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Lesson 2 - Financial Stement Analysis
Lesson 2 - Financial Stement Analysis
AROCENA, GIRANO V.
CANLAS, JONAS C.
EBBAH, ROBI ANGELO B.
PRE-MBA 102
Financial Statement
Analyzing Financial Statements
Interpret Financial Ratios
Statement of Cash Flows
What is a financial statement?
These are documents which show where the money came from,
where it went, and where it is now
The four basic financial statements:
A.) Balance Sheet
B.) Income Statement
C.) Cash Flow Statement
D.) Statement of Shareholder’s Equity
https://www.sec.gov/reportspubs/investor-publications/investorpubsbegfinstmtguidehtm.html
BALANCE SHEET
Through Financial Statement Analysis, the company can determine its strengths and
weakneses,
Can help the company can realize if it has adequate liquidity to meet upcoming debts
Can help reduce production cost and increase “Bottom line”
Helps determine wether you have enough inventory to meet projected sales figures
Compare your financial statement analysis values to spot trends and changes that affect
the business
Limitations of Financial Statement Analysis
Source: https://www.thebalance.com
Trend Analysis
Trend analysis is also called time-series analysis. Trend analysis helps a firm's financial
manager determine how the firm is likely to perform over time. Trend analysis is
based on historical data from the firm's financial statements and forecasted data
from the firm's pro forma, or forward-looking, financial statements.
Common Size Financial Statement Analysis
Common size financial statement analysis, also called a vertical analysis, is just one
technique that financial managers use to analyze their financial statements. It is not
another type of income statement, but is rather a tool used to analyze the income
statement.
Interpreting Financial Ratios
Ratio Analysis compares one indicator to another. Ratios can give
you significant insight into the performance and relative importance
of two indicators. A ratio, which may either, be a percentage, a
rate, or simple proportion, expresses the mathematical relationship
between one quantity and another.
Managers and investors can use ratio analysis to understand the
health of an entity. Ratios lend insight into many critical aspects
such as present and future profit potential, expense control , and
solvency.
Classified into three major groupings: Liquidity, profitability and
solvency ratios.
Reference: Ballada, W and Ballada, S. (2016). Accounting Fundamentals Made Easy. Manila: Dynasty
Booksource Asia.
Liquidity Ratios
Creditors and potential creditors are interested in continuously monitoring an entity’s ability to
pay interest as it comes due and to repay the principal of the debt at maturity. An analysis of a
firm’s liquid position provides indicators of its short-term debt-paying ability. It is also used to
evaluate management’s current operating efficiency.
Measuring the Ability to Pay Current Liabilities.
Working Capital
Current Ratio
Quick Ratio
Measuring the Ability to Sell Inventory and Collect Receivables
Account Receivable Turnover
Average Age of Receivables
Inventory Turnover
Average Age of Inventory
Operating Cycle
Liquidity Ratio
Working Capital
Formula: Current Assets - Current Liabilities
Meaning: This equation describes the amount of capital used to run
day to day business operations. It is necessary to finance an entity’s
cash conversion cycle.
Improved by: Increasing current assets (increase turnaround on
accounts receivable), decrease current liabilities (reduce short term
debt), increase net income to improve cash flow
Liquidity Ratio
Current Ratio
Formula: Current Assets / Current Liabilities
Meaning: Measures the ability of an entity to meet current debt
obligations with assets that are readily available. It is used to
evaluate an entity’s liquidity and short-term debt-paying capacity.
A healthy current ratio should be or in excess the value of 2.0.
Improve by: Increase current assets by increasing profit, selling
additional capital stock, borrowing additional long term debt, or
disposing of unproductive fixed assets and retaining proceeds.
Reduce current liabilities by retaining a greater portion of allocated
savings. Avoid financing non-current assets with current liabilities.
Liquidity Ratio
Quick Ratio.
Formula: Quick Assets / Current Liabilities
Meaning: 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. Creditors generally use the rule of thumb that a
quick ratio of at least 1:1 is satisfactory.
Liquidity Ratio
Accounts Receivable Turnover
Formula: Net Credit Sales / Average Net Account Receivable
Meaning: Measures the entity’s ability to collect from credit
customers. It indicates the number of times that the average
balance of accounts receivable is collected during the period.
In general, the higher the ratio, the more successfully the
business collects cash.
Improve by: Tightening credit policies and by more proactively
seeking payment of outstanding accounts.
Liquidity Ratio
Average Age of Receivables.
Formula: 365 days / Accounts Receivable Turnover
Meaning: Provides a rough approximation of the average time
that it takes to collect receivables. The general rule is that the
collection period should not materially exceed the credit period.
Liquidity Ratio
Inventory Turnover
Formula: Cost of Goods Sold / Average Merchandise Inventory
Meaning: Is a measure of the number of times an entity sold its
average level of inventory during the period. A high rate of
turnover indicates relative ease in selling inventory. Cost of
goods sold is used instead of net sales because both cost of
goods sold and merchandise inventory are stated at cost.
Higher inventory turnover ratios generally increase profitability
since an entity can use the cash normally tied up in inventory for
higher return investments.
Liquidity Ratio
Average Age of Inventory
Formula: 365 days / Inventory Turnover
Meaning: Provides a rough measure of the length of time it takes
to acquire, sell and replace inventory.
Liquidity Ratio
Operating Cycle
Formula: Average age of inventory + Average Age of Receivables
Meaning: Measures the average time period between buying the
inventory and receiving cash form its sales.
Profitability Ratios
Profitability ratios are a class of financial metrics that are used to
assess a business's ability to generate earnings compared to its
expenses and other relevant costs incurred during a specific period
of time. For most of these ratios, having a higher value relative to a
competitor's ratio or relative to the same ratio from a previous period
indicates that the company is doing well.
Return on Total Assets
Return on Ordinary Equity
Basic Earning Per Ordinary Share
Price-Earning Ratio
Dividend Yield
Profitability Ratios
Dividend Yield
Formula: Cash Dividends Per Ordinary Share / Market Price per
Ordinary Share
Meaning: The ratio of dividends per share to the share’s market
price. Measures the percentage of a share’s market value that is
returned annually as dividends.
Solvency ratios
Solvency Ratios measure the ability of an entity to survive over a
long period of time. Long term creditors and shareholders are
interested in the long-run solvency, particularly its ability to pay
interest as it comes due and repay the principal of the debt at
maturity.
Time Interest Earned ratio
Debt to Total Assets Ratio
Equity to Total Assets ratio
Solvency Ratios
The cash flow statement is distinct from the income statement and
balance sheet because it does not include the amount of future
incoming and outgoing cash that has been recorded on credit.
Therefore, cash is not the same as net income, which on the income
statement and balance sheet, includes cash sales and sales made
on credit.
Cash flow is determined by looking at three components by which
cash enters and leaves a company: core operations, investing and
financing,
Operations. Measuring the cash inflows and outflows caused by core business
operations, the operations component of cash flow reflects how much cash is
generated from a company's products or services.
Source : http://www.investopedia.com
Investing. Changes in equipment, assets, or investments relate to cash from investing.
Usually, cash changes from investing are a "cash out" item, because cash is used to buy
new equipment, buildings, or short-term assets such as marketable securities.