Analysis of Financial Statements (WILD and
WILLIAMS)
Financial Statement Analysis
- analytical tools to general-purpose
financial statements and related data for
making business decisions.
- involves transforming accounting data
into more useful information.
*FSA does not lessen the need for expert judgment;
instead, it provides us an effective and systematic
basis for making business decisions.
Building Blocks of Analysis
- involves;
-the objective of analysis
-the relative emphasis among the building
blocks
 Liquidity and efficiency—ability to
meet short-term obligations and to
efficiently generate revenues.
 Solvency—ability to generate future
revenues and meet long-term
obligations.
 Profitability—ability to provide
financial rewards sufficient to attract
and retain financing.
 Market prospects—ability to generate
positive market expectations.
Financial Reporting refers to the
communication of financial information useful
for making investment, credit, and other
business decisions.
Standards for Comparison
 Intracompany—The company under
analysis can provide standards for
comparisons based on its own prior
performance and relations between its
financial items.
 Competitor—One or more direct
competitors of the company being
analyzed can provide standards for
comparisons.
 Industry—Industry statistics can
provide standards of comparisons.
 Guidelines (rules of thumb)—General
standards of comparisons can develop
from experience. Examples are the 2:1
level for the current ratio or 1:1 level for
the acid-test ratio. Guidelines, or rules of
thumb, must be carefully applied
because context is crucial.
Tools of Analysis
 Horizontal analysis—comparison of a
company’s financial condition and
performance across time.
 Vertical analysis—comparison of a
company’s financial condition and
performance to a base amount.
 Ratio analysis—measurement of key
relations between financial statement
items.
Comparative Statements
Comparative Financial Statements
- comparing amounts for two or more
successive periods often helps in
analyzing financial statements.
- used for amount changes and percent
changes from time to time.
*When comparing period to another, it is crucial to
apply learnings from the prior accounting theories or
even problem. The effects, causes and significance of
increases or decreases depends on situations.
*When a negative amount appears in the base period
and a positive amount in the analysis period (or vice
versa), we cannot compute a meaningful percent
change.
*When no value is in the base period, no percent
change is computable.
Trend Analysis (trend percent analysis or index
number trend analysis)
 - is a form of horizontal analysis that can Efficiency
reveal patterns in data across successive
- refers to how productive a company is in
periods.
using its assets.
- : Index refers to the comparison of the
analysis period to the base period. Working Capital (Net Working Capital)
Percents determined for each period are
called index numbers. - excess of current assets to current
- expresses a percent of base, not a liabilities.
percent of change. - A company needs adequate working
capital to meet current debts, to carry
sufficient inventories, and to take
advantage of cash discounts.
Common-size Statements
- reveal changes in the relative
importance of each financial statement Current Ratio
item.
- Ratio to compare current assets to the
*The lack of substantial change in the balance sheet current obligations. The higher the ratio,
suggests a mature company, but with some lack of the stronger the liquidity.
focus as evidenced by the increasing amount in short-
and long-term securities. This buildup in securities is *Although, high current ratio indicates more current
a concern as the return on securities is historically assets than current liabilities, excessive investment in
smaller than the return on operating assets from current assets is not totally that efficient in terms of
successful reinvestment. using funds because current assets normally generate
a low return on investment. On the other hand, an
entity that has a good ‘leverage’ is more efficient.
RATIOS
- are among the more widely used tools of
financial analysis because they provide
clues to and symptoms of underlying
conditions.
- help us uncover conditions and trends
difficult to detect by inspecting
individual components making up the
ratio.
- are usually future oriented; that is, they
are often adjusted for their probable
future trend and magnitude, and their
usefulness depends on skillful
interpretation.
*Each item to be expressed in ratio must have
meaningful relationship.

Liquidity
- refers to the availability of resources to
meet short-term cash requirements.