UNIVERSITY OF MAKATI

J. P. Rizal Ext., West Rembo, Makati City

COLLEGE OF BUSINESS AND FINANCIAL SCIENCE
Department of FINANCE MANAGEMENT
Course Title Title
Module
3
No. FINANCIAL MANAGEMENT 2

FINMAN 2 Module Leader PROF. RENNIEL B. HALLERA

Module
none
Contributors
Time Frame:
You are expected to finish all the activities, assignments, and
assessments of this 4th week of the semester.

How to Complete this .

module? 1. Complete the reading assignment
2. View the shared educational video/reading materials about the course.
3. Participate in this week’s discussion (if any)
4. Complete the Module 3 requirement given by the professor
5. Submit other required outputs

Teaching Strategies Use of UMAK-LMS- TBL, Suggested Education video about the subjects ,
Online discussion (GoogleMeet, Zoom, Messenger, Google classroom) Voice-
over PowerPoint, or video-recorded lectures, Online links, and Online quizzes.

INTRODUCTION

Financial statement analysis can be referred as a process of understanding the risk and
INTRODUCTION

profitability of a company by analyzing reported financial info, especially annual and quarterly
reports. Putting another way, financial statement analysis is a study about accounting ratios
among various items included in the balance sheet. These ratios include asset utilization ratios,
profitability ratios, leverage ratios, liquidity ratios, and valuation ratios. Moreover, financial
statement analysis is a quantifying method for determining the past, current, and prospective
performance of a company.
LEARNING OUTCOMES

By the end of this module , you should be able to

1. Knowledge: Definition and Importance of Financial Statement Analysis

2.
3. Skills: Assess the best practices of the organization by using the financial statement
analysis and use

4. Attitude: The learner will learn team collaboration in analysing financial statement data.

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 Financial Statement Analysis and Implications to Management

Financial statement analysis is the process of analyzing a company's financial statements for
decision-making purposes. External stakeholders use it to understand the overall health of an
organization as well as to evaluate financial performance and business value. Internal
constituents use it as a monitoring tool for managing the finances.

The financial statements of a company record important financial data on every aspect of a
business’s activities. As such they can be evaluated on the basis of past, current, and projected
performance.

In general, financial statements are centered around generally accepted accounting principles
(GAAP). These principles require a company to create and maintain three main financial
statements: the balance sheet, the income statement, and the cash flow statement. Public
companies have stricter standards for financial statement reporting. Public companies must
follow GAAP standards which requires accrual accounting.1

Private companies have greater flexibility in their financial statement preparation and also have
the option to use either accrual or cash accounting

Several techniques are commonly used as part of financial statement analysis. Three of the
CONTENT

most important techniques include horizontal analysis, vertical analysis, and ratio analysis.
Horizontal analysis compares data horizontally, by analyzing values of line items across two or
more years. Vertical analysis looks at the vertical affects line items have on other parts of the
business and also the business’s proportions. Ratio analysis uses important ratio metrics to
calculate statistical relationships.

As mentioned, there are three main financial statements that every company creates and
monitors: the balance sheet, income statement, and cash flow statement. Companies use these
financial statements to manage the operations of their business and also to provide reporting
transparency to their stakeholders. All three statements are interconnected and create different
views of a company’s activities and performance.

Advantages of financial statement analysis

 The most important benefit if financial statement analysis is that it provides an idea to
the investors about deciding on investing their funds in a particular company.
 Another advantage of financial statement analysis is that regulatory authorities like IASB
can ensure the company following the required accounting standards.
 Financial statement analysis is helpful to the government agencies in analyzing the
taxation owed to the firm.
 Above all, the company is able to analyze its own performance over a specific time
period.

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 Limitations of financial statement analysis

In spite of financial statement analysis being a highly useful tool, it also features some
limitations, including comparability of financial data and the need to look beyond ratios. Although
comparisons between two companies can provide valuable clues about a company’s financial
health, alas, the differences between companies’ accounting methods make it, sometimes,
difficult to compare the data of the two.

Besides, many a times, sufficient data are on hand in the form of foot notes to the financial
statements so as to restate data to a comparable basis. Or else, the analyst should remember
the lack of data comparability before reaching any clear-cut conclusion. However, even with this
limitation, comparisons between the key ratios of two companies along with industry averages
often propose avenues for further investigation.

HORIZONTAL ANALYSIS

Horizontal analysis is used in financial statement analysis to compare historical data, such as
ratios, or line items, over a number of accounting periods. Horizontal analysis can either use
absolute comparisons or percentage comparisons, where the numbers in each succeeding
period are expressed as a percentage of the amount in the baseline year, with the baseline
amount being listed as 100%. This is also known as base-year analysis.

 Horizontal analysis is used in the review of a company's financial statements over

multiple periods.
 It is usually depicted as a percentage growth over the same line item in the base year.
 Horizontal analysis allows financial statement users to easily spot trends and growth
patterns.
 It can be manipulated to make the current period look better if specific historical periods
of poor performance are chosen as a comparison.

Generally accepted accounting principles (GAAP) are based on consistency and comparability
of financial statements. Consistency is the ability to accurately review one company's financial
statements over a period of time because accounting methods and applications remain
constant. Comparability is the ability to review side-by-side two or more different companies'
financials. Horizontal analysis not only improves the review of a company's consistency over
time directly, but it also improves comparability of growth in a company to that of its competitors
as well.

Horizontal analysis allows investors and analysts to see what has been driving a company's
financial performance over a number of years, as well as to spot trends and growth patterns
such as seasonality. It enables analysts to assess relative changes in different line items over

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 time, and project them into the future. By looking at the income statement, balance sheet, and
cash flow statement over time, one can create a complete picture of operational results, and
see what has been driving a company’s performance and whether it is operating efficiently and
profitably.

The analysis of critical measures of business performance, such as profit margins, inventory
turnover, and return on equity, can detect emerging problems and strengths. For example,
earnings per share (EPS) may have been rising because the cost of goods sold (COGS) have
been falling, or because sales have been growing strongly. And coverage ratios, like the cash
flow-to-debt ratio and the interest coverage ratio can reveal whether a company can service its
debt through sufficient liquidity. Horizontal analysis also makes it easier to compare growth
rates and profitability among multiple companies.

Examples;
Horizontal analysis typically shows the changes from the base period in dollar and percentage.
For example, when someone says that revenues have increased by 10% this past quarter, that
person is using horizontal analysis. The percentage change is calculated by first dividing the
dollar change between the comparison year and the base year by the line item value in the
base year, then multiplying the quotient by 100.

For example, assume an investor wishes to invest in company XYZ. The investor may wish to
determine how the company grew over the past year. Assume that in company XYZ's base
year, it reported net income of PHP10 million and retained earnings of PHP50 million. In the
current year, company XYZ reported net income of PHP20 million and retained earnings of
PHP52 million. Consequently, it has an increase of PHP10 million in its net income and PHP2
million in its retained earnings year over year. Therefore, company ABC's net income grew by
100% ((PHP20 million - PHP10 million) / PHP10 million * 100) year over year, while its retained
earnings only grew by 4% ((PHP52 million - PHP50 million) / PHP50 million * 100).

VERTICAL ANALYSIS

Vertical analysis is a method of financial statement analysis in which each line item is listed as
a percentage of a base figure within the statement. Thus, line items on an income statement
can be stated as a percentage of gross sales, while line items on a balance sheet can be stated
as a percentage of total assets or liabilities, and vertical analysis of a cash flow statement shows
each cash inflow or outflow as a percentage of the total cash inflows.

 Vertical analysis makes it easier to understand the correlation between single items on
a balance sheet and the bottom line, expressed in a percentage.
 Vertical analysis can become a more potent tool when used in conjunction with horizontal
analysis, which considers the finances of a certain period of time.

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 Vertical analysis makes it much easier to compare the financial statements of one company
with another, and across industries. This is because one can see the relative proportions of
account balances. It also makes it easier to compare previous periods for time series analysis,
in which quarterly and annual figures are compared over a number of years, in order to gain a
picture of whether performance metrics are improving or deteriorating.

For example, by showing the various expense line items in the income statement as a
percentage of sales, one can see how these are contributing to profit margins and whether
profitability is improving over time. It thus becomes easier to compare the profitability of a
company with its peers.

Financial statements that include vertical analysis clearly show line item percentages in a
separate column. These types of financial statements, including detailed vertical analysis, are
also known as common-size financial statements and are used by many companies to provide
greater detail on a company’s financial position.

TREND ANALYSIS

Trend analysis is a technique used in technical analysis that attempts to predict future stock
price movements based on recently observed trend data. Trend analysis is based on the idea
that what has happened in the past gives traders an idea of what will happen in the future. There
are three main types of trends: short-, intermediate- and long-term.

 Trend analysis tries to predict a trend, such as a bull market run, and then ride that trend
until data suggests a trend reversal, such as a bull-to-bear market.
 Trend analysis is based on the idea that what has happened in the past gives traders an
idea of what will happen in the future.
 Trend analysis focuses on three typical time horizons: short-; intermediate-; and long-
term.

Trend analysis tries to predict a trend, such as a bull market run, and ride that trend until data
suggests a trend reversal, such as a bull-to-bear market. Trend analysis is helpful because
moving with trends, and not against them, will lead to profit for an investor.

A trend is the general direction the market is taking during a specified period of time. Trends
can be both upward and downward, relating to bullish and bearish markets, respectively. While
there is no specified minimum amount of time required for a direction to be considered a trend,
the longer the direction is maintained, the more notable the trend.

Trend analysis is the process of looking at current trends in order to predict future ones and is
considered a form of comparative analysis. This can include attempting to determine whether
a current market trend, such as gains in a particular market sector, is likely to continue, as well

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 as whether a trend in one market area could result in a trend in another. Though a trend analysis
may involve a large amount of data, there is no guarantee that the results will be correct.

Examples of Trend Analysis

In order to begin analyzing applicable data, it is necessary to first determine which market
segment will be analyzed. For instance, you could focus on a particular industry, such as the
automotive or pharmaceuticals sector, as well as a particular type of investment, such as the
bond market.

Once the sector has been selected, it is possible to examine its general performance. This can
include how the sector was affected by internal and external forces. For example, changes in a
similar industry or the creation of a new governmental regulation would qualify as forces
impacting the market. Analysts then take this data and attempt to predict the direction the
market will take moving forward.

COMMON SIZE FINANCIAL STATEMENT

A common size financial statement displays items as a percentage of a common base figure,
total sales revenue, for example. This type of financial statement allows for easy analysis
between companies, or between periods, for the same company. However, if the companies
use different accounting methods, any comparison may not be accurate.

While most firms do not report their statements in common size format, it is beneficial for
analysts to do so to compare two or more companies of differing size or different sectors of the
economy. Formatting financial statements in this way reduces bias that can occur and allows
for the analysis of a company over various periods. This analysis reveals, for example, what
percentage of sales is the cost of goods sold and how that value has changed over time.
Common size financial statements commonly include the income statement, balance sheet, and
cash flow statement.

Common size financial statements reduce all figures to a comparable figure, such as a
percentage of sales or assets. Each financial statement uses a slightly different convention in
standardizing figures.

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 ASSIGNMENT

1. Reaction Paper/ Discuss; If you are the investor, how will you use these “Financial Statement
Analysis” I terms of your Investment decision?
ASSESSMENT

Recitation or Class Participation thru online via Zoom or any instructed by the school
Lecture Analysis
Reaction paper thru Google classroom

Rule: In a self-paced and self-contained online classroom, Rubric is required to guide students how to
perform the task assessments.

Lesson Analysis of reading materials

Critical Analysis ( reaction paper about the reading materials provided) 80%
RUBRICS

Writing Skills (Grammar/Sentence Construction) 20%

With Online discussion/ Face to face class

Note
In the event of online discussion- Presentation skills 30%
Summary (Quizzes and Activities) 20%
Critical Analysis ( Reaction paper about the reading materials provided) 40%
Writing Skills (Grammar /Sentence construction) 10%

https://www.investopedia.com/terms/t/trendanalysis.asp
REFERENCES

https://www.investopedia.com/terms/c/commonsizefinancialstatement.asp

readyratios.com/reference/analysis/financial_statement_analysis.html

https://www.investopedia.com/terms/v/vertical_analysis.asp

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