FINANCIAL STATEMENT ANALYSIS

Financial Statement (FS) Analysis

• It is the process of evaluating risks,
performance, financial health, and future
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).
Three kinds of FS Analysis Techniques:

• Horizontal Analysis
• Vertical Analysis
• Financial Ratios
RATIO ANALYSIS

• RATIO ANALYSIS expresses the relationship among

selected items of financial statement data.
• The relationship is expressed in terms of a percentage, a
rate, or a simple proportion (Weygandtet.al. 2013).
RATIO ANALYSIS

• A financial ratio is composed of a numerator and a

denominator. For example, a ratio that divides sales by
assets will find the peso amount of sales generated by
every peso of asset invested. This is an important ratio
because it tells us the efficiency of invested asset to
create revenue. This ratio is called asset turnover.
• There are many ratios used in business. These ratios are
generally grouped into three categories: (a) profitability,
(b) efficiency, and (c) financial health.
Profitability Ratios

• Profitability Ratios measure the ability of the company

to generate income from the use of its assets and
invested capital as well as control its cost. The following
are the commonly used profitability ratios:

⮚ Gross profit ratio reports the peso value of the gross

profit earned for every peso of sales. We can infer the
average pricing policy from the gross profit margin.
Profitability Ratios
⮚ Operating income ratio expresses operating income as a percentage
of sales. It measures the percentage of profit earned from each peso of
sales in the company’s core business operations (Horngren et.al.
2013). A company with a high operating income ratio may imply a lean
operation and have low operating expenses. Maximizing operating
income depends on keeping operating costs as low as possible
(Horngren et.al. 2013).
⮚ Net profit ratio relates the peso value of the net income earned to
every peso of sales. This shows how much profit will go to the owner
for every peso of sales made.
Profitability Ratios
⮚ Return on asset(ROA) measures the peso value of income
generated by employing the company’s assets. It is viewed as an
interest rate or a form of yield on asset investment. The numerator
of ROA is net income. However, net income is profit for the
shareholders. On the other hand, asset is allocated to both
creditors and shareholders. Some analyst prefers to use earnings
before interest and taxes instead of net income. There are also
two acceptable denominators for ROA – ending balance of total
assets or average of total assets. Average assets is computed as
beginning balance + ending balance divided by 2.
Profitability Ratios

⮚ Return on equity(ROE) measures the return (net

income) generated by the owner’s capital invested in the
business. Similar to ROA, the denominator of ROE may
also be total equity or average equity
 Profitability Ratios

Cash P200,000 Sales P 900,000

Accounts Receivable 400,000 Cost of Goods Sold 400,000
Inventory 250,000 Gross Profit 500,000
Equipment 550,000 Operating Expenses 200,000
Total Assets P 1,400,000
Operating Income 300,000
Interest Expense 20,000
Accounts Payable P300,000 Net Income P 280,000
Notes Payable 400,000
Owner, Capital 700,000
Total Liabilities and Equity P 1,400,000
Profitability Ratios
Operational Efficiency Ratio

Operational Efficiency Ratio measures the ability of the

company to utilize its assets. Operational efficiency is
measured based on the company’s ability to generate sales
from the utilization of its assets, as a whole or individually.
The turnover ratios are primarily used to measure
operational efficiency.
⮚ Asset turnover measures the peso value of sales
generated for every peso of the company’s assets. The
higher the turnover rate, the more efficient the company is
in using its assets.
Operational Efficiency Ratio

⮚ Fixed asset turnover is indicator of the efficiency of fixed

assets in generating sales.
⮚ Inventory turnover is measured based on cost of goods
sold and not sales. As such both the numerator and
denominator of this ratio are measured at cost. It is an
indicator of how fast the company can sell inventory. An
alternative to inventory turnover is “days in inventory”.
This measures the number of days from acquisition to
sale.
Operational Efficiency Ratio

⮚ Accounts receivables turnover the measures the

number of times the company was able to collect on its
average accounts receivable during the year. An
alternative to accounts receivable turnover is “days in
accounts receivable”. This measures the company’s
collection period which is the number of days from sale to
collection
 Operational Efficiency Ratio

Cash P200,000 Sales P 900,000

Accounts Receivable 400,000 Cost of Goods Sold 400,000
Inventory 250,000 Gross Profit 500,000
Equipment 550,000 Operating Expenses 200,000
Total Assets P 1,400,000
Operating Income 300,000
Interest Expense 20,000
Accounts Payable P300,000 Net Income P 280,000
Notes Payable 400,000
Owner, Capital 700,000
Total Liabilities and Equity P 1,400,000
Operational Efficiency Ratio
Financial Health Ratios

Financial Health Ratios look into the company’s solvency

and liquidity ratios. Solvency refers to the company’s
capacity to pay their long term liabilities. On the other hand,
Liquidity ratio intends to measure the company’s ability to
pay debts that are coming due (short term debt).
⮚ Debt ratio indicates the percentage of the company’s assets that
are financed by debt. A high debt to asset ratio implies a high level
of debt. Equity ratio indicates the percentage of the company’s
assets that are financed by capital. A high equity to asset ratio
implies a high level of capital.
Financial Health Ratios

⮚ Debt to equity ratio indicates the company’s reliance to

debt or liability as a source of financing relative to equity.
A high ratio suggests a high level of debt that may result
in high interest expense.
⮚ Interest coverage ratio measures the company’s ability
to cover the interest expense on its liability with its
operating income. Creditors prefer a high coverage ratio
to give them protection that interest due to them can be
paid.
Financial Health Ratios

⮚ Current ratio is used to evaluate the company’s liquidity.

It seeks to measure whether there are sufficient current
assets to pay for current liabilities. Creditors normally
prefer a current ratio of 2.
⮚ Quick ratio is a stricter measure of liquidity. It does not
consider all the current assets, only those that are easier
to liquidate such as cash and accounts receivable that are
referred to as quick assets.
 Financial Health Ratios

Cash P200,000 Sales P 900,000

Accounts Receivable 400,000 Cost of Goods Sold 400,000
Inventory 250,000 Gross Profit 500,000
Equipment 550,000 Operating Expenses 200,000
Total Assets P 1,400,000
Operating Income 300,000
Interest Expense 20,000
Accounts Payable P300,000 Net Income P 280,000
Notes Payable 400,000
Owner, Capital 700,000
Total Liabilities and Equity P 1,400,000
Financial Health Ratios