Financial Statement Analysis

Prepared by:
Arman Jay L. Dizon, CPA
Introduction

• How can we determine:

• The ability of an organization to pay loans?
• Whether we are earning a fair return on our
investment?
• The adequacy of cash flow to pay operating
expenses?
• How to improve the overall performance of
the company?
Financial Statements

• The preparation of the financial statement is

not end but is a beginning of a more
important process.
• The main purpose of financial statements is
to guide users in making informed, prudent
or sound economic decisions.
• Prior to making decisions, an essential
process must be done, that is to make
thorough analyses of the information found
in the financial statements.
Financial Statement Analysis

• Financial Statement Analysis will help

business owners and other interested
people to analyze the data in financial
statements to provide them with better
information about such key factors for
decision making and ultimate business
survival.
Financial Statement Analysis

• Financial statement analysis involves

analyzing the information provided in the
financial statements to:
– Provide information about the organization’s:
• Past performance
• Present condition
• Future performance
– Assess the organization’s:
• Earnings in terms of power, persistence, quality
and growth
Purpose of Financial Statement Analysis
• Financial statement analysis helps users
make better decisions.
Internal Users External Users
• Managers • Shareholders
• Officers • Lenders
• Internal Auditors • Customers

• The primary goal of financial management

is to maximize shareholders' wealth.
Limitations of F.S. Analysis

• Its failure to consider changes in the

purchasing power , inconsistencies as well
as dissimilarities in the accounting
principles, policies and procedures used
by the firms in the industry.
• Its failure to consider changes in the
purchasing power of currencies.
Limitations…

• The age of the financial statement is a

limitation. The older it gets, the less
reliable it become thus, considered as a
risk management tool.
• Failure to read and understand the
information in the Notes to the financial
statements may obscure managers in
evaluating the degree of risk.
Limitations…

• Financial statements that have not

undergone external auditing procedures
may or may not conform with the
Generally Accepted Accounting Principles
(GAAP) and standards thus, usage of
these statements may lead to erroneous
analysis, and ultimately erroneous
decisions.
Limitations…

• Financial statements that have not

undergone external auditing procedures
may prove to be inaccurate or worse
fraudulence hence, do not fairly present
the company's financial condition
• Audited statements do not guarantee
accuracy.
 Building Blocks of Analysis

Ability to meet Ability to

short-term generate future
obligations and revenues and
to efficiently Liquidity and meet long-term
Efficiency Solvency
generate obligations
revenues
Ability to
Ability to provide generate
financial rewards positive
sufficient to market
attract and retain Profitability expectations
Marketability
financing
Different Tools in Analyzing Financial
Statements
• Horizontal analysis (trend analysis)
• Vertical analysis (common-size analysis)
• Ratio analysis
Tools in F.S. Analysis

• Horizontal Analysis
– Comparing a company's financial condition and
performance across time.
– Changes may be in amount or in percentage as
the company's past performance is its base year.
– Also called “trend analysis.”
– In horizontal analysis, the balance of the
accounts in the financial statements of the
previous year is subtracted from the current year.
This would result to a change, either a growth or
a reduction.
Formulas in Horizontal Analysis

• Change in amount = current year amount – base year

amount

• Change in % = change in amount / base year amount

• Trend % = current year amount / base year amount

Horizontal Analysis Sample Problem:
• Supply the missing info. using horizontal analysis using
2016 as base year:
CBA Company
Comparative Balance Sheet
As of December 31, 2016 and 2017

2016 2017 Change in Change in %

amount
Current Assets P20,000 P25,000
Fixed Assets 500,000 450,000
Total Assets P520,000 P475,000

Total Liabilities P200,000 P300,000

Shareholders’ Equity 320,000 175,000
Total Liabilities and P520,000 P475,000
Shareholders’ Equity
Trend Analysis
• Supply the missing info. on the comparative income
statements of CBA Company for 2016, 2017 and 2018
using 2016 as base year:
CBA Company
Comparative Income Statements
For the years ended December 31, 2016, 2017 and 2018

2016 2017 2018

Amount % amount % amount %
Sales P100,000 P60,000 P130,000
Less: Cost of Sales 50,000 40,000 55,000
Gross Profit 50,000 P20,000 P75,000
Less: Other 25,000 15,000 40,000
operating expenses
Net Income P25,000 P5,000 P35,000
Tools in F.S. Analysis

• Vertical Analysis
– Comparing the company's financial condition and
performance to a base amount.
– Related to common-size financial statements,
statements in which all items have been restated as
a percentage of a selected item on the statement.
– Vertical analysis is commonly applied to the
balance sheet and the income statement.
– The common size statements are sometimes called
component percentage or 100 percent statements.
Formulas in Vertical Analysis

• Balance sheet %
% = Amount / Total assets
% = Amount / Total liabilities and equity

• Income statement %
% = Amount / Net sales

• Note: Convert it to percent by multiplying the answer by 100% or moving 2 decimal places to the right
Vertical Analysis Sample Problem
• Prepare vertical analysis of CBA Company:
CBA Company
Balance Sheet
As of December 31, 2017

Amount %
Cash P20,000
A/R 40,000
Inventory 40,000
Fixed Assets 400,000
Total Assets P500,000

A/P P30,000
Bonds and Mortgage Payable 300,000
Shareholders’ Equity 170,000
Total Liabilities and SHE P500,000
Vertical analysis Sample problem
• Prepare vertical analysis of CBA Company:
CBA Company
Income Statement
For the year ended December 31, 2017

Amount %
Sales P1,000,000
Less: Cost of sales 700,000
Gross Profit P300,000
Less: Operating 120,000
Expenses
Operating Income P180,000
Less: Tax expense 54,000
(30%)
Net income P126,000
Tools in F.S. Analysis

• Ratio Analysis
– involves calculating and analyzing ratios that
uses one or more financial statements.
– also expresses relationships between
different financial statements.
Ratio Analysis
• Ratio analysis categorized into five(5):
– Liquidity Ratios - show relationship of a firm's ability to pay
liabilities on a short-term basis
– Asset Management Ratios - shows the relationship on how the
company uses its assets efficiently
– Debt Management Ratios - shows relationships on the
company's ability to pay long-term debt and how the company
has financed its assets (solvency)
– Profitability Ratios - shows how profitably the company is
operating and utilizing its assets
– Market Value Ratios - which bring in the stock price and gives
ideas on what investors think about the company and its future
prospects (attractiveness of the company)
Liquidity Ratios

• Ratios that show the relationships of a

company's cash and other current assets
to its current liabilities.
Liquidity Ratios

• Net Working Capital = shows the

difference between the current assets and
current liabilities.

Net Working Capital = Current Assets - Current Liabilities

• If the current assets is P1,000,000 and the
current liabilities is P800,000, how much is
the working capital?
• Supposing that the working capital is
P500,000 and the current assets is
P600,000, how much is the current
liabilities?
Liquidity Ratios

• Current Ratio - indicates the extent to

which current liabilities are covered by
those assets expected to be converted
into cash in the near future.

• Current Ratio = Current Assets

Current Liabilities
• If a company has total current assets of
P6,000,000 and current liabilities of
P3,000,000, what is the company’s current
ratio?
• If the current ratio of a company is 2.5x
and the current liabilities is P5,000, what is
the company’s current assets?
Liquidity Ratios

• Quick/Acid Test Ratio - Same as current

ratio, except that the inventories and
prepayments (if there is any) are deducted
to the current assets.

Quick/Acid Test Ratio = Current Assets - Inventories - Prepayments

Current Liabilities
• Supposing that the current assets is
P1,000,000, of which 20% consists of
inventory, and current liabilities amounting
to P500,000, what is the company’s quick
ratio?
• If the quick ratio is 3x and the current
liabilities is P50,000, how much is the
company’s total current assets if the
inventory for the period is P10,000?
Asset Management Ratios

• Set of ratios that measure how effectively

and efficiently a firm is managing its
assets.
Asset Management Ratios
• Inventory Turnover Ratio - shows how
many times the inventory is turned over
during the year.

Inventory Turnover = Cost of Goods Sold

Average Inventory*

*Note that if the numerator is in the income statement and the denominator is in the balance sheet,
the denominator must be the average of the past year and the current year's balance. If there is
only one year given (for example, only the current year), then the amount for the current year is
the average balance itself. To be applied also in other formulas.
Asset Management Ratios
• Average Days in Inventory – tells the number of days
that the inventory purchased be sold to customers.
(number of days between the time inventory was
purchased and the time it was sold to customers)

Average Days in Inventory = 365 days ___

Inventory Turnover

= Ave. Inventory ___

Cost of goods sold/365 days**
**Note: It depends on the company whether actual or ordinary days in a year will be used. (360 days if
ordinary days per year)
• If the purchases for the year totaled
P500,000 and the inventories at the
beginning and end of the period amounted
to P20,000 and P40,000, respectively,
how much is the company’s inventory
turnover?
Asset Management Ratios

• Receivable Turnover - shows relationship

on how many times the receivable is
collected during the year.

Receivable Turnover = Credit Sales

Average Receivables
Asset Management Ratios

• Days Sales Outstanding (DSO) = indicates the average

length of time the company must wait after making a
sale before it receives cash. (average collection period)

DSO = Ave. Receivables

Credit Sales/365 days**

or

DSO = 365 days**

Receivable Turnover
**Note: It depends on the company whether actual or ordinary days in a year will be used.
• If the average accounts receivable for the
year is P50,000 and the total sales for the
current year is P200,000, how much is the
accounts receivable turnover?
• Using the same problem, assuming a 365-
day period, what is the company’s days
sales outstanding?
Asset Management Ratios

• Fixed Asset Turnover = Sales

Average Fixed
Assets

• Total Asset Turnover = Sales

Average Total
Assets
If the total sales for the year is P1,000,000
and the total assets for the year is P800,000
including total fixed assets of 62.50% of the
company’s assets, compute:
1. Fixed Asset Turnover
2. Total Asset Turnover
Debt Management Ratios

• Set of ratios that measure how effectively

a company manages its debt (especially
the company's long-term debt).
Debt Management Ratios

• Debt Ratio - percentage of funds provided

by creditors. (used in assessing financial
leverage and solvency)

Debt Ratio = Total Debt_

Total Assets
Debt Management Ratios

• Debt-to-Equity Ratio - ratio of debt to the

NET assets of the company. (used in
assessing financial leverage and solvency)

Debt-to-Equity Ratio = Total Debt

Total Equity
• If the total assets for the year is
P1,000,000 and the total debt is P500,000,
what is the company’s debt ratio?
• Using the same problem, what is the
company’s debt-to-equity ratio?
• If the debt-to-equity ratio is 1/3, what is the
company’s debt ratio?
Debt Management Ratios

• Times-Interest-Earned Ratio - ratio of

earnings before interest and taxes to
interest charges; a measure of the
company's ability to meet its annual
interest payments.

Times-Interest-Earned Ratio = Income before Interest and taxes

Interest Expense
Profitability Ratios

• Ratios that show the combined effects of

liquidity, asset management, and debt
management on operating results.
Profitability Ratios

• Gross Margin - ratio of gross profit to

sales.

Gross Margin (%) = Gross Profit x 100%

Sales
Profitability Ratios

• Profit Margin - ratio measures income per

dollar of sales.

Profit Margin = Net Income x 100%

Sales
Profitability Ratios

• Return on Total assets (ROA) - ratio of the

net income to total assets.

ROA = Net operating profit after tax

Average Total Assets*

(Net operating profit after tax = Profit + interest expense)

Profitability Ratios
• Return on Equity (ROE) - measures the
rate of return on the shareholders'
investment.

ROE = Net Income – preference dividends

Average Shareholders' Equity***

***Note: Only the ordinary/common stockholders, preferred stockholder is not included, because in
management accounting, preferred stockholders are considered more as a liability because of
preference to receive dividends every year, not equity.
Profitability Ratios

• Return on Equity using DuPont Formula

ROE = Profit Margin x Total Asset Turnover x Equity Multiplier

Or

ROE = Net income x Sales x Total Assets

Sales Total Assets Total Equity
Sample Problems:

Given the ff. information:

Sales, P20,000; Cost of Sales; P12,000;
Interest Expense, P2,000; Operating Expenses,
P3,000; Return on assets, 20%, Debt ratio, 40%.

Compute: (1) Gross margin,

(2) Profit Margin,
(3) Times-interest-earned,
(4) Return on equity
Market Value Ratios

• Ratios that relate the company's stock

price to its earnings and book value per
share.

• Other books consider this category as part of profitability ratios.

Market Value Ratios

• Book Value Per Share - ratio of the

common shareholders' equity to the
shares outstanding

Book Value/Share = Common equity

Shares outstanding
Market Value Ratios

• Earnings per Share (EPS) - ratio of net

income to the number of outstanding stock
to common stockholders.

EPS = Net Income - Dividends to Preferred Stock

No. of Outstanding Common Stock
Market Value Ratios

• Market Price per Share - ratio of the

market price of the common stock to the
number of outstanding common stock.

Price/Share = Market Value of Common Stock

No. of Outstanding Common Stock
Price per Earnings Ratio
• Measures the ratio of the market price of the
shares to the company’s net income.

P/E Ratio = Market Value of Company’s Stock

Net Income – Dividends to
Preferred stock

or

P/E Ratio = Price per share

Earnings per share
Sample Problems

Given the ff. information:

Net income, P1,000,000; Dividends to
preferred stock, P200,000; Average common
stockholders’ equity, P400,000; issued and
outstanding stock, 10,000 shares;
Price/earnings ratio, 5
Compute:
(1) Earnings per share
(2) Book value per share
(3) Market price per share
Interpreting F.S. Analysis

• Intracompany – same entity, different years

(changes in financial relationships and
trends)
• Intercompany – same item, different entities
(competitive position)
• Industry averages – compare item/financial
relationships to industry norms published
by financial ratings organizations
(benchmarking)
Thank you!

God bless!