Financial

Statement
Analysis
LESSON 2: FINANCIAL
MANAGEMENT
Financial Statement

A financial statement is an official document of the firm,

which explores the entire financial information of the firm.
Financial Statement

The main aim of the financial statement is to provide

information and understand the financial aspects of the
firm. Hence, preparation of the financial statement is
important as much as the financial decisions.
Four Basic Financial Statements

Statement of
Statement of
Comprehensive
Financial Position
Income

Statement of
Cash Flow
Changes in
Statement
Equity
 Four Basic Financial Statements

Statement of The balance sheet, which shows

Financial what assets the company owns and
Position (Balance who has claims on those assets as
Sheet) of a given date.

Statement of The income statement, which

Comprehensive shows the firm’s sales and costs
Income (Income (and thus profits) during some past
Statement) period.
 Four Basic Financial Statements

Statement of The statement of changes in equity, which

shows the amount of equity the stockholders
Changes in had at the start of the year, the items that
increased or decreased equity, and the equity
Equity at the end of the year.

Cash Flow The statement of cash flows, which shows

how much cash the firm began the year
Statement with, how much cash it ended up with, and
what it did to increase or decrease its cash.
Financial Statements can be analyzed in
terms of:

Liquidity is the ability of the company to

settle its current obligations as they fall due.
Financial Statements can be analyzed in
terms of:

Solvency is the ability of a company to meet its

long-term financial obligations and the interest
related to these obligations.
Financial Statements can be analyzed in
terms of:

Financial stability is a state in which the financial

system, i.e. the key financial markets and the financial
institutional system is resistant to economic shocks
and is fit to smoothly fulfill its basic functions: the
intermediation of financial funds, management of
risks and the arrangement of payments.
Financial Statements can be analyzed in
terms of:

Profitability measures the company’s

operating performance as a return on its
investment.
Financial Statements can be analyzed in
terms of:

Market Value or Valuation measures the

company’s potential for future earnings,
dividend payments and stock price growth.
The two phases involved in the analysis of
financial statements are:

Computation Phase – Interpretation Phase –

we compute for we interpret the results
differences, of the figures we get
percentages, or ratios from the first phase
Types of Financial Statement Analysis

Based on
materials used Based on methods
of operations
Financial Statement Analysis based on
Material Used

External Analysis

• Outsiders of the business concern do normally external

analyses, but they are indirectly involved in the business
concern such as investors, creditors, government
organizations and other credit agencies.
• External analysis is very much useful to understand the
financial and operational position of the business concern.
External analysis mainly depends on the published
financial statement of the concern. This analysis provides
only limited information about the business concern.
Financial Statement Analysis based on
Material Used

Internal Analysis

• The company itself does disclose some of the

valuable information to the business concern in this
type of analysis. This analysis is used to understand
the operational performances of each department
and unit of the business concern.
• Internal analysis helps to take decisions regarding
achieving the goals of the business concern.
Financial Statement Analysis based on
Method of Operations

Horizontal Analysis

• Under the horizontal analysis, financial statements are

compared with several years and based on that, a firm
may take decisions.
• Normally, the current year’s figures are compared with
the base year (base year is consider as 100) and how the
financial information are changed from one year to
another.
• This analysis is also called as dynamic analysis.
Horizontal Analysis

In the balance sheet, a significant

increase in property, plant, and
equipment will indicate purchases of
land, equipment, machinery or other
plant assets necessary for use in the
business.
On the other hand, a significant
decrease will reveal disposal of such
assets as management may have
deemed necessary.
Horizontal Analysis

For income statement accounts, horizontal analysis helps

management analyze significant increases or decreases in
sales, cost of sales, and expenses.
Steps in Performing Horizontal Analysis

1. Prepare comparative financial

statements of two consecutive
years.

2. Add a third column for the increase

or decrease in amount and a fourth
column for the percentage of the
increase or decrease.

3. Get the percentage of increase

or decrease for each year.
Steps in Performing Horizontal Analysis

4. Choose a base year which is

usually the initial year of analysis.

5. Deduct the amount of the

current year from the base year.

6. Divide the difference above by

the amount of the base year.
Steps in Performing Horizontal Analysis

7. Multiply the quotient by 100 to get the

percentage of change

% change = Current year amount – Base year Amount x 100%

Base year amount

8. Interpretation of analyzed data

Interpreting Analyzed data

It is important to note that the

materiality of increase or decrease
depends on the size of the company.
A material amount may not be
material to another.
Interpreting Analyzed data

In analyzing the significance of a

percent change in value, the
analysis should not only center
on internal factors controllable
by management.
Interpreting Analyzed data

Internal factors are not the only

factors considered in data analysis
and interpretation but external
factors as well.
 Fidas Merchandising
Income Statement
For Years Ended December 31
(in millions)

Increase (Decrease)

2017 2016 Amount Percentage

Net Sales ₱ 2,213.3 ₱ 1,738.7 ₱ 474.6 27.3

Cost of Goods Sold 1,032.1 831.8 200.3 24.1
Gross Profit ₱ 1,181.2 ₱ 906.9 ₱ 274.3 30.2
Selling and Administrative Expenses 889.2 659.5 229.7 34.8
Operating Income ₱ 292.0 ₱ 247.4 ₱ 44.6 18.0

Interest Expense 90.9 30.5 60.4 198.0

Income Before Income Taxes ₱ 201.1 ₱ 216.9 (₱ 15.8) (7.3)
Income Tax Expense 60.3 65.0 (4.7) (7.2)
Net Income ₱ 140.8 ₱ 151.9 (₱ 11.1) (7.3)
Financial Statement Analysis based on
Method of Operations

Vertical Analysis

• Under the vertical analysis, financial statements

measure the quantities relationship of the various
items in the financial statement on a particular
period.
• It is also called as static analysis, because this
analysis helps to determine the relationship with
various items appeared in the financial statement.
For example, a sale is assumed as 100 and other
items are converted into sales figures.
Vertical Analysis

Otherwise known as common-size analysis, it helps

management analyze the components of the total assets as
well as the components of the total liabilities and owner’s
equity.
Vertical Analysis

It helps management answer certain questions as follows:

Of the total assets, what percent is classified as current?

Non-current?

Of the total assets, what percent is accounts receivable?

Merchandise Inventory?

Of the total liabilities, what percent is classified as

current? Non-current?

Of the total liabilities and owner’s equity, what percent is

liabilities? What percent is owner’s equity?
Vertical Analysis in Income Statement

In the income statement, vertical analysis helps management

analyze the components of the income statement in relation to
its revenue account, which is sales.
It helps management answer certain questions as follows:
 What percentage of net sales is cost of sales or cost of goods sold?
Gross profit? Operating expenses?
 If operating expenses were divided between selling and
administrative expenses, what percent of net sales is absorbed by
selling expenses? Administrative expenses?
 What is the percentage of net income to sales?
Steps in Performing Vertical Analysis

1. Prepare comparative
financial statements of
two consecutive years.

2. Add one addition

column on the right
side of each year.
Steps in Performing Vertical Analysis

3. For the comparative statement of financial

position, express each account as a percentage of
the total assets. The total assets is automatically
100%. Likewise, total liabilities and owner’s equity
is automatically 100%.
Steps in Performing Vertical Analysis

4. For the comparative income statement,

express each account as a percentage of
net sales. Net sales is automatically 100%.
Vertical Analysis: SFP
Vertical ANALYSIS: SCI
Techniques of Financial Statement Analysis

Financial statement analysis is

interpreted mainly to determine
the financial and operational
performance of the business
concern. Several methods or
techniques are used to analyze
the financial statement of the
business concern.
Techniques of Financial Statement Analysis

Comparative
Common Size
Statement Trend Analysis
Analysis
Analysis

Common Flow Cash Flow

Ratio Analysis
Analysis Analysis
Comparative Statement Analysis

Comparative statement analysis

is an analysis of financial
statement at different period. This
statement helps to understand the
comparative position of financial
and operational performance at
different period.
Comparative Statement Analysis

Comparative Balance Sheet Analysis

• Comparative balance sheet analysis concentrates only

the balance sheet of the concern at different period. Under
this analysis the balance sheets are compared with
previous year’s figures, or one-year balance sheet figures
are compared with other years.
• Comparative balance sheet analysis may be horizontal or
vertical basis. This type of analysis helps to understand
the real financial position of the concern as well as how
the assets, liabilities and capitals are placed during a
particular period.
Comparative Statement Analysis

Comparative Income Statement

Analysis

• Under this analysis, only profit and loss account is

taken to compare with previous year’s figure or
compare within the statement. This analysis helps
to understand the operational performance of
the business concern in each period. It may be
analyzed on horizontal basis or vertical basis.
Trend Analysis

The financial statements may be

analyzed by computing trends of
series of information. It may be
upward or downward directions which
involve the percentage relationship of
every item of the statement with the
common value of 100%.
Trend Analysis

Trend analysis helps to understand the trend relationship

with various items, which appear in the financial statements.
These percentages may also be taken as index number
showing relative changes in the financial information
resulting with the various period. In this analysis, only
major items are considered for calculating the trend
percentage.
Trend Analysis: Illustrative Example

Calculate the Trend Analysis from the following information

of Sienna Mercantile Bank Ltd., taking 2018 as a base year
and interpret them (in thousands of pesos).

Year Deposits Advances Profit

2018 2,050,590,498 970,140,728 3,500,311
2019 2,660,450,251 1,250,500,440 4,060,287
2020 3,190,800,696 1,580,830,495 5,040,020
2021 3,720,990,877 1,770,260,607 5,530,525
2022 4,080,450,783 1,950,990,764 6,370,634
2023 4,400,420,730 2,110,390,869 8,060,755
 Trend Analysis (Base year 2018 =100)

Year Deposits Advances Profit

Amount Trend Amount Trend Amount Trend
% % %
2018 2,050,590,498 100.0 970,140,728 100.0 3,500,311 100.0

2019 2,660,450,251 129.6 1,250,500,440 129.2 4,060,287 115.9

2020 3,190,800,696 155.5 1,580,830,495 163.5 5,040,020 143.9

2021 3,720,990,877 181.4 1,770,260,607 182.5 5,530,525 150.0

2022 4,080,450,783 198.7 1,950,990,764 201.8 6,370,634 182.0

2023 4,400,420,730 214.2 2,110,390,869 217.6 8,060,755 230.3

Common Size Analysis

Another important financial

statement analysis techniques are
common size analysis in which
figures reported are converted into
percentage to some common base.
Common Size Analysis

In the balance sheet the total assets figures is assumed to be

100 and all figures are expressed as a percentage of this total.
It is one of the simplest methods of financial statement
analysis, which reflects the relationship of each item with
the base value of 100%.
Funds Flow Statement

Funds flow statement is one of the important tools, which is

used in many ways. It helps to understand the changes in
the financial position of a business enterprise between the
beginning and ending financial statement dates. It is also
called as statement of sources and uses of funds.
Cash Flow Statement

Cash flow statement is a statement which shows the sources

of cash inflow and uses of cash out-flow of the business
concern during a particular period. It is the statement, which
involves only short-term financial position of the business
concern.
Cash Flow Statement

Cash flow statement provides a summary of operating,

investment and financing cash flows and reconciles them
with changes in its cash and cash equivalents such as
marketable securities.
Difference Between Funds Flow and Cash Flow
Statement Funds
Ratio Analysis

Ratio analysis is a commonly used tool of financial

statement analysis. Ratio is a mathematical relationship
between one number to another number. Ratio is used as an
index for evaluating the financial performance of the
business concern.
Ratio Analysis

An accounting ratio shows the mathematical relationship

between two figures, which have meaningful relation with
each other. Ratio can be classified into various types:

Liquidity Solvency
Activity Ratios
Ratios Ratios

Market Value
Profitability
or Valuation
Ratios
Ratios
Liquidity Ratios

LIQUIDITY RATIOS - these ratios calculate the company’s

current or quick assets against its outstanding liabilities.
Generally, a high ratio indicates that the company has low
risk of defaulting payment.
Common Types of Liquidity Ratios:

Receivable
Current Ratio Quick Ratio
Turnover

Average
Inventory Average Sales
Collection
Turnover Period
Period

Working
Capital
Current Ratio

Current Ratio – measures the ability of the business to pay

its short-term obligations as they fall due.
Current Ratio

Generally, a current ratio of 1 or 1.5 is considered

satisfactory to serve as a company’s cushion to its
current liabilities, although the industry average
must be taken into consideration.

However, some banks and financial institutions

require a current ratio of 2 or 3 before extending
credit to assure the collection of the principal with
interest.
Current Ratio

Nonetheless, this does not mean that the higher the

current ratio the better.

Although a low current ratio may mean that the company may
not be able to pay its short-term debt as they mature, a very high
current ratio may mean that the company is holding too much
cash or liquid assets when in fact, a part of these could be put in
long-term investment which will yield higher income.

The component of the current assets should also be determined

because a significant part of it might be inventory and prepaid
expenses.
Current Ratio
Quick Ratio

Quick Ratio – otherwise known as

acid test ratio, it measures
immediate liquidity with the
ability to pay current liabilities
with the most liquid assets.
The quick ratio is a more
conservative measure of liquidity
since it only considers current
assets that can be converted to
cash easily or quickly.
Quick Ratio

Current assets are composed of cash,

short-term investments, receivables,
merchandise inventory, and prepaid
expenses. From these, we can notice
that merchandise inventory is not
easily convertible to cash as it must be
sold first which does not guarantee
instant cash because sometimes, it is
sold on credit.
Quick Ratio

Furthermore, some inventory items are slow moving. Due

to obsolescence, these items may not even be sold in the
long run.
On the other hand, prepaid expenses will never be
converted to cash since they are not sold but used in the
normal operating cycle of the business. It is because of these
reasons that these two accounts are not considered when
computing for the quick ratio.
Quick Ratio
Receivable Turnover

Receivable Turnover – also known as trade receivable

turnover, it measures the efficiency to collect the amount due
from credit customers.
Receivable Turnover

Generally, a high trade receivable turnover is considered

favorable since it may indicate a company’s strict credit
policies combined with aggressive collection efforts while a
low trade receivable turnover may indicate loose credit
policies combined with inadequate collection effort.
However, imposing a very strict credit and collection
policy may lead to looser sales as some customers may opt
to buy from other companies with more lenient credit terms.
Receivable Turnover
Average Collection Period

Average Collection Period –

otherwise called day’s sales
outstanding, is the approximate
number of days it takes a business to
collect its receivables from credit or
account sales.
In assessing whether the average
collection period is favorable or
unfavorable, the credit terms
extended by the company to its
customers should be considered.
Average Collection Period
Average Collection Period
Inventory Turnover

Inventory Turnover – measures

the number of times a company’s
inventory is sold and replaced
during the year.
Since the company generates
income from sales, the faster the
movement of the inventory, the
higher the company’s net
income.
Inventory Turnover

Low inventory turnover may

indicate overstocking of inventory
or the presence of obsolete items.
This is not favorable as inventory
items tend to deteriorate, spoil, or
be obsolete when stocked in the
warehouse for some time unless it
is planned stocking in anticipation
of product shortage or price
increase.
Inventory Turnover

High inventory turnover may

indicate strong sales. However, it
may also indicate inefficient
purchasing where purchases are
made often in small quantities
resulting in insufficient stock of
goods or inadequate inventory
levels.
Inventory Turnover

This may result in losses in terms of sales as customer

demand is not served when the product is out of stock. This
may also result in higher purchase price of goods as the
company cannot avail of the maximum trade discount
available due to purchases made in small volumes.
Inventory Turnover
Inventory Turnover
Average Sales Period

Average Sales Period – otherwise

known as the inventory
conversion period, it is the
average time to convert inventory
to sales.
Generally, the lower the average
sales period, the more favorable
it is for the company since it
signifies a shorter period to sell
inventory.
Average Sales Period
Working Capital

Working Capital – measures the short-term liquidity of a

company
Solvency Ratio

SOLVENCY RATIOS - otherwise known as leverage ratios,

measure the company’s ability to pay its maturing long-term
debts while sustaining operations indefinitely.
Common Types of Solvency Ratio

Debt Ratio Equity Ratio

Times
Debt to
Interest
Equity Ratio
Earned
Debt Ratio

Debt Ratio – otherwise known as the debt to assets ratio, it

measures business liabilities as a percentage of total assets. It
measures the extent of the total assets financed by liabilities.
Generally, a lower ratio is favorable since it means that
more funds are provided by the owner.
Debt Ratio

The accounting equation (Assets = Liabilities + Owner’s

Equity) very well shows that business funds come from two
sources, namely liabilities from creditors and owner’s equity
from the owner.
Debt Ratio

Generally, a 50-50 ratio where

liabilities and owner’s equity have
the same proportion is considered
fair as this is determined to be the
optimal debt ratio.
However, slightly higher debt ratio
is also acceptable although we must
consider the industry and the
payment history of the company.
Debt Ratio
Equity Ratio

Equity Ratio – it measures the percentage of total assets

financed by the owner’s investment. It measures the extent of
total assets owned by the owner. This is his/her stake in the
company.
Equity Ratio

Generally, the higher the equity

ratio, the more favorable it is for
the company. This is also an
advantage if the company is to
apply for a loan as potential
creditors will find the company to
be less risky.
Equity Ratio
Debt to Equity Ratio

Debt to Equity Ratio – also known as financial leverage

ratio, it measures the financing provided by the creditors
against those provided by the owner. This measures the
extent of the borrowed funds as compared to the
investment by the owner.
Debt to Equity Ratio

The optimal fair ratio is 1 or 100%. This means that

liabilities are equal to owner’s equity.
The higher the ratio, the higher the risk as interest
payments on liabilities are onerous. Hence a lower ratio is
favorable.
Debt to Equity Ratio
Times Interest Earned

Times Interest Earned – it measures the company’s ability to

pay the interest charged to the company for its outstanding
liabilities. It measures the number of times operating income
can cover interest expenses.
Times Interest Earned

The higher the number of times

the operating income can cover
the interest expense, the more
favorable it is for the creditors
because it means the company is
not struggling to pay its interests
from loans.
Times Interest Earned
Profitability Ratios

PROFITABILITY RATIOS - these measure a company’s

overall efficiency and performance based on its ability to
generate profit from operations relative to its available assets
and resources.
Common Types of Profitability Ratios

Gross Profit Operating

Ratio Profit Margin

Net Profit Return on

Margin Assets
Gross Profit Ratio

Gross Profit Ratio – otherwise known as Gross Margin

Ratio, it measures the percentage of peso sales earned after
deducting the cost of goods sold.
Gross Profit Ratio

Hence, this is the percentage of

mark-up a company adds to the
cost of its inventory which will later
absorb the operating expenses related
to the sale of the goods.
A high gross profit ratio is
favorable as there will be greater
operating income after all operating
expenses have been paid.
Gross Profit Ratio
Operating Profit Margin

Operating Profit Margin – measures the percentage of

income earned after deducting the cost of sales and the
operating expenses.
Operating Profit Margin

In short, it is the income earned

per peso of net sales after the cost
of inventory and the related
operating expenses are deducted.
This is an indication of how the
company is effectively and
efficiently managing its expenses at
its sales level. Hence, a higher
ratio is favorable since it indicates
efficiency in managing expenses.
Operating Profit Margin
Net Profit Margin

Net Profit Margin – also known

as return on sales, it measures the
percentage of net income earned
from net sales after all other
income has been added and all
operating expenses and other
expenses including income taxes
have been paid. A high net profit
margin is favorable for the
company.
Net Profit Margin
Return on Assets

Return on Assets – otherwise called

return on investment, it measures the
company’s efficiency in using its level
of investment in assets to generate
income.
Generally, a high ratio is favorable.
Since capital assets are one of the
company’s investments, the return on
assets measures the income derived
from these asset acquisitions.
Return on Assets
Any Questions?