ANALYSIS AND

INTERPRETATION OF
FINANCIAL STATEMENT
 FINANCIAL STATEMENT
• Historical document
• Serve as the fundamental material in financial analysis
• Most users of financial statement are concerned on what
will happen in the future.
FINANCIAL STATEMENT ANALYSIS

• Examining trends in the key financial data

• Comparing financial data across companies
• Analysing financial ratios
 to assess the financial health and future prospects of a
company.
 OBJECTIVES OF THE ANALYSIS
• Liquidity
- the ability of an entity to pay current maturing financial obligations.
• Solvency or Stability
- the ability of an entity to settle long-term debt when they mature and still
remain stable. the ability of an entity to earn an income equal to or above the
industry
• Profitability
- also reflects the efficiency of the management in utilizing the resources
entrusted to them.
DIFFERENT METHODS IN ANALYZING
FINANCIAL STATEMENT

1. Horizontal Analysis

2.Vertical Analysis

3. Financial Ratios
 1. Horizontal Analysis
(trend analysis)
- Analysing financial data over a period of time, such as
analysing year-to-year dollar percentage changes in the
amounts of corresponding financial statement items.
- The statements for two or more periods are used.
- The changes are generally shown both in dollars and
percentage.
COMPARATIVE
BALANCE
SHEET
COMPARATIVE
INCOME
STATEMENT
 TREND PERCENTAGES

• To calculate a change over a period of time.

• Multiple Financial Statements are being compared.
• A base year is selected and data for all years are stated
as a percentage of that base year.
 TREND
PERCENTAGES
 2.Vertical Analysis
(common-size financial statements)

- focuses on the relations among financial statement account

at a given point in time.
- each financial statement account is expressed as a
percentage.
- each asset account is expressed as a percentage of total
assets
- each liability and owner’s equity account is expressed as a
percentage of total liabilities and owner’s equity account.
- for the income statement, percentage figures for each year
are expressed as a percentage of total sales for the year.
 COMMON-SIZE
COMPARATIVE
BALANCE SHEET
 COMMON-SIZE
COMPARATIVE
INCOME STATEMENT
 3. Financial Mix Ratio Analysis
Analytical tool employing ratio or proportion of a
certain item in the financial statement in relation to
other related items, in the same financial statement or
other statements, to judge comparative performance.
FOUR BASIC CLASSIFICATION OF
FINANCIAL RATIOS

1. Liquidity Ratios
2. Solvency Ratios
3. Profitability Ratios
4. Growth Ratios
 I. LIQUIDITY RATIOS
• Liquidity Ratios Measure the ability of the business firm to pay off
short-term obligations as they mature.
• Shows the relationship of the current assets to current liabilities .

Will the business firm be able to pay off its currently

maturing obligations when they fall due?
I. LIQUIDITY RATIOS
 Current Ratio
 Quick or Acid Test Ratio
 Receivable Turnover
 Average Collection Period
 Inventory Turnover
 Average Sales Period
I. LIQUIDITY RATIOS
1. Current Ratio
- Indicates in which current liabilities are covered by current assets.
- Term of short-term debt paying ability

Formula:
Current Ratio = Current Assets / Current Liabilities
 I.I. LIQUIDITY
LIQUIDITYRATIOS
RATIOS
2. Quick or Acid-Test Ratio
- Inventories and prepaid expenses are excluded from total current
assets, leaving only the more liquid assets to be divided by current
liabilities.
- Measures how well a company meet its obligations without having to
liquidate or depend too heavily on its inventory.
Formula:
Acid-Test Ratio = (Cash + Marketable Securities + Accounts
Receivable + Short-term Notes Receivable) / Current Liabilities
 I. LIQUIDITY RATIOS
3. Receivable Turnover
- Measures the speed by which trade receivables are converted into cash during
the year
- How many times during the year has a receivable converted into cash?

Formula:
Receivable Turnover = Net Credit Sales / Average Trade Receivables

Average Trade Receivable = (Receivable beginning + Receivables End) / 2

 I. LIQUIDITY RATIOS
4. Average Collection Period
- Measures the speed in collecting trade receivables
- It represents the average length of time that the business must wait to
received cash after making a scale.

Formula:
Average Collection Period = 365 days / Receivable Turnover
I. LIQUIDITY RATIOS
5. Inventory Turnover
- Measures the number of times inventories are acquired and sold
during the year.

Formula:
Inventory Turnover = Cost of Goods Sold / Average Inventory
Average inventory = (Inventory beginning + Inventory end) / 2
I. LIQUIDITY RATIOS
6. Average Sales Period
- Measures the length of time to sell the inventory to customers.

Formula:
Average Sales Period = 365 days / Inventory Turnover
II. SOLVENCEY RATIOS
- Stability Ratios
- Measures the ability of the business firm to settle its financial
obligations when they mature and still remain stable.
Financial Leverage Ratios
-It affects the right-hand side of the statement of financial position or
the short-term debt, long-term debt, and shareholders’ equity.
-It reflects the amount of debts utilized in the capital structure of the
business firm.
II. SOLVENCEY RATIOS
 Debt Ratio
 Equity Ratio
 Debt-to-Equity Ratio
 Time Interest Earned
II. SOLVENCY OR STABILITY RATIOS
II. SOLVENCEY RATIOS
1. Debt Ratio
- It measure the proportion of cash provided by the creditors.
- Reflects the percentage of total assets that are financed with debts.

Formula:
Debt Ratio = Total Liabilities / Total Assets
II. SOLVENCEY RATIOS
2. Equity Ratio
-Determines the proportion of resources provided by the owners of
the business firm.
-It presents the financial strengths of the business because it provides
the margin of safety that the company affords to creditors.

Formula:
Equity Ratio = Total Equity / Total Assets
II. SOLVENCEY RATIOS
3. Debt to Equity Ratio
-It measures the proportion of debt and equity in the capital structure
of the company.

Formula:
Debt to Equity Ratio = Total Liabilities / Total Equity
II.II. SOLVENCEY
Solvency RATIOS
or stability ratios
4. Time Interest Earned
- It is a tool that measures the debt-paying ability of the company.
- It reflects the degree of protection provided by an entity to its long-
term creditors.

Formula:
Times Interest Earned = Income before interest and taxes / Interest Expense
IV. PROFITABILITY RATIOS
- It reflects the combined effects of liquidity, management efficiency in
handling the assets, and liabilities on the operating results of the
business.
- It shows the effectiveness of business operations.
IV. PROFITABILITY RATIOS
 Gross Profit Rate
 Operating Profit Margin
 Net Profit Margin
 Return on Investment
 Return on Equity
IV. PROFITABILITY RATIOS
1. Gross Profit Rate
- It measures the gross profit rate to sales.
- It indicates margin available to cover operating expenses.
- Gross Profit is the difference between sales and cost of sales.

Formula:
Gross Profit Rate = Gross Profit / Net Sales
IV. PROFITABILITY RATIOS
2. Operating Profit Margin
- Measure the percentage of profit available after deducting the cost of
sales and operating expenses from sales.
- Reflects the overall efficiency of the management in handling the
production, selling, and administrative costs.

Formula:
Operating Profit Margin = Operating Profit / Net Sales
IV. PROFITABILITY RATIOS
3. Return of Sales
(Net Profit Margin)
- Measures the overall operating results of an entity
-The measures considers all income recognized and all expenses
incurred during the period.

Formula:
Return of Sales = Net Income / Net Sales
 IV. PROFITABILITY RATIOS
4. Return on Asset
(Return on Investment)
- Measures the amount of net income per peso of investment in the
business.
- Reflects the profitability of every peso invested.
Formula:
Return on Investment = Net Income + [interest(1-tax rate)] / Average Total Assets
 IV. PROFITABILITY RATIOS
5. Return on Equity
- Measures the rate of return on the investment of the owner.

Formula:
Return on Equity = Net Income applicable to ordinary shares / Average owner’s
equity
V. GROWTH RATIOS
Market Value Ratios
- Reflect the value of the shares to their earnings, book value per
share, and cash flow.
1. Earnings per share
2. Price-earnings ratio
3. Dividend-yield ratio
4. Dividend pay-out ratio
5. Book Value per Share