Financial Statement Analysis

Overview

Financial Statements present the company’s financial picture and its report on the financial
performance. However, reports will just remain as pictures that might get old over time when
they will not be utilized for the benefit of the company. Thus, there is a need for the analysis of
these financial statements.

Learning Objectives

At the end of this module, the learner shall be able to:

1. Appreciate more the value of the FS by analyzing their components and identifying their
effect to the over-all financial performance of the company;
2. Compute for the peso and percentage changes in account balances
3. Analyze FS using the vertical and horizontal approaches.

Discussion

The Financial Statements have been prepared. However, the work of the accountant does not
end there. He/She uses different ways of utilizing and appreciating the FS. The accountant
helps the management come up with a sound decision which is based on the financial reports as
presented. This is known to be the process of Financial Statement Analysis.

WHAT IS A FINANCIAL STATEMENT ANALYSIS?

Financial Statement Analysis is the process of assessing the financial performance and position
of a given company. It tries to evaluate the trends of the firm’s financial status over a certain
period by performing this trends analysis involving the company’s FS from the preceding years
up to the present FS being evaluated. Also, FS analysis would involve the computation of ratios
to assess the company’s profitability, liquidity, equity management and financial structure of
the organization. Thus, the succeeding chapters will be devoted to the FS analysis involving the
trends in the horizontal-vertical analyses and the financial ratios.

WHAT IS THE IMPORTANCE OF THE FINANCIAL STATEMENT ANALYSIS?

Information that one can get from the Financial Statements per se do not suffice for a basis in
making a sound decision for the company. One has to dig deep into these reports to see the
meat of what will constitute as an important basis for the said decision making.

Let us consider the following situation. Suppose you were invited to invest into two
companies. However, because of your limited situation, you can only choose one to invest into.
How will you choose which company to trust your investment? Will it be Company Alpha or
Bravo?
Suppose further that the two companies are both merchandising businesses offering the same
line of products and targeting the same market. Checking on their FS, you were provided with
these information:

FS DATA COMPANY ALPHA COMPANY BRAVO

NET INCOME, Dec. 2019 PhP 2,000,000 PhP 1,850,000

TOTAL ASSETS, Dec. 2019 PhP 22,114,800 PhP 19,394,811

With these data, you might choose Company Alpha for it reports an income and total assets
higher than that of the Company Bravo. However, we have seen just the tip of the iceberg. This
information will not suffice for us to have a proper decision yet.

Looking into these two companies FS for the previous years, we have these data to find out:

NET INCOME COMPANY ALPHA COMPANY BRAVO

FY 2019 PhP 2,000,000 PhP 1,850,000
FY 2018 2,375,200 1,573,350
FY 2017 2,801,148 1, 397,480

Given this additional information, does your initial choice change? As future investors and
economic leaders for that matter, you have to be concerned about the continuing effects of the
business operation in the over-all status of the business. In the above example, looking just at
the current FS will mislead us in choosing Company Alpha whose Net Income is diminishing
over time. Company Bravo, on the other hand, shows a much stable market acceptance having
maintained a continuous increase in business profit.

HORIZONTAL ANALYSIS

Horizontal analysis of the FS is the method of comparing an account title over a number of
accounting periods. For example, you will analyze the trend of the Cash account for several
accounting periods. Therefore, you will compare the Cash balances for Year 1, Year 2, and the
following years. This is the reason why it is called horizontal analysis following the direction of
comparing the balances of just one account side by side this account’s balances making a
horizontal comparison. The movement, i.e. the increase or decrease in the balances will consist
the analysis. This technique is also called TREND ANALYSIS.

As what has been said, horizontal analysis involves FS of two or more accounting periods.
Commonly, this technique is used on the Balance Sheet accounts and Income Statement
accounts but can also be used in analyzing any other FS. Putting the FS of different accounting
periods side by side will lead us to account for the changes in each account title over time. This
changes can be expressed either in monetary value or in percentage. You may use the following
formulas to compute for the changes.

CHANGE IN PESO = Balance of the Current Period – Balance of the Previous Period
 Change in Peso
CHANGE IN PERCENTAGE = ----------------------------------------------------
Balance of the Previous Period

VERTICAL ANALYSIS

Vertical Analysis of the FS is also called COMMON SIZE ANALYSIS because it presents the FS
account titles as a percentage of a base amount. Normally, the Balance Sheet items are
presented as a percentage of the Total Assets while the Income Statement items as a percentage
of Sales/Net Sales.

In this regard, we can present all the items of the Balance Sheet as a percentage of the total
assets. This will give us an information regarding the composition of the assets as each asset
account is presented as a percentage of the total assets. To the other side of the equation, we
can infer on what percentage of asset is financed by the liability and what part of the asset goes
to the owners.

In the Income Statement, account balances are presented as a percentage of sales. This will give
us the data about the amount/percentage of sales that is used up by a particular expense. It
will also present the Net Income as the part of sales that were not used up.

References:

Books

Arganda, Amelia M., Herrero, Carmen C. Accounting Principles I: Textbook/

Workbook. Quezon City: Kalayaan Press Mktg. Ent. Inc., 2015.

Horngren, Charles T., Harrison, Walter T., Oliver, Suzanne. Accounting. Jurong,

Singapore: Pearson Education South Asia Pte. Ltd., 2009.

Rabo, Tugas, Slendrez. Fundamentals of Accountancy, Business and Management 1. Quezon

City: Vibal Group, Inc., 2016

Web References
“Horizontal or Trend Analysis of Financial Statements.” Accounting for Management
https://www.accountingformanagement.org/horizontal-analysis-of-financial-statements/