Financial

Analysis
 Concepts

Financial Statement Analysis

– is the process of evaluating risks, performance, financial health, and
prospects of a business by subjecting financial statement data to
computational and analytical techniques with the objective of making
economic decisions (White et.al 1998).

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There are three kinds of FS
analysis techniques:
• Horizontal analysis
• Vertical analysis
• Financial ratios

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Horizontal analysis
- also called trend analysis, is a technique for evaluating a series of
financial statement data over a period with the purpose of determining
the increase or decrease that has taken place (Weygandtet.al 2013).
This will reveal the behavior of the account over time. Is it increasing,
decreasing or not moving? What is the magnitude of the change? Also,
what is the relative change in the balances of the account over time?
- uses financial statements of two or more periods.
- all line items on the FS may be subjected to horizontal analysis.
- only the simple year-on-year (Y-o-Y) grow this covered in this lesson.

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- Changes can be expressed in monetary value (peso) and percentages
computed by using the following formulas:
Peso change=Balance of Current Year-Balance of Prior Year
Percentage change= (Balance of Current Year-Balance of Prior
Year)/(Balance of Prior Year)
• Example:
2014 2013
Sales P 250,000 P175,000

✓Peso change = P250,000 - P175,000 = P75,000

✓Percentage change = (P250,000 - P175,000) / P175,000 = 42.86%
✓This is evaluated as follows: Sales increased by P75,000. This represents growth of 42.86% from 2013
levels.

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Vertical analysis
- also called common-size analysis, is a technique that expresses each
financial statement item as a percentage of a base amount (Weygandt
et.al. 2013)

For the SFP, the base amount is Total Assets.

- Balance of Account / Total Assets. • From the common-size SFP, the
analyst can infer the composition of assets and the company’s financing
mix

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Example:
% of assets
Cash P 200,000 200,000/1,400,000 = 14.3%
Accounts Receivable 400,000 400,000/1,400,000 = 28.6%
Inventory 250,000 250,000/1,400,000 = 17.9%
Equipment 550,000 550,000/1,400,000 = 39.3%
Total Assets P 1,400,000 Sum of the components is 100%

Accounts Payable P 300,000 300,000/1,400,000 = 21.4%

Notes Payable 400,000 400,000/1,400,000 = 28.6%
Owner, Capital 700,000 700,000/1,400,000 = 50.0%
Total Liabilities and Equity P 1,400,000 Sum of the components is 100%
✓The above may be evaluated as follows:
The largest component of asset is Equipment at 39.3%.
Cash is the smallest component at 14%. On the other hand, 50% of assets are financed by debt and the other half
is financed by equity

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For the SCI, the base amount is Net Sales.
- Balance of Account / Total Sales. •
- This will reveal how “Net Sales” is used up by the various expenses.
- Net income as a percentage of sales is also known as the net profit margin

% of net sales
Net Sales P 900,000
Cost of Goods Sold 400,000 400,000/900,000 = 44.4%
Gross Profit 500,000 500,000/900,000 = 55.5%
Operating Expense 200,000 200,000/900,000 = 22.2%
Net Income 300,000 300,000/900,000 = 33.3%

✓The above may be evaluated as follows:

• The cost of goods sold is 44% of sales. The company has a gross profit rate of 55.5%. Operating expenses is
22% of sales.
• The company earns income of P 0.33 for every peso of sales. Gross profit generated for every peso of sale is P
0.555.

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The use of common-size financial
statements allows the comparison of two
companies of different sizes. This is because
the SFP and SCI comparative information
are standardized as a percentage of assets
and sales, respectively
FINANCIAL
RATIO
A. Operating Expense to Sale Ratio
B. Return on Assets Ratio
C. Return on Equity Ratio
D. Asset Turnover Ratio
 Operating Expense to Sale Ratio

- Show the efficiency of a company’s management by comparing the total

operating expense of a company to the net sales.
- Operating expenses are classified into general & administrative expenses
and selling expenses. These expenses are needed to generate sales
- Shows how efficient a company’s management is at keeping cost low
while generating revenue or sales. The smaller the ratio, the more the
company is at generating revenue versus expenses.
- It indicates how much each peso in sales revenue cost the company to
achieve. An operating expense ratio of 0.63 means that for every peso of
sales, the company spent 63 cents to create the sale.
- An expense ratio that increasing over time means the company is
operating less efficiently from period to period.
 Formula:
Operating Expense to Sale Ratio = Operating Expenses / Net Sales

2019
Operating Expenses 450,000

Net Sales 1,000,000

Operating Expense Ratio 45%

2020

Operating Expenses 475,000

Net Sales 1,100,000

Operating Expense Ratio 43.18%
 Return on Assets

- Return on total assets

- A profitability ratio that measures the net income produced by total assets
during a period by comparing net income to the average total assets
- In other words, the return on asset ratio or ROA measures how efficiently a
company can manage its assets to produce profits during a period.
- Since the company assets’ sole purpose is to generate revenues and
produce profits, this ration helps both management and investors see how
the company can convert its investment in assets into profits.
- In short, this ratio measure how profitable a company’s assets are.
 Formula:
Return on Assets = Profit / Average total assets

2019
Profit 245,600

Average total assets 678,900

Return on Asset 0.362

2020

Profit 255,700

Average total assets 690,000

Return on Asset 0.371
 Return on Equity

- One of the most profitability metrics for investors is company’s return on

equity (ROE).
- Reveals how much after-tax income a compony earned in comparison to
the total amount of shareholder equity found on the balance sheet.
- In other word, it conveys the percentage of investor peso that has been
converted into income, giving sense of how efficiently the company is
handling their money.
- A business with a higher ROE is more likely to be one that can better
generate income with new investment.
- The key to finding stocks that are lucrative investments in the long run
often involves finding companies capable of consistently generating an
outsized ROE over decades.
 Formula:
Return on Equity = Profit / Stockholder equity

2019
Profit 245,600

Average Stockholder 678,900

Return on Equity 0.450

2020

Profit 255,700

Average Stockholder 548,400

Return on Equity 0.466

Asset Turnover Ratio
- Total asset turn over ratio
- Measures the efficiency with which a company uses its assets
to produce sales
- A company with high asset turnover ratio operates more
efficiently as compared to competitors with a lower ratio.
- A higher ratio is favorable as it indicates a more efficient use
of assets.
 Formula:
Asset Turnover Ratio = net sales / average total assets

2019
Net Sales 1,000,000

Average Total Assets 678,900

Asset Turnover Ratio 1.47

2020

Net Sales 1,100,000

Average Total Assets 690,000

Asset Turnover Ratio 1.59