FINANCIAL

STATEMENT
ANALYSIS
Part 1
 LEARNING OBJECTIVES
 Know and explain the various ways financial
statements are analyzed
Know and explain the objectives of financial statement
analysis
Know the steps in doing financial statement analysis

Know and explain the limitations of financial statement

analysis
Perform the steps in financial statement analysis by
applying the different techniques, interpretations,
conclusions, and draw the implications based on the
results of the application
FINANCIAL STATEMENT ANALYSIS
Parts of Financial Statements – quantitative and
verbal/narrative information.
Quantitative portion presents the assets, liabilities,
equity and results of operations.
Verbal/narrative portion explains why and how those
results came to be.
How?

By doing a longitudinal evaluation of the financial data

and analysis of financial ratios
FINANCIAL STATEMENT ANALYSIS
Credible financial statement analysis is a by-product if
a good analytic mind and the application of thorough
research skills.
Research is important to account for and explain the
results of the analyst’s computations.
As analyst, you must be able to account for the increase
or decrease of the items in the financial statements,
which in your judgment is considered salient.
This means you must be able to explain why these
increases of decreases occurred.
 OBJECTIVES OF FINANCIAL
STATEMENT ANALYSIS
Profitability. It pertains to the ability of the firm to
yield a sufficient amount of return on company sales
assets and invested capital. It also refers to the firm’s
capacity to generate earnings vis-à-vis its expenses and
other relevant costs incurred during a specific period of
time.
Liquidity and Stability. Liquidity is also referred to as
working capital position or short-term financial
position. It is the ability of the firm to meet or pay its
current or short-term maturing obligations.
 OBJECTIVES OF FINANCIAL
STATEMENT ANALYSIS
Asset Utilization or Activity. This pertains to how
efficient the company is in managing its resources. It
also refers to the firm’s speed or pace in turning over
accounts receivable, inventory and long term assets.
This reveals the frequency of the firm in selling its
products or in collecting its receivable. In so far as fixed
or long terms assets are concern, it reveals how the
company uses their fixed assets to yield revenue.
Debt Utilization or Leverage. This pertains to the
overall debt status of the company. It measures the
degree of how the firm is financed. The debt is evaluated
using other variables like assets, equity an earning
power.
 FINANCIAL STATEMENT ANALYSIS
RESPONSIBILITIES:
 The CFO (Chief Financial Officer) is responsible for
analyzing financial statements, and for preparing
reports and recommendations to Top Management and
the Board of Directors concerning financial
performance.
 Top Management and the Board of Directors are
responsible for reviewing financial analysis and
approving corrections or improvements to financial
policies, objectives, or activities.
 The Controller is responsible for providing the CFO
with financial accounting statements at the end of
each financial period.
FINANCIAL STATEMENT ANALYSIS DEFINITIONS:

 Financial Statements – Statements, typically created

monthly, that give an overall picture of business
operations and of financial condition.
 Financial Analysis – To perform appropriate
calculations and evaluations of information contained
in financial statements in the form of historical trends,
relationship ratios.
 Financial or Accounting Period – The length of time
businesses use for preparing and reviewing internal
accounts to monitor business performance (e.g.,
weekly, monthly). The period used depends on the
industry, business model, and business dynamics.
LIMITATIONS OF FINANCIAL STATEMENT
ANALYSIS

 1. The primary purpose of financial statement analysis

is to examine the present, as well as past, financial
position and results of operations of the firm in order
to determine the best suitable estimate and predict the
future state and performance of the company.
 With this in mind, it would be fair to state that
interpretations of financial ratios are not ultimately
conclusive.
 Results from the analysis are refutable.
LIMITATIONS OF FINANCIAL STATEMENT
ANALYSIS

 2. The main object (the financial statement) used for

the analysis is also subject to limitations due to its
failure to consider changes in the purchasing power,
inconsistencies a well as dissimilarities in the
accounting principles, policies and procedures used by
the firms in the industry.
 3. The reality that a firm is trading in the stock
exchange and that its financial statements are readily
available does not guarantee that the company in
question is financially stable and credit worthy
PRACTICAL STEPS PROPOSED IN ANALYZING
FINANCIAL STATEMENTS

 1. Determine which objectives would be the coverage of

the analysis.
 2. Learn about the retrospective, current, as well as
prospective conditions of the industry because the
analysis done may cover not only the subject firm but
could involve other firms belonging to the same
industry.
 3. Get to know the firm you are analyzing. Know their
vision, mission, strategic plans because it may prove to
have a bearing on your financial analysis.
PRACTICAL STEPS PROPOSED IN ANALYZING
FINANCIAL STATEMENTS

 4. ASSESS/ ANALYZE the financial statements. The

analysis should cover the salient areas namely:
profitability, liquidity or solvency, stability, and
operational efficiency of the firm.
 Horizontal Analysis ( Dynamic measure or Trend
Ratios) – comparative analysis
 Vertical Analysis (Static Measure of Structural Ratios)
– common size statement
 5. INTERPRET the results of the computations and
ratios.
 6. Draw CONCLUSIONS from the interpretations
made taking into consideration the objectives you
have set.
COMPARATIVE
ANALYSIS -
HORIZONTAL
 Comparative Financial Statement
Analysis is a form of horizontal analysis where
Financial Statements of two or more years or of
two or more different companies or of a company
and its industry are compared, analyzed and
interpreted. Therefore, this technique of
analysis is also called Inter-period Analysis
(when Financial Statements of two or more
years are taken into consideration) or Inter-firm
Analysis (when Financial Statements of two or
more companies are taken into consideration).
THE FOLLOWING ARE THE MOST
COMMONLY USED FORMS OF SUCH
ANALYSIS:

 Comparative Balance Sheet

 Comparative Income Statement
 Comparative Cash Flow Statement
 Under year to year change analysis, all the
elements of Balance Sheet or Income
Statement are compared and absolute changes
as well as percentage changes are calculated
on the basis of previous year as the base year.
 Changes in Fixed Assets, Investments,
Current Assets, proprietor Fund, Current
Liabilities, etc. are compared to determine
long-term solvency position of the firm,
growth, etc. of the firm.
 From Comparative Income Statement, we are
able to know absolute and percentage changes
in gross profit, operating profit, net profit, etc.
A comparative statement exhibits the following
pertinent information:
 Absolute figures for two or more years of the
items appearing in Financial Statements (i.e.,
in the Balance Sheet and in Income
Statement).
 Changes in absolute figures of the current year
as compared to the previous year taken as the
base year (or firm-wise changes).
 Percentage changes in absolute figures of the
current year on the basis of the base year (or
percentage of firm-wise changes).
FORMAT
2018 2019 Amount of Percentage
Increase of Increase
(Decrease) (Decrease)
Cash and 400,000 600,000 200,000 50
Cash
Equivalents
Trade and 2,600,000 2,900,000 300,000 11.54
Other
Receivables
Inventories 1,200,000 1,000,000 (200,000) (11.67%)

Prepaid 0 400 400 n/a

Expenses
 Comparative financial analysis is the
process of analyzing the data found in a
financial report in comparison with similar data
from other reports. This allows whoever is doing
the analysis to get some context which makes
the raw numbers more meaningful. An
individual can do comparative financial analysis
by studying several reports of the same company
from different time periods in an effort to spot
trends. Another way to practice this type of
analysis is to compare the reports of different
companies that compete with each other in the
same industry.
LEARNING ACTIVITIES
 Assignment