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Analysis and Interpretation of Financial Statement

This document discusses reasons for analyzing and interpreting financial statements including transforming data into useful information for decision making, determining profitability and stability. It outlines various users of financial statements like investors, lenders, suppliers and government agencies. Methods of analysis covered include horizontal analysis, trend percentages, vertical analysis and different types of ratios to evaluate liquidity, profitability and solvency.

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Ugly Duckling
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649 views

Analysis and Interpretation of Financial Statement

This document discusses reasons for analyzing and interpreting financial statements including transforming data into useful information for decision making, determining profitability and stability. It outlines various users of financial statements like investors, lenders, suppliers and government agencies. Methods of analysis covered include horizontal analysis, trend percentages, vertical analysis and different types of ratios to evaluate liquidity, profitability and solvency.

Uploaded by

Ugly Duckling
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPTX, PDF, TXT or read online on Scribd
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ANALYSIS

AND
INTERPRETATION
OF
FINANCIAL
STATEMENTS

CHAPTER 4
REASONS TO ANALYZE
AND INTERPRET
FINANCIAL STATEMENTS
 Transform data in the statements into
information which is interpreted and used as
basis for better economic decisions and
actions.
 Analyze statements to determine if it is
profitable to lend money.
 Organized whether it is reasonable to
demand increases in wages.
REASONS TO ANALYZE
AND INTERPRET
FINANCIAL STATEMENTS
Analyze the statements to see if the
companies are conforming with
government regulations.
 To determine past performance as a
means of control and as a guide for
future.
USERS OF FINANCIAL
STATEMENTS
 INVESTORS - to determine
whether to buy, hold or sell their
investments in equity ownership in
the business.
 EMPLOYEES - to determine
stability and profitability of
employers.
 LENDERS - to determine the ability
of the borrowers to pay the loans and
granted to them on time.
 SUPPLIERS - to determine the
ability of the customers to pay debts
as they fall due.
 MANAGEMENT - to determine the
activities of the enterprise for
planning, organizing, leading and
controlling.
 CUSTOMER - to determine the
ability of the enterprise to be a
continuing source of supply.
 PUBLIC - to determine contribution
to the economy in the form of
 number of employees
 ownership of assets

 prices of their products


 patronage of local suppliers
 patronage of customers

GOVERNMENT AGENCIES - to
determine the capacity of enterprise
to pay taxes and its tax compliance.
COMPARATIVE ANALYSIS
 INTRACOMPANY - it involves
comparison within the entity.
 INTERCOMPANY - it involves
comparison of data of one entity with
those of another entity.
 INDUSTRY AVERAGES - it shows
the standing of the entity in the
industry where it belongs.
HORIZONTAL ANALYSIS
 A technique for evaluating a series of financial
statement data over a period of time.
 Increases or decreases from period to period
are computed in peso and percentage.
Involves sidewise comparison shows changes
from year to year.
𝑨𝒎𝒐𝒖𝒏𝒕 𝒐𝒇 𝒄𝒉𝒂𝒏𝒈𝒆
Percentage of change = x 100%
𝑩𝒂𝒔𝒆 𝒚𝒆𝒂𝒓 𝒂𝒎𝒐𝒖𝒏𝒕
TREND PERCENTAGE
– help you compare financial
information over time to a base year or
period.
– The earliest year will be the base
year.
𝑵𝒆𝒕 𝑰𝒏𝒄𝒐𝒎𝒆
TREND PERCENTAGE = X 100%
𝑩𝒂𝒔𝒆 𝒚𝒆𝒂𝒓 𝒂𝒎𝒐𝒖𝒏𝒕
VERTICAL ANALYSIS
COMPOSITION OF ASSETS AND
EQUITIES
It is a technique for evaluating
financial statement data that express
each item in a financial statement as a
percentage of base amount.
The total assets are the base or the
100%. Each asset item is a component
part of the total assets. Each asset
items is dividend by the total asset to
arrive at the percentage.

𝑨𝒎𝒐𝒖𝒏𝒕 𝒐𝒇 𝒂𝒔𝒔𝒆𝒕
Composition Percentage = x 100%
𝑻𝒐𝒕𝒂𝒍 𝑨𝒔𝒔𝒆𝒕𝒔
COMPOSITION OF INCOME AND
EXPENSE
INCOME - is the result of two kinds of
flows which have opposite effects;
Revenue - which tends to increase
income,
Expense - which tends to reduce it.
𝑨𝒎𝒐𝒖𝒏𝒕 𝒐𝒇 𝒍𝒊𝒂𝒃𝒊𝒍𝒊𝒕𝒚 𝒐𝒓 𝒆𝒒𝒖𝒊𝒕𝒚
Composition Percentage = x 100%
𝑻𝒐𝒕𝒂𝒍 𝒍𝒊𝒂𝒃𝒊𝒍𝒊𝒕𝒊𝒆𝒔 𝒂𝒏𝒅 𝒆𝒒𝒖𝒊𝒕𝒚
RATIO ANALYSIS
 LIQUIDITY RATIOS - measure the
ability of an entity to pay currently
maturing obligations and meet
unexpected cash needs.
 PROFITABILITY RATIOS - measure
the ability of an entity to earn income
over a period of time.
 SOLVENCY RATIOS – measure the
ability of an entity to survive over a long
time period.
LIQUDITY RATIOS
 CURRENT RATIO - is the
relationship between current assets to
meet payments of current liabilities.
 It is also called working capital ratio
or banker’s ratio.
𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝑨𝒔𝒔𝒆𝒕𝒔
Curent Ratio=
𝒄𝒖𝒓𝒓𝒆𝒏𝒕 𝑳𝒊𝒂𝒃𝒊𝒍𝒊𝒕𝒊𝒆𝒔
ACID TEST OR QUICK RATIO
- A significant portion of its assets may
be in inventory in which may not be
readily convertable to cash. This delay
in the realization of inventory may
cause delays in payment to creditors.
𝑪𝒂𝒔𝒉+𝑻𝒆𝒎𝒑𝒐𝒓𝒂𝒓𝒚 𝑰𝒏𝒗𝒆𝒔𝒕𝒎𝒆𝒏𝒕𝒔+𝑹𝒆𝒄𝒆𝒊𝒗𝒂𝒃𝒍𝒆𝒔
Quick Ratio=
𝑻𝒐𝒕𝒂𝒍 𝒍𝒊𝒂𝒃𝒊𝒍𝒊𝒕𝒊𝒆𝒔
Prepaid expenses as well as other
receivables which will not become
cash in the near future are not
considered as quick assets.
PROFITABILITY RATIOS

Profitability ratios are a set of


measurements used to determine the
ability of a business to create earnings.
 RATIO OF GROSS PROFIT TO
NET SALES - is the relationship
between gross profit and net sales.
The gross profit must be sufficient to
cover all expenses and to yield income
to the owners of the business. This
ratio is computed by dividing gross
profit by net sales.
Gross Profit Ratio = Gross Profit/Net Sales
 RATIO OF NET INCOME TO NET
SALES - is a measure of the
profitability for each peso sales.
Net Profit Ratio = Net Income/Net Sales
 OPERATING RATIOS - is the
relationship of cost of sales and
operating expenses to net sales.
Operating Ratio = Cost + Operating Expenses/Net Sales
RATIO OF NET INCOME TO
OWNER’S EQUITY - is a measure of
financial performance calculated by
dividing net income by shareholders'
equity or Average Owners Equity.

𝑵𝒆𝒕 𝑰𝒏𝒄𝒐𝒎𝒆 𝒇𝒐𝒓 𝒕𝒉𝒆 𝒑𝒆𝒓𝒊𝒐𝒅


Ratio of Net Income to Owner's Equity =
𝑨𝒗𝒆𝒓𝒂𝒈𝒆 𝑶𝒘𝒏𝒆𝒓’𝒔 𝑬𝒒𝒖𝒊𝒕𝒚
RATIO OF NET INCOME TO
TOTAL ASSETS - is used to
determine the efficiency with
which management utilizes the
assets of the business.
Ratio of Net Income to Total
Assets = Net Income/ Total
Assets
RATIO OF NET SALES TO
TOTAL ASSETS - it shows the
relationship between the peso sales
volume and total assets of the
business. It measures efficiency in the
use of the company's resources.
Ratio of Net Sales to Total Assets
= Net Sales/Total Assets
SOLVENCY RATIOS
A key metric used to measure an
enterprises’ ability to meet its debt
obligations and is used often by
prospective business lenders.
Debt to Equity Ratio =
Total Liabilities /Total Owner’s Equity
Debt to Total Assets Ratio=
Total Liablities/Total Assets
 PROPRIETORY OR EQUITY
RATIO – is the ratio of the total
owner’s equity to the total assets.
Proprietory Ratio
= Total Owner’s Equity/Total Assets

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