FINANCIAL

STATEMENT
ANALYSIS
BSBA – IIA
GROUP 1
The goal of financial management is to maximize the stockholders’
wealth through the current value of the existing stock (Ross et al.,
2008).
FINANCIAL STATEMENTS
 Is the summarized data of a company’s assets, liabilities, and equities in the
balance sheet and its revenue and expenses in the income statements
 Its objectives is to provide information about the financial position, result of
operations, and cash flows of an enterprise that is useful for decision-making
to a wide range of users.
FINANCIAL MANAGERS
 Use financial statements in financing, investing, and formulating dividend
policy decisions.
 Concerned primarily with the standing of the company and its profitability that
leads to maximization of stockholders’ wealth.
 Use financial statements as their first-hand information about the company’s
performance in the past and its prospects in the future.
 Use financial statements to get information and feedback in assessing the
economic progress of the firm.
FINANCIAL INSTITUTIONS
 Use the financial statements as a tool in ascertaining the company’s capability
to produce cash in making payments.
 Knowing the financial health of a firm places the creditors in a much safer
position if ever loans are granted to a company in need of additional capital.
COMPONENTS OF FINANCIAL
STATEMENTS
 Balance Sheet
 Income Statement
 Statement of Stockholders’ Equity
 Cash Flow Statement
 Accounting Policies and Notes to Financial Statements
BALANCE SHEET
 It is a statement showing the financial position of the company at a particular
time.
 Composed of company’s assets and liabilities and stockholders’ equity.
BALANCE SHEET - ASSETS
 The first section of the balance sheet lists all the assets of the firm.
 Current assets
Cash and other items such as accounts receivable and inventories that can be
converted to cash within one year.
Prepaid expenses and accrued income.
 Non-current assets
Assets compromise by land, building, machinery, equipment, furniture and
fixture, transportation vehicle, and many more.
BALANCE SHEET -
LIABILITIES
 Liabilities section comprises of current and non-current liabilities.
 Current liabilities
Accounts payable, short-term notes payable, accrued expenses, taxes
payable, interests payable, and other obligations that are due within one year.
 Non-current liabilities
Long-term notes payable, bonds payable, and other obligations which are
due beyond one year.
BALANCE SHEET –
STOCKHOLDERS’ EQUITY
 Net worth or the residual value of the company.
 Divided into par value stock, additional paid-in capital, and retained earnings.
 FMA Company
Balance Sheet
December 31, 2014

Current Assets Liabilities

Cash P 65,000 Current Liabilities P 110,800
Accounts Receivable 40,000 Long-term liabilities 160,000 P 270,800
Marketable Securities 40,000
Inventory 100,000 P 245,000 Stockholder’s Equity
Common Stock, P5 par
value, 20,000 shares P 100,000
Non-current assets Retained earnings 74,200 174,200
Plant assets 200,000
Total Liabilities and
Total Assets P 445,000 Stockholder’s Equity P 445,000
INCOME STATEMENT
 It is a formal statement that shows the result of the operations for a certain
period of time.
 It presents the revenues generated during the operation period, the expenses
incurred, and the company’s net earnings.
INCOME STATEMENT
 Distinguishes four broad classes of expenses
Cost of goods sold
Direct cost attributable to manufacturing the product sold by the firm
General and administrative expenses
Expenses, salaries, advertising and other operating cost that are not directly
attributable to production.
Interest on the firm’s debt
Taxes on earnings owed to the government
 FMA Company
Income Statement
For the Year Ended December 31, 2014

Sales P 200,000
Less: Sales returns and allowances 40,000
Net Sales P 160,000
Less: Cost of Goods Sold 100,000
Gross Profit 60,000
Less: Operating Expenses
Selling Expenses P 22,000
General Expenses 8,000 30,000
Income from operations P 30,000
Add: Non-operating income 6,000
Income before interest expenses P 36,000
Less: Interest Expense 4,000
Income before tax expense P 32,000
Less: Income Taxes (35%) 11,200
Net Income P 20,800
CASH FLOW STATEMENT
 A financial statement that shows the firm’s cash receipts and cash payments
during a specified period of time.
 Recognizes only transactions in which cash changes hands.
SAMPLE OF USE OF CASH
FLOW STATEMENTS
 The cash from operating activities is compared with the company’s net
income.
If the cash from operating activities is consistently greater than the net income, the
company’s net income or earnings is said to be of “high quality”.
If the cash from operating activities is less than net income, a red flag is raised as to
why the reported net income is not turning into cash.
SAMPLE OF USE OF CASH
FLOW STATEMENTS
 The cash flow statement identifies the cash that is coming in and going out of
the company.
If a company is consistently generating more cash than it is using, the company will
be able to increase its dividend, buy back some of its stock, reduce debt, or acquire
another company.
 Some financial decisions such as capital budgeting decisions are based on cash
flow.
ACCOUNTING POLICIES AND
NOTES TO FINANCIAL
STATEMENTS
These are guidelines used in the preparation of financial statements.

 Detailed information not appearing in the financial statements is also located
in this part for clarification, for instance, the method used in depreciating the
assets (straight-line method, sum-of-the-years’ digit method, declining
method) valuation of inventory (FIFO, LIFO, moving average), and issuance
of capital stocks.
LIMITATIONS OF FINANCIAL
STATEMENTS
 Differences in accounting methods between companies sometimes make
comparisons difficult.
We used the LIFO method to value inventory.
we used the average cost method to value inventory.
4 TYPES OF SOME OF THE
LIMITATIONS OF FINANCIAL
STATEMENTS.
There are variations in the application of accounting principles.
 Financial statements are interim in nature.
 Financial statements do not reflect changes in the purchasing power of the
peso
 Financial statements do not contain all significant facts about the business.

Reminder: Financial ratios serves only as an attention directly device.

FINANCIAL STATEMENT
ANALYSIS
 Financial statement analysis involves calculation.
 Firms compute by combining accounts coming from an income statement to
the balance sheet or vice-versa or by simply relating an account within the
statement.
 These calculations help the management assess the deficiencies and take
necessary actions to improve performances.
FINANCIAL STATEMENT
ANALYSIS
 It is important for the owner and manager of the entity to be able to evaluate
the results of all their business activities.
 This analysis can help them:
1. Confirm past expectation.
2. Evaluate present financial
3. Predict future outcome results.
THE ROLE OF FINANCIAL STATEMENT
ANALYSIS IN DECISION-MAKING.

 Financial ratio is one of the methods used to analyze a company’s financial

statements. It is necessary in order to assess whether or not the firm has
performed well over a period of time.
MANAGERS SHOULD LOOK
BEYOND THE RATIOS
 Technological changes.
 Industry Trends.
 Consumer taste
 Economic factors.
TOOLS AND TECHNIQUES IN
FINANCIAL ANALYSIS
 Analyst should use this tools and techniques used in financial statement
analysis: They are as follows:
 Horizontal Analysis
 Vertical Analysis
TOOLS AND TECHNIQUES IN
FINANCIAL ANALYSIS
 Horizontal Analysis - This is used to evaluate the trend in the accounts over the
years.
Comparative Statements - Used to evaluate the changes or behavior patterns
of the different accounts in the financial statements for two or more years.
Trend Ratio - Firm’s present ratio is compared with its past and expected
future ratios to determine if the company’s financial condition is improving
or deteriorating over time.
TOOLS AND TECHNIQUES IN
FINANCIAL ANALYSIS
 Vertical Analysis - It is uses a significant item on the financial statement as a
base value.
Common Size Statement. Each account in the financial statements is
expressed by dividing them to a common base account.
TOOLS AND TECHNIQUES IN
FINANCIAL ANALYSIS
 Financial Ratios: This is classified into five groups:
Liquidity ratio- a company’s ability to meet its maturing short-term
obligations.
Activity or asset utilization ratio – used to determine how quickly various
accounts are converted into sales or cash
Leverage ratio- the company’s ability to meet its long-term obligations as
they become due.
Profitability ratio – shows the profitability of the operations of the company.
Market value ratio – relates the firm’s stock price to its earnings.
 FMA Company
Comparative Income Statement
December 31, 2014, 2013, and 2012
(Increase (Percentage of Increase
or Decrease) or Decrease)
2014- 2013- 2014- 2013-
2014 2013 2012 2013 2012 2013 2012
Sales P 200,000 P 210,000 P 100,000 P(10,000) P110,000 -4.76% 110.00%
Sales return and allowances 40,000 25,000 6,000 15,000 19,000 60.00% 316.67%
Net Sales 160,000 185,000 94,000 (25,000) 91,000 -13.51% 96.81%
Cost of Goods Sold 100,000 115,625 50,000 (15,625) 65,625 -13.51% 131.25%
Gross Profit P 60,000 P 69,375 P 44,000 P (9,375) P 25,375 -13.51% 57.67%
Operating Expenses
Selling Expenses P 22,000 P 25,000 P 16,000 P (3,000) P 9,000 -12.00% 56.25%
General Expenses 8,000 12,000 8,000 (4,000) 4,000 -33.33% 50.00%
Total Operating Expenses 30,000 37,000 24,000 (7,000) 13,000 -18.92% 54.17%
Income from Operations 30,000 32,375 20,000 (2,375) 12,375 -7.34% 61.88%
Non-operating Income P 6,000 P 2,500 P 3,500 P 3,500 P (1,000) 140.00% -28.57%
Income before interest
expense and taxes P 36,000 P 34,875 P 23,500 P 1,125 P 11,375 3.23% 48.40%
Interest Expense 4,000 3,500 3,000 500 500 14.29% 16.67%
Income before taxes 32,000 31,375 20,500 625 10,875 1.99% 53.05%
Income Taxes (35% rate) 11,200 10,981 7,175 219 3,806 1.99% 53.05%
Net Income P 20,800 P 20,934 P 13,325 P 406 P 7,609 1.99% 53.05%
FINANCIAL RATIOS
 The principal idea in analyzing financial ratios is that there are several major
financial statements of the firm that reveals its financial health.
 Financial ratio analysis provides a broader basis of comparison than raw
numbers do.
 Ratios without year-to-year or other industry/firm comparative ratios, are of
little use in judging the health or future of the firm being analyzed.
FINANCIAL RATIOS
Financial ratios provide two types of comparisons:
 Industry Comparison – Financial ratios are computed and compared with the
industry average. The company may be able to compare their performance
against their competitors’ and how they fare with them.
 Trend Analysis – Financial ratios are computed and compared with their past
performance.
LIQUIDITY RATIO
 Liquidity ratios are an important class of financial metrics used to determine a
debtor's ability to pay off current debt obligations without raising external
capital.
 Liquidity ratios measure a company's ability to pay debt obligations and its
margin of safety through the calculation of metrics including the current
ratio, quick ratio, and operating cash flow ratio.
TYPES OF LIQUIDITY RATIOS
 Current Ratio = Current Assets
Current Liabilities
 Quick Ratio = (Cash + Accounts Receivable + Marketable Securities)
Current Liabilities
 Cash Ratio = Cash + Marketable Securities
Current Liabilities
ACTIVITY RATIO
 An activity ratio is a type of financial metric that indicates how efficiently a
company is leveraging the assets on its balance sheet, to generate revenues and
cash. Commonly referred to as efficiency ratios, activity ratios help analysts
gauge how a company handles inventory management, which is key to its
operational fluidity and overall fiscal health.

 An activity ratio broadly describes any type of financial metric that helps
investors and research analysts gauge how efficiently a company uses its assets
to generate revenues and cash.
ACTIVITY RATIO
 Activity ratios may be utilized to compare two different businesses within the
same sector, or they may be used to monitor a single company's fiscal health
over time.

 Activity ratios can be subdivided into merchandise inventory turnover ratios,

total assets turnover ratios, return on equity measurements, and a spectrum of
other metrics.
RISKS AND RETURN TRADE-OFF BETWEEN
LIQUIDITY AND ACTIVITY RATIO
 A trade off exists between liquidity risk and retActivity5 ~ding a high
amount of current assets means less liquidity risk and less returns to the firms.
Maintaining a high level of current assets than productive fixed assets is a sign
of risk aversion of the firm. The firm would rather have a small return on
short-term investment on current assets rather than generate more income in
fixed assets.
 On the other hand, firms which invest more on fixed assets are more exposed
to liquidity risk due to fund tied. Firms which succeed with fixed assets
investment enjoy more economic returns to the firm. Maintaining a proper
balance between liquidity and return is important to the overall financial health
of a business.
LEVERAGE RATIOS
 A leverage ratio is any one of several financial measurements that look at how
much capital comes in the form of debt (loans) or assesses the ability of a
company to meet its financial obligations. The leverage ratio category is
important because companies rely on a mixture of equity and debt to finance
their operations, and knowing the amount of debt held by a company is useful
in evaluating whether it can pay off its debts as they come due.
DEBT RATIO
 The term debt ratio refers to a financial ratio that measures the extent of a
company’s leverage. The debt ratio is defined as the ratio of total debt to total
assets, expressed as a decimal or percentage. It can be interpreted as the
proportion of a company’s assets that are financed by debt.
DEBT TO EQUITY RATIO
 Debt-to-equity ratio is used to evaluate a company’s financial leverage and is
calculated by dividing a company’s total liabilities by its shareholder equity.
D/E ratio is an important metric in corporate finance. It is a measure of the
degree to which a company is financing its operations with debt rather than its
own resources. Debt-to-equity ratio is a particular type of gearing ratio.
TIMES INTEREST EARNED
RATIO
 The times interest earned (TIE) ratio is a measure of a company's ability to
meet its debt obligations based on its current income. The formula for a
company's TIE number is earnings before interest and taxes (EBIT) divided by
the total interest payable on bonds and other debt.
GROSS PROFIT MARGIN
 Gross profit margin is a metric analysts use to assess a company's financial
health by calculating the amount of money left over from product sales after
subtracting the cost of goods sold (COGS). Sometimes referred to as the gross
margin ratio, gross profit margin is frequently expressed as a percentage of
sales.
PROFIT MARGIN
 It is one of the commonly used profitability ratios to gauge the degree to which
a company or a business activity makes money. It represents what percentage
of sales has turned into profits. Simply put, the percentage figure indicates how
many cents of profit the business has generated for each dollar of sale.
RETURN OF INVESTMENT
 It is the key measure of the profit derived from any investment. It is a ratio that
compares the gain or loss from an investment relative to its cost. It is useful in
evaluating the current or potential return on an investment, whether you are
evaluating your stock portfolio's performance, considering a business
investment, or deciding whether to undertake a new project.
DUPONT ANALYSIS
 It is a framework for analyzing fundamental performance popularized by the
DuPont Corporation. DuPont analysis is a useful technique used to decompose
the different drivers of return on equity (ROE).
MARKET VALUE RATIO
DEVIDEND RATIOS
 The dividend payout ratio measures how much of a company's earnings are
paid out as a dividend.
 To calculate a company's dividend payout ratio, simply divide the amount of
dividends it paid over a certain time period by the amount of earnings it
generated.
SUMMARY OF FINANCIAL
RATIO
 Financial ratio analysis is the technique of comparing the relationship (or ratio)
between two or more items of financial data from a company's financial
statements. It is mainly used as a way of making fair comparisons across time
and between different companies or industries.
LIMITATION OF RATIO
ANALYSIS
 Ratio analysis does not measure the human element of a firm. ratio analysis
can only be used for comparison with other firms of the same size and type. It
may be difficult to compare with other businesses as they may not be willing
to share the information.
CASH FLOW STATEMENT
 Analyzes change in cash and in cash iquavalents (CCE) During a period.
 Is a valuable tool for finance manager
 Use the evaluate the cash inflows (source) and cash outflows (uses)
 Provide concise information on how the company generated and use its cash
during the period
PURPOSES/FUNCTION OF THE
CASH FLOW STATEMENT
 It provides relevant information and the cash receipt and cash payment of
enterprise as of a given period.
 It states changes in the financial position of the film
 It the presence information on the structural health, liquidity and profitability
of the firm.
 It gives insight of the different activities of the film
 It determine the capability of the firm to produce cash and cash equivalents
MAIN SECTION OF THE
STATEMENT OF CASH FLOWS
 Cash flows from Operating Activities
 Cash flows from Investing Activities
 Cash flows from financing Activities
INFLOWS
 Cash receipt from sale of good or services, Including receipts from collection
or sale or accounts and both short and long- term, notes receivable from
customers arising from those sales.
 Cash receipt from returns on loans, other dept instruments the other entities,
and equality securities- interest and dividends
 All the other cash receipts that do not stem from transaction defined As
investing or financing activities such as refunds from suppliers amount or
receive to settle lawsuits and proceeds of insurance settlement.(expect from
those that are directly related to investingor financing activities, such as from
destruction of a building
OUTFLOWS
 Cash payments to acquire materials including principal payments on accounts
and both short and long-term payable to supplies.
 Cash payments to the other suppliers and employees for other goods or
services.
 Cash payments from the government for taxes duties and lines, and the other
fees or penalties.
 Cash payments to lenders and other creditors for interest.
 Other cash payments that do not stem from transaction defined as for investing
or financing activities such as payment to settle lawsuits cash contributions to
charities and cash refund to the customers.
Example :
A business reports a net income of P100,000. Depreciation expense is P22,000, amortization
expense P10,000, and amortization of deferred income is P7,000. Cash provided from operating
activities is calculated as follows:

Net income P100,000

Add: Non-cash expenses

Depreciation expense 22,000

Amortization expense 10,000
Amortization of deferred income (7,000)

Net cash provided by operating P125,000

activities