FINANCIAL

MANAGEMENT
PRELIM
FINANCIAL ANALYSIS PART ONE

PREPARED: MR.CATALINO A.
MENDOZA
 EXPECTED LEARNING OUTCOMES

Understand how business activities are reported

through the financial statements
Appreciate the general objectives of financial
statements.
Know the nature and significance of the financial
statements.
Define financial statement analysis
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 UNDERSTANDING FINANCIAL STATEMENTS 1

INTRODUCTION

How business activities are reported

To be able to analyze a company effectively or infer its value , it is important that one
must understands the company’s business activities. This can be accomplished through
the financial statements . Financial statement report on a company’s performance and
financial condition and reveal executive managements privileged information and
insights.

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Accounting information should be used in the business context in
which the information is created. All companies without
exception , plan business activities, finance those activities, invest
in those activities and then engage in operating in operating
activities. Business firms conduct all these activities while
confronting business forces, including market constraints and
competitive pressure.

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GENERAL OBJECTIVES OF FINANCIAL STATEMENTS
The important objectives of the financial statements are:
1. Providing information for economic decisions.
The economic decisions that are taken by the users of financial statements
require an evaluation of the ability of an enterprise to generate cash and
cash equivalent and the timing and certainty of their generation.

2. Providing information about financial position

The financial position of an enterprise is affected by the economic resources
such as :

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a. Information about the economic resources controlled by the enterprise and its
capacity in the past to modify these resources is useful in predicting the ability of
the enterprise to generate cash and cash equivalents in the future.
b. Information about financial structure is useful in predicting future borrowing needs
and how future profits and cash flows will be distributed among those with an
interest in the enterprise.
c. Information is useful in predicting how successful the enterprise is likely to be in
raising further finance.
d. Information about liquidity and solvency is useful in predicting the ability of the
enterprise to meet the financial commitments as fall due. Liquidity refers to the
availability of cash in the near future after taking account of financial commitments
and solvency refers to the availability of cash over the longer term to meet financial
commitments as they fall due.

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3. Providing information about performance of an enterprise.

Another important objective of the financial statements is that , it provides

information about the performance and in particular its profitability, which is
required in order to assess potential changes in the economic resources that
are likely to control the future..

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4.Providing information about changes in financial position

The financial statements provide information concerning changes in the

financial position of an enterprise, which is useful in order to assess its
investing , financing and operating activities during the reporting period.

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DEMAND FOR FINANCIAL ACCOUNTING
INFORMATION

Decision makers and other stakeholder demand information on the company’s

past and prospective returns and risks to facilitate efficient contracting and risk
– sharing.

1. Managers and employees.

For their own well – being and prospective earnings, potential managers and
employees need accounting information on the financial conditions,
profitability and prospects of their companies as well as comparative

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2. Investors and Analysts
Financial statement are used by these parties to decide whether to buy or sell
equity shares. Expectation about future profitability and the ability to generate
cash influence the price of securities and a company’s ability to borrow money
at favorable terms. Other information intermediaries such as, financial press
writers and investment analysts are interested in predicting companies future
performance.

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3. Creditors and suppliers
Banks and other lenders need financial accounting information to help
determine loans terms, loan amount, interest rates and required collateral.

4. Shareholders and directors

Financial accounting information are needed by owners and directors of the
company to assess its profitability and risks , to evaluate managerial
performance and to help make leadership decisions.

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5. Regulatory and tax agencies
The SEC, BIR, BSP and other legal institutions demand financial accounting
information to monitor the business firms compliance with laws, for public
protection, price setting and for setting tax and other regulatory policies.

6. Customers and potential strategic partners

Customers both current and potential need accounting information to evaluate
a company’s ability to provide products and services as agreed and to assess
the company’s reliability and staying power. Potential strategic partners would
wish to estimate the firm’s profitability to asses the fairness of returns on
mutual transaction and strategic alliances.

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7. Other decision makers
Financial accounting information are required for varied purposes by other
parties from assessing damages for environment abuses to making policy
decisions involving economic, social, taxation and other initiatives.

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CONTRAINST ON RELEVANT AND RELIABLE INFORMATION

1. Timeless
If there is undue delay in the reporting of information it may lose its
relevance . Management may need to balance the relative merits of timely
reporting and the provision of reliable information . To provide information
on a timely basis , it may often be necessary to report before all aspects of
a transaction

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. In achieving a balance between relevance and reliability , the overriding
consideration is hoe best to satisfy the economic decision making needs of
users.

2. Balance between benefits and cost.

The balance between benefit and cost is a pervasive constraint rather than a
qualitative characteristic. The benefits derived from information should exceed
the cost pf providing it. The evaluation of benefits and costs is however ,
substantially a judgmental process.

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3. Balance between qualitative characteristics
In practice , balancing or trade –off between qualitative characteristics is
often necessary. Generally , the aim is to achieve an appropriate balance
among the characteristics in order to meet the objective of financial
statements. The relative importance of the characteristics in different cases is
a matter of professional judgment.

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4. True fair view or fair presentation
Financial statements are frequently described as showing a true and fair view
of the financial position , performance and changes in financial position of an
enterprise. Although , this framework does not deal directly with such
concept, the application of the principal qualitative characteristics and of
appropriate standards, normally results in financial statements that convey
what is generally understood as a true and fair view of such information.

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Financials statement

Business activities are periodically reported by companies using four financial

statement: the Statement of financial Position, Statement of comprehensive
income, statement of stockholders’ equity and the statement of cash flow.
Figure 1.1 shows how these statement are interconnected across time . A
statement of financial position reports on a company’s financial position at
point in time. The statement of comprehensive income , statement of
stockholders’ equity and the statement of cash flow report on performance over
a period of time.

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 ss
Statement of cash flow

Statement of
Statement of Statement of Stockholders financial position
financial position Equity
(end – of –
(beginning of period)
period)

Statement of
comprehensive Income
FIGURE : 1.2 ARTICULATION OF Orange Inc. Financial
Statement
There is an order to financial statement preparation . First , a company
prepares its income statement using the statement of comprehensive income
accounts. It then uses the net income number and dividend information to
update the retained earning account. Second , it prepare the statement of
financial position using the updated retained earning account along with
the remaining statement of financial position accounts from the trial balance.
Third, it prepare the statement of stockholder’s equity. Fourth, it prepare the
statement of cash flows using the information from the cash account and other
sources.

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STATEMENT OF FINANCIAL POSITION
A Statement of financial Position reports a company’s financial position at a
point in time, the company’s resources ( asset) namely : , what the company
owns and also the sources of asset financing. There are two ways a company
can finance its asset.
1. Owner financing : it can raise money from stockholders.
2. Non owner financing : it can also raise money from banks or other creditor
and suppliers.

Owners claims on asset are referred to as Equity, and non owner claims are
referred to as Liabilities, (or debt). Since all financing must be invested in
something we obtain the following basic relation (investing = financing). The
equality is called the accounting equation which follows: ( ASSETS =
Liabilities + owner’s equity)
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Report amounts at a
point in time

Investing

Total Resources

Financing

Non owner claim on

resource

Owner claim on
resource
o Most asset and liabilities are reported on the statement of financial position
at their acquisition price, called historical cost.
Working capital
Current assets are often called working capital because these assets “turn
over” that is , they are used and then replaced throughout the year.
Net working capital is the difference between current assets minus current
liabilities while net operating working capital is the difference between
current assets and non- interest bearing liabilities.
STATEMENT OF COMPREHENSIVE INCOME
The statement of Comprehensive income report on a company’s performance
over a period of time and list amount for revenues(also called sales), expenses
and other comprehensive income. Revenues less expenses yield the bottom
line net income amount.

REPORT AMOUNT OVER A PERIOD OF

TIME

GOODS OR SERVICES PROVIDED TO

CUSTOMERS

COSTS INCURRED TO GENERATE REVENUES

 Manufacturing and merchandising companies typically include an additional
expense account called cost of good sold ( or cost of sales), in the statement of
comprehensive income following revenues . It is also common to report a
subtotal called gross profit ( or gross margin), which is revenues less cost of
good sold. The company’s remaining expenses are then reported below gross
profit. This income statement layouts follows:

Revenues
- Cost of good sold Cost of materials , labor, and overhead

= Gross profit Revenue less cost of good sold

- expenses Expenses other than product cost of sales

= Net income (loss)

STATEMENT OF STOCKHOLDERS’ EQUITY
The statement of stockholders’ equity report on changes in key types of
equity over a period of time. For each type of equity, the statement reports the
beginning balance , a summary of the activity in the account during the year
and the ending balance.
Contributed capital represent the cash that the company received from the
sale of stock to stockholders( also called shareholders ), less any funds
expended for the repurchase of stocks. Retained earnings ( also called
earned capital or reinvested capital ) represent the cumulative total amount
of income that the company has earned and that has been retained in the
business and not distributed to shareholders in the form of dividends. The
change in retained earning links consecutive statement of financial position
via the income statement: Ending retained earnings = Beginning retained
earnings + Net income - Dividends .
STATEMENT OF CASH FLOWS
The statement of cash flows report the change ( either an increase or decrease
) in a company’s cash balance over a period of time. The statement report on
cash inflows and outflows from operating, investing and financing activities
over a period of time.
Operating Activities
Operating activities use company resources to produce, promote and sell its
products and services. These activities extend from input markets involving
suppliers of materials and labor to a company’s output markets involving
customers of products services. Input markets generate most expenses (or cost )
such as inventory , salaries, materials and logistics . Output markets generate
revenues( or sales) to customers.

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Investing activities

Statement of financial position is organized like the accounting equation .

Investing activities are represented by the company’s assets. These assets are
financed by a combination of non owner financing (liabilities ) and owner
financing ( equity)

Financing Activities
Asset must be paid for, and funding is provided by a combination of owner
and non owner financing. Owner (or equity) financing includes resources
contributed to the company by its owners along with any profit retained by

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Basic of profitability analysis
The primary goal of financial management is to maximize
shareholders; wealth, not accounting measures such as net
income or earning per share (EPS)
 However, accounting data influence stock prices and this
data can be used to see why a company is performing the
way it is and where it is heading.

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If the management is to maximize a firm’s value, it must take advantage of the
firms strength and correct its deficiencies and weaknesses.
Financial analysis involves
• Comparing the firm’s performance to that other firms in the same industry
• Evaluating trends in the firm’s financial position over time.
These studies help managers identify deficiencies and take position over time.

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LIMITATION OF FINANCIAL STATEMENTS ANALYSIS

1. Information derived by the analysis are not absolute measures of

performance in any and all of the areas of business operations. They are
only indicator of degree of profitability and financial strength of the firm.
2. Limitation inherent in the accounting data the analyst work with. These are
brought by among others. A. variation and lack of consistency in the
application of accounting principles, policies and procedure, B too
condensed presentation of data, and C. failure to reflect change in
purchasing power.

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3. Limitation of the performance measure or tools and technique used in the
analysis. Quantitative measurements are not absolute measure but should be
interpreted relative to the nature of the business and in the light of past,
current and future operation. Timing of transaction and the use of average can
also affect the results obtained in applying the techniques in financial
analysis.
4. Analyst should be alert to the potential for management to influence the
outcome of financial statements in order to appeal to creditor, investors and
other.

.
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 STATEMENT IN COMMON – SIZE AND
COMPARATIVE

Common size statements

An item on a financial
statement has little
meaning by itself. The
meaning of the number of Peso and percentage changes on
the number can be
enhanced by drawing statement
comparison

Financial Ratios
 Common – Size Statement

Vertical analysis focuses on the

relationship among financial statement
items at a given point in time .
A common – size financial statement is a
vertical analysis in which each financial
statement item expressed as a percentage.

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In balance sheet - all items usually are expressed as a percentage
of total asset, total liabilities and equity.

In income statement - all items usually are expressed as a

percentage of sales

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VERTICAL ANALYSIS FOR BALANCE
SHEET
Peso and percentage changes on
statement
Horizontal analysis ( or trend analysis) shows changes between years in
the financial data in both PESO and PERCENTAGE form

Qualifying percentage
Qualifying peso
changes over time
changes over time
serves to highlight the
serves to highlight the
changes that are the
changes that are the
most unusual.
most important
economically

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HORIZONTAL ANALYSIS OR TREND
ANALYSIS
Horizontal analysis of financial statement can be also be carried out by computing
trend percentage . Trend percentage states several years financial data in terms of a
base year. The base year equal 100% , with all other years stated in some percentage of
this base .
 USES OF FINANCIAL STATEMENT
ANALYSIS
Trends
The results given in generally cover at least the previous three
full accounting years therefore any fluctuation in any area can
be easily pinpointed .
BENCHMARKS

The average result for each ratio together with the industry
profile of the average company in the sector can both be
used as benchmarks to compare individuals company
performance.
 SIZE
All the major companies in the sector are ranked on the basis of sales , profits,
total asset and employee numbers. The largest and smallest of the key players
can be easily identified , while the relative size of any company can be
assessed.

GROWT
H average annual growth of each company’s
The sales ,
profits , total assets and number of employees over the three –
years periods being analyzed is calculated and ranked.

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END OF MODULE

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