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YouControl’s method of financial scoring

Методика
фінансового скорингу
від YouControl

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Financial scoring
This is a system of estimation of a company’s financial sustainability by translating the calculated financial indicators into scores. YouControl’s financial scoring results in a composite index called FinScore.

FinScore

FinScore is a score index that measures a company’s financial sustainability, calculated by YouControl analysts. It is based on 10 financial indicators that provide a comprehensive description of the company’s liquidity, solvency, profitability and business activity. Since this index is used, first of all, to compare competitors in the market of Ukraine, it is not vulnerable to global changes within a particular industry. This index describes a company’s financial standing in comparison to other companies in a particular industry.

The values of the FinScore index may vary from 1 (minimum financial sustainability) to 4 (maximum financial sustainability), depending on the values of the company’s financial indicators.

Components of this index have been thoroughly selected based on the results of empirical analysis of trends of about 50 conventional financial indicators.

Risk indicators used in calculating this index demonstrate maximum forecasting capacity that allows predicting the probability of a company’s bankruptcy.

That means that Ukrainian companies with lower values of these indicators more often went bankrupt than their competitors during the analysed period of 2011 to 2015.

Components of the FinScore index

Financial indicator
FORMULA
Liquidity
Financial indicator
Current Ratio
FORMULA
Current Ratio =

Current assets / Current liabilities x 100%

Current Ratio - measures a company’s ability to pay off its current liabilities with an up to one year’s period of maturity, with its current assets. This ratio shows whether the company has sufficient resources to satisfy short-term claims of its creditors. Recommended value > 100%.

Financial indicator
Cash Ratio
FORMULA
Cash Ratio =

Cash & Equivalents / Current liabilities x 100%

Cash Ratio is the strictest liquidity ratio that measures a company’s ability to pay off its current liabilities with only cash or cash equivalents. This ratio shows whether a company has sufficient cash to satisfy creditors’ claims at any particular point in time. Recommended value > 20%.

Solvency
Financial indicator
Equity-to-Assets
FORMULA
Equity-to-Assets =

Equity / Assets x 100%

Equity-to-Assets is a solvency indicator. Proportion of assets financed with equity.

Profitability
Financial indicator
ROA – Return on Assets
FORMULA
ROA =

Net Profit / Assets x 100%

Return on Assets (ROA) is a profitability indicator. ROA gives an idea as to how efficiently management use company assets to generate profit

Financial indicator
RCA – Return on Current Assets
FORMULA
RCA =

Net Profit / Current Assets x 100%

Return on Current Assets (RCA) is a profitability indicator calculated as profit divided by current assets. Firm's efficiency to use its current assets.

Financial indicator
NPM – Net Profit Margin
FORMULA
NPM =

Net Profit / Revenue x 100%

Net Margin (NPM) is a profitability ratio of a company’s net profit to total revenues. The higher is the net profit margin, the more efficient the company is in terms of its ability to translate sales into real profit. Negative values mean losses.

Financial indicator
ROTA – Return on Total Assets
FORMULA
ROTA =

EBIT / Assets x 100%

Return on Total Assets (ROTA) is a profitability indicator. ROA gives an idea as to how efficiently management use company assets to generate operational profit (or earnings before interest and taxes).

Business activity
Financial indicator
Total Assets Turnover
FORMULA
Total Assets Turnover =

Revenue / avg Assets

Total Assets Turnover is a business activity indicator. The efficiency of a company's use of its assets to product sales. The ratio helps to measure the productivity of a company's assets.

Financial indicator
Working Capital Turnover
FORMULA
Working Capital Turnover =

Revenue / avg Working Capital

Working Capital Turnover is a business performance indicator that measures how well a company is utilizing its working capital in terms of the generated sales revenues. Working capital is the difference between the current assets and current liabilities. Optimal values vary for various industries.

Financial indicator
Receivables Turnover
FORMULA
Receivables Turnover =

Revenue / avg Receivables

Receivables Turnover is a business activity indicator. This ratio determines how quickly a company collects outstanding cash balances from its customers during an accounting period.

Index FinScore

The values of each indicator included in the FinScore index are automatically translated into 1 to 4 scores depending on their rank against empirical quartiles of a set of values of a respective indicator for the rest of the companies in the market. Where the value of a company’s indicator tends towards the maximum positive value in terms of financial sustainability, the company gets 4 for this indicator. Companies with worse values get lower scores.

Example:

Empirical quartiles of a set of values of the net profit margin (NPM) indicator for the analysed year and a respective sector of economy were [0%, 1%, 5%]. So the score for this indicator for the companies in the sector was calculated in the following manner:

Where the company had very high net profit margin (NPM > 5%) it got 4 scores.

In case 1 < NPM < 5% the company got 3 scores.

In case 0 < NPM < 1% the company got 2 scores.

In case NPM < 0% the company got only 1 score.

Scores for the rest of the indicators included in the FinScore index can be calculated in a similar manner.

The general FinScore index is calculated using the following formula:

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Fi – score for the factor expressed as indicator i. Constraint: youcontrol

Wi – weight of factor Fi — Constraint: youcontrol

n – number of index indicators. n= 10.

The FinScore index cannot be calculated where it is impossible to calculate all component indicators. Though you can view values of the available components in the YouControl system at any time.

Numeric value of FinScore

Each numeric value of FinScore (4 to 1) corresponds to a particular letter of the alphabet which describes the relative level of financial sustainability in a particular market.

A

High level of financial sustainability
(Above the upper FINSCORE quartile)

B

Good level of financial sustainability
(Above the median line of FinScore)

C

Satisfactory level of financial sustainability
(Above the lower FINSCORE quartile)

D

Unsatisfactory level of financial sustainability
(Below the lower FINSCORE quartile)

Numeric value of FinScore

Each numeric value of FinScore (4 to 1) corresponds to a particular letter of the alphabet which describes the relative level of financial sustainability in a particular market.

FinScore’s historically proved forecasting capacity

The efficiency of the financial scoring model suggested by YouControl analysts has been proved by the history of bankruptcies of Ukrainian companies.

Thus, the companies that went bankrupt had demonstrated average lower values of the index compared to the survived companies. Decrease of this index also signals about potential degradation of financial sustainability.

Years displayed
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Thus, the companies that went bankrupt in 2017 had been demonstrating decreasing FinScore index during the previous 7 years (Diagram 1), unlike the still existing companies whose FinScore median had not been changing (Diagram 2).

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DIAGRAM 1. FINSCORE INDEX OF BANKRUPT COMPANIES

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DIAGRAM 2. FINSCORE INDEX OF SURVIVED COMPANIES

Keep in mind

FinScore method is a quick analysis of the level of a company’s financial risks that helps users to make quick decisions on whether or not a further deeper study of the company is needed. Please be advised that this index cannot be qualified as credit rating as the latter requires a more detail expert analysis and taking account of a series of additional qualitative factors, in particular level of external support, reputation of shareholders and other operational and legal risks.

The FinScore index has a probabilistic nature, that’s why even maximum values of this index never provide a 100% guarantee of financial sustainability, but only suggest that the probability of bankruptcy for such company is relatively lower. This is an information product that reflects YouControl’s vision of the general level of financial risks. It is the user who is supposed to draw final conclusions about a particular company’s financial sustainability taking account of other, including qualitative, factors and additional sources of information.

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