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The Research on Evaluation System of Financial Strength PAN Huiming, DU Yaxin College of Economics and Management, Wuhan Textile University, P.R.China, 430073 [email protected] Abstract: Based on the literatures, this paper established the financial performance evaluation system with newly-added macroeconomic environment factors. This paper analyzed the global economy situation and indicated the post financial crisis existed. By the entropy weight method, each indicator was weighed. This newly financial evaluation system is more suitable for the companies in the post-crisis era. Keywords: post-crisis era, financial evaluation index system ,entropy -weight , 1. Introduction Company's financial strength evaluation is to estimate the company's financial position and operating results in ordering to reveal the financial situation and further trend, which based on the main index in the financial reports. Financial strength evaluation is important for investors to assess the value of listed companies, for the company's manager to make productive and financial decisions, for market regulators to judge the company's financial situation and adopt regulatory measures. Therefore establish a scientific, reasonable and comprehensive evaluation model of the company is actual important. In the early twentieth century, Donaldson Brown from the American Donaldson company proposed the famous Donaldson system to analyze the company's financial position. In 1928 American Alexander wall used seven financial indexes by a linear relation to evaluate the company's financial condition. Pnches Ming and Caruters adopted the factor analysis method which 48 financial indicators were divided into investment return, capital and the stock, inventory, financial lever and the receivable account. Muresan and Wolitzer introduced PALMS profit, asset utilization ratio, long-term liquidity, market value, short-term liquidity to assess situation in 2004. On the basis of the foreign studies, the study of company financial evaluation in Chinese started in the 1990. Liu Zhichun 2005 used the total index methods of the coefficient variation to carry on comprehensive calculation to 50 typical every financial index of listed company. Wangman and Liqian 2007 adopted the factor analysis based on the company's survival and development capability to evaluate the listed company's financial competitiveness. There are some shortages about above. First, selecting indicator random resulting to the difference in the same company indicators should conform to the economic environment and establish the index system including the economic environment is necessary. Secondly, most of the appraisal methods not avoided people’s subjectivity affecting the fairness of the evaluation. Thirdly, many research methods, such as the factor of analysis are requiring for samples which have quantities and obey normal distribution. ( 2. ) ( ) ) ( Post –crisis Era With the global financial crisis gone, most of global economy reached the lowest point in the second half of 2009 and started recovery. According to the latest statistics show that the world economy declined 0.6% in 2009 comparing with the last year, GDP of USA declined 2.14 ;GDP of Japan increased by 3.81% ,Europe declined 4.1%. China increased by 10.7% in the fourth quarter and total GDP reached 8.7%. The latest report< The world economic outlook report> written by International Monetary Fund (IMF) shows global economic growth will reached 4.2% in 2010 which higher 0.3% than the forecast figure in January. The world economy recovery is better than expected and will reach the growth of 4.3% in the next year. Thus the global economy is being out of the financial crisis, but the % 793 recovery process will not smooth sailing, there are a lot of uncertainties which might destroy the economic recovery in some time. There are these factors as follows: 1 The risk of inflation. In defending global financial crisis, the major nations introduced various measures to stimulate the economic. China also took the economical plan to stimulate the real economy which may have he pressure of inflation. It is expected that CPI index will rise, total of the CPI is -0.7 by 2009, but CPI has changed from negative to positive since last November and December. CPI increased 1.9% in December that main reasons were food and real estates increased. 2 Global trade protectionism is popular. In ordering to defend financial crisis and promote economic recovery, most countries adopt degrees of trade protectionism, trade protectionism is prevalent, which has exacerbated the crisis to recovery. According to the figure shows there are 105 items of global trade protection while the liberalization of trade policy is only 12, the former is nearly nine times than later since the economic submit were held in Pittsburgh in September to December 2009. Discriminatory trade policy and trade liberalization policies is close to 1:6 since last November to December in the relevant policy taken by many countries. “Indeed, protectionism in trade has not yet been reached level of the economic depression 1930 , but water is not in the boil point necessary" Switzerland Sankt Gallen University professor Simon said “they are in the way to increases trade protection, this trend is not hold up.” The International Trade Center warns that protectionist measures number is approximately expected 70 in the first half year. China is the most affected by the trade protectionist. 3 Economic restructuring, sustainable development and low carbon economy are important features in the post-crisis era. After Financial crisis, there are various transformations of industrial structure. The new energy industry and environmental industry is expected to lead to the global industry upgrade. In response to the financial crisis, many countries have increasing invest in the new energy and other areas of technical development. Green industries development may lead to a new global industrial structure and promote world economic growth. 4 Global economy recovery is unbalanced. In the recovery process different regions of the economic situation show a sharp contrast. New market economy growth strong, America recovery progress remains good, but on the other hand, Europe economic growth stagnated. On the debt restructuring and tightening monetary policies, the government of the measures to stimulate the economy has gradually failure. Therefore, to the economic outlook is still cautious, the economic growth of Europe will slow down slightly to 0.8% in the second half year. . . ( ) . . 3. Construction Evaluation Index System of the Financial Strength 3.1 Principles of financial evaluation index system Financial indicator is the carrier of evaluation and the competitiveness of enterprises. For assessing the financial strength, it is necessary to formulate a set of appraisal target scientific system. The complex system were divided into several parts in according a higher level an order, appraisal each parts strength in ordering to assess the entity. Construct the financial index system should follow the following principles . The comprehensive principle. The evaluation should be comprehensive and complete to assess the company's financial strength and conditions. System should consider not only financial capacity of dominant potential but also macroscopic external environment. Scientific principle. The evaluation system should scientifically reflect true financial power and facilitate the competence of their financial strength comparing with other companies. Purposeful principle. The target evaluation system aims to measure of financial capability and find out company's financial weaknesses, avoiding financial risk. Universal and developmental principle. The indicator system designed has wide application and development in the different corporations, which makes the auto-adjustments with environmental changes. ① : ② ③ ④ 794 3.2 Construction evaluation index system of the financial strength Establish financial evaluation index system of 5 parts including basic financial viability, profitability, operating capability, innovation growth and resistance to the risk Enterprises financial viability continue survival ability . Enterprise viability is to maintain survival and normal operation in the daily life. Many companies pull through the global financial crisis based on the strong financial viability even the poor profitability. It has great significance. current rate= current assets ÷current liabilities ×100% cash -liabilities rate=cash flow ÷current liabilities×100% assets- debt rate=total liabilities÷ total assets×100% cash total liabilities rate=cash ÷ total liabilities×100% Profitability indicators. Profits is the first goal for the enterprises, in the post-crisis, consider not only profit amount but also the profitable quantity, including inflation ,the cash flows and the costs of major economic indicators. Thus select the adjusted net assets profit rates, net cash flow profit rate , ① ( ) ① - main operating margins rate, which uses the method of EVA(economic value added) Adjust net assert profit rate=EVA ÷average total assets ×100%. EVA=economic profit cost of capital . Use of the EVA avoiding the limitations of accounting profit, the capital cost of the adjustment including inflation, the staff training expenses and profit Main operating margins=main operation profit ÷ business income×100% This indicator reflect the profit level net cash flaw profit rate=cash flow ÷ net profit×100% Management ability. It is results and capabilities made by efficient management, including its operating capabilities and management efficiency. velocity of account receivable=total income ÷account receivable×100% inventory turnover=sales cost ÷ total inventory×100% total assets turnover rate=total income÷ total assets×100% management cost rate=cost of management ÷operation income×100% Sustainable development ability. It is primarily includes the ability of enterprises growth and innovation ability. Growing capacity means the extending of enterprises scales from inner or other ways to obtain funds and enlarge production. Selecting the income growth rate, assets increase rate, net profit growth rate. Innovation select technology input rates, the ability of newly product profitability. sales growth rate of 3years= main operation income÷ main operation income before 3 years-1 1/3×100 ② ③ % ( ( ( ) % ) total assets growth rate of 3years= total assets÷ total assets before 3 years-1 1/3×100 net profit growth rate of 3years= net profit÷ net profit before 3 years-1 1/3×100 Technology input rate=cost of research ÷total income. Newly product profit ability= profit of new production ÷profit. The resistance to the risk. It mainly included financial risks and operational risks. Operational risks refer to the operation change resulting to the enterprises risk while financial risk by debt financing for the company's shares by shareholders. ) % ⑤ Index system evaluation of financial strength Index Evaluation index Analysis index Detailed appraisal index current rate Enterprises financial viability Profitability indicators 、 Pay ability cash ability profit ability 795 cash debt rate assert- debt rate cash total debt rate adjust net assert profit rate main operating margins net cash flaw profit rate velocity of account receivable Management ability Operational ability Grow ability Sustainable development ability Innovation inventory turnover total assets turnover rate circulating asset turnover rate sales growth rate total asset growth rate net profit growth rate technological input rate new product profit ability financial risk The resistance to the risk 4. Risk level operational risk comprehensive ability Entropy weight Entropy coming from thermodynamic is later introduced to information theory. It is measurement of unsorted in the system, for a given indicator, the greater of sample data difference, which has the more information; the greater play the role in the evaluation, giving the big weight to the indicator. Using Entropy Weight to give the weight of each indicator to reflect the data’s dispersion degree and dynamic change which can avoid the artificial factors There are basic steps as follows: 1. Establish a sequence of analysis. Treating financial strength as a research system, i is the number of enterprises, and j is the number of indicator,( j= 1, 2, 3... ) xij is the actual target indicators of i enterprise j indicator. 2. The processing of data in dimensionless. Different data type has different dimensions, leading to difficult to compare, therefore, it is necessary to dimensionless and standardized. The standardized indicators is in 0,1 . Positive type data most include benefit indicator which means the bigger number the better financial situation. xij − min( xij ) 4.1 pij = max ( xij ) − min( xij ) Negative indicator most include cost type indictor which means the smaller the number, the better financial situation. , 【 】 pij = max( xij ) − xij max ( xij ) − min( xij ) 4.2 xij is the actual indicators of i enterprise j indicator. min( xij ) is the minimum of j indicator, max( xij ) is the maximum of j indicator 3. Entropy weight 796 p f ij = ij n ∑ p ij j = 1 4.3 ei = −1 n ∑ p ij ln( p ij ) ln j = a 4.4 n fij is Feature proportion , pij is the standard indicator ∑p ij is the sum of the j indicator number. j =1 ei is the Entropy of indicator wi = 1 − ei 4.5 m m − ∑ ei i =1 Wi is the Entropy weight of j indicator 5. Conclusion In recent years, with the development of science, the financial strength of the appraisal method shows diversity. How to evaluate the financial strength of the enterprises scientific is becoming increasingly popular topic. This paper analyzed the economic situation firstly indicating that most countries have shaken off the shadow of the financial crisis and started recovery, but will not be smooth sailing still facing many challenges. This paper established evaluation index system of the financial strength, which including inflation and sustainable development of enterprises facing the risk and other factors with combination of cash flow. The comprehensive evaluation system was divided into five parts including the enterprises financial viability, profit-making capacity, managerial capacity, growth ability, the risk level. By the method of entropy weight to give the weight of each indicator to reflect the data’s dispersion degree and dynamic change which can avoid the artificial factors. 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