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FINANCIAL STATEMENT ANALYSIS

AROCENA, GIRANO V.
CANLAS, JONAS C.
EBBAH, ROBI ANGELO B.
PRE-MBA 102
Financial Statement
Analyzing Financial Statements
Interpret Financial Ratios
Statement of Cash Flows
What is a financial statement?
 These are documents which show where the money came from,
where it went, and where it is now
 The four basic financial statements:
A.) Balance Sheet
B.) Income Statement
C.) Cash Flow Statement
D.) Statement of Shareholder’s Equity
https://www.sec.gov/reportspubs/investor-publications/investorpubsbegfinstmtguidehtm.html
BALANCE SHEET

 It Shows the company’s assets, and liabilities


 It has 2 parts:
- Assets: things that a company owns that
have value
-Liabilities: amount of money that a
company owes to others
 INCOME STATEMENT

 is a report that shows how much revenue a company earned over


a specific time period
 This report also shows the costs that are associated in earning that
revenue
CASH FLOW STATEMENT

 It reports inflows and outflows of company’s cash


 Reports the effect of operating, investing,
and financing activities on cash flows
STATEMENT OF SHAREHOLDER’S EQUITY

 It reports the changes in stockholder’s equity


Advantages of Financial Statement Analysis

 Through Financial Statement Analysis, the company can determine its strengths and
weakneses,
 Can help the company can realize if it has adequate liquidity to meet upcoming debts
 Can help reduce production cost and increase “Bottom line”
 Helps determine wether you have enough inventory to meet projected sales figures
 Compare your financial statement analysis values to spot trends and changes that affect
the business
Limitations of Financial Statement Analysis

 Dependence on historical costs


 Different accounting methods and techniques in financial
statement analysis
 Financial statement analysis does not project the actual
problems of a company
 Based on specific time period
 Subject to fraud.
 No discussion of non-financial issues
 No predictive value
Analyzing Financial Statements
 There are a number of techniques you can use to
perform financial statement analysis for your business
firm, depending on what you are trying to find out.
The financial statements you want to use in your
analysis is the balance sheet, income statement,
and statement of cash flows. First, you need to know
how to prepare the financial statements. After
learning preparation, financial analysis comes next.

Source: https://www.thebalance.com
Trend Analysis
 Trend analysis is also called time-series analysis. Trend analysis helps a firm's financial
manager determine how the firm is likely to perform over time. Trend analysis is
based on historical data from the firm's financial statements and forecasted data
from the firm's pro forma, or forward-looking, financial statements.
Common Size Financial Statement Analysis
 Common size financial statement analysis, also called a vertical analysis, is just one
technique that financial managers use to analyze their financial statements. It is not
another type of income statement, but is rather a tool used to analyze the income
statement.
Interpreting Financial Ratios
 Ratio Analysis compares one indicator to another. Ratios can give
you significant insight into the performance and relative importance
of two indicators. A ratio, which may either, be a percentage, a
rate, or simple proportion, expresses the mathematical relationship
between one quantity and another.
 Managers and investors can use ratio analysis to understand the
health of an entity. Ratios lend insight into many critical aspects
such as present and future profit potential, expense control , and
solvency.
 Classified into three major groupings: Liquidity, profitability and
solvency ratios.

Reference: Ballada, W and Ballada, S. (2016). Accounting Fundamentals Made Easy. Manila: Dynasty
Booksource Asia.
Liquidity Ratios
 Creditors and potential creditors are interested in continuously monitoring an entity’s ability to
pay interest as it comes due and to repay the principal of the debt at maturity. An analysis of a
firm’s liquid position provides indicators of its short-term debt-paying ability. It is also used to
evaluate management’s current operating efficiency.
 Measuring the Ability to Pay Current Liabilities.
 Working Capital
 Current Ratio
 Quick Ratio
 Measuring the Ability to Sell Inventory and Collect Receivables
 Account Receivable Turnover
 Average Age of Receivables
 Inventory Turnover
 Average Age of Inventory
 Operating Cycle
Liquidity Ratio
 Working Capital
 Formula: Current Assets - Current Liabilities
 Meaning: This equation describes the amount of capital used to run
day to day business operations. It is necessary to finance an entity’s
cash conversion cycle.
 Improved by: Increasing current assets (increase turnaround on
accounts receivable), decrease current liabilities (reduce short term
debt), increase net income to improve cash flow
Liquidity Ratio
 Current Ratio
 Formula: Current Assets / Current Liabilities
 Meaning: Measures the ability of an entity to meet current debt
obligations with assets that are readily available. It is used to
evaluate an entity’s liquidity and short-term debt-paying capacity.
A healthy current ratio should be or in excess the value of 2.0.
 Improve by: Increase current assets by increasing profit, selling
additional capital stock, borrowing additional long term debt, or
disposing of unproductive fixed assets and retaining proceeds.
Reduce current liabilities by retaining a greater portion of allocated
savings. Avoid financing non-current assets with current liabilities.
Liquidity Ratio
 Quick Ratio.
 Formula: Quick Assets / Current Liabilities
 Meaning: Tells whether the entity could pay all its current
liabilities even if none of the inventory is sold. Quick assets are
those that may be converted directly into cash within a short
period of time. Creditors generally use the rule of thumb that a
quick ratio of at least 1:1 is satisfactory.
Liquidity Ratio
 Accounts Receivable Turnover
 Formula: Net Credit Sales / Average Net Account Receivable
 Meaning: Measures the entity’s ability to collect from credit
customers. It indicates the number of times that the average
balance of accounts receivable is collected during the period.
In general, the higher the ratio, the more successfully the
business collects cash.
 Improve by: Tightening credit policies and by more proactively
seeking payment of outstanding accounts.
Liquidity Ratio
 Average Age of Receivables.
 Formula: 365 days / Accounts Receivable Turnover
 Meaning: Provides a rough approximation of the average time
that it takes to collect receivables. The general rule is that the
collection period should not materially exceed the credit period.
Liquidity Ratio
 Inventory Turnover
 Formula: Cost of Goods Sold / Average Merchandise Inventory
 Meaning: Is a measure of the number of times an entity sold its
average level of inventory during the period. A high rate of
turnover indicates relative ease in selling inventory. Cost of
goods sold is used instead of net sales because both cost of
goods sold and merchandise inventory are stated at cost.
Higher inventory turnover ratios generally increase profitability
since an entity can use the cash normally tied up in inventory for
higher return investments.
Liquidity Ratio
 Average Age of Inventory
 Formula: 365 days / Inventory Turnover
 Meaning: Provides a rough measure of the length of time it takes
to acquire, sell and replace inventory.
Liquidity Ratio
 Operating Cycle
 Formula: Average age of inventory + Average Age of Receivables
 Meaning: Measures the average time period between buying the
inventory and receiving cash form its sales.
Profitability Ratios
 Profitability ratios are a class of financial metrics that are used to
assess a business's ability to generate earnings compared to its
expenses and other relevant costs incurred during a specific period
of time. For most of these ratios, having a higher value relative to a
competitor's ratio or relative to the same ratio from a previous period
indicates that the company is doing well.
 Return on Total Assets
 Return on Ordinary Equity
 Basic Earning Per Ordinary Share
 Price-Earning Ratio
 Dividend Yield
Profitability Ratios

 Return on Total Assets


 Formula: (Profit + Interest Expense) / Average Total Assets
 Meaning: Is a measure of managements’ efficiency in using its
assets to earn profits
Profitability Ratios

 Return on Ordinary Equity


 Formula: (Profit – Preference Dividends) / Average Ordinary Equity
 Meaning: Shows the relationship between profit and ordinary
shareholder’s investment in the entity. Average ordinary equity is
an approximation of the amount invested by group of owners
throughout the year.
Profitability Ratios

 Basic Earnings Per Ordinary Share


 Formula: (Profit – Preference Dividends) / Average Number of
Ordinary Shares Outstanding
 Meaning: Is a measure of the profit earned on each ordinary
share.
 Improve by: increasing profit can directly increase earnings per
share by providing highly demanded products or services in a
cost-effective manner.
Profitability Ratios
 Price – Earning Ratio (P/E)
 Formula: Market Price Per Ordinary Share / Basic Earning Per
Ordinary Share
 Meaning: Indicates the degree to which investors value an entity.
When investors pay a high price for a given amount of corporate
earnings, they increase the entity’s P/E ratio.
 The higher the P/E ratio, the more potential investors typically see
in the particular entity. Corporations with higher P/E ratios tend to
have higher growth rates and deliver products and services that
will probably be in demand for a significant time into the future.
Profitability Ratios

 Dividend Yield
 Formula: Cash Dividends Per Ordinary Share / Market Price per
Ordinary Share
 Meaning: The ratio of dividends per share to the share’s market
price. Measures the percentage of a share’s market value that is
returned annually as dividends.
Solvency ratios
 Solvency Ratios measure the ability of an entity to survive over a
long period of time. Long term creditors and shareholders are
interested in the long-run solvency, particularly its ability to pay
interest as it comes due and repay the principal of the debt at
maturity.
 Time Interest Earned ratio
 Debt to Total Assets Ratio
 Equity to Total Assets ratio
Solvency Ratios

 Time Interest Earned Ratio


 Formula: Profit Before Interest Expense and Income taxes / Annual
Interest Expense
 Meaning: Is a measure how readily an entity can meet interest
payments with profit earned from operations. The times interest
earned ratio indicates the margin of safety provided by current
earnings in meeting the entity’s interest responsibilities.
 Improve by: Paying off debt and reducing interest expense
and/or increasing operations profitability.
Solvency Ratios

 Debt to Total Assets Ratio / Debt Ratio


 Formula: Total Liabilities / Total Assets
 Meaning: Shows the percentage of the entity’s assets financed by
debt. Higher ratios indicate that an entity has financed a large
portion of assets with debt.
Solvency Ratios

 Equity to Total Assets Ratio / Equity Ratio


 Formula: Total Equity / Total Assets
 Meaning: Shows the percentage of the firm’s assets financed by
shareholders. The higher the ratio, the smaller the risk that the
entity will be unable to meet its obligations when due.
Statement of Cash Flows

 The cash flow statement is distinct from the income statement and
balance sheet because it does not include the amount of future
incoming and outgoing cash that has been recorded on credit.
Therefore, cash is not the same as net income, which on the income
statement and balance sheet, includes cash sales and sales made
on credit.
 Cash flow is determined by looking at three components by which
cash enters and leaves a company: core operations, investing and
financing,
 Operations. Measuring the cash inflows and outflows caused by core business
operations, the operations component of cash flow reflects how much cash is
generated from a company's products or services.

 Example of Operating Activities


 Cash Inflow
 Receipts from sales of goods and performance of services
 Receipts from royalties, fees, commissions and other revenues
 Cash Outflow
 Payments to suppliers of goods and services
 Payment to employees
 Payment for taxes
 Payment for interest expense
 Payment for another operating expenses

Source : http://www.investopedia.com
 Investing. Changes in equipment, assets, or investments relate to cash from investing.
Usually, cash changes from investing are a "cash out" item, because cash is used to buy
new equipment, buildings, or short-term assets such as marketable securities.

 Example of Investing Activities


 Cash Inflows
 Receipts from sale of property and equipment
 Receipts from sale of investments in debt or equity securities
 Receipts from collection on notes receivable
 Cash Outflow
 Payments to acquire property and equipment
 Payments to acquire dept or equity securities
 Payments to make loans to others generally in the form of notes receivable
 Financing. Changes in debt, loans or dividends are accounted for in cash from
financing. Changes in cash from financing are "cash in" when capital is raised, and
they're "cash out" when dividends are paid.

 Examples of Financing Activities


 Cash Inflows
 Receipts from investments by owners
 Receipts from issuance of notes payable
 Cash Outflow
 Payment to owners in the form of withdrawals
 Payments to settle notes payable
A company can use a cash flow statement to predict
future cash flow, which helps with matters in
budgeting. For investors, the cash flow reflects a
company's financial health: basically, the more cash
available for business operations, the better. However,
this is not a hard and fast rule. Sometimes a negative
cash flow results from a company's growth strategy in
the form of expanding its operations