Wright Technological College of Antique

Senior High School

San Jose, Antique

LEARNER’S MODULE
BUSINESS FINANCE: Chapter 3

Rodalyn Claire R. Huervana

Instructor

First
Semester

2020 – 2021
School Year
1
WEEK 2
CONTENT: Analysis and Interpretation of Financial Statement

Most Essential Learning: Performing Analysis and Interpretation of Financial statements

Learning Competencies
After reading this module, you will be able to analyze and interpret financial statements using
traditional approaches.

Introduction
Financial statement analysis is the process of selecting related data from financial statements
to evaluate the entity’s past financial position and operating performance and predict the outcome of
future operations.
The financial statements become more meaningful, understandable, and relevant to the users if
the pieces of information contained therein are analyzed and interpreted.
In this module, the methods of analyzing the financial statements include the following:
a. horizontal or comparative approach
b. vertical or common-size approach
c. trend approach

Enrich your vocabulary:

Liquidity - refers to the ability of a business entity to settle its currently maturing financial
obligations
Solvency – the ability of a business to pay its long-term financial obligations (beyond one year
maturity)

Horizontal or Comparative Approach

The horizontal or comparative analysis approach is an analytical tool that evaluates the present
performance of an entity compared to last year’s. The analysis reflects the differences in absolute
amount and in percentage between two periods only, namely the present year and the previous year.
The primary objective of horizontal or comparative analysis is to determine the present status
of the business particularly in terms of financial position, result of operation and cash flows against
last year’s only.
The basic concept in analyzing financial statement using horizontal or comparative analysis is
to look for significant changes, and to determine their probable cause.
There are two methods of performing horizontal or comparative analysis:
a. absolute amount comparison
the amount in each item appearing in the financial statements is determined be deducting
the amount of the current date from the amount of the previous year
b. percentage comparison
this method of comparison works on the percentage of change which is determined by
dividing the absolute amount of change by the base figure
The horizontal or comparative analysis is a powerful analytical tool used by investors and
financial market players to assess the operating performance and long-term potentials of business
entities.

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Sample statement

Alpha Merchandising
Statement of Comprehensive Income
December 31, 2014 to 2018
(amounts in thousands pesos)

2014 2015 2016 2017 2018

Sales 2,560 2,598 3,585 4,551 4,933
Cost of goods sold 1,872 1,885 2,584 2,983 3,164
Gross profit 688 713 1,001 1,568 1,769
Operating expenses
Selling expenses 345 348 547 632 760
Administrative expenses 149 162 238 245 278
Total 494 510 785 877 1,038
Operating income 194 203 216 691 731
Interest expense 20 32 29 28 24
Income before tax 174 171 187 663 707
Income tax 52 51 56 199 212
Net income 122 120 131 464 495

Answer:

Alpha Merchandising
Horizontal Analysis
Comprehensive Income
December 31, 2017 and 2018

2018 2017 Increase Peso

(Decrease) Percent

3
 Sales 4,933,000 4,551,000 382,000 8.4
Cost of goods sold 3,164,000 2,983,000 181,000 6.1
Gross profit 1,769,000 1,568,000 201,000 12.8
Operating expenses
Selling expenses 760,000 632,000 128,000 20.3
Administrative expenses 278,000 245,000 33,000 13.5
Total 1,038,000 877,000 161,000 18.4
Operating income 731,000 691,000 40,000 5.8
Interest expense 24,000 28,000 (4,000) (14.3)
Income before tax 707,000 663,000 44,000 6.6
Income tax 212,000 199,000 13,000 6.5
Net income 495,000 464,000 31,000 6.7

Vertical or Common-size Approach

The vertical or common-size approach is an analytical tool that determines the size or
proportion of an item in the financial statements in relation to the total.
This approach involves the process of determining the proportional component of each item
in the financial statements in relation to the base. The accounting period involved in the
mathematical process is one or single period only.
Vertical or common-size analysis becomes more valuable if the common-size financial
statements of an entity are compared with the statements of the other entities in the industry. The
result of the analysis assists the management and other interested users in making the economic
decision relative to the allocation and proper utilization of resources.

The following guidelines maybe observed in the preparation of common-size financial

statements:
1. convert the absolute peso amount of the items in the financial statements into percentage
by dividing each item by the base. The base shall be equal to 100%.
2. use the following as base:
a. total assets for statement of financial position
b. total or net sales for statement of performance
c. total or net cash available for the statement of cashflows
3. make a conclusion on the allocation and indications of possibilities

Sample statement:

Alpha Merchandising
Statement of Comprehensive Income
December 31, 2018
4
Sales 4,933,000
Cost of goods sold 3,164,000
Gross profit 1,769,000
Operating expenses
Selling expenses 760,000
Administrative expenses 278,000 1,038,000

Operating income 731,000

Interest expense 24,000
Income before tax 707,000
Income tax 212,000
Net income 495,000

Answer:

Alpha Merchandising
Statement of Comprehensive Income
December 31, 2018

Sales 100 %
Cost of goods sold 64.14 %
Gross profit 35.86 %
Operating expenses
Selling expenses 15.41%
Administrative expenses 5.64%
Total 21.05 %
Operating income 14.81 %
Interest expense 0.49

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 Income before tax 14.32%
Income tax 4.30%
Net income 10.02 %

Trend Percentage Approach

The trend percentage approach is used to analyze the financial statements that extend beyond
two years through the use of index number or percentages. It converts the absolute peso into
percentages.
The reader of the financial statements is cautioned that the upward trend does not necessarily
indicate a favorable financial performance. The trend in one account of the financial statements
should be crossed-referenced with other accounts that directly or indirectly affect it before forming
a conclusion.
The following guidelines may be followed in conducting a trend analysis:
1. present in tabular format the financial statements covering several years. The arrangement
is usually in ascending order of the dates
2. select a base year that is purely judgmental. The base year should, however, serve as the
normal operating activity of an entity. Normally, the base year is the earliest year used in the
analysis and has an index of 100 or 100%
3. divide each amount by the base year in order to determine the relationship of each item
with the base year. Multiply the result by 100 in order to express the data in percentage.

Sample statement

Alpha Merchandising
Statement of Comprehensive Income
December 31, 2014 to 2018
(amounts in thousands pesos)

2014 2015 2016 2017 2018

Sales 2,560 2,598 3,585 4,551 4,933
Cost of goods sold 1,872 1,885 2,584 2,983 3,164
Gross profit 688 713 1,001 1,568 1,769
Operating expenses
Selling expenses 345 348 547 632 760
Administrative expenses 149 162 238 245 278
Total 494 510 785 877 1,038
Operating income 194 203 216 691 731
Interest expense 20 32 29 28 24
6
 Income before tax 174 171 187 663 707
Income tax 52 51 56 199 212
Net income 122 120 131 464 495

Answer:

Alpha Merchandising
Trend Analysis of the Comprehensive Income
December 31, 2014 to 2018

2014 2015 2016 2017 2018

Sales 100 101 140 178 193
Cost of goods sold 100 101 138 159 169
Gross profit 100 104 145 228 257
Operating expenses
Selling expenses 100 101 159 183 220
Administrative expenses 100 109 160 164 187
Total 100 103 159 181 210
Operating income 100 105 111 356 377
Interest expense 100 160 145 140 120
Income before tax 100 98 107 381 406
Income tax 100 98 108 382 408
Net income 100 98 107 380 406

Self-check: Use clean sheet of paper.

Problem 1: Prepare a horizontal analysis for YZA Trading using the given data and make and
interpretation.

2018 2017
Net sales 3,056,250 3,000,000
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 Cost of goods sold 1,833,750 2,100,000
Gross profit 1,222,500 900,000
Operating expenses 300,000 337,500
Income before interest 922,500 562,500
Interest expense 112,500 112,500
Income before tax 810,000 450,000
Income tax- 30% 243,000 135,000
Income after tax 567,000 315,000

Problem 2: Prepare a common-size analysis of financial position of HENNEY Enterprise for the
year ended December 31, 2018 and make and interpretation.

Assets
Current assets
Cash and cash equivalents 686,250
Trading securities 337,500
Trade and other receivables 1.143,750
Inventories 100,000
Prepayments 45,000
Total current assets 2,512,500

Non-current assets
Property, plant and equipment 1,312,500
Long-term investment 562,500
Intangibles 112,500
Total non-current assets 1,987,500

Total assets 4,500,000

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 Liabilities and Owner’s Equity
Liabilities
Trade and other payables 581,250
Bonds payable 1,500,000
Total liabilities 2,081,250
Owner’s Equity
D. Henney, Capital 2,418,750
Total liabilities and owner’s equity 4,500,000

Problem 3: Prepare trend percentage of the following data from CITRUS Merchandising and make
and interpretation.

2015 2016 2017 2018

Accounts receivable 90,000 108,000 150,000 285,000
Inventory 262,500 393,750 465,000 525,000
Sales 900,000 937,500 1,035,000 1,125,000
Cost of goods sold 337,500 375,000 435,000 457,500

Source: Aduana, Nick L.. “Business Finance in the Philippine Setting for Senior Highschool” 2017