Review of Financial Statement

Preparation, Analysis, and

Interpretation
Parts 7 & 8

Week 9
CASE ANALYSIS: (Business case)

Part 7
Below is the business case:

• Chloe’s Closet

• Chloe Mendez owns a clothing company, Chloe’s Closet.

She has a team of tailors who work for 8 hours every
day from Monday to Saturday. Demand for her business
is strong but there seems to be something preventing
her from meeting the demands of her customers.
• Chloe sells to both big department stores and small
boutique stores under the brand Chloe’s Closet.
Some brands also ask her to manufacture their
own designs. Business for Chloe has been good
since it started last 2014. In fact, despite the tough
competition from cheaper manufacturers abroad,
she still manages to grow her customer base.
• On December 4, 2015, Chloe received a billing
statement from a raw material supplier for an
amount of PHP400,000 which will be due in 5
days. She is also scheduled to pay her
employees’ monthly salary of PHP70,000 the
following day. Upon checking her bank
account, she only has a PHP67,000 balance.
• She knew she had exceeded her sales target
last October and November so she is
wondering why she only has this amount of
cash in her bank account. Was her money
stolen? Being a CPA, she checked the bank
statement and her financial records and
found no mistakes.
What’s wrong
with Chloe’s
Closet?
Here is the latest financial statement of
Chloe’s Closet as of November 30, 2015
 Measuring Company Efficiency
To Maximize Profits
• Analyzing a company's inventories and
receivables is a reliable means of helping to
determine whether it is a good investment
play or not. Companies stay efficient and
competitive by keeping inventory levels down
and speeding up collection of the moneys
they're owed.
• Efficiency ratios determine how productively a
company manages its assets and liabilities to maximize
profits. Shareholders look at efficiency ratios to assess
how effectively their investments in the company are
being used. Some of the most commonly considered
efficiency ratios include inventory turnover, accounts
receivable turnover, accounts payable turnover, and
the cash conversion cycle
• Inventory turnover measures how
quickly the company is moving
merchandise through the warehouse to
customers.
• Profitability
ratios help determine and
evaluate the company’s ability to generate
the in against the expenses it incurs and
consider the different elements of the
balance sheet and profit and loss account of
the company for analyzing the company’s
performance.
 Given below are the formula for calculating
profitability ratios which are most widely used.
Importance:

• Some importance of good profitability

ratios is as follows:
• Good profitability ratios are used to assess how
a company performs, measured by calculating
profitability at different levels, i.e., gross profit,
profit after tax, and EBITDA.
• These ratios show the percentage of sales at
different levels absorbed by the operating expense.
Hence, the lower the operating expense ratio, the
higher the profitability, indicating better
performance.
• However, there remains a limitation of the
profitability ratio as it is useful only when
comparing companies in the same industry.
Limitations:
• Some limitations of these ratios are given
below.
• The ratios do not consider the risks that any business
faces to earn the revenue and profits that the ratios are
using for calculation.
• It is possible to manipulate the financial data of any
company. In that case, the ratio will not show the
actual financial condition of the company.
• Different companies might have different methods of
displaying financial data. This makes the use of ratio for
profitability analysis hard for comparison purpose.
• It takes into account a limited time frame. Any new
investment, expansion plan takes time to show good result.
The ratios are not able to capture the positive results
because they do not come immediately.
• These ratios show the status of the current performance but
cannot forecast the future.
Financial Statements
Part 8
 What are Financial Statements?

• Financial statements are a collection of

summary-level reports about an
organization's financial results, financial
position, and cash flows. They include the
income statement, balance sheet, and
statement of cash flows.
The following is the Financial
Statements of ABC, Inc.
• Is ABC, Inc. profitable?
• Is the company’s financial performance
improving based on the two-year data
presented?
• Is the company heavily financed by debt or
equity?
compute the percentage share of each
Balance Sheet account vis a vis total
assets.
compute the percentage share of each
Income Statement vis a vis Net Sales.
compute the percentage share of each Balance Sheet account vis a vis total assets.
compute the percentage share of each
Income Statement vis a vis Net Sales.
financial statement analysis with emphasis on
common size and horizontal analyses
• 1. Analysis and Interpretations of
Financial Statements
• •To guide different users of financial
statements, i.e. creditors, investors, regulators
and managers, in their decisions, financial
statement analysis tools can be used.
• •These are financial ratios, common size
financial statements, and trend or horizontal
analyses.
• •For the purposes of this course, four major
categories of financial ratios will be covered:
liquidity ratios, efficiency or turnover ratios,
profitability ratios, and leverage ratios.
• •To be more specific, financial statement
analysis is undertaken to serve the following
purposes (objectives):
• •To assess the current profitability and
operational efficiency of the firm as a whole as
well as its different departments so as to judge
the financial health of the firm.
• •To ascertain the relative importance of
different components of the financial
position of the firm.
• •To identify the reasons for change in
the profitability/financial position of the
firm.
 • •To judge the ability of the firm to repay
its debt and assess the liquidity and
solvency position of the firm.
• •For this module inform the learners that
focus will be on common size or vertical
analysis and trend or horizontal analysis.
• 2.Vertical Analysis or common size
analysis.
• • This is a technique for evaluating the
data of financial statements that express
each item within a financial statement in
terms of a percent of a base amount.
• •For the Statement of Financial Position
or Balance Sheet, all accounts are
presented as a percentage of total assets.
• •For the statement of Profit or Loss or
Income Statement, all accounts are
presented as a percentage of net sales.
• •In using this type of analysis, attention must be focused on
items with significant changes from one period to another.
Depending on the nature of the business, it is possible that
even a slight change in he percentage may warrant the
attention of top management.
• • For example, a reduction of 0.5% in the gross profit margin
of a consumer based company with annual sales of PHP 200
billion translate to a PHP 1 billion in gross profit.
• 3. Horizontal Analysis
• •This allows the learners to see the trend for the
different accounts in the Financial Statements.
• •This is also known as trend analysis.
• •To establish the trend, percentage changes of
accounts from one period to another have to be
made.
• To compute:
• Amount of change = Current year amount –
Base (earlier) year amount
• Percent of change = Amount of
change/Base (earlier) year amount
• Some of the more important accounts to monitor
when doing trend analysis are the following:
• •Sales
• •Operating profits
• •Total assets
• • Interest-bearing liabilities
• •Interest expense
Practice Exercises:
• Is ABC, Inc. profitable?
• Is the company’s financial performance
improving based on the two-year data
presented?
• Is the company heavily financed by debt or
equity?
 Activity 9 (30 pts.)
• Below is the Statement of Financial Position
and Statement of Result of Operation of JFC
for the Years 2012 to 2014. Perform a
Horizontal and Vertical analysis of both
statements