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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
is a report that shows how much revenue a company earned over a specific time
period
This report also shows the costs that are associated in earning that revenue
CASH FLOW STATEMENT
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.