Financial Statement (FS) Analysis


The process of evaluating risks,
performance, financial health, and
future prospects of a business by
subjecting financial statement data
to computational and analytical
techniques with the objective of
making economic decision
3 Kinds of FS Analysis Techniques

Horizontal Analysis
Vertical Analysis
Financial Ratios
 Horizontal Analysis

Called trend analysis
A technique for evaluating a series of
financial statement data over a period of
time with the purpose of determining the
increase or decrease that has taken place
Reveal the behavior of the account over
time (it is increasing, decreasing or not
moving?)
 Horizontal Analysis

Uses financial statements of two or more periods
All line items on the FS may be subjected to
horizontal analysis
Changes can be expressed in monetary value (peso)
and percentage computed by using the following
formulas:
• Peso Change = Balance of Current Year – Balance of Prior
Year
• Percentage Change = (Balance of Current Year – Balance
of Prior Year) / (Balance of Prior Year)
 Horizontal Analysis

2015 2014
Sales ₱250,000 ₱175,000
Peso Change = ₱250,000 - ₱175,000 = ₱75,000
Percentage Change = (₱250,000 - ₱175,000) / ₱175,000 = 42.86%

Interpretation:
• Sales increased by ₱75,000 from CY 2014
• It represents growth of 42.86% in 2015
 Vertical Analysis

Also called common-size analysis
A technique that expresses each
financial statement item as a
percentage of a base amount
 Vertical Analysis

For SFP, the base amount is Total
Assets
• Balance of Account/Total Assets
• From the common-size SFP, the
analyst can infer the composition of
assets and the company’s financing
mix
 Vertical Analysis
 For the SFP example

% of assets
Cash ₱200,000 200,000/1,400,000 = 14.29%
Acct. Receivable 400,000 400,000/1,400,000 = 28.57%
Inventory 250,000 250,000/1,400,000 = 17.88%
Equipment
 e: 550,000 550,000/1,400,000 = 39.29%
Total Assets ₱1,400,000 Sum of the components is
100%
The largest component of Asset is equipment at 39.29%.
Cash is the smallest component at 14%.
 Vertical Analysis

 For the SFP example:
% of assets
Acct. Payable ₱300,000 300,000/1,400,000 = 21.43%
Notes Payable 400,000 400,000/1,400,000 = 28.57%
Owner, Capital 700,000 700,000/1,400,000 = 50.00%
Total Liabilities ₱1,400,000 Sum of the components is
and Equity 100%

50% of assets are financed by debt and the other half

is financed by equity.
 Vertical Analysis

For the SCI, the base amount is
Net Sales
• Balance of Account / Total Sales
• This will reveal how “Net Sales” is
used up by the various expenses
• Net income as a percentage sales is
also known as the net profit margin
 Vertical Analysis
 For the SCI example:

% of Net Sales
Net Sales ₱900,000
Cost of Goods Sold 400,000 400,000/900,000 = 44.44%
Gross Profit 500,000 500,000/900,000 = 55.56%
Operating Expenses 200,000 200,000/900,000 = 22.22%
Net Income 300,000 300,000/900,000 = 33.33%

• The cost of goods sold is 44.44% of sales. The

company has a gross profit rate of 55.56%. Operating
expenses is 22.22% of sales
 

RATIO ANALYSIS
 Ratio Analysis

Expresses the relationship among
selected items of financial statement data
The relationship is expressed in terms of
a percentage, a rate, or a simple
proportion
Financial Ratio – composed of a numerator
and denominator
3 Financial Ratios Performance Indicators

Profitability
Operational Efficiency
Financial Health
Profitability Ratios

 Profitability Ratios

Measure the ability of the company to
generate income from the use of its assets
and invested capital as well as the ability to
control its cost
• Gross Profit Margin
• Operating Income Margin
• Net Profit Margin
• Return on Assets (ROA)
• Return on Equity (ROE)
 Gross Profit Margin

 expresses gross profit as a percentage of
sales
 it can be interpreted as the peso value of the
gross profit earned for every peso of sales
Operating Income Margin

 expresses operating income as a percentage
of sales
 it is the peso value of the operating income
earned for every peso of sales
 operating income is computed as gross
profit less operating expenses
 Net Profit Margin

 expresses net income as a percentage of sales
 it is can be interpreted as the peso value of
the net income earned for every peso if sales
 shows how much profit will go to the owner
for every peso of sales made
 Return on Asset (ROA)

 measures the peso value of income
generated by employing the company’s assets
 it is viewed as an interest rate or form of
yield on asset investment
 in comparing companies, the company with
a higher ROA is judged to be more profitable
Return on Equity (ROE)

 measures the return (net income)
generated by the owner’s capital invested
in the business
 similar to ROA, the company with a
higher ROE is judged to be more
profitable
Operational Efficiency

Operational Efficiency Ratio

 measures the ability of the company to utilize its assets
 measured based on the company’s ability to generate sales
from the utilization of its assets, as a whole or individually
 the turnover ratios are primarily used to measure
operational efficiency
• Asset Turnover
• Fixed Asset Turnover
• Inventory Turnover
• Days in Inventory
• Accounts Receivable Turnover
• Days in Accounts Receivable
 Asset Turnover

 an indicator of the efficiency with which the
company is utilizing all of its assets
 it measures the peso value of sales generated
for every peso of the company’s assets
 the higher the turnover rate, the more efficient
the company is in using its assets
 Fixed Asset Turnover

 similar to asset turnover, except that it is
focused on fixed assets only which is composed
of property, plant and equipment.
 an indicator of the efficiency of fixed assets in
generating sales
 Inventory Turnover

 measured based on cost of goods sold and not
sales because inventory, upon sale, is
transferred to cost of goods sold
 it makes both numerator and denominator
measured at cost
 this ratio is an indicator of how fast the
company can sell its inventory
 Days in Inventory

 computes the average number of days that
inventories are held until sold
 measures the number of days from acquisition
to sale
Accounts Receivable Turnover

 measures the number of times the company
can convert accounts receivable to cash during
the year
 how many times the company was able to
collect on its average accounts receivable
during the year.
 Days in Accounts Receivable

 measures the company’s collection period
which is the number of days from sale to
collection
 a more visual indicator as compared to
accounts receivable turnover
Financial Health

 Financial Health

 look into the company’s solvency and liquidity ratios
Solvency – refers to the company’s capacity to pay their
liabilities
• Debt to Equity Ratio
• Debt Ratio
• Equity Ratio
• Interest Coverage Ratio
Liquidity – intents measure the company’s ability to pay debts
that are coming due (short term debt)
• Current Ratio
• Quick Ratio
 Debt to Equity Ratio

 indicates the company’s reliance to debt or
liability as a source of financing elative to
equity
 a high ratio suggests a high level of debt that
may result in high interest expense
 a debt to equity ratio of greater than 1 implies
that the company’s debt exceeds capital
 Debt Ratio

indicates the percentage of the company’s
assets that are financed by debt
A high debt to asset ratio implies a high level of
debt
 Equity Ratio

 indicates the percentage of the company’s
assets that are financed by capital
 a high equity to asset ratio implies high level
of capital
 Interest Coverage Ratio

 measures the company’s ability to cover the
interest expense on its liability with its operating
income
 creditors prefer a high coverage ratio to give them
protection that interest due to them can be paid
 the ratio greater than 1 means the company
operating income can meet its interest expense
 Current Ratio

 used to evaluate the company’s liquidity
 basically, we want to know whether there are
sufficient current assets to pay liabilities
 a ratio of 1 means current assets can fully
cover current liabilities, however, creditors
want a margin of safety. Some creditor require
a current ratio of 2
 Quick Ratio

 stricter measure of liquidity
 it does not consider all the current assets, only
those that are easier to liquidate such as cash
and accounts receivable that are referred to as
quick assets