what is monitored within the company. Subsequently: if the companys growth is envisaged, the diagnosis is oriented towards the companys investment resources and yield. If it refers to the yield of the company, the financial diagnosis is oriented toward comparing the results obtained by the resources employed. If the companys balance is pursued, the diagnosis is oriented towards the financial structure of the company. If the company risk is pursued, the diagnosis is oriented towards the companys weaknesses, including the identification of bankruptcy risks. The objectives of financial diagnosis are subordinate to the interests of the users, the role of the financial analysis being adapted to the type of diagnosis. So, the financial diagnosis needed by the company management envisages the answer to four essential questions regarding: Growth: how the companys activity carried out throughout the examined period and what was the growth rate compared to that of the sector; Yield: whether the results obtained are proportionate with resources used and whether the growth was accompanied by a satisfactory yield; Balance: what is the financial structure of the company and whether it is balanced or not, in the context of the ratio between the capital masses for a suitable financial support; Risks: their nature, whether the company has weaknesses and whether or not there is an increased bankruptcy risk. If growth is sought after, the company is checked to see whether it has enough resources for investments and a satisfactory level of the net working capital for the current activity, without the risk of offsetting the balance of the financial structures. Also it is verified whether the company has a satisfactory yield to face the growth, which imposes the comparison between the results obtained and the resources employed for that purpose and the calculation of the efficiency indicators. Knowing the results and the way they were constituted and distributed between the companys stakeholders allows the evaluation of the companys performance, which is reflected in the financial balance. Firstly, it is of interest here whether the financial structures of the company are balanced, in the sense of the companys ability 352 to deal with long and short-term commitments, which imposes the examination of the companys solvency and liquidity. Secondly, it is interesting to study the way the company is financed, which demands the knowledge of the structure of the companys capital by reporting equity to debts. By comparing the results obtained to the capital employed we have economical yield and financial yield, to which the afferent risks relate. Thirdly, we have to see whether the company was able to maintain the financial balance throughout the course of its evolution, which implies the study of the financial cash flows throughout one or more financial years. Of interest here are the new uses of the company (investments in fixed tangible or intangible assets, financial assets, reimbursement of debts) and the new resources the company held throughout the same period (self-financing or credit). The financial diagnosis arose out of objective needs of various users of its results, in the situation of making a

decision regarding: patrimony and financial management of the company, buying or selling stock, granting or turning down a loan, buying or selling the company, partly or entirely, taking on investment projects, liquidation decisions. In a market economy, companies are interested in knowing the stability of their competitors, the structure of their product portfolio, their strengths and weaknesses, in order to identify the sources of competitor advantage and to better orient their own development strategy. By exploiting the information provided by accounting under circumstances of quality exigency imposed by international standards, the financial analysis contributes to a better exploitation of the company resources, to the strategic choice that optimizes the report between yield and risk, to the increase of efficiency in a given market environment. Traditionally speaking, the financial diagnosis envisages company performance and solvency. Solvency refers to the companys ability to honor its commitments, i.e. to pay debts as they mature. This subject is of major importance in the evolution of financial analysis. Firstly, this subject consists its first area of interest. The instruments of financial analysis were created by bankers and other creditors wanting to evaluate rigorously the risks related to a current or potential debtor. Secondly, the subject of solvency has a particular importance because the insolvent company displays a bankruptcy risk and so it is exposed to extinction. The diagnosis regarding solvency is confronted with a major difficulty. Evaluating solvency implies a forecasting process regarding the conditions under which the studied company is in the situation of handling its future maturities. The financial diagnosis must proceed to the anticipation and elaborating of forecasts regarding the evolution of the company, its financial position and its financial balance. There is the tendency of expressing doubt over the possibility of a pertinent and efficient financial diagnosis. A preoccupation of the financial diagnosis refers to the exact measurement of the results obtained in the past and in the present and in anticipating the trend of evolution in the future. An evaluation of the level, instability and evolution of the these results stems from this measurement. Once these results are established, they have to be compared to the referential levels, expressed either by the level of company activity (production or sales), or by the average value of the capital employed in order to obtain these results. Only through such a comparison can the company efficiency be evaluated. We can thus evaluate the companys ability to carry out activities which are profitable enough to compensate the cost of resources used and its capacity to value financial and fixed assets at its disposal. Financial autonomy represents an important objective for the company leaders. In financial terms, autonomy is evaluated firstly by studying equity, its structure and the relationships of command over the company that it can express. On the other hand, financial autonomy can be evaluated by analyzing the structure of financing. The dependency of the company on its creditors (and especially on banks) represents the essential element to be explored. The distribution of financial resources and other liabilities between own funds and various debts constitutes one of the characteristics best explaining a companys financial autonomy. The companys flexibility expresses its capacity to adapt to unforeseen transformations in its envir onment and within its own activity and is closely followed in all management fields. Financial flexibility is evaluated compared to the ability the company manifests in relation to the rapid mobilization of liquidities. Financial flexibility is evaluated c ompared to the companys ability to finance itself. And it can be related to the possibilities the company has in dividing financing needs in order to accomplish investment projects, unfolding or forecasted, and also to perform its current activity. The role of the financial diagnosis is to evaluate the companys financial position. Based on this diagnosis, a new strategy for maintaining and developing in the environment specific to the local economy will be elaborated. Practically, the finality of the financial diagnosis consists in offering financial information to both those inside the company and interested parties outside the company. In case of internal financial diagnosis, the users can be leaders, current shareholders or employees. The objective pursued in this case is to detect eventual offsets of the financial balance and to adopt new decisions for 353 managing the company. These decisions are based on identifying the origins and causes of the offsets on the one hand and, on the other hand, to establish measures for fixing the offsets. Outside the company, the users can be financial analysts, potential shareholders, banks, financial companies and even the state. The objective pursued is the companys ability to generate profit, to honor long -term and short-term obligations (the companys liquidity and solvency), as well as the value of the company. In most cases, external users need a financial diagnosis either for giving the company a loan (especially banks), or for making decisions regarding investing in a companys capital (potential shareholders or other companies). Both internal and external analysis have the objective of evaluating the companys performance and the risks it deals with and closely follow: yield analysis, risk analysis and company value analysis. Elaborating the financial diagnosis has the objective of evaluating the companys financial performance at the end of the financial year. The main goals considered are: evaluating the financial results, highlighting the ways to ensure financial balance, examining the yield of the invested capital, evaluating the risks.

The results of the analysis may be used as basis for making management decisions, elaborating a global strategic diagnosis, elaborating development policies. In conclusion, the financial diagnosis supplies information regarding: current and past performance and its perspectives, the financial position and its modification, ways to manage resources and the administrative results of the management teams, the companys ability to generate cash or equivalents of cash. Thus, the financial diagnosis becomes an indispensable instrument, capable of ensuring the identification of development opportunities, the identification of different types of risk and the optimal strategic choice.

Bibliography:
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