FINANCIAL

STATEMENT
AND ANALYSIS
MODULE 7 and 8 - Learning Material
 Understanding the Basic Financial Statements

THE STATEMENT OF FINANCIAL POSITION

is also called “balance sheet”. It is a financial snapshot of your

business at a given date in time.
provides information on the company’s assets, liabilities, and
equity.

The Accounting Equation is (ASSETS = LIABILITIES + OWNER’S

EQUITY).
It is the basis for the statement of financial position.
It can be reported in two formats: the REPORT FORM and the
ACCOUNT FORM.
1. REPORT FORM - the statement of
financial position can be presented
in vertical format known as the
report form with the assets section
above the liabilities and equities
section, that together, balance it.
2. ACCOUNT FORM - the
entire statement of financial
position is normally presented
in horizontal lay out, with an
assets page on the left, and a
page for liabilities and equities
on the right.
 STATEMENT OF COMPREHENSIVE INCOME - also known as the “Income Statement” where it
summarizes the company’s revenues or sales and expenses quarterly and annually for its fiscal year.

FORMS OF PRESENTATION OF STATEMENT OF COMPREHENSIVE INCOME:

A. MULTI-STEP APPROACH - the statement of comprehensive income using the multi-step approach
shows the various profitability stages from gross profit, operating profit up to the net profit which is
essential in terms of cost control and management.

B. SINGLE STEP APPROACH - the service type of statement of comprehensive income was shown using a
single step approach as it simply identifies the income that comes from professional fee and all expenses
group together to arrive to a net profit.

STATEMENT OF CHANGES IN EQUITY - shows all changes in owner’s equity for a period of time. Its
purpose is to provide readers with the useful information on how the capital or fund of an entity is utilized
and used since it shows the movements of equity and accumulated earnings and losses, the readers can
depict on where the company’s equity came from and where did it go.
OVERVIEW OF FINANCIAL STATEMENT ANALYSIS - is the process of identifying financial strength
and weakness of the firm by properly establishing relationship between the items of the balance sheet
and income statement account.

USES OF FINANCIAL STATEMENT ANALYSIS - financial statements are prepared to commit external
reporting obligations and also for decision making purposes. It played a dominant role in setting
framework of managerial decisions. But the information provided in the financial statements is not an
end to itself as no meaningful conclusions and can be drawn from this statement alone.

TRENDS - the results given in generally cover at least the previous three full accounting years therefore
any fluctuations in any area can be easily pinpointed.
BENCHMARKS - the average result for each ratio together with the industry profile of the average
company in the sector can be both be used as benchmarks to compare individual company
performance.
SIZE - all the major companies in the sector are rank on the basis of sales, profit, total assets and
employee numbers. The largest and smallest of the key players can be easily identifies, while the
relative size of any company can assessed.
GROWTH - the average annual growth of each company's sales, profits, total assets and number of
employees over the three year period being analyzed is calculated and ranked.
ADVANTAGES OF FINANCIAL STATEMENT ANALYSIS
The major benefit is that the investors get enough idea to decide about the investments of their funds in the
specific company.
Secondly, regulatory authorities like International Accounting Standards Board can ensure whether the
company is following accounting standards or not.
Thirdly, financial statements analysis can help the government agencies to analyze the taxation due to the
company.

LIMITATIONS OF FINANCIAL STATEMENT ANALYSIS - Although financial statement analysis is highly useful tool. It
has two limitations:

1. COMPARISON OF FINANCIAL DATA - Comparison of one company with another can provide valuable clues
about the financial health of an organization. Unfortunately, differences to accounting methods between
companies sometimes make it difficult to compare the companies' financial data.

2. THE NEED TO LOOK BEYOND RATIOS - an inexperienced analyst may assume that ratios are sufficient in
themselves as a basis for judgment about the future. Conclusion based on ratios analysis must be regarded as
tentative. It should not be viewed as an end, but rather they should be viewed as starting point, as an indicator of
What to pursue in greater depth. In addition to ratios, other sources of data should be analyzed order to make
judgment about the future of an organization.
TOOLS AND TECHNIQUES OF FINANCIAL STATEMENT ANALYSIS:
HORIZONTAL ANALYSIS OR TREND ANALYSIS - Comparison of two or more year’s financial data. It is facilitated by
showing changes between years in both peso and percentage form.
VERTICAL ANALYSIS - The procedure of preparing and presenting common-size statements.
Common-size statement is one that shows the items appearing on it in percentage form as well as in
peso form. Key financial changes and trends can be highlighted by the use of common-size
statements.
 RATIO ANALYSIS
The most powerful tool of financial statement analysis.
Ratio simply means one number expressed in terms of another.
Ratios can be found out by dividing one number by another number.
Ratios shows how one number is related to another in terms of another.

PROFITABILITY RATIO. Measures the results of business operations or overall performances and effectiveness of
the firm. Some of the most popular profitability ratios are:

A. GROSS PROFIT RATIO

FORMULA: Gross profit ratio= (gross profit / net sales) x 100
NET SALES is the total revenue, less the cost of sales returns, allowances, and discounts.
EXAMPLE: Total sales = P260,00; Sales returns= P10,000; Cost of goods sold P200,000
CALCULATION: Gross profit = [(260,000 - 10,000) - 200,000] = 50,000
Gross Profit Ratio = (50,000/250,000) x 100 = 20%

SIGNIFICANCE: Gross Profit ratio reflects efficiency with which a firm produces its products. As the gross profit is
found by deducting cost of goods sold from net sales, the higher the gross profit, the better it is. There is no
standard gross profit ratio, and it varies from business to business. However, gross profit earned should be
sufficient to recover all operating expenses and to build up reserves after paying all fixed interest charges and
dividends.
 B. NET PROFIT RATIO
FORMULA: Net profit ratio = (net profit / net sales) x 100
EXAMPLE: Using same example above except that net profit is P20,000
CALCULATION: Net Sales = (260,000 – 10,000) = 250,000
Net Profit Ratio = [(20,000/250,000) x 100] = 8%

SIGNIFICANCE: This ratio measures the overall profitability and very useful to proprietors or owners of the company.
This indicates the firm's capacity to face adverse economic conditions such as price Competitions, low demand, and
similar situations, The higher the ratio the better is the profitability.

C. OPERATING RATIO
FORMULA: Operating ratio =((Cost of goods sold + Operating expenses)) / Net Sales x 100
EXAMPLE: Cost of goods sold is P90,000 and other operating expenses are P15,000 and net sales is P150,000.
CALCULATION: Operating ratio = {(90,000 + 15,000) / 150,000} x 100 = {115,000/ 150,000} x 100 = 70%

SIGNIFICANCE: This ratio shows the operational efficiency of the business. Lower operating ratio shows higher
operating ratio and vice versa. An operating ratio ranging between 75% and 80% is for manufacturing generally
considered as standard yardstick of operating efficiency, but number of uncontrollable factors beyond the control of
the firm.
LIQUIDITY RATIO

Measures the short-term solvency of financial position of a firm. These ratios are calculated to comment
upon the short-term paying capacity of a concern or the firms ability to meet its current obligations.
Following are the most important liquidity ratios.

a. CURRENT RATIO
FORMULA: Current ratio = Current Assets/Current Liabilities
EXAMPLE: Current Assets are P600,000 and total current liabilities are P300 000
CALCULATION: Current ratio= P600,000/P300,000 = 2:1

SIGNIFICANCE: This ratio is a general and quick measure of liquidity of a firm. It is an index of the firm's
financial stability, technical solvency and strength of working capital. A high current ratio is an indication
that the firm is liquid and has the ability to pay its current obligation in time and when they become due.
A ratio equal to or near 2:1 is considered as a standard or normal or satisfactory. The idea of having
double the current assets as compared to current liabilities is to provide for the delays and losses in the
realization of current assets.
 b. LIQUID/ ACID TEST/ QUICK RATIO

FORMULA: [Liquid ratio = Liquid Assets/Current Liabilities]

EXAMPLE: Cash P90 :Accounts receivable P730: Inventory P900: Marketable securities P800
Accounts Payable P350 : Notes payable P500 : Accrued expenses P75: Tax payable P550
CALCULATION: Liquid Assets = 90 + 730+ 800 = P 1,620
Current Liabilities= 350+ 500+ 75+ 550 = P1,475
Liquid Ratio = 1,620/1,475 = 1.10 :1

SIGNIFICANCE: The quick ratio measures the firm's capacity to pay off current obligations
immediately and is more rigorous test of liquidity than the current ratio. It is more rigorous because
it eliminates inventories and prepaid expenses as a part of current assets. Usually, a high liquid
ratio is an indication that the firm is liquid and has the ability to meet its current or liquid liabilities in
time and on the other hand, a low liquidity ratio represents that the firms liquidity position is not
good. A quick ratio of 1:1 is considered as satisfactory.
 Thank
you very
much!