ANALYSIS AND

INTERPRETATION OF
FINANCIAL
STATEMENTS
The users of financial statements have different reasons for analyzing and
interpreting the financial statements; every item in these reports is of
varying importance to the users:
 
²  Investors  
²  Employees  
²  Lenders  
²  Suppliers  
²  Management  
²  Customer  
²  Public  
²  Government Agencies
 Financial Statement (FS) Analysis
 
•  The method of determining a company's risks, performance, financial
health, and future prospects by subjecting financial statement data to
statistical and analytical techniques with the purpose of better
economic decision making.

•  Depending on the objective of the analysis, a financial statement

analysis may involve analyzing one or more of the following:

Industry & Economic Trend

Solvency & Capital Structure

Opera9onal Efficiency

Profitability
1. Industry & Economic Trend
 
•  This includes examining the market environment in which the company
operates.

•  This is important because various external factors such as economic

conditions, competition, demand and supply, market prices,
government regulations, technological advances, and the like influence
a business' ability to not only survive but thrive.

•  A company's FS doesn't have all the details required to evaluate the

market and the economic trend. External sources are needed such as
published industry averages, current events, statistical data, research
papers, and financial data from key players in the industry.
2. Solvency and Capital Structure
 
•  Solvency refers to the ability of the business to pay its debts and
remain as a going concern.
•  This can be short-term (liquidity) or long-term (solvency).

•  Capital Structure refers to how a business efficiently finances its

operations using different sources of funds such as debt and equity

•  The stability of a business is dependent to both solvency & capital

structure.
3. Operational Efficiency
 
•  This refers to how well a business is managing its resources to
maximize earnings.
 

4. Profitability
 
•  This refers to the ability of the business to generate profit.
3 Financial Statements Analysis Techniques

Vertical Analysis

Horizontal Analysis

Financial Ratio
Analysis

 VERTICAL ANALYSIS

•  It is also called common-size analysis

•  It involves the analysis of the financial statements of one reporting

period.

•  It is a technique that expresses each financial statement item as a

percentage of a base amount

•  Base amount:

•  Statement of Financial Position - TOTAL ASSETS

•  Statement of Comprehensive Income – TOTAL REVENUE

 Common-size Percentage Formula:

( Balance of Account / Base Amount ) X 100

CS %

CS %

 HORIZONTAL ANALYSIS

•  It is also called trend analysis

•  It is a technique for evaluating a series of financial statement data

over a period of time with the purpose of determining the increase
or decrease that has taken place

•  Horizontal analysis uses financial statements of two or more periods.

•  The purpose is to analyze if changes in amounts are unusually high or

low, which may entail investigation of the reason for the unusual
change.

Comparison of like accounts to each other over periods of time

 • Peso change =

Balance of Current Year-Balance of Prior Year

• Year-on-year (Y-o-Y) Growth Percentage Change =

(Balance of Current Year-Balance of Prior Year)/(Balance of Prior

Year)

 2014 2015 Peso Change Y-o-Y %

Sales 175,000 250,000 75,000 42.86%

Let’s Wrap Up
 
•  The Financial Statement Analysis is the method of determining a
company's risks, performance, financial health, and future prospects
by subjecting financial statement data to statistical and analytical
techniques with the purpose of better economic decision making.
•  Depending on the objective of the analysis, a financial statement
analysis may involve analyzing one or more of the following: industry
and economic trend, solvency & capital structure, operational
efficiency, and profitability.
•  There are 3 Financial Statements Analysis Techniques: Vertical
Analysis, Horizontal Analysis, and Financial Ratio Analysis.
•  Vertical analysis involves proportional analysis of the financial
stataements of an entity in one reporting period, where each
amount is shown as a percentage of a base account.
•  Horizontal analysis is the comparison of financial information over
two or more reporting periods.
 ANALYSIS AND
INTERPRETATION OF
FINANCIAL
STATEMENTS
 FINANCIAL RATIO

•  Ratio analysis expresses the relationship among selected items of

financial statement data. The relationship is expressed in terms of a
percentage, a rate, or a simple proportion.

•  There are many ratios used in a business. These ratios are generally
grouped into three categories:

A.  Profitability,

B.  Operational Efficiency, and

C.  Financial Health

 Operational Financial
Profitability
Efficiency Health
Ratio
Ratio Ratio
Measures Measures It looks into the
the ability of company’s
the ability of solvency and
the company the company liquidity ratios
to generate to utilize its
income from assets Solvency refers to
the use of its the company’s
assets and capacity to pay their
long term liabilities
invested It is measured
based on the
capital as company’s ability to
Liquidity ratio
well as generate sales from
intends to measure
the utilization of its
control its assets, as a whole
the company’s
ability to pay debts
cost or individually
that are coming due
 PROFITABILITY RATIO

Gross profit ratio

•  reports the peso value of the gross profit earned for every peso
of sales

 PROFITABILITY RATIO

Operating income ratio

•  expresses operating income as a percentage of sales

•  It measures the percentage of profit earned from each peso of

sales in the company’s core business operations

•  A company with a high operating income ratio may imply a lean

operation and have low operating expenses. Maximizing operating
income depends on keeping operating costs as low as possible

 PROFITABILITY RATIO

Net profit ratio

•  Relates the peso value of the net income earned to every peso of
sales

•  This shows how much profit will go to the owner for every peso of
sales made

 PROFITABILITY RATIO

Return on asset (ROA)

•  It measures the peso value of income generated by employing the

company’s assets.

•  It is viewed as an interest rate or a form of yield on asset

investment.

Profit for the year

Total Assets
 PROFITABILITY RATIO

Return on Equity (ROE)

•  It measures the return (net income) generated by the owner’s capital

invested in the business.

•  Similar to ROA, the denominator of ROE may also be total equity or

average equity.

Profit for the year

Total Equity
 OPERATIONAL EFFICIENCY RATIO

Asset Turnover Ratio

•  It measures the peso value of sales generated for every peso of the
company’s assets.

•  The higher the turnover rate, the more efficient the company is in
using its assets.

Net Sales
Total Assets
 OPERATIONAL EFFICIENCY RATIO

Fixed Asset Turnover

•  It measures the company’s ability to generate net sales

from its fixed asset investment.

•  It is an indicator of the efficiency of fixed assets in

generating sales.

Net Sales
Total Fixed Assets
 OPERATIONAL EFFICIENCY RATIO

Inventory turnover

•  It is measured based on cost of goods sold and not sales.

•  It is an indicator of how fast the company can sell inventory

Days in inventory

•  This measures the number of days from acquisition to sale

 OPERATIONAL EFFICIENCY RATIO

Accounts Receivables Turnover

•  It is a measure of the number of times accounts receivables have

been collected during the period.

Days in Accounts Receivable

•  It is a measure of the average time to collect a receivable.

 FINANCIAL HEALTH RATIO

Solvency Measures

Debt Ratio (Debt-to-Asset Ratio)

•  It indicates the percentage of the company’s assets that are financed

by debt.

•  A high debt to asset ratio implies a high level of debt.

Total Liabilities
Total Assets
 FINANCIAL HEALTH RATIO

Solvency Measures

Equity Ratio

•  It indicates the percentage of the company’s assets that are

financed through equity.

•  A high equity to asset ratio implies a high level of capital.

Total Equity
Total Assets
 FINANCIAL HEALTH RATIO

Solvency Measures

Debt-to-Equity Ratio

•  It indicates the company’s reliance to debt or liability as a source of

financing relative to equity.

•  A high ratio suggests a high level of debt that may result in high
interest expense.

Total Liabilities
Total Equity
 FINANCIAL HEALTH RATIO

Solvency Measures

Interest Coverage Ratio

•  It measures the company’s ability to cover the interest expense on

its liability with its operating income.

•  Creditors prefer a high coverage ratio to give them protection that

interest due to them can be paid.

 FINANCIAL HEALTH RATIO

Liquidity Measures

Current Ratio

•  It is used to evaluate the company’s liquidity.

•  It seeks to measure whether there are sufficient current assets to

pay for current liabilities.

•  Creditors normally prefer a current ratio of 2.

 FINANCIAL HEALTH RATIO

Liquidity Measures

Quick Ratio

•  It is a stricter measure of liquidity.

•  It does not consider all the current assets, only those that are easier
to liquidate such as cash and accounts receivable that are referred to
as quick assets.