UNDERSTANDING AND INTERPRETATION OF FINANCIAL like, usually is due within 30 to 60 and usually will have

STATEMENT
What is the purpose of financial statement analysis?
The objective of financial statements analysis is to
determine the extent of a firm’s success in attaining its
financial goals, namely:
To earn maximum profit
To maintain solvency
To attain stability
Three major financial statement user
1. Creditors – creditors lend money to a company on
either a short – term or a long term basis.
Short - term creditors include trade creditors
and lending institutions.
Long – term creditors include lending
institutions and corporate bondholders.
All creditors want to be assured of receiving
prompt payments from the company.
2. Equity investors – Equity investors are those who
purchase an ownership interest in a company.
They want to determine if the company will be
able to distribute dividends in the future and if its
shares will rise in value.
3. Management – management analyzes the company’s
financial statements with a view toward favorably
impressing external parties.
Management ‘s objective is to monitor the company’s
overall performance.
a very low ceiling. Long term debt, on the other hand,
can be have maturities as long as 20 years and an
almost unlimited upper limit.
What is meant by trading on the equity?
Trading on the equity also known as financial leverage is
a phrase used to describe the situation whereby the
cost of borrowed funds is less than the rate earned on
the funds. If debt is costing 12% and the return on
shareholders/ equity is 15%, the firm is said to be
trading on the equity and has positive financial
leverage.
Distinguish between horizontal and vertical analysis
Horizontal analysis is the comparison of the same
information for two or more years to determine the
amount of the change and percentage increase or
decrease. For instance, if accounts receivable were
P100,000 last year and P125,000 this year, the change
represents a P25,000 increase or 25%. Vertical analysis
is the comparison of one item to others in the same
group for a given year. For instance, the P100,000 of
accounts receivable might have represented 35% of the
current assets last year, while the P125,000 represents
45% of current assets in this year.

What is profitability, liquidity and solvency?

Profitability is the ease with which a company
generates income
Liquidity – is the ease with which an item, such as an
asset, can be converted to cash. The liquidity of a firm
refers to the company’s ability to generate sufficient
cash to meet its short term obligations.
Solvency – is a company’s ability to meet the obligations
created by its long term debt.

Six limitations of ratio analysis

1. The greatest single limitation of ratio analysis is
that people tend to place too much reliance on
the ratios. Information gathered from ratio
analysis is only a part of what is needed to make
good economic decisions.
2. Attempting to predict the future using past
results is problematic at best.
3. The financial statements used as the basis of
the ratios are based on historical cost.
4. Figures from the balance sheet used in the
calculation of the ratios are year end numbers.
5. Comparing the ratios of a company in one
industry with those of a company in another
industry is difficult because industry
peculiarities will cause the ratios to differ.
6. There are no hard and fast rules telling the
analyst what numbers to use to calculate ratios.
WHAT ARE SOME OF THE RELATIVE ADVANTAGES OF
SHORT TERM AND LONG TERM DEBT?
Short term debt usually has no costs, while
long term debt always has costs. The main
disadvantages to short term debts are the limited
amount that can be borrowed and the due date of the
repayment. Short term debt, accounts payable and the