FINANCIAL STATEMENT ANALYSIS

Financial statement analysis – involves the assessment and evaluation of the firm’s past performance, its
present condition and future business potential. The analysis serves to provide information regarding:
1. Profitability of the business firm
2. The firm’s ability to meet its obligations
3. Safety of the investment in the business
4. Effectiveness of management in running the firm
5. Over-all company marketability

Horizontal analysis (Trend analysis) – involves comparing figures shown in the financial statements
of two or more consecutive periods.
o It is used to evaluate trends over a period of several years for a single business. It is also
called variation analysis.
o It can be used to evaluate the company’s effort to improve its operations or its financial
status.

Assets 2019 2020 2021

Cash 12.10% P148,000 P100,000 (32.4%) P90,000 (10%)
Accounts receivable 23.14% 283,000 410,000 44.9% 394,000 (3.9%)
Inventory 26.32% 322,000 616,000 696,000
Other current assets 0.82% 10,000 14,000 15,000
Total current assets 62.39% P763,000 P1,140,000 P1,195,000
PPE 37.61% 460,000 904,000 974,000
TOTAL ASSETS 100% P1,223,000 P2,044,000 P2,169,000

Vertical analysis (Common Size FS) – involves comparing the figures in the financial statements of
a single period. A common-size financial statement is one that shows each item as a percentage of a
total rather than in peso form.
o It covers one year’s operating results and expresses each component as a percentage of
a total called base amount.
o Generally, there are three common base amounts: Total Assets, Total Liabilities and
Equity and Total Sales. However, other base amounts may be used like total current
assets, total operating expenses, etc.

2019 2020 2021

Net sales P1,235,000 100% P2,106,000 P2,211,000
Cost of goods sold 849,000 68.74% 1,501,000 1,599,000
Gross profit 386,000 31.26% 605,000 612,000
Operating expense 180,000 383,000 402,000
Operating income 206,000 222,000 210,000
Interest expense 20,000 51,000 59,000
Earnings before taxes 186,000 171,000 151,000
Income tax expense 74,000 68,000 60,000
Income after taxes 112,000 9.1% 103,000 91,000
Ratio analysis – involves the development of mathematical relationships between accounts in the
financial statements.

Test of Liquidity (the company’s ability to pay short-term current liabilities as they fall due)
1. Current Ratio = Current Assets/Current Liabilities
2. Acid Test Ratio Quick ratio = Quick Assets (Cash+MS+AR) /Current Liabilities
3. Activity Ratios (Asset management ratio)
Accounts Receivable Turnover = Net Credit Sales/Ave. Receivables (Beg+End/2)
Age of Receivables= 360 or 365/AR Turnover
Days sales outstanding/average collection period/days in receivables

Inventory Turnover = Cost of Goods Sold/Ave. Merchandise Inventory (Beg+end/2)

Age of Inventory = 360 or 365/Inventory Turnover
Days in inventory/average holding period

Trade Payables Turnover = Net Credit Purchases/Ave. Trade Payables

Age of Trade Payables = 360 or 365/Payables Turnover
Days in payables/deferral period

Operating Cycle = Age of Inventory + Age of Receivables

Cash Flow Cycle (Cash Conversion Cycle) = Operating cycle – Age of Payables

Test of Solvency (the company’s ability to pay all its debt as they fall due whether such
liabilities are current or noncurrent)
1. Debt Ratio = Total Liabilities/Total Assets
2. Equity Ratio = Total Stockholders’ Equity/Total Assets
3. Debt-To-Equity Ratio = Total Liabilities/Total Stockholders’ Equity
4. Times Interest Earned = Earnings before interest and taxes/Interest Expense
5. Fixed Assets to Long-term Liabilities = Fixed Assets/Long-term Liabilities
6. Fixed Assets to Total Equity = Fixed Assets/Total Equity
7. Fixed Assets to Total Assets = Fixed Assets/Total Assets
8. Sales to Fixed Assets = Net Sales/Net Fixed Assets

Test of Profitability
1. Return on Sales = Income after tax/Net Sales
2. Return on Total Assets = Income before interest and taxes/Ave Total Assets
3. Return on Equity = Income after tax/Ave owner’s equity
4. Earnings per share = Net income – preferred dividends (if any)/Weighted Ave. Number of
Common Shares
5. Return on Current Assets = Net Income/Ave Current Assets

Market Tests
1. Price/Earnings Ratio = Price per share/Earnings per share
2. Dividend yield = Ordinary Dividend Per Share/Price Per Share
3. Dividend Payout = Ordinary Dividend Per Share/ Earnings per share
Exercises

Company A Company B Company C

Current assets 200,000 60,000 120,000
Current liabilities 80,000 50,000 (120,000/1.5) 80,000
Inventory 40,000 20,000 24,000
Current ratio (200/80) 2.5:1 (60/50) 1.2 1.5:1
Acid test ratio (160/80) 2:1 (40/50) 0.8 1.2:1 (96/80)
Working capital (net) 120,000 10,000 40,000

Company A Company B Company C

Sales 800,000 960,000 400,000
Cost of sales 500,000 500,000 250,000
Purchases 400,000 600,000 180,000
Accounts receivable 40,000 80,000
Inventory 50,000 100,000
Accounts payable 80,000 50,000
Inventory turnover COGS/MI = 10 times (COGS/MI) 5 times
Age of inventory 360/ITO = 36 days 360/5 = 72 days 144 days
Receivables turnover Sales/AR = 20 times (Sales/AR) 12
Age of receivables 360/ARTO = 18 days 360/12 = 30 days 180 days
Payables turnover P/AP = 5 times (P/AP) 12
Age of payables 360/APTO = 72 days 360/12 = 30 days 60 days
Operating cycle (36+18) 54 days (72+30) 102 days
Cash conversion cycle (54-72) (18 days) (102-30) 72 days

A skeleton of Drogon Company’s balance sheet appears as follows (in thousands):

Cash P75 Total Current Liabilities P1,900

Receivables 685 Long-term note payable
Inventory 725 Other long-term liabilities 980
Prepaid expenses 35
Total current assets 1,520 Stockholders’ Equity 2,325
Plant assets
Other assets 2,000
Total Assets P6,800 Total Liabilities and Equity

Current ratio = CA/CL 1,520/1900 = 0.80:1

Quick ratio = QA/CL 760/1900 = 0.40:1
We are given the following information for Ally Corporation:

Sales (credit) P7,200,000

Cash 300,000
Inventory 2,150,000
Current liabilities 1,400,000
Asset turnover 1.20
Current ratio 2.50
Debt-to-assets ratio 40%
Receivables turnover 8

Current assets are composed of cash, marketable securities, accounts receivable and inventory.
Compute for the following balance sheet items: Accounts receivable, Marketable securities, Fixed
Assets and Long-term debt (300,000+150,000+900,000+2,150,000 = 3,500,000)

CR = CA/CL 2.5 = CA/1,400,000 = 3,500,000 2.5 = 3500/1400

ARTO = Sales/AR 8 = 7,200,000/AR = 900,000 8 = 7200/900

The following figures (in thousands) were provided regarding Klaus Company’s balance sheet:
Cash ? Gross margin 25%
Accounts receivable ? Debt to equity ratio 0.25
Inventory 80 Current ratio 3
Fixed Assets (net) ? Inventory turnover 15
Current liabilities 100 Ave. Collection period
(360 days) 15 days
Common stock 100
Retained earnings ?

Add as much to Klaus’ balance sheet as possible from the data provided.

Hargreeves Corporation reported the following figures (in thousands):

ARTO = Sales/Ave AR ARTO = 20,941/(1813+1611/2) = 20,941/1712 = 12 times

Age of AR = 360/12 = 30 days
ITO = COGS/Ave MI ITO = 7,055/(1324+1060/2) = 7055/1192 = 6 times
Age of MI = 360/6 = 60 days
Operating cycle = 90 days
CR = CA/CL = 7296/7230 = 1.01
QR = QA/CL = 4263/7230 = 0.59
2021 2020

Cash and cash equivalents P2,450 P2,094

Receivables 1,813 1,611
Inventory 1,324 1,060
Prepaid expenses 1,709 2,120
Total Current Assets 7,296 6,885
Other Assets 18,500 15,737
Total Assets P25,796 P22,622
Total Current Liabilities 7,230 8,467
Long-term Liabilities 4,798 3,792
Common Stock 6,568 4,363
Retained Earnings 7,200 6,000
Total Liabilities and Equity P25,796 P22,622

Sales P20,941 100%

Cost of Sales (7,055) (34%)
Gross profit 13,886 66%
Operating Expenses (7,065) (34%)
Operating Income 6,281
Interest Expense 210
Income tax 2,563
Net Income P4,048 19%

1. Horizontal analysis of Hargreeve’s balance sheet for 2021 would report

a. Cash as 9.5% of total assets c. current ratio of 1.01
b. 17% increase in cash d. inventory turnover of 6 times

2. Vertical analysis of Hargreeve’s balance sheet for 2021 would report

a. Cash as 9.5% of total assets c. current ratio of 1.01
b. 17% increase in cash d. inventory turnover of 6 times

3. A common-size income statement would report

a. Net income of 19% c. cost of sales at 34%
b. Sales of 100% d. all of the choices

4. Which statement best describes Hargreeve’s acid test ratio?

a. Greater than 1 c. less than 1
b. Equal to 1 d. none of the above

5. Hargreeve’s inventory turnover during 2021 was

a. 6 times c. 8 times
b. 7 times d. not determinable with the given data

6. During 2021, the firm’s days’ sales in receivable

a. 34 days c. 32 days
b. 30 days d. 28 days

7. Which measure expresses the firm’s times-interest-earned ratio?

a. 54.7% c. 34 times
b. 19 times d. 32 times

8. The company has 2,500 shares of common stock outstanding. What was the firm’s earnings per
share?
a. P1.62 c. P2.73
b. P1.75 d. 2.63 times
9. Hargreeve’s stock has traded recently around P48 per share. Use your answer in question 8 to
measure the company’s price earnings ratio.
a. 1.01 c. 48
b. 30 d. 78