TOPIC 3

CREATING FINANCIAL MODEL

Allam, Jerico A.
Guzman, Ella Marie A.
Macapulay, Cecil C.
Malamug, Marife E.
Manauis, Alyssa Clarisse F.

BSAIS 4B
 CREATING FINANCIAL MODEL
Financial Statements
 Are the means by which the information accumulated and processed in financial accounting is
periodically communicated to the users.
 It is used by investors, market analysts, and creditors to evaluate a company's financial health and
earnings potential.

1. Statement of Financial Position or Balance Sheet

- List all assets, liabilities and equity of an entity at a specific date.
- Provides a snapshot of what a company’s owns and owes as well as the amount invested by the
shareholders.

Balance Sheet can be presented in two different formats:

a. REPORT FORM
- This form sets forth the three major sections in a downward sequence of assets, liabilities and
equity.

b. ACCOUNT FORM
- The presentation follows that of an account, meaning, the assets are shown in the left side and the
liabilities and equity on the right side of the statement of financial position.
REPORT FORM ACCOUNT FORM
Asset
- is a resource that a business or corporation owns or controls with the expectation that it will provide
a future benefit.

a. Current Assets
- is a company's cash and its other assets that are expected to be converted to cash within one year
of the date appearing in the heading of the company's balance sheet. Current assets are usually
presented first on the company's balance sheet and they are arranged in their order of liquidity.

b. Non-Current Asset
- is an asset that is not expected to turn to cash within one year of date shown on a
company's balance sheet. A non-current asset is also known as a long-term asset.

Liabilities
- Something that a business owes to outside parties usually a sum of money.
- It is the money attributable to the owners or shareholders after subtracting liabilities from assets.

a. Current Liabilities
- Current liabilities are a company's short-term financial obligations that are due within one year or
within a normal operating cycle.

b. Non-Current Liabilities
- Non-current liabilities, also called long-term liabilities or long-term debts, are long-term financial
obligations listed on a company’s balance sheet. These liabilities have obligations that become due
beyond twelve months in the future.

Owner’s Equity
- It is the money attributable to the owners or shareholders after subtracting liabilities from assets.
Example of a Balance Sheet:
2. Statement of Financial Performance or Income Statement
- Presents a summary of the revenues and expenses of an entity for a specific period.
- The primary purpose of an income statement is to convey details of profitability and business
activities of the company to the stakeholders. By understanding the income and expense
components of the statement, an investor can appreciate what makes a company profitable.
3. Statement of Cash Flows
- Reports the amount of cash received and cash disbursed during the period.
- The cash flow statement displays the change in cash per period, as well as the beginning and ending
balance of cash.
- Has three sections: cash flows from operating activities, investing activities and financing activities.
a. Cash flows from Operating Activities
- Operating activities involves the providing of services and producing/delivering of goods.
- Cash inflows (receipts from the sales of goods and performance of service)
- Cash outflows (payments to suppliers for goods and payment to employees)
b. Cash flows from Investing Activities
- Investing activities include the making and collecting of loans, acquiring investments or debts
securities and obtaining or selling of PPE’s.
- Cash inflows (receipts from the sales of PPE’s)
- Cash outflows (payments to acquire PPE’s, payments to acquire debts securities and payments to
make loans)
c. Cash flows from Financing Activities
- Financing activities include obtaining resources from owners and creditors.
- Cash inflow (receipts from investments by the owners)
- Cash outflow (payments to the owners in the form of withdrawal)
 Example of a Statement of Cash Flows

4. Statement of Changes in Equity

- Represents a summary of the changes in capital such as in investments, profit or loss and withdrawals
during a specific period.
- Summarizes the changes occurred in owner’s equity
 Example of Statement of Changes in Equity

5. Notes to Financial Statements

- Provide a narrative description or disaggregation of items presented in the financial statements and
information about items that do not qualify for recognition
- Supplemental notes that explains the assumption used to prepare the numbers in the financial
statements as well as the accounting policy adopted by the entity.
- Common notes are the accounting policies, depreciation of assets and inventory valuation
1. FINANCIAL STATEMENT ANALYSIS

 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.

PURPOSE:
a. To use financial statements to evaluate an organization’s financial performance, financial
position, and prediction of future performance.
b. To provide information about the organization’s past performance, present condition, and future
performance.

FINANCIAL STATEMENT ANALYSIS

- Business Strategy
- Objectives
- Annual report and other documents like articles about the organization in newspapers and business
reviews.

Requires that you:

- Understand the nature of the industry in which the organization works.
- Understand that the overall state of the economy may also have an impact on the performance of the
organization.

Advantage:
- Develops a more distinct picture of a company’s financial profile

Limitation:
- Strong financial statement analysis does not necessarily mean that organization has a strong financial
future.
2. TREND ANALYSIS

 A trend analysis is an aspect of technical analysis that tries to predict the future movement of a stock
based on past data. It is based on the idea that what has happened in the past gives traders an idea of
what will happen in the future.

WHY WE MAKE TREND ANALYSIS?

- A trader may be able to match purchases and sales of particular stocks, maximizing his or her potential
for profits.
- To evaluate company performance over a period of time.
- To compare one-time period to another time period, also geographic area.
- To make future protection.
- To allow business users to make analytical decisions about those business processes that maximized
revenue from core customers.

METHODS:

1. FREE HAND GRAPHICAL METHOD

- Under this method, the values of a time series are plotted on a graph paper in the form of a histogram.
For this, the time variable is shown on the horizontal axis, the value variable on the vertical axis,
and the dots are plotted on the graph paper at the intersecting points of the time and value variables.
After this, a curve is drawn with free hand through the plotted dots in such a manner that it
represents the general tendency of time series.
 Year 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

Production of Sugar Cane 60 80 100 70 80 110 120 130 90 100

Example of Free Hand Graphical Method

2. SEMI-AVERAGE METHOD
- This method is sometimes employed when a line appears to be an inadequate explanation of the
trend. According to this method, the original data are divided into two equal parts and the values of
each part are then summed up and averaged. The average of each part is centered in the period of
time of the part from which it has been calculated and then plotted on a graph. Then a straight line
is drawn to pass through the plotted points. This line constitutes the semi-average trend line.

YEAR COMMODITY

1992 65

1993 80

1994 100

1995 70

1996 80

1997 110

1998 115

1999 130

2000 90

2001 100
 2002 150

2003 160

SOLUTION:

𝟔𝟓 + 𝟖𝟎 + 𝟏𝟎𝟎 + 𝟕𝟎 + 𝟖𝟎 + 𝟏𝟏𝟎
𝑭𝒊𝒓𝒔𝒕 𝑯𝒂𝒍𝒇: = 𝟖𝟒. 𝟏𝟔
𝟔

𝟏𝟏𝟓 + 𝟏𝟑𝟎 + 𝟗𝟎 + 𝟏𝟎𝟎 + 𝟏𝟓𝟎 + 𝟏𝟔𝟎

𝑺𝒆𝒄𝒐𝒏𝒅 𝑯𝒂𝒍𝒇: = 𝟏𝟐𝟒. 𝟏𝟔
𝟔

3. MOVING AVERAGE METHOD

- In Statistics, a moving average (rolling average or running average) is a calculation to analyze data
points by creating series of averages of different subsets of the full data set. It is also called a moving
mean (MM) or rolling mean and is a type of finite impulse filter.

Example of Moving Average Method

Moving
YEAR SALES(M)
Average

2003 4

2004 6

2005 5 6.4
 2006 8 6.6

2007 9 6.2

2008 5 5.8

2009 4 5.6

2010 3 5.4

2011 7

2012 8

0
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
 4. LEAST SQUARE METHOD
- The least square method is a form of mathematical regression analysis that finds the line of best fit
for a dataset, providing a visual demonstration of the relationship between the data points. Each
point of data is representative of the relationship between a known independent variable and an
unknown dependent variable.

- The straight line trend is represented by the equation Y = a + bX where Y is the actual value, X is
time, a, b are constants.

∑𝑌 ∑ 𝑋𝑌
𝑎= 𝑏= ∑ 𝑋2
𝑛

The constant ‘a’ gives the mean of Y and ‘b’ gives the rate of change (slope)

Example
Given below are the data relating to the production of sugarcane in a district.

YEAR 2000 2001 2002 2003 2004 2005 2006

PRODUCTION OF
40 45 46 42 47 50 46
SUGARCANE

YEAR (X) PRODUCTION OF SUGAR CANE (Y) X = (X- 2003) X2 XY TREND VALUES (Yt)
 2000 40 -3 9 -120 42.04

2001 45 -2 4 -90 43.07

2002 46 -1 1 -46 44.11

2003 42 0 0 0 45.14

2004 47 1 1 47 46.18

2005 50 2 4 100 47.22

2006 46 3 9 138 48.25

N=7 ∑ Y=316 ∑X = 0 ∑ X2 =28 ∑ XY = 29 ∑ Y(t) = 316

∑𝑌 316 ∑ 𝑋𝑌 29
𝑎= = = 45.143; 𝑏= ∑ 𝑋2
= = 1.036
𝑛 7 28

Therefore, the required equation of the straight line trend is given by: Y = a + bX ;
Y = 45.143 + 1.036 (X-2003)

The trend values can be obtained by:

When X = 2000, Y(t) = 45.143 + 1.036(-3) = 42.035
When X = 2001, Y(t) = 45.143 + 1.036(-2) = 43.071
When X = 2002, Y(t) = 45.143 + 1.036(-1) = 44.107
When X = 2003, Y(t) = 45.143 + 1.036(0) = 45.143
When X = 2004, Y(t) = 45.143 + 1.036(1) = 46.179
 When X = 2005, Y(t) = 45.143 + 1.036(2) = 47.215
When X = 2006, Y(t) = 45.143 + 1.036(3) = 48.251

Horizontal and Vertical Analysis

1. Horizontal Analysis
- Is used in financial statement analysis to compare historical data such as ratios or line items, over a
number of accounting period.

For example, assume an investor wishes to invest in ABC Company. The investor may wish to determine
how the company grew over the past year. Assume that in company’s base year, it reported net income of
$10,000,000 and retained earnings of $50,000,000. In the current year, ABC Company reported a net
income $20,000,000 and $52,000,000 in its retained earnings over year.

P1 P2 Change
Base Current

Net Income $10,000,000 $20,000,00 +$10,000,000

Retained Earnings $50,000,000 $52,000,000 +$2,000,000

Therefore, ABC Company’s net income grew by 100% (($20million-$10million)/$10million * 100) year over
year, while its retained earnings only grew by 4% (($52million-$50million)/$50million*100).

2. Vertical Analysis
- Is used in financial statement analysis to analyze company performance, but it is also useful tool for
comparing the financial statements of two (2) companies.

Vertical Analysis= individual item/base amount * 100

For example:
XYZ Company has total sales of $1,000,000 and COGS of $400,000. In addition, the company has paid
salaries of the workers amounting to $300,000 and office rent of $30,000, utilities worth $40,000 and
other expenses of $60,000.

Horizontal Analysis= Individual Item /Total Sales * 100

PARTICULARS TOTALS PERCENTAGE

Sales $ 1,000,000 100%

COGS 400,000 40%

Gross Profit 600,000 60%

Salary 300,000 30%

Rent 30,000 3%

Utilities 40,000 4%

Other expenses 60,000 6%

Total Expenses 430,000 43%

Net Profit 170,000 17%

SENSITIVITY ANALYSIS

What is Sensitivity Analysis?

- It is a Financial Model that reasons the changes in other factors, known as input variables, affect target
variables.
- It is also known as WHAT-IF or Simulation Analysis. It is a method of predicting the result of choice
based on a set of variables.
BENCHMARKING

What is Benchmarking?
- It is a process of comparing a company to its competitors in order to identify areas for improvement.