BA 2103

Financial Management
Analysis of Financial Statements

BA 2103– Financial Management| RCDBadoy | CBA-USeP

 Intended Learning Outcomes
• Discuss the objectives of financial statement analyses
• Summarize the limitations of financial statement analyses
• Illustrate the steps in doing financial statement
• Evaluate financial statements by applying appropriate tools
and techniques
• Interpret results of computations

BA 2103 – Financial Management| RCDBadoy | CBA-USeP

 Financial Statements
• Statement of Financial Position (Balance Sheet)
• Statement of Income
• Statement of Cash Flows
• Statement of Changes in Owner’s Equity

• Accounting Policies and Explanatory Notes

BA 2103 – Financial Management| RCDBadoy | CBA-USeP

 Objectives of Financial Statement Analysis
Financial analysis aims to look into the firm’s:
• Profitability
• Liquidity
• Stability
• asset utilization
• debt utilization

BA 2103 – Financial Management| RCDBadoy | CBA-USeP

 Limitations of Financial Statements
• Its failure to consider inconsistencies and
dissimilarities in the accounting
principles, policies and procedures used
by the firms in the industry
• Its failure to consider changes in the
purchasing power of currencies
• The age of the financial statements; the
older it gets, the less reliable it becomes

BA 2103 – Financial Management| RCDBadoy | CBA-USeP

 Limitations of Financial Statements
• Failure to read and understand the information
in the Notes to Financial Statements may
obscure managers in evaluating the degree
of risk involved
• Financial statements that have not undergone
external auditing procedures may or may not
conform to Generally Accepted Accounting
Principles (GAAP) and standards;
usage of these statements may lead
to erroneous analysis and decisions

BA 2103 – Financial Management| RCDBadoy | CBA-USeP

 Limitations of Financial Statements
• Financial statements that have not
undergone external auditing procedures
may prove to be inaccurate or fraudulent
and do not fairly present the firm’s
financial condition
• Audited financial statements do not
guaranty accuracy

BA 2103 – Financial Management| RCDBadoy | CBA-USeP

 Procedures in Analyzing Financial Statements
• Establish the objective of the financial analysis
• Gather complete information about the firm and study the
industry in which the firm operates
• Perform mathematical analysis using applicable tools
• Make conclusions relative to the established objectives

BA 2103 – Financial Management| RCDBadoy | CBA-USeP

 Tools & Techniques for Financial Analysis
Horizontal Analysis
• Determining the changes in the behavioural patterns of
the different items in financial statements of two or more
years
- Gross profit variation analysis
- Analysis of variation in net income
- Use of comparative statements / common size statements
- Use of trend ratios

BA 2103 – Financial Management| RCDBadoy | CBA-USeP

 Tools & Techniques for Financial Analysis
Vertical Analysis
• Analysis of financial data as contained in one set of
financial statements
- Use of common size statements
- Use of financial ratios
- Cash flow analysis

BA 2103 – Financial Management| RCDBadoy | CBA-USeP

 Tools & Techniques for Financial Analysis
Gross Profit Variation Analysis & Analysis of Variation
in Net Income
• Analysis of financial data as contained in one set of financial
statements
- Use of common size statements
- Use of financial ratios
- Cash flow analysis

BA 2103 – Financial Management| RCDBadoy | CBA-USeP

 Tools & Techniques for Financial Analysis
Gross profit is affected as follows:

• Increase in volume increase

• Decrease in volume decrease
• Increase in unit selling price increase
• Decrease in unit selling price decrease
• Increase in unit cost decrease
• Decrease in unit cost increase

BA 2103 – Financial Management| RCDBadoy | CBA-USeP

 Tools & Techniques for Financial Analysis
Comparative Statements
Figures of two successive financial statements are compared to
show the changes (increase or decrease) in peso amount and
percentages
Inc (Dec)
Year 2 Year 1 Amount %
Sales xxx xxx
Cost of Sales (xxx) (xxx)
Gross Profit on Sales xxx xxx
Operating Expenses (xxx) (xxx)
Net Income xxx xxx
=== ===
BA 2103 – Financial Management| RCDBadoy | CBA-USeP
 Tools & Techniques for Financial Analysis
Common Size / Common Peso Statements
•Show the equivalent percentage of each item in relation to a
common base number
Income Statement – net sales
Balance Sheet – TA or TL & OE
Base number is 100% / P1.00

•Used in analyzing the financial statements of one

company and in comparing those of different
companies (or responsibility centers)
BA 2103 – Financial Management| RCDBadoy | CBA-USeP
 Tools & Techniques for Financial Analysis
Trend Analysis
•Undertaken to determine the behavioral patterns of the
different account balances
•Trend ratios or percentages are computed using the figures
of the base year (usually the earliest year) as divisors

BA 2103 – Financial Management| RCDBadoy | CBA-USeP

 Financial Ratios
• Significant relationships between items in the financial
statements (total or per responsibility center)
expressed in mathematical form
• As indicators of profitability, liquidity, and stability:
they are used to determine the possible areas of
weaknesses and strengths of an organization

BA 2103 – Financial Management| RCDBadoy | CBA-USeP

 Financial Ratios
• In doing ratio analysis, the relationships arrived at are
compared with chosen standards such as industry ratios,
the financial ratios per budgets, or those derived from
financial statements of the preceding period
• Important: ratios are mere indicators; interpretations
thereof should not be considered conclusive

BA 2103 – Financial Management| RCDBadoy | CBA-USeP

 Financial Ratios
Financial Performance (Profitability) Ratios
Return on Sales – indicates profitability based on sales
Return on Assets – indicates profitability in the use of TA
* Profit Margin
* Asset Turnover
Return on Equity – indicates profitability in the use of OE
* Profit Margin
* Asset Turnover
* Financial Leverage

BA 2103 – Financial Management| RCDBadoy | CBA-USeP

 Financial Ratios
Financial Condition Ratios –
Short Term Solvency (Liquidity Ratios)
Current Ratio – indicates the ability to pay current obligations
Acid Test Ratio – indicates the ability to pay current obligations
from the more liquid assets
Operating Cycle – the length of time it takes to convert cash to
inventories, then inventories to receivables,
then receivables to cash
Cash Cycle – indicates time interval for which additional
short term financing may be needed
BA 2103 – Financial Management| RCDBadoy | CBA-USeP
 Financial Ratios
Financial Condition Ratios – Long Term Solvency
(Stability Ratios / Leverage Ratios)
Debt / Equity Ratio – measures the proportion of borrowed capital to
invested capital
Debt Ratio – indicates what portion of total assets is provided by creditors
Equity Ratio – indicates what portion of total assets is provided by owner’s
equity
Times Interest Earned – indicates the company’s ability to pay fixed
interest charges
Times Fixed Charges Earned – indicates the ability to meet
annual fixed charges

BA 2103 – Financial Management| RCDBadoy | CBA-USeP

Funds Flow Analysis

BA 2103 – Financial Management| RCDBadoy | CBA-USeP

 Funds Flow Analysis
• in analyzing funds flow, first know what are the sources
and uses of funds
• flow of funds is a continuous process
• for every use of funds, there is a corresponding source

BA 2103 – Financial Management| RCDBadoy | CBA-USeP

BA 2103 – Financial Management| RCDBadoy | CBA-USeP
 “Thou shalt not play games with numbers.”

Lifted from Ten Commandments for Moral Executives / Management for Filipinos. Iñigo, 2007

BA 2103 – Financial Management| RCDBadoy | CBA-USeP