Chapter 4

INFLATION AND FINANCES

 

The inflationary phenomenon widely explains and justifies the tax direction of the accounting. Process due to the loss of the buying power of the money, every time more monetary units are required to acquire goods or to cover the costs, which causes that the companies retain profits through mechanisms that reduce the payment of them of less imposing and fewer dividends. The approach to this subject is eminent, independent of the accounting procedure.

The money loses its character of exact measurement because the dollar of today is different from the dollar of some time. Ago in a balance, they appear money of the day of closing (effective), with money of months prior (accounts to receive and inventories) and money with prior years (fixed assets).

This article explains the economic phenomenon. We left from the base that it exists and consequently it is an obstacle that must be overcome by the businessman. Let us remember briefly that the phenomenon is explained fundamentally by an imbalance between supply and demand. This grows permanently; however, the supply in the short-term is non-flexible, when more is as much specialized more is the product in individual.

The economists and mathematicians decide on a periodic rate that serves as a base for the calculation. For them, it is based on the cumulative formulas, the same ones that are used to calculate the compound interest.

P1= P (1 + i) P2= P + P1 (1 + i)2 Pn= P2 + P1 (1 + i)n

Now let us concentrate on an approach eminently lay.

In real life, the phenomenon is another one. For each company, the raw materials raise in intermittent form. Usually, the manual labor is increased once a year, raw materials once or twice a year, agricultural products, according to the time, the scholastic texts once a year, etc.

It is more recommendable, to come closer to reality, to treat the inflation in this way: When processing the plan of value generation, the company tries to predict with its own experience, the possible rises and the repercussions of the sale prices and the additional requirements of work capital.

Some authors suggest as a more recommendable measurement of the financial situation of a company, who deflates the earnings statements in accordance with the PAAG indexes, percentage of adjustment of the accountable year.

The technique is very simple. It consists of multiplying all the adjustable figures by the PAAG and expressing them as one acquires knowledge in the example. Although the technique introduces additional elements of information, it does not solve in a satisfactory way the problem that raises from the permanent loss of buying power of the currency as a result of inflation. We are going to explain it.

Two basic problems to consider:

a. Which index to choose?

b. Accounts, which are affected in a direct way with the variation of the indexes? 

1. WHAT INDEX TO CHOOSE?

General and by sectors Index appears. Some suggest each company must use the index of the sector in which it operates. Others propose the use of the general index arguing that, although the company operates in a certain sector, the monies that it generates, finally go to the owners who use them to satisfy needs of a different order and not very often it is possible to be identified by the cost and the source of used money and, in addition, it doesn't make any sense to do it. By simple logic, it is more recommendable the (PAAG) indicator, the rate of devaluation for assets and obligations in foreign currency, and UPAC for the specific cases that they appear. 

2. ACCOUNTS THAT ARE AFFECTED AND HOW?

Let us begin to say that except for the account of cash and banks, all the others are affected by the inflationary phenomenon, but not necessarily in direct proportion. In the case of the temporary investments, the yield margin must contemplate the expected inflation in a directly proportional way.

To the accounts to receive it happens something similar but in inverse proportion. Those who sell on credit must consider when fixing the yield margins, the reduction of prices based on the term. If the rate of inflation that appears surpasses the expectation that is considered to make the calculation, the selling company is affected in that proportion and the benefited buyer. In the opposite case, is the contrary?
With the inventories, it is too relative. In the case of consumption product stores, the effect is directly proportional as it happens in the supermarkets, with the products that compose the basic goods and groceries of a household. Another great amount of goods completely has independent specific behaviors of the index of prices that are published. In this heading, they prioritize other variables like the type of products, the phenomena of technical obsolescence, fashionable changes, technological innovations, costumers changes, and others that require specific analysis.

With the fixed assets in general, the index of increase in the cost of living, little, or anything can be done. A good exercise consists of taking the value from the purchase of machinery (as the phenomenon is opposite), instead of deflating; to extend by the corresponding index and soon to do its own thing with the depreciation it must have and compare the net value that is obtained with the value of the market, to see the independent thing that are the two variables (index of prices to the consumer and value of the market in the machinery and the team in general).

With the real state, the phenomenon is more independent. In this case, the valuation or possible devaluation depends on another great amount of variables that are not the object of this article, as in general the economic conditions, the situation of public order, etc. Some authors teach that, with inflation, the debtors are benefited and recommend the indebtedness widely when the economy is inflationary. Serious mistake. Whoever lends money (the financial sector), and then calculate the interest rate by means of the sum of the inflation expected, the risk, and an awaited yield. The indebtedness is recommendable in the measurement that it exists a clear expectation of yield, with reasonable risk.

All the presented objections, take us to a clear conclusion. And it is that the arithmetical operation does not solve the disinformation problem that appears in regard to the currency principle, which assumes the constant value. If the method of adjustment of financial statements does not solve the problem what do we do?

It depends on the spreading of the decision, to know how much we are going to invest in the calculation of a very precise value. As a general recommendation, the use of a criterion of valuation adapted for all the headings of the assets and the liabilities; the patrimony or value of the company calculates by difference. Don’t forget that in the event of distractions, the effect of taxes is by occasional gains. 

3. HOW TO SOLVE THE PROBLEM? - General Recommendations

A. TO INCREASE THE PRODUCTIVITY: while the productivity is increased, will be the relative increase of the costs will be less, by the effect of the behavior of the fixed average cost. In the measurement that the costs of the particular company are raised in a smaller proportion than the general index of prices, the situation will be more advantageous.

The great advance in communications has shortened enormously the distances between the towns. Through the television and the Internet, the world simultaneously lives the launching of a fashion, a technological development, a scientific advance, etc. The speed of information and the advance in transportation have contributed enormously to the development of foreign trade and each time more and more it speeds up.

While the difference of prices is greater between produced comparable goods in different countries, greater it will be the temptation of the consumers and users to matter, because we must not forget that in the long run, the forces of the market prevail.

Whoever obtains smaller production costs, is in better condition to compete in the market and to obtain the best margin of contribution. Benchmarking is a problem for each industrialist to look for the different possibilities of increasing the productivity of its useful raw materials. 

B. HIGH ROTATION OF ASSETS IN GENERAL: while more express the costs to recover and profit is obtained, greater will be the probability of pesos of the same buying power of the invested ones are received. The sale of counted aid much to this intention; thus they are possible as the profits in the cash flow. 

C. NEGOTIATION IN HARD CURRENCY: these have the particularity of not losing buying capacity. Consequently, the weak currencies lose in relation to them. Whoever exports, receives more and more pesos, by such dollars, which represents an automatic mechanism of readjustment of prices, plus the possible increases that are agreed upon in terms of that strong currency, based on the small devaluation that it can sustain. 

D. TO AVOID INDEBTEDNESS IN HARD CURRENCY: by the same previous explanation, viewed in the opposite sense, as long as the circumstances allow it because we know that the generally sophisticated machinery and equipment come from the industrialized countries. The same case appears with some basic raw materials. 

E. RETENTION OF PROFITS: it represents an automatic capitalization. Logically, this affirmation is due to interpreting as a guide, not forgetting that the investors look for attractive yields in the long term, but wishes immediate benefits for the sake of their liquidity.

Of course, all the investors do not have the same expectations and the management must look for the capitalization of the company, forgetting all the group of shareholders or owners, but consulting the general interest through the growth of the value of the shares in the market. 

F. USE LIFO FOR COSTS: the method assumes that the last units in entering inventory are the first in leaving, therefore to the profits and therefore the payment of taxes and the distribution of dividends are reduced. This method interprets the principle of the company very well because the legal entity has indefinite life with a permanent increase and it will always have to replace and increase its inventories. 

G. ACCELERATED DEPRECIATION: this accounting processing helps to reduce the profits and to recover the investment with devalued pesos. Thus the replacement of equipment in agreement with the technological advances is facilitated, increasing levels of productivity and therefore, competitiveness. 

H. OLD FASHIONED ACCOUNTING: as in the previous cases, it reduces the apparent profits, not the real ones, which are rather increased by the no paid taxes. Once again, we remember that we cannot absolutely forget the shareholders, who constitute the most important pillar for the company. 

F. TO PAY FOR STANDARD: the most valuable technique, because one goes ahead to the inflationary phenomenon, projecting increases of raw materials using the indicators available and the criterion of the experts.
The analysis of the causes of variation in the three elements of the cost: manual labor, raw materials, and general expenses of manufacture, helps to detect problems, improve future estimations, and to implement oriented plans to increase the .
Thus the industrialist goes ahead to the occurrence of the phenomenon and can fix prices that maintain the expected margins for him of profit in real terms, in addition to being a base for the control of costs and the increase of productivity. 

G. TO TREAT THE NOT PAYMENT TAXES BY MONETARY CORRECTION: in case it exists in the taxing legislation. For it, one looks for an equilibrium between the value of the patrimony and the value of the monetary assets to neutralize the effect of the adjustments on the profit or monetary loss. Analyzing the structure of the equilibrium, differentiating active monetary three general situations can appear:

a. Non Monetary assets superior to the Patrimony

Monetary assets Non Monetary assets

Patrimony

It implies greater monetary profit and therefore more taxes from rent. One is a no distributable profit because it is not endorsed by a cash flow.

b. Active monetary = Patrimony

Monetary assets

Patrimony

In this case, the account of monetary correction is neutral; it is most recommendable to neutralize the tributary effect due to the tributary phenomenon.

c. Active no monetary minors that the patrimony

Monetary assets Non Monetary assets

Patrimony

This it is the case of an account of monetary correction with smaller profit and fewer payments of taxes. 

4. ACCOUNTS OF MONETARY CORRECTION

It summarizes by counterpart, all the no monetary adjustments of assets and liabilities, those of patrimony, and those of income, costs, and expenses. It does not consider the adjustments in foreign currency and in UPAC, whose adjustment goes directly to the earnings statement.

One occurs as understood that the general management and particularly the financial executive must be permanently found out the taxing legislation on the matter to be able to take the most recommendable measures for the company individually. Independently if the government demands or not adjustments by inflation or as it regulates them, it is a managerial and very special responsibility of the executives of the accounting and financial area, to prepare financial statements with an eminently administrative approach, which helps to calculate the possible and most objective way the value of the company so that therefore the shareholder can know the intrinsic value of the share and can make a guess of the right decisions.

Example:
In the following pages one acquires knowledge with a good example the re-ex-pressing financial statements (PAAG = 15,69)

GENERAL BALANCE SHEET
(expressed in thousands of pesos)

Non Current liabilities
Financial obligations	20,530,287	23,425,589	27,101,064
Received advance payments and advances	0	2,085,457	2,412,665
Deferred taxes	10,889,250	8,202,286	9,489,225
Credits by monetary correction	7,503,277	7,893,038	9,131,456
Commercial bonds and papers	4,500,000	4,900,000	5,668,810
Non Current passive total	43,442,814	46,506,370	53,803,220
Passive total	65,200,047	66,637,694	77,093,145
Patrimony of the shareholders
Share capital	15,644,483	15,644,483	15,644,483
Premium in positioning of shares	46,574,957	46,576,957	46,576,957
Accumulated gains:
Reserves	17,630,091	14,209,440	14,209,440
Results of exercise	10,546,547	13,011,463	15,052,962
Total accumulated gains	28,176,638	27,220,903	29,262,402
Revaluation of the patrimony	69,167,840	48,459,168	68,054,103
Surplus by valuations	12,498,176	17,747,070	20,531,585
Surplus participation method	715,471	256,797	297,088
Total patrimony of the shareholders	172,777,565	155,903,378	180,364,618
PASSIVE TOTAL AND PATRIMONY OF THE SHAREHOLDERS	237,977,61	222,541,072	257,457,763
ORDER ACCOUNTS ON THE OTHER HAND	48,977,007	43,981,788	50,882,531

 

RESULT  STATEMENT
(expressed in thousands of pesos)

Non Current liabilities
Financial obligations	20,530,287	32,425,589	27,101,064
Received advance payments and advances	0	2,085,457	2,412,665
Deferred taxes	10,889,250	8,202,286	9,489,225
Credits by monetary correction	7,503,277	7,893,038	9,131,456
Commercial bonds and papers	4,500,000	4,900,000	5,668,810
Non Current passive total	43,442,814	46,506,370	53,803,220
Passive total	65,200,047	66,637,694	77,093,145
Patrimony of the shareholders
Share capital	15,644,483	15,644,483	15,644,483
Premium in positioning of shares	46,574,957	46,576,957	46,576,957
Accumulated gains:
Reserves	17,630,091	14,209,440	14,209,440
Results of exercise	10,546,547	13,011,463	15,052,962
Total accumulated gains	28,176,638	27,220,903	29,262,402
Revaluation of the patrimony	69,167,840	48,459,168	68,054,103
Surplus by valuations	12,498,176	17,747,070	20,531,585
Surplus participation method	715,471	256,797	297,088
Total patrimony of the shareholders	172,777,565	155,903,378	180,364,618
PASSIVE TOTAL AND PATRIMONY OF THE SHAREHOLDERS	237,977,61	222,541,072	257,457,763
COUNTS  ORDER	48,977,007	43,981,788	50,882,531

The total effect of the adjustments by taking inflation to results was a loss of $1.609.439 (1997 utility by $1.001.812)

 

STATE OF CASH FLOW
(expressed in thousands of Dollars)

	Year n ___________	Year (n - 1) ___________	Year (n - 1) (re expressed) _______________
BY OPERATION ACTIVITIES
Received cash of clients	87,106,196	89,032,877	103,002,135
Paid cash a:
Suppliers	20,787,674	16,518,356	19,110,086
List, benefits and contribute	5,221,986	4,143,694	4,793,840
Payments to third	21,473,990	23,473,634	27,156,647
Subtotal cash payments	47,483,650	44,135,684	51,060,573
Other income of operation	340,314	30,956	35,813
Effective Subtotal generated by the operation	39,962,860	44,928,149	51,997,375
Investment in properties, plants and equipment	-5,265,642	-9,605,854	-11,113,012
Income in properties, plant and equipment	4,418,329	0	0
Subtotal (effective net by investment in capital assets)	-847,313	-9,605,854	-11,113,012
Investments in shares and quotas of social interest	-3,423,796	-11,026,382	-12,756,421
Income by sale of shares	0	6,000	6,941
Received dividends	0	652,173	754,499
Received interests and monetary correction	171,909	499,164	577,483
Subtotal (cash flow by investment in titles values)	-3,251,887	-9,869,045	-11,417,498
Subtotal of net cash by investment	-4,099,200	-19,474,899	22,530,510
Received loans	25,227,384	39,810,696	46,056,994
Payment of loans	-31,908,935	-56,741,846	-65,644,642
Paid interests	-4,179,242	-5,092,975	-5,892,063
Emission of shares	0	19,267,116	22,290,127
Paid dividends	-8,443,041	5,446,116	-6,300,612
Payment of quotas of capital of titles debt	-400,00	-100,000	-115,690
Subtotal of net cash by financing	-19,703,834	-8,303,125	-9,605,886
Income of cash by other concepts	2,810,570	2,018,261	2,334,926
Exits of cash by other concepts	-19,997,290	-17,876,118	-20,680,881
Subtotal of net cash by other concepts	-17,186,720	-15,857,857	-18,345,955
TOTAL NET INCREASE OF CASH	-1,026,894	1,292,268	1,495,025
To eating of the year	2,715,696	1,423,428	1,646,764
At the end of the period	1,688,802	2,715,696	3,141,789

 

STATE OF CHANGES IN the FINANCIAL SITUATION
(expressed in thousands of Dollars)

	Year n ___________	Year (n - 1) ___________	Year (n - 1) (reexpressed) ______________
SOURCES OF FUNDS
Net profit	10,546,547	13,011,463	15,052,962
Depreciation and amortization of deposits	22,184,233	18,346,286	21,224,818
Deferred taxes to pay	2,686,964	2,546,825	2,946,422
Credit by deferred monetary correction	0	491,505	568,622
Total resources generated by the operations	35,417,744	34,396,079	39,792,824
Financial resources generated by other sources
Diminution in accounts to receive length term	524,777
Increase in the share capital	0	1,427,194	1,651,121
Premium of positioning of shares	0	17,839,923	20,639,007
Revaluation of the patrimony	20,708,672	16,589,612	19,192,522
Surplus participation method	458,674	202,213	233,940
Total resources generated by other sources	21,692,123	36,058,942	41,716,590
Total financial resources generated in the year	57,109,867	70,455,021	81,509,414
USED FINANCIAL RESOURCES
Diminution in anticipios and advances	2,085,457	764,543	884,500
Increase in properties, plants and equipment	35,068,791	37,953,564	43,908,478
Incremet in positions deferred by deferred C.M	194,239	171,213	198,076
Diminution in financial obligations	3,295,302	4,008,422	4,637,343
Payments in cash of dividends and others	9,590,812	5,725,387	6,623,700
Increase in accounts to receive length term	0	4,546,669	5,260,041
Increase in investments	4,598,778	12,563,964	14,535,250
Deferred positions	655,775	1,424,594	1,648,113
Total used financial resources	55,489,154	67,158,356	77,695,501
INCREASE (DIMINUTION) OF THE CAPITAL OF WORK	1,620,713	3,296,665	3,813,913
TOTAL USED RESOURCES	57,109,867	70,455,021	81,509,414
Discrimination of the variation in the work capital :
Increase (diminution) in the current assets
Available	1,267,823	-172,449	-199,506
Investments	-2,294,717	1,464,717	1,694,531
Indebted	2,633,144	-2,122,812	-2,455,881
Inventories	1,252,660	908,433	1,050,966
Paid in advance expenses	407,711	321,154	371,543
Total increase (diminution) T in active-duty current	3,266,621	399,043	461,653
(Increase) diminution in the current liabilities	3,266,621	399,043	461,653
Financial obligations	-3,133,881	5,665,128	6,553,987
Suppliers	-242,542	44,219	51,157
Accounts to pay	-674,508	-159,291	-184,284
Received advance payments and advances	166,221	57,467	66,484
Tax, burdens, and rates	2,266,734	-2,614,844	-3,056,349
Labor obligations	-27,932	-68,057	-78,735
Total (increase) diminution in the current liabilities	-1,645,908	2,897,622	3,352,260
INCREASE (DIMINUTION) OF THE WORK CAPITAL	1,620,713	3,296,665	3,813,913

Note:
In Colombia, the adoption of International Financial Reporting Standards (IFRS) from 2017 is a sign of the evolution that our country is having towards an accelerated process of internationalization and good corporate governance practices.