FABM REVIEWER - FINALS

Lesson 1:

BASICS OF FINANCIAL STATEMENT ANALYSIS

three characteristics of an entity;

its liquidity, its profitability and its solvency.

STANDARDS FOR COMPARATIVE ANALYSIS

1. Intracompany basis.
- This basis compares an item or financial relationship within an entity in the current
year with the same time or relationship in one or more prior year.

For example, a comparison of L. Victory’s cash balance at the end of the current year
with last year’s balance will show the amount of the increase or decrease.

2. Industry averages.
-This basis compares an items or financial relationship of an entity with industry
averages or norms published by financial rating organizations.

For Example. L. Victory’s profit can be compared with the average profit of all entities in
the same industry.

3. Intercompany basis.
- This basis compares an item or financial relationship of one entity with the same item
or relationship in one or more competing entities. The comparisons are made on the
basis of the published financial statement of the individual entities.

For examples, L. Victory’s total sales for the year can be compared with the total sales
of its major competitors.

TOOLS OF FINANCIAL STATEMENT ANALYSIS

1. HORIZONTAL ANALYSIS
- is a technique for evaluating a series of financial statement data over a period of time.

2. VERTICAL ANALYSIS
- is a technique for evaluating financial statement data that expresses each item in a
financial statement in terms of a percent of a base amount.

3. RATIO ANALYSIS
- expresses the relationship among selected items of financial statement data.
HORIZONTAL ANALYSIS
- also called trend analysis
- is a technique for evaluating a series of financial statement data over a period of time.
- - determine the increase or decrease that has taken place, expressed as either an
amount or a percentage.

Vertical Analysis
- is a method of analyzing financial statements in which you can compare individual line
items to a baseline items such as net sales from the statement of comprehensive
income, total assets from the asset section of the statement of financial position, and
total liabilities and owner’s equity in the liabilities and owner’s equity section of the
statement of financial position

common-size statement
- each item is expressed as a percentage of the net sales amount.
Net sales
- is the “common size” to which we relate the statement ‘s other amounts.

LESSON 2:

RATIO ANALYSIS
- Compares one indicator to another
- give you significant insight in to the performance and relative importance of two
indicators.
- may either be a percentage , a rate or simple proportion , expresses the
mathematical relationship between one quantity and another.

LIQUIDITY RATIOS
Examples:

Current ratio- the most commonly used ratio in measuring the ability of a business to
pay its short term debts. Describes the ability of an entity to meet current debts
obligations with assets that are readily available. Current ratio is used to evaluate
an entity ‘s liquidity and short-term debt paying capacity

Formula:
Current ratio = Current Asset
Current Liabilities
Working Capital
- similar to current ratio but measures the ability of a business to pay its short-term
debts by the excess or deficiency of current assets over current liabilities.
- This equation describes the amount of capital used to run day-to-day business
operations.
- Necessary to finance an entity’s cash conversion cycle.

Quick ratio- or acid ratio- tells whether the entity could pay all its current liabilities
even if none of the inventory is sold.

Quick assets are those that may be converted directly into cash within a short period
of time. These include cash, trading investments and receivables.

Merchandise inventory is omitted because merchandise is normally sold on credit

and then the receivable must be collected before cash is realized.
Welch Corporation quick ratio on Dec.31, 2018 is calculated as follows:

Quick ratio = Quick Assets

Current Liabilities

Average Age of Inventory

- provides a rough measure of the length of time it takes to acquire, sell and replace
inventory .

Average Age of Inventory = 365 days

Inventory Turnover

Operating Cycle
- this measure the average time period between buying the inventory and receiving
cash proceeds from its sales, it is determined by adding the average age of
inventory and the average age of receivable.