Republic of the Philippines

Laguna State Polytechnic University

Province of Laguna
ISO 9001:2015 Certified
Level I Institutionally Accredite

LSPU Self-Paced Learning Module (SLM)

Course Financial Analysis and Reporting

Sem/AY Second Semester/2023-2024
Module No. 1
Lesson Title Introduction to Financial Analysis and Reporting

Week
1-5
Duration
Date January 29 - March 1, 2024
Description This module covers the overview of financial reporting and
of the analysis, roles of financial statement, basic and expanded
Lesson accounting equation.

Learning Outcomes

Intended Students should be able to meet the following intended

Learning learning outcomes:
Outcomes  Describe the nature and purpose of financial analysis
and reporting.
Targets/ At the end of the lesson, students should be able to:
Objectives  State the importance of financial analysis.
 Enumerate the roles of financial statement.
 Republic of the Philippines
Laguna State Polytechnic University
Province of Laguna
ISO 9001:2015 Certified
Level I Institutionally Accredite

Student Learning Strategies

Online Activities A. Online Discussion via Google Meet

(Synchronous/ You will be directed to attend in a One Hour class
Asynchronous) discussion on the nature and types of educational
technologies. To have access to the Online Discussion,
refer to this link: https://meet.google.com/uaa-jmdj-bmj /
https://meet.google.com/tpn-zfmk-pnk
The online discussion will happen on January 29 to March 1,
2024, from 8:00 am to 11:00 am.
(For further instructions, refer to your Google Classroom and
see the schedule of activities for this module)
 Republic of the Philippines
Laguna State Polytechnic University
Province of Laguna
ISO 9001:2015 Certified
Level I Institutionally Accredite

Lesson 1:
Introduction to Financial Accounting

Definition of accounting
Accounting is a process of identifying, recording and communicating
economic information that is useful in making economic decisions.

Essential elements of the definition of accounting

1. Identifying - The accountant analyzes each business transaction and identifies
whether the transaction is an "accountable event" or "non-accountable event." This is
because only "accountable events" are recorded in the books of accounts. "Non-
accountable events" are not recorded in the books of accounts.
"Accountable events" (or 'economic events') are those that affect the assets,
liabilities, equity, income or expenses of a business. Sociological and psychological
matters are outside the scope of accounting.

2. Recording - The accountant recognizes (i.e., records) the identified "accountable

events." This process is called "journalizing."
After journalizing, the accountant then classifies the effects of the event on
the "accounts." This process is called "posting."
 Account is the basic storage of information in accounting, e.g., "cash,"
"land," "sales," etc.

3. Communicating - At the end of each accounting period, the accountant

summarizes the information processed in the accounting system in order to produce
meaningful reports. This is important because information processed in the
accounting system is useless unless it is communicated to interested users.
Accounting information is communicated to interested users through accounting
reports, the most common form of which is the financial statements.

Nature of accounting
Accounting is a process with the basic purpose of providing information about
economic activities that is intended to be useful in making economic decisions.
 Republic of the Philippines
Laguna State Polytechnic University
Province of Laguna
ISO 9001:2015 Certified
Level I Institutionally Accredite

Types of information provided by accounting

1. Quantitative information - information expressed in numbers, quantities, or units.
2. Qualitative information - information expressed in words or descriptive form.
Qualitative information is found in the notes to financial statements as well as on the
face of the other components of financial statements.
3. Financial information - information expressed in money. Financial information is
also quantitative information because monetary amounts are normally expressed in
numbers.

Functions of Accounting in Business

Accounting is often referred to as the "language of business" because it is
fundamental to the communication of financial information.
Accounting has the following two broad functions in a business:
1. To provide external users with information that is useful in making, among others,
investment and credit decisions; and
2. To provide internal users with information that is useful in managing the business.

Users of Accounting Information

Users of accounting information are broadly classified into two, namely:
1. Internal users those who are directly involved in managing the business.
Examples of internal users include:
a. Business owners who are directly involved in managing the business
b. Board of directors
c. Managerial personnel
2. External users those who are not directly involved in managing the business.
Examples of external users include:
a. Existing and potential investors (e.g., stockholders who are not directly
involved in managing the business)
b. Lenders (e.g., banks) and Creditors (e.g., suppliers)
c. Government agencies (e.g., Bureau of Internal Revenue 'BIR', Securities
and Exchange Commission 'SEC')
d. Non-managerial employees
e. Customers
f. Public
 Republic of the Philippines
Laguna State Polytechnic University
Province of Laguna
ISO 9001:2015 Certified
Level I Institutionally Accredite

Forms of Business Organizations

A business is an activity where goods or services are exchanged for money.
A person who is engaged in business is called an entrepreneur or businessman.
Businesses in the Philippines are organized in one of the following:
1. Sole or single proprietorship - is a business that is owned by only one individual.
It is the most common and simplest form of a business organization. The business
owner is called a "sole proprietor."
A sole proprietorship is registered with the Department of Trade and Industry
(DTI).
2. Partnership is a business that is owned by two or more individuals who entered
into a contract to carry on the business and divide among themselves the earnings
therefrom. The business owners are called partners.
A partnership is registered with the Securities and Exchange Commission
(SEC).
3. Corporation - a corporation is also owned by more than one individual. However,
unlike a partnership, a corporation is created by operation of law rather than a
contract. Ownership in a corporation is represented by shares of stocks. The owners
are called stockholders or shareholders.
A corporation is an artificial being or a juridical person, meaning in the eyes of
the law, a corporation is like a person, separate from its owners. Therefore, a
corporation can transact on its own, have its own properties, incur its own obligations,
and sue or be sued.
For example, when you buy goods from a corporate business, you are
actually transacting with the corporation and not its owners. If you get sick from
consuming the goods, you will sue the corporation and not its owners.
A partnership also has a juridical personality. However, unlike for corporations,
the partners are viewed as agents of the partnership. Meaning, the partners transact
on behalf of the partnership.
For example, if you transact with a partner of a business, you are transacting
with the partnership through the partner; while if you transact with a stockholder, this
does not necessarily mean that you are transacting with the corporation.
The incorporators (i.e., founders) of a corporation shall not be less than 5 but
not more than 15 individuals. However, a corporation can have as many stockholders
as its authorized capitalization permits.
A corporation is registered with the Securities and Exchange Commission (SEC).
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ISO 9001:2015 Certified
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4. Cooperative - a cooperative is also owned by more than one individual. However,

a cooperative is formed in accordance with the provisions of The Philippine
Cooperative Code of 2008 The owners of a cooperative are called members.
From the root word "cooperate," a cooperative is an association of individuals
who joined together to contribute capital and cooperate in order to achieve certain
goals.
For example, a group of farmers may form a cooperative to acquire delivery
trucks to be used in transporting their produce to the market. In here, the farmers
voluntarily join together to achieve a common goal, which is to address their need to
get their produce to the market.
A cooperative also has juridical personality similar to a corporation.
The founding members of a cooperative shall not be less than 15 individuals.
However, a cooperative can have as many members as its by-laws permit.
A cooperative is registered with the Cooperative Development Authority
(CDA).

Forms of Business Organizations

Form of business
Ownership Formation/ Registration
organization
1. Sole proprietor  One individual (ie.,  Registered with the
sole proprietor) DTI.
2. Partnership  More than one  Formed by contractual
(i.e., partners) agreement.
 Registered with the
SEC.
3. Corporation  More than one (ie.,  Formed by operation
stockholders) of law
 Registered with the
SEC.
4. Cooperative  More than one  Formed in accordance
(i.e., members) with the Cooperative
Code.
 Registered with the
CDA.
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Province of Laguna
ISO 9001:2015 Certified
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Advantages and Disadvantages of the Different Forms of Business

Organizations

Sole Proprietorship
Advantages Disadvantages
 You are the boss and you keep  You assume all the risk of loss.
all the profits.
 Decision making is simple  You take all responsibility and
because you have complete rely mostly on yourself in making
control over the business. decisions.
 Relatively easier and less costly  It is more difficult to raise capital
to form because there are fewer because you rely mostly on your
formal business requirements. personal assets and loans to
initially finance the business.
 Lower extent of government  You are personally liable for the
regulation and relatively lower debts and obligations of the
taxes. business.

Partnership
Advantage Disadvantage
 Better business decisions can be  Making business decisions may
made because "two heads are give rise to conflict among the
better than one." partners.
 You share the business risk and  You don't keep all the profits
the responsibility of running the because you need to share them
business with your partner(s). with your partner(s).
 Compared to corporations and  Limited life, in the sense that a
cooperatives, a partnership is partnership can be easily
easier to form because only a dissolved by the withdrawal,
contractual agreement between retirement, death or insanity of
the partners is needed. one of the partners.
 Greater capital compared to  Lesser capital compared to a
Lesser capital compared to a corporation.
sole proprietorship.
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Laguna State Polytechnic University
Province of Laguna
ISO 9001:2015 Certified
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 Relatively lower extent of  A partnership (other than a
government regulation compared general professional partnership)
to corporations. is taxed like a corporation.
 Unlimited liability. The partners
can be held liable for partnership
debts up to their personal assets.

Corporation
Advantage Disadvantage
 A stockholder who is not a  Your "say" on corporate affairs
member of the corporation's board depends on the number of
of directors is relieved from shares you own. Those who
managerial responsibilities. Only own more shares are the
the stockholders that are elected bosses and enjoy a larger share
as members of the board of of the corporation's profits.
directors and those they hire or
appoint are tasked with
managerial responsibilities. This
can be an advantage because a
regular investor does not need to
work for the corporation to earn
income.
 Limited liability of the owners  A corporation is more difficult
because stockholders are liable and more costly to form
for corporate debts only up to the because there are more formal
amount they have invested. business requirements.
 Greater capital and ease in raising  Greater extent of government
additional funds because a regulation and higher taxes.
corporation can issue shares to a
wider extent of investors.
 If the corporation is listed, you can  Unlike for a sole proprietorship
easily transfer your shares to or a partnership where business
other investors by selling them in profits are easily distributed to
the stock market. Many investors the owner(s), in a corporation,
 Republic of the Philippines
Laguna State Polytechnic University
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ISO 9001:2015 Certified
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earn profit this way - by buying you have to wait for the board of
shares at a cheap price, wait for directors to declare dividends
prices to go up, and then sell before you can get your share in
them. This activity is referred to as the profits.
stock trading.
 Unlimited life, in the sense that
the withdrawal, retirement, death
or insanity of one of the
stockholders does not dissolve
the corporation.
Although a corporation has
a legal life of 50 years, this can be
renewed for an indefinite number of
renewals.

Cooperative
Advantage Disadvantage
 Unlike in a corporation, your  A cooperative is prone to poor
"say" on cooperative affairs is management.. Cooperatives are,
not affected by the number of more often than not, managed by
shares you own. This is members who were elected as
because, in a cooperative, each board of directors rather than by
member is entitled to only one employed professional managers.
vote regardless of his or her Since there is a 'one- member,
shareholdings. However, one-vote' policy in a cooperative,
members with larger influential members tend to
shareholdings are entitled to dominate the election process.
larger share in profit (net The result is that those who get
surplus). elected may not be the ones who
are most qualified for the task.
 A cooperative is generally  A cooperative is susceptible to
exempt from paying taxes. This corruption. Due to its
is the main advantage of a management structure and lack
cooperative and the most of profit motive, the elected
 Republic of the Philippines
Laguna State Polytechnic University
Province of Laguna
ISO 9001:2015 Certified
Level I Institutionally Accredite
common reason why officers may be inclined to act on
cooperatives are organized. their personal interests.
Moreover, a cooperative may
receive assistance from the
government.
 Compared to a corporation, a  The Cooperative Code places
cooperative is easier and less some restrictions on the
costly to form because there are distribution of a cooperative's
fewer formal business profit to its members. More
requirements. specifically, the Code requires a
cooperative to appropriate a
portion of its annual profit to
some funds. Only the remaining
portion can be distributed to the
members.
Furthermore, when the
cooperative is dissolved, the amount
accumulated in a fund called the
"reserve fund" will not be returned to
the members, but rather donated to
another cooperative or to the
community.
 Limited liability - the members  Compared to a corporation, it is
are liable for cooperative debts more difficult for a cooperative to
only up to the amount they have sustain growth. This is in part
invested. because of the lack of profit
motive and the lack of
management expertise.
Moreover, a cooperative's
success strongly depends on the
members' cooperation and
members are not always willing to
cooperate. The success of a
business depends on continuing
effort. Sadly, many cooperatives
 Republic of the Philippines
Laguna State Polytechnic University
Province of Laguna
ISO 9001:2015 Certified
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are zealous at the start but fail to
sustain continuing effort resulting
to the waning down of their
activities. This does not mean
though that all cooperatives are
small businesses. There are
many multi-billionaire
cooperatives in our country.
Some might be located in your
community.
 Unlimited life, in the sense that  Unlike in a corporation where the
the withdrawal, retirement, death stockholder can freely transfer his
or insanity of one of the shares, in a cooperative, there
members does not dissolve the are restrictions on the transfer of
cooperative. a member's shares. For example,
Although a cooperative has a legal the approval of the board of
life of 50 years, this can be renewed directors must first be obtained
for an indefinite number of renewals. before a member can transfer his
or her shares.

Types of Business According to Activities

The following are the major types of business according to the activities they
undertake:
1. Service business
2. Merchandising (Trading)
3. Manufacturing

Service business
A service business is one that offers services as its main product rather than
physical goods. A service business may offer professional skills, expertise, advice,
lending service, and similar services.
Examples of service businesses include:
a. Schools
b. Professionals (accounting firm, law firm, electrician, etc.)
c. Hospitals and clinics
d. Banks and other financial institutions
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e. Hotels and restaurants
f. Transportation and travel (taxi operator, travel agency, etc.)
g. Entertainment and event planners (wedding planners, concert
promoters, etc.)

Merchandising business
A merchandising business (or trading business) is one that buys and sells
goods without changing their physical form.
Examples of merchandising businesses include:
a. General merchandise resellers (grocery stores, department stores,
hardware stores, pharmacies, online stores, sari-sari stores, etc.)
b. Distributors and dealers (rice wholesalers, vegetable dealers, 2nd-
hand cars dealers, etc.)

Manufacturing business
A manufacturing business is one that buys raw materials and processes them
into final products. Unlike a merchandising business, a manufacturing business
changes the physical form of the goods it has purchased in a production process.
For example, a business that buys and sells eggs is a merchandising
business. On the other hand, a business that buys eggs and uses the eggs as
ingredient in making cakes for sale is a manufacturing business.
Examples of manufacturing businesses include:
a. Car manufacturers (Toyota, Isuzu, Volkswagen, etc.)
b. Technology companies (Apple, Samsung, Sony, etc.)
c. Food processing companies (San Miguel Pure Foods, Silver Swan,
etc.)
d. Factories (clothing factories, animal feeds factories, plastic wares
factories, etc.)
Some businesses, called hybrid businesses, engage in more than one type of
activity. For example, a restaurant uses ingredients to cook a meal (manufacturing),
sells Coca-Cola drinks (merchandising), and serves food to customers (service).
Nevertheless, a hybrid business is classified into one of the major types based on the
activity that is most in line with the business purpose. Restaurants are expected to
fill-in customer orders and provide dining services, thus, they are more of a service-
type business.
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Province of Laguna
ISO 9001:2015 Certified
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Advantages and Disadvantages of the Different Types of Business

Service Business
Advantages Disadvantages
 You don't need to worry about  You may not have a flexible
inventory, warehousing and personal time because you need
distribution costs because you to be directly involved in
don't have any inventory. You providing a service to a
only have some minimal customer. You can stock
supplies necessary in inventory but not service.
providing your services. For example, if you are a
manufacturer, you can spend over
time to produce goods, stock them,
and then take a break. However, if
you are a doctor, you are on call, and
have to be the one to personally
examine a patient.
Until your business is big enough
to be able to hire other professionals
to do the work for you, you will need
to render the services yourself.
 You may only need a small  Service businesses normally
capital because what you are suffer first from decline in
selling is your skill set and you demand during times of
only need yourself to render a economic difficulty. This is
service. If you are a because most services are
manufacturer, you need to buy perceived as luxuries rather than
raw materials and machinery necessities for survival.
to produce your product. For example, a guy with low
funds would refrain from having a
haircut and uses his funds for food
instead. A smart gal with low funds
would cut back her expenditures on
spa and pedicure.
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 You are perceived as an  Your business' success depends
expert in your chosen field. on your credibility. Personally,
People respect you. you must have a good
reputation. You need to be
always discreet in the things you
say and the way you act in the
society.
 Since a service business is
founded on good reputation, it is
more costly to commit an error in
a service business compared to
a merchandising business. For
example, if a merchandising
business erroneously sells
damaged goods, the customer
can just return the goods and
have them replaced. However, if
you are a barber and commits an
error, you can't just replace your
customer's hair!

Merchandising Business
Advantages Disadvantages
 Compared to a manufacturing  You need to have a retail store
firm, you may need a much to display your goods and the
lower start-up capital because store must be in a strategic
you don't need to acquire location for it to attract more
machineries to produce your customers.
goods.
 You can take advantage of  Less flexibility in managing
price fluctuations. For costs. This is because the cost
example, when goods are on of your goods is based primarily
sale, you can acquire them at on their purchase price, which
a discounted price and resell you do not control.
 Republic of the Philippines
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ISO 9001:2015 Certified
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them at a much higher price. In a manufacturing business,
You can't do this in a service you can cut down costs by
business. redesigning your product, improving
your processes, acquiring more
efficient machines, employing more
skillful personnel, and so much more.
 Lower cost of quality. This is  Keeping track of inventory is
because "what you buy is what tedious, most especially when
you sell." you are selling numerous and
In a service or manufacturing varied items with fast turnover
business, you need to continually rate, like for example if your
improve your products to maintain business is a hardware store or
their salability. In a merchandising a grocery store. Also, you can
business, if a certain product is not incur additional costs due to
selling well, you can just stop spoilages, theft, breakages,
buying it and find an alternative damages, and obsolescence.
product, another brand maybe.
 It is much easier to start a  Self-satisfaction is low because
merchandising business you did not produce the products
because you don't need to you sold.
have an expertise or a special
skill (service business) and you
don't need to have invented a
new product or have
conceptualized an innovative
idea for an existing product
(manufacturing business).
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Manufacturing Business
Advantages Disadvantages
 You have a high growth  You need a high start-up capital
potential because you can tap to acquire machineries, to employ
into a wider market and can people, and to acquire a big
produce in large quantities. space for your production.
 You have the opportunity to  Conceptualizing a viable
establish a brand that could manufacturing business is
last longer than your lifetime. difficult. This is why more
This is the ultimate dream of entrepreneurs would rather
most entrepreneurs. engage in merchandising.
 Self-satisfaction is high.  You need to be continuously
Knowing that consumers are innovative and abreast of
happy and satisfied with a changes in technology. If another
tangible product you have company comes up with a better
produced brings you pride and cheaper product, your
and joy. product will automatically lose
demand.
 You may not need to have a  Warehousing and logistics costs
strategically located retail can be high.
store to display your products
because you can sell directly
to wholesalers rather than to
end consumers.
 You can have a better pricing  You rely on raw materials. You
policy because mass need to manage them properly to
production can decrease your ensure that they are available
unit cost (often called when they a needed. This is
'economies of scale'). because a shortage in a raw
For example, you are paying material can disrupt your
rent of P100,000 for your factory operation, and that can be very
space. If you produce only 1 unit costly.
of a product, your unit cost is high For example, when cooking rice,
because the rent will be allocated all the ingredients you need must be
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to only 1 unit, i.e., P100,000 unit available. You cannot cook the rice
cost (P100,000 + 1 unit). now and just add the water later on.
Therefore, you need to sell this In a merchandising business, if
unit for more than P100,000 to you run out of a specific good, you
earn profit. However, if you don't necessarily need to close your
produce 10,000 units, your unit store because you can still sell other
cost would be much lower goods.
because the rent will be allocated
to more units, i.e., P10 (P100,000-
10,000 units). You can now sell
each unit at a much lower price.
 Greater flexibility in managing  Managing a manufacturing
costs. business can be difficult because
production processes are often
complicated and there is always
some room for improvement
(although many skilled managers
may take this positively as a
challenge).
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Laguna State Polytechnic University
Province of Laguna
ISO 9001:2015 Certified
Level I Institutionally Accredite

Lesson 2:
Introduction to Financial Analysis and Reporting

Financial reporting and analysis is the process of collecting and tracking data
on a company’s finances, including its revenues, expenses, profits, capital, and
cash flow. Businesses use them to inform their strategic decisions and stay
compliant with tax regulations.
Each of these financial KPIs is incredibly important because they
demonstrate the overall ‘health’ of a company – at least when it comes to the small
matter of money. These types of KPI reports don’t offer much insight into a
company’s culture or management structure, but they are vital to success,
nonetheless.
There are various types of financial reporting that can serve different
purposes. Some of the most common ones include:

 Income Statement: Also known as profit and loss, an income statement is a

financial analysis report that shows the company’s income and expenses over a
given period of time with a focus on four key elements: revenue, expenses,
gains, and losses. The main goal of this statement is to understand if the
business is making money or not. It does this by summarizing key sales
activities, costs of production, and any other operational expenses during an
accounting period. The report subtracts the revenue from all expenses to
understand how much profit (or loss) the business had.

 Balance Sheet: It provides a detailed overview of a company's assets, liabilities,

and stockholders’ equity. Essentially, a balance sheet provides a summary of the
business’s financial health at a given point, which is usually a monthly or
quarterly period, and it can be used for internal or external purposes. On one
hand, it can be reviewed internally by any stakeholder such as managers or
employees in order to understand if the company is going in the right direction.
And on the other hand, a balance sheet can be used externally by anyone who
is interested in investing in the company, as the report provides useful
information about the available resources and how they were financed.
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 Cash Flow Statement: Putting it in simple words, a cash flow statement shows
the amount of cash that the company is generating and for what costs the cash
is being spent. It contains elements of both the income statement and the
balance sheet and it is critical to the successful management of a business. A
cash flow statement is usually divided into 3 different areas that classify all the
cash received and paid. First, we see the operating cash flow which shows
revenue, expenses, gains, and losses, then we have the investing one which
shows the cash from debt and equity purchases and sales. Lastly, we have the
financial one, which reports on long-term liabilities such as loan payments and
equity items such as the sales of company stock.

 Statement of shareholder equity: As its name suggests, this report shows the
changes in shareholders' equity from the beginning to the end of an observed
accounting period, which is typically a year. It gives investors transparency
regarding their equity, how it is fluctuating, and what business activities are
responsible for those changes. It does this by calculating the difference between
the company’s assets and liabilities and it constitutes a key part of a balance
sheet, although, big corporations might generate it as a separate statement. The
statement of shareholders' equity is usually composed of the following elements:
preferred and common stock, treasury stock, additional paid-up capital, retained
earnings, and unrealized gains and losses, among other things.

 Statement of retained earnings: Connected to the previous report type, the

statement of retained earnings shows the accumulated profit of a company after
net income has been summed and dividends have been paid to shareholders. It
shows how much earnings a company has made during an observed period and
it helps owners and decision makers to assess the financial situation of the
business and evaluate potential reinvestment or growth opportunities based on
the retained earnings left for the coming accounting period.
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Importance in Decision Making

It is crucial to understand the financial health of your company in order to
make informed decisions and guide your organization toward growth and success.
Financial analysis is a critical tool that helps you achieve this understanding, enabling
you to evaluate your business’s financial performance and identify areas for
improvement.

We will discuss the importance of conducting a financial analysis for your

business, the key components of this process, and how it can benefit your
organization in the long run.

1. Informed Decision Making

One of the primary benefits of conducting a financial analysis is that it

empowers you to make informed decisions. With a clear understanding of your
business’s financial performance, you can identify areas that require attention and
allocate resources accordingly. Financial analysis allows you to evaluate the
effectiveness of your current strategies and make adjustments to achieve its goals.

2. Identifying Strengths and Weaknesses

Financial analysis provides insights into the strengths and weaknesses of

your business. By examining key financial metrics, such as revenue growth,
profitability, and cash flow, you can determine which aspects of your business are
performing well and which may need improvement. This data allows you to focus on
the areas that will have the most significant impact on your organization’s overall
success.

3. Risk Management

Every business face risks, and understanding these risks is essential for
effective management. Financial analysis allows you to identify potential risks and
vulnerabilities in your business’s financial performance. By addressing these risks
proactively, you can mitigate their impact and protect your business from financial
setbacks.
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4. Bench-marking and Industry Comparisons

Conducting a financial analysis enables you to benchmark your business

against industry standards and competitors. Comparing your financial performance to
that of similar businesses can highlight areas where your company may be drifting or
excelling. This information can help you identify best practices and adapt your
strategies to better compete in the marketplace.

5. Securing Financing

Whether you are looking to secure a loan or attract investors, providing a

complete financial analysis is crucial. Lenders and investors want to be confident in
your business’s ability to generate profits and repay debts. A thorough financial
analysis validates the understanding of your company’s financial position and
showcases your commitment to responsible financial management.

6. Financial Planning and Forecasting

Financial analysis is a key component of financial planning and forecasting.

By examining historical financial data, you can identify trends and patterns that can
inform your future financial projections. Accurate financial forecasts enable you to
make strategic decisions and allocate resources effectively, ensuring your business
remains on track to achieve its goals.

7. Improved Efficiency and Profitability

Financial analysis can help you identify inefficiencies in your business

operations and make data-driven decisions to improve overall efficiency. This
process often leads to cost savings and increased profitability. By monitoring key
financial metrics, you can track the success of your efforts and make adjustments to
maximize your business’s financial performance.

8. Enhanced Communication and Transparency

A well-organized financial analysis promotes transparency within your

organization. Sharing financial information with key stakeholders, such as employees,
investors, and board members, fosters a culture of liability and teamwork. By clearly
communicating your business’s financial performance, you can ensure that everyone
is working towards the same goals and objectives.
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Roles of Financial Statement

Financial statements consists of all the financial information that can be used
for analyzing and understanding the performance of a firm. It provides information
about the financial position, financial performance, and changes in the financial
position of a firm which are crucial for making financial decisions.

The major roles of financial statements are:

 Helps in Decision Making

A proper analysis of financial statements helps a firm to identify its weakness

and strength. It is said that a problem recognized is half solved. Hence
managers can make important business decisions based on the financial
statement which contains all the information regarding the firm’s financial
position, financial performance and all other information regarding finance.

 Helps in Reporting

A financial statement includes the income statement, balance sheet which

represents the historical financial performances of a firm over the period. Such
financial information can be used to report to shareholders, creditors, managers,
and other stakeholders about the financial condition of a firm. Hence, it can be
used for reporting the stakeholders of a firm.

 Helps in Forecasting

Financial statements also play a great role to provide an estimate of the future
financial course of action. The firm prepared Pro-forma financial statements to
provide a future forecast of expenditure, revenues, investment, and financing.

 Used in Expansion of Credit

The borrowed capital of the corporation is made available by lenders or

creditors. Before providing the money they see or use the information provided
in the financial statement of the corporation. On the other hand, the financial
management department of the corporation also uses the information of financial
statements to restrict or expand the extent of credit or borrowed capital of the
corporation.
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 Other Uses

There are abundant roles in financial statements in firms. Financial institutions,

banks, and finance companies use financial statements to decide where to grant
a loan or not. Government organizations, such as tax authorities employ
financial statements to determine the correctness of taxes affirmed and paid by
the firm. Media and the general public are also interested in a firm's financial
statements for many reasons.
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Lesson 3:
The Accounting Equation

All the processes in an accounting system must observe the equality of the
accounting equation, which is basically an algebraic equation. The basic accounting
equation is shown below:
Assets = Liabilities + Equity
ASSETS - are the economic resources you control that have resulted from past
events and can provide you with economic benefits.

Control
You don't necessarily need to own the economic resource for it to be
considered your asset. What is important is that you control the right over the
economic benefits that the resource may produce. "Control" means you have the
exclusive right to enjoy those benefits and the ability to prevent others from enjoying
those benefits.

Example 1: Resource owned but not considered an asset

You own a building. However, you do not have the right to use, sell, lease, or
transfer (or other similar rights over) the building- another party does.

Analysis: The building is not your asset because you do not control the right over
the economic benefits from it, even if you are the legal owner.

Example 2: Resource not owned but considered an asset

You acquired a cellphone from a telecommunications company on a 2-year
installment plan. The agreement states that if you miss an installment payment, the
telecommunications company can get the cellphone back.

Analysis: Upon taking possession, the cellphone becomes your asset even if you do
not actually own it yet until you have fully paid the installment price. This is because
you control the right over the economic benefits of the cellphone through exclusive
use.
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Past events
The control over an economic resource have resulted from a past event or
transaction. Therefore, resources for which control is yet to be obtained in the future
do not qualify as assets in the present.
For example, you have an intention of purchasing a cellphone next year.
Right now, the cellphone is not yet your asset. The cellphone becomes your asset
only after you have purchased it and have taken possession over it.
Physical possession, however, is not always necessary for control to exist.
For example, the money that you have deposited to a bank remains your asset
despite the transfer of physical possession. This is because you still control the right
over the money by withdrawing it or spending it through electronic means.

Economic benefits
To be an asset, the economic resource must have the potential to provide you
with economic benefits in at least one circumstance. For example, the economic
resource can be:
a. Sold, leased, transferred or exchanged for other assets;
b. Used singly or in combination with other assets to produce goods or provide
services;
c. Used to enhance the value of other assets;
d. Used to promote efficiency and cost savings; or
e. Used to settle a liability.

LIABILITIES - are your present obligations that have resulted from past events and
can require you to give up economic resources when settling them.

Obligation
Obligation means a duty or responsibility. An obligation is either.
a. Legal obligation - an obligation that results from a contract, legislation,
or other operation of law; or
b. Constructive obligation - an obligation that results from past actions
(e.g., past practice or published policies) that have created a valid expectation
on others that you will accept and discharge certain responsibilities.
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Giving up of economic resources

Settling the obligation necessarily would require you to pay cash, to transfer
other non-cash assets, or to render a service.

Present obligation as a result of past events

A present obligation exists as a result of past events if:
a. you have already obtained economic benefits or taken an action;
b. as a consequence, you are required to transfer an economic resource.
Example:
You have an intention to purchase a cellphone in the future.
Analysis:
You have no present obligation, and hence no liability, because you have
not yet purchased and received the cellphone, and therefore, you are not required to
pay for the purchase price.

Example:
You purchased a cellphone on credit. You took possession over the cellphone
but have not yet paid the purchase price.
Analysis:
You have a present obligation, and hence a liability, because:
a. you have already purchased and received the cellphone; and
b. as a consequence, you are required to pay for the purchase price.

Your obligation is a legal obligation because it arises from a contract (i.e.,

purchase contract).
Example:
You earned taxable income during the period but have not yet paid the tax
due to the government.

Analysis:
You have a present obligation because:
a. you earned taxable income; and
b. as a consequence, you are required to pay the corresponding tax due.
Your obligation is a legal obligation because it arises from legislation (i.e.,
tax law).
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Example:
Although not stated in the sales contract, you have a publicly- known policy of
providing free repair services for the goods your business sells. You have
consistently honored this implied policy in the past.
Analysis:
You have a present obligation to provide free repair services for the goods
you have already sold because:
a. you have already taken an action by creating valid expectation on your
customers that you will provide free repair services;
b. as a consequence, you will have to provide those free services.

Your obligation is a constructive obligation.

EQUITY - is simply assets minus liabilities. Other terms for equity are "capital," "net
assets," and "net worth."

Illustration 1:
You decided to put up a barbecue stand and have estimated that you will be
needing P2,000 as start-up capital.
You then went to your closet and broke Mr. Piggy Bank, which you have been
saving for quite some time now. Alas! You only have 800. You went to your Mama
and asked her to give you P1,200 but she told you that she has been feeding you for
far too long. Oh man! But don't give up hope yet, Mr. Bombay is just around the
corner.
As of this point, your accounting equation is as follows:
ASSETS = LIABILITIES + EQUITY
800 = 0 + 800

Notes:
 Your total assets are P800- the amount of economic resources that you control.
 You don't have any liability yet because you are still negotiating with Mr. Bombay.
 Your equity is also P800 (800 assets-0 liabilities 800 equity).
After a lengthy negotiation, Mr. Bombay agreed to lend you $1,200.
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As of this point, your accounting equation is as follows:

ASSETS = LIABILITIES + EQUITY
2,000 = 1,200 + 800

Notes:
 Your total assets are now 2,000 - the total amount of economic resources that
you control (P800 from Mr. Piggy plus P1,200 from Mr. Bombay).
 Of your total assets of P2,000:
a. P1,200 represents your liability, the amount you are obligated to pay Mr.
Bombay in the future.
b. 800 represents your equity (ie., P2,000 assets P1,200 liabilities).

 Liabilities represent the creditors' claim, while equity represents the owner's
claim, against the total assets of the business.
Notice that from Piggy to Bombay, the accounting equation remains
balanced. Please DO NOT forget this concept my friend! The equality of the
accounting equation must be maintained in all the accounting processes of recording,
classifying and summarizing. If the accounting equation doesn't balance, there is
something wrong!
As mentioned earlier, the accounting equation is basically an algebraic
equation. Therefore we can make variations from it. Analyze the variations below:

Original form of the equation:

ASSETS = LIABILITIES + EQUITY
2,000 = 1,200 + 800

Variation #1:
ASSETS - LIABILITIES = EQUITY
2,000 - 1,200 = 800

Variation #2:
ASSETS - EQUITY = LIABILITIES
2,000 - 800 = 1,200
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The Expanded Accounting Equation

We can expand the basic accounting equation by including two more
elements income and expenses. The expanded accounting equation shows all the
financial statement elements. The expanded accounting equation is as follows:

Assets = Liabilities + Equity + Income - Expenses

Notice that income is added while expenses are deducted in the equation.
These are because income increases equity while expenses decrease equity.

INCOME - is increases in economic benefits during the period in the form of

increases in assets, or decreases in liabilities, that result in increases in equity,
excluding those relating to investments by the business owner.

EXPENSES - are decreases in economic benefits during the period in the form of
decreases in assets, or increases in liabilities, that result in decreases in equity,
excluding those relating to distributions to the business owner.

The difference between income and expenses represents profit or loss.

 If income is greater than expenses, the difference is profit ("profit' means 'kita' or
'tubo' in Filipino)."
 If income is less than expenses, the difference is loss (loss means 'lugi' in
Filipino).

We can make another variation to the equation above as follows:

ASSETS = LIABILITIES + EQUITY + PROFIT/ - LOSS

Profit increases equity while loss decreases equity.

Illustration 2: (Continuation of 'Illustration 1' above)

During the period, you earned income of $10,000 and incurred expenses of
P6,200.
At the end of the period, your total assets increased from P2,000 to 15,000
and your total liabilities decreased from P1,200 to P400.
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 Your expanded accounting equation is as follows:

ASSETS = LIABILITIES + EQUITY + INCOME - EXPENSES

5,000 = 400 + 800 + 10,000 - 6,200

*This represents you equity from 'Illustration l' above.

We can also derive the following variation from the equation above:

ASSETS + EXPENSES = LIABILITIES + EQUITY - INCOME

5,000 + 6,200 = 400 + 800 - 10,000

Your profit for the period is P3,800 (P10,000 income minus P6,200
expenses). There is profit because income is greater than expenses.

A variation of the expanded accounting equation is shown below:

ASSETS = LIABILITIES + EQUITY + PROFIT
5,000 = 400 + 800 + 3,800

Income and expenses (or profit or loss) are closed to equity at the end of
each accounting period. Thus, the adjusted ending balance of equity is computed as
follows:

Equity, beginning 800

Add: Income 10,000

Less: Expenses (6,200)

Equity, ending 4,600

OR

Equity, beginning 800

Add: Profit 3,800

Equity, ending 4,600

Notice that regardless of its form or variation, the accounting equation (basic
or expanded) remains balanced.
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Applications of the Accounting Equation

Before we move on, let us master first how the accounting equation works. I
encourage you to diligently study the following
drills:

Case #1: Total assets

If you have total liabilities of P1,200 and equity of 800, how much are your
total assets?
Solution:
ASSETS = LIABILITIES + EQUITY
? = 1,200 + 800

Answer: Total assets = (1,200+800) = 2,000

Case #2: Total liabilities

If you have total assets of $2,000 and equity of P800, how much are your
total liabilities?
Solution:
ASSETS = LIABILITIES + EQUITY
2,000 = ? + 800

Variation #1 of the basic equation:

LIABILITIES = ASSETS - EQUITY
? = 2,000 - 800

Answer: Total liabilities (2,000-800) = 1,200

Case #3: Total equity

If you have total assets of P2,000 and total liabilities of P1,200, how much is
your total equity?
Solution:
ASSETS = LIABILITIES + EQUITY
2,000 = 1,200 + ?
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Variation #2 of the basic equation:

EQUITY = ASSETS - LIABILITIES
? = 2,000 - 1,200

Answer: Total equity = (2,000 - 1,200) = 800

Case #4.1: Profit or loss

If you have total income of $5,000 and total expenses of $2,000, how much is
your profit (or loss)?
Solution:

Total Income 5,000

Less: Total Expenses (2,000)

Profit 3,000

Case #4.2: Profit or loss

If you have total income of P6,000 and total expenses of P11,000, how much
is your profit (or loss)?
Solution:

Total Income 6,000

Less: Total Expenses (11,000)

Loss 5,000

In accounting, amounts in parentheses are negative amounts.

Case #5: Income

If you have total expenses of P2,000 and a profit of $3,000, how much is your
total income?
Solution:

Total Income ? (squeeze)

Less: Total Expenses (2,000)

Profit 3,000 (start)

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The unknown ("?") is simply "squeezed." In accounting, to "squeeze" means

to come up with an unknown amount in a given formula by performing basic
arithmetic functions like adding subtracting, multiplying or dividing. When squeezing
"upwards" (just like in the illustration above), the arithmetic function is simply
reversed. Thus, the $2,000 amount which is deducted when solving downwards is
added when "squeezing" upwards.

Answer: Total income (3,000+2,000)-5000

When "squeezing" upwards, it is always advisable to recheck your answer by

squeezing downwards. This is done as follows:

Rechecking:

Total Income 5,000 (squeeze)

Less: Total Expenses (2,000)

Profit 3,000 (start)

"Squeezing" simplifies the computation process because it eliminates the

need to make variations of a formula. If we did not squeeze the amount above, we
would have made the following variation to the formula:
 Original formula: Income - Expenses = Profit
 Variation: Profit + Expenses = Income

Case #6: Expenses

If you have total income of $5,000 and a profit of $3,000, how much are your
total expenses for the period?
Solution:

Total Income 5,000

Less: Total Expenses ? (squeeze)

Profit 3,000

Answer: Total expenses (5,000 - 3,000) = 2,000

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Rechecking:

Total Income 5,000

Less: Total Expenses (2,000) (squeeze)

Profit 3,000

Case #7: Income

You have ending" total assets of P4,800, ending total liabilities of P1,000 and
beginning equity is P800. If your total expenses for the period amount to 2,000, how
much is your total income?
"(In accounting parlance, the term beginning' means 'at the start of an accounting
period while ending' means 'at the end of an accounting period.)

Solution:

ASSETS = LIABILITIES + EQUITY + INCOME - EXPENSES

4,800 = 1,000 + 800 + ? - 2,000

Answer: Total income (4,800-1,000-800+2,000) = 5,000

Rechecking: (Check out the equality of the accounting equation.)

ASSETS = LIABILITIES + EQUITY + INCOME - EXPENSES

4,800 = 1,000 + 800 + 5,000 - 2,000

Case #8: Expenses for the period

You have ending total assets of P4,800, ending total liabilities of P1,000 and
beginning equity of P800. If your total income for the period amounts to $5,000, how
much are your total expenses?

Solution:

ASSETS = LIABILITIES + EQUITY + INCOME - EXPENSES

4,800 = 1,000 + 800 + 5,000 - ?

Total expenses (4,800-1,000-800-5,000) = 2,000

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Rechecking: (Check out the equality of the accounting equation.)

ASSETS = LIABILITIES + EQUITY + INCOME - EXPENSES

4,800 = 1,000 + 800 + 5,000 - 2,000

Case #9.1: Ending equity

Your beginning equity is $5,000. If your total income for the period is 8,000,
while your total expenses are P6,000, how much is the ending balance of your equity?
Solution:

Equity, beginning 5,000

Add: Income 8,000

Less: Expenses (6,000)

Equity, ending 7,000

OR
Equity, beginning 5,000

Add/Less: Profit or Loss (8,000 - 2,000) 2,000

Equity, ending 7,000

Case #9.2: Ending equity

Your beginning equity is P12,000. If your total income for the period is $5,000,
while your total expenses are P8,000, how much is the ending balance of your equity?
Solution:

Equity, beginning 12,000

Add: Income 5,000

Less: Expenses (8,000)

Equity, ending 9,000

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OR

Equity, beginning 12,000

Add/Less: Profit or Loss (5,000 - 8,000) (3,000)

Equity, ending 9,000

Notice that profit is an addition to equity while loss is a deduction.

Case #10.1: Profit for the period

If your beginning equity is P5,000, while your ending equity is $7,000, how
much is your profit or loss for the period?
Solution:

Equity, beginning 5,000

Add: Profit (or Less: Loss) ? (squeeze)

Equity, ending 7,000

Profit = (7,000-5,000) = 2,000

Rechecking:

Equity, beginning 5,000

Add: Profit (or Less: Loss) 2,000

Equity, ending 7,000

Case #10.2: Loss for the period

If your beginning equity is P6,000, while your ending equity is P2,000, how
much is your profit or loss for the period?
Solution:

Equity, beginning 6,000

Add: Profit (or Less: Loss) ? (squeeze)

Equity, ending 2,000

Loss = (2,000-6,000)=(4,000)
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Rechecking:

Equity, beginning 6,000

Add: Profit (or Less: Loss) (4,000)

Equity, ending 2,000

Case #11: Ending total assets

You had total assets, liabilities, and equity of 10,000, P7,000 and $3,000,
respectively, at the beginning of the period. During the period, your total liabilities
decreased by P4,000, while your profit was $5,000. How much are your ending total
assets?
Solution:

Assets = Liabilities + Equity

Beginning 10,000 = 7,000 + 3,000
Decrease in liabilities/ Profit _______ = (4,000) + 5,000
End. ? = 3,000 + 8,000

Answer: Ending total assets = (3,000 liabilities, end. +8,000 equity, end.) = 11,000

Rechecking: (Ending balances)

Assets = Liabilities + Equity

End. 11,000 = 3,000 + 8,000

Case #12: Ending total assets

You had total assets, liabilities, and equity of P10,000, $7,000 and P3,000,
respectively, at the beginning of the period. During the period, your total liabilities
decreased to P4,000, while your profit was $5,000. How much are your ending total
assets?
Solution:

Assets = Liabilities + Equity

Beginning Irrelevant(a) = Irrelevant + 3,000
Profit __________ = Irrelevant + 5,000
End. ? = 4,000 (b)
+ 8,000
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(a)
(Irrelevant: These amounts are not needed in computing for the requirement in the
problem.)
(b)
The phrase "decreased to P4,000" means that P4,000 is the ending balance of
liabilities. Notice the difference between the phrases "decreased by" (Case #11) and
"decreased to" (Case #12).

Answer: Ending total assets (4,000 liabilities, end. +8,000 equity,

end.) = 12,000
Rechecking: (Ending balances)

Assets = Liabilities + Equity

End. 12,000 = 4,000 + 8,000
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Learning Resources

 Millan, Zeus Vernon B. (2008), Financial Accounting and Reporting

(Fundamentals) by Nation’s Foremost CPA Review Inc. (NCPAR)
 https://www.datapine.com/blog/financial-reporting-and-
analysis/#:~:text=Financial%20reporting%20and%20analysis%20is,stay%20com
pliant%20with%20tax%20regulations.
 https://www.linkedin.com/pulse/importance-conducting-financial-analysis-your-
gavin-
bottrell#:~:text=One%20of%20the%20primary%20benefits,attention%20and%20
allocate%20resources%20accordingly.