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Chapter 1-2 Advance Financial Analysis and Stock Market

Special Topics in Financial Management (Cavite State University)

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CHAPTER 1
ADVANCED FINANCIAL ANALYSIS AND VALUATION

I. Understanding the Basic Financial Statements

• The Statement of Financial Position

- Also known as the balance sheet is a financial snapshot of your business at a
given date in time.
- Provides information about the financial condition, position, and structure of the
company in terms of its assets, liabilities, and the difference between the two,
which is the equity or net worth.
- The accounting equation (assets = liabilities + owner’s equity) is the basis for the
financial position or balance sheet.
- Usually presented in comparative form.
- Comparative financial statements include the current year’s statement and
statement of one or more of the preceding accounting periods.
- Notes added to the statement of financial position provide additional information
not included in the accounts on the financial statements as well as explanations
of figures presented.
Key Takeaways
The balance sheet is a snapshot, representing the state of a company's finances
(what it owns and owes) as of the date of publication.
Fundamental analysts use balance sheets, in conjunction with other financial
statements, to calculate financial ratios.
The balance sheet is a snapshot representing the state of a company's finances at a
moment in time. By itself, it cannot give a sense of the trends that are playing out
over a longer period. For this reason, the balance sheet should be compared with
those of previous periods. It should also be compared with those of other businesses
in the same industry since different industries have unique approaches to financing.
Several ratios can be derived from the balance sheet, helping investors get a sense
of how healthy a company is. These include the debt-to-equity ratio and the acid-test
ratio, along with many others. The income statement and statement of cash flows
also provide valuable context for assessing a company's finances, as do any notes
or addenda in an earnings report that might refer to the balance sheet.

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Illustrative Example of the Corporation Statement of Financial Position

a. Report Form – the statement of financial position can be presented in vertical
format known as the report form, with the Assets Section above the Equities
sections that, together, balance it.

Source: google images

b. Account Form – the entire statement of financial position is normally
presented in horizontal layout, with an Assets page on the left, and a page for
Liabilities and Equity.

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Source: google images

Assets
Within the assets segment, accounts are listed from top to bottom in order of their
liquidity – that is, the ease with which they can be converted into cash. They are divided
into current assets, which can be converted to cash in one year or less; and non-current
or long-term assets, which cannot.
Here is the general order of accounts within current assets:
• Cash and cash equivalents are the most liquid assets and can include Treasury
bills and short-term certificates of deposit, as well as hard currency.
• Marketable securities are equity and debt securities for which there is a liquid
market.
• Accounts receivable refers to money that customers owe the company, perhaps
including an allowance for doubtful accounts since a certain proportion of
customers can be expected not to pay.

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• Inventory is goods available for sale, valued at the lower of the cost or market
price.
• Prepaid expenses represent the value that has already been paid for, such as
insurance, advertising contracts or rent.
Long-term assets include the following:
• Long-term investments are securities that will not or cannot be liquidated in the
next year.
• Fixed assets include land, machinery, equipment, buildings, and other durable,
generally capital-intensive assets.
• Intangible assets include non-physical (but still valuable) assets such as
intellectual property and goodwill. In general, intangible assets are only listed on
the balance sheet if they are acquired, rather than developed in-house. Their
value may thus be wildly understated – by not including a globally recognized
logo, for example – or just as wildly overstated.
Liabilities
Liabilities are the money that a company owes to outside parties, from bills it has to pay
to suppliers to interest on bonds it has issued to creditors to rent, utilities and salaries.
Current liabilities are those that are due within one year and are listed in order of their
due date. Long-term liabilities are due at any point after one year.
Current liabilities accounts might include:
• current portion of long-term debt
• bank indebtedness
• interest payable
• wages payable
• customer prepayments
• dividends payable and others
• earned and unearned premiums
• accounts payable
Long-term liabilities can include:
• Long-term debt: interest and principal on bonds issued
• Pension fund liability: the money a company is required to pay into its employees'
retirement accounts
• Deferred tax liability: taxes that have been accrued but will not be paid for
another year (Besides timing, this figure reconciles differences between
requirements for financial reporting and the way tax is assessed, such as
depreciation calculations.)
Some liabilities are considered off the balance sheet, meaning that
they will not appear on the balance sheet.

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Shareholders' Equity
Shareholders' equity is the money attributable to a business' owners, meaning its
shareholders. It is also known as "net assets," since it is equivalent to the total assets of
a company minus its liabilities, that is, the debt it owes to non-shareholders.
Retained earnings are the net earnings a company either reinvests in the business or
use to pay off debt; the rest is distributed to shareholders in the form of dividends.
Treasury stock is the stock a company has repurchased. It can be sold at a later date to
raise cash or reserved to repel a hostile takeover.
Some companies issue preferred stock, which will be listed separately from common
stock under shareholders' equity. Preferred stock is assigned an arbitrary par value – as
is common stock, in some cases – that has no bearing on the market value of the
shares (often, par value is just $0.01). The "common stock" and "preferred stock"
accounts are calculated by multiplying the par value by the number of shares issued.
Additional paid-in capital or capital surplus represents the amount shareholders have
invested in excess of the "common stock" or "preferred stock" accounts, which are
based on par value rather than market price. Shareholders' equity is not directly related
to a company's market capitalization: the latter is based on the current price of a stock,
while paid-in capital is the sum of the equity that has been purchased at any price.

Statement of Comprehensive Income

- Summarizes a company’s revenue (sales) and expenses quarterly and annually
for its fiscal year.
- The final net figure, as well as various others in this statement, is of major
interest to the investment community as it represents the company’s financial
performance for the current year.
- Also called as “statement of income”, “statement of earnings”, “statement of
operations”, and “statement of operating results”. Some professionals call it “P &
L” which stands for profit and loss statement.

Forms and Presentation of the Statement of Comprehensive Income

a. Multi-Step Approach – the statement of comprehensive income using the

multi-step approach shows the various profitability stages from gross profit,
operating profit up to the net profit which is essential in terms of cost control
and management.

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b. Single Step Approach – the service type of statement of comprehensive

income was shown using a single step approach as it simply identifies the
income that comes from professional fee and all expenses grouped together
to arrive at net profit.

Source: google images

Statement of Changes in Equity
- A statement of changes in equity shows all changes in owner’s equity for a
period.
- The purpose of the statement of changes in equity is to provide readers with the
useful information on how the capital or fund of an entity is utilized and used.
- Since it shows the movements of equity and accumulated earnings and losses,
the readers can depict on where the company’s equity came from and where did
it go.

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Source: google images

II. Overview of Financial Statement Analysis

• Financial Statement Analysis
- The process of identifying financial strengths and weaknesses of the firm by
properly establishing relationship between the items of the balance sheet and the
income statement account.
- There are various methods and techniques that are used in analyzing financial
statement analysis such as comparative statements, schedule of changes in
working capital, common size percentages, funds analysis, trend analysis, and
ratios analysis.

• Uses of Financial Statement Analysis

- Financial statements are prepared to meet external reporting obligations and for
decision making purposed. They play a dominant role in setting the framework of
managerial decisions.

- Question: What can you look for when reading financial statement analysis report
and how do you use it?

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a. Trends – the results given in general cover at least the previous three full
accounting years therefore any fluctuations in any area can be easily
pinpointed.
b. Benchmarks – the average results for each ratio together with the industry
profile of the average company in the sector can be both used as benchmarks
to compare individual company performance.
c. Size – all the major companies in the sector are ranked based on sales,
profits, total assets, and employee numbers. The largest and smallest of the
key players can be easily identified, while the relative size of any company
can be assessed.
d. Growth – the average annual growth of each company’s sales, profits, total
assets, and number of employees over the three-year period being analyzed
is calculated and ranked.

• Advantages of Financial Statement Analysis

- The investors get enough idea to decide about the investments of their funds in
the specific company.
- Regulatory authorities like International Accounting Standards Board can ensure
whether the company is following accounting standards or not.
- Financial statements analysis can help the government agencies to analyze the
taxation due to the company. Moreover, a company can realize its own
performance over the period through financial statements analysis.

• Limitations of Financial Statement Analysis

- Comparison of financial data
- The need to look beyond ratios

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TOOLS AND TECHNIQUES OF FINANCIAL STATEMENT ANALYSIS

Horizontal Analysis or Trend Analysis

- Comparison of two or more year’s financial data is known as horizontal analysis,
or trend analysis. Horizontal analysis is facilitated by showing changes between
years in both peso and percentage form.
- Illustrative Example 1– Horizontal Analysis (Balance Sheet)

Ka ja 's Re ta i l Corpora ti on
Common Si ze Compa ra ti ve Sta te me nt of Fi na nci a l Pos i ti on
De ce mbe r 31, 2018 a nd 2017
(I n thous a nd P)
Hori zonta l Ana l ys i s
2018 2017 I nc (De c) %
Assets
Current Assets
Ca s h 600 1175 -575 -48.94%
Accounts Re ce i va bl e 3000 2000 1000 50.00%
I nve ntory 4000 5000 -1000 -20.00%
Pre pa i d Expe ns e s 150 60 90 150.00%
Total Current Assets 7750 8235 -485 -5.89%

Non Current Assets

La nd 2000 2000 0 0.00%
Bui l di ngs , ne t 3000 2500 500 20.00%
Equi pme nt, ne t 2000 1000 1000 100.00%
Furni ture a nd fi xture s , ne t 1000 750 250 33.33%
Total Non Current Assets 8000 6250 1750 28.00%

Total Assets 15750 14485 1265 8.73%

Liabiilites and Stockholder's Equity

Current Liabilities
Accounts Pa ya bl e 2900 2000 900 45.00%
Accrue d Pa ya bl e 450 200 250 125.00%
Note s Pa ya bl e , s hort te rm) 150 300 -150 -50.00%
Total Current Liabilities 3500 2500 1000 40.00%

Non-Current Liaibilities
Mortga ge Pa ya bl e 2750 2000 750 37.50%
Bonds , pa ya bl e , 5% 1000 2000 -1000 -50.00%
Total Non-Current Liabilities 3750 4000 -250 -6.25%

Total Liabilities 7250 6500 750 11.54%

Stockholder's Equity
Pre fe rre d Stock, P100, 6% 1000 1000 0 0.00%
Common Stock, P12 pa r 3000 3000 0 0.00%
Addi ti ona l Pa i d i n Ca pi ta l 500 500 0 0.00%
Tota l Pa i d i n Ca pi ta l 4500 4500 0 0.00%
Re ta i ne d Ea rni ngs 4000 3485 515 14.78%
Total Stockholder's Equity 8500 7985 515 6.45%

Total Liabilities and Stockholder's Equity 15750 14485 1265 8.73%

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- Illustrative Example 2 – Horizontal Analysis (Income Statement)

Ka ja 's Retai l Corpora ti on

Common Si ze Compa ra ti ve Statement of Fi na nci a l Pos i ti on
December 31, 2018 a nd 2017
(In thous a nd P)
Hori zontal Ana l ys i s
2018 2017 Inc (Dec) %
Sa l es , net 26000 24000 2000 8.33%
Les s : Cos t of Sa l es 18000 15750 2250 14.29%
Gros s Ma rgi n 8000 8250 -250 -3.03%

Les s : Sel l i ng a nd Admi ni s tra ti ve Expens es

Sel l i ng Expens es 3500 3250 250 7.69%
Admi ni s tra ti ve Expens e 2930 3050 -120 -3.93%
Total S & A Expens es 6430 6300 130 2.06%
Net Opera ti ng Income 1570 1950 -380 -19.49%
Les s : Interes t Expens e 320 350 -30 -8.57%
Net Income Before Ta xes 1250 1600 -350 -21.88%
Les s : Income Ta xes (35%) 375 480 -105 -21.88%
Net Income 875 1120 -245 -21.88%

Trend Percentage
- Horizontal analysis of financial statements can also be carried out by putting
trend percentages. Trend percentage states several years’ financial data in terms
of a base year. The base year equals 100%, with all other years stated in some
percentage of this base.

To illustrate, let us look at the summary of Kaja Retail Company’s sales and net
income from 2013 to 2018.

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Sales and Net Income in Peso

2013 2014 2015 2016 2017 2018

18,000.0 19,500.0 24,000.0 27,000.0 25,000.0

Sales 15,000.00 0 0 0 0 0

Net Income 500.00 630.00 720.00 815.00 890.00 1,180.00

The data below show sales and net income in percentages, and this is computed as:
Base Year = 2013 = P15,000.00 = 100% for sales and P535.00 = 100% for net income.

Using the base year, we compute for the succeeding years as:

Year Sales Base Percentag Net Income Base Percentag

Amount e Amount e

2014 18,000.0 15,000.0 120% 630.00 500.00 126%

0 0

2015 19,500.0 15,000.0 130% 720.00 500.00 144%

0 0

2016 24,000.0 15,000.0 160% 815.00 500.00 163%

0 0

2017 27,000.0 15,000.0 180% 890.00 500.00 178%

0 0

2018 25,000.0 15,000.0 167% 1,180.00 500.00 236%

0 0

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Sales and Net Income in Percentage

2013 2014 2015 2016 2017 2018

Sales 100% 120% 130% 160% 180% 167%
Net
Income 100% 126% 144% 163% 178% 236%

Sales Trend Percentage Chart

Sales Trend Percentage Chart

200%
180%
180% 167%
160%
160%
140% 130%
120%
120%
100%
Sales

100%
80%
60%
40%
20%
0%
2013 2014 2015 2016 2017 2018
Year

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Net Income Trend Percentages Chart

Net Income
250% 236%

200% 178%
163%
144%
Axis Title

150% 126%
100%
100%

50%

0%
2013 2014 2015 2016 2017 2018
Axis Title

Vertical Analysis
Vertical analysis is the procedure of preparing and presenting common size
statements. Common size statement is one that shows the items appearing on it in
percentage form as well as in peso form. Each item is stated as percentage of some
total of which that item is a part. Key financial changes and trends can be highlighted
using common size statements.

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Illustrative Example 1: Common Size Comparative Balance Sheet

Kaja's Retail Corporation

Common Size Comparative Statement of Financial Position
December 31, 2018 and 2017
(In thousand P)
Common Size %
2018 2017 2018 2017
Assets
Current Assets
Cash 600 1175 3.81% 8.11%
Accounts Receivable 3000 2000 19.05% 13.81%
Inventory 4000 5000 25.40% 34.52%
Prepaid Expenses 150 60 0.95% 0.41%
Total Current Assets 7750 8235 49.21% 56.85%

Non-Current Assets
Land 2000 2000 12.70% 13.81%
Buildings, net 3000 2500 19.05% 17.26%
Equipment, net 2000 1000 12.70% 6.90%
Furniture and
fixtures, net 1000 750 6.35% 5.18%
Total Non-Current Assets 8000 6250 50.79% 43.15%

Total Assets 15750 14485 100.00% 100.00%

Liabiilites and Stockholder's

Equity
Current Liabilities
Accounts Payable 2900 2000 18.41% 13.81%
Accrued Payable 450 200 2.86% 1.38%
Notes Payable, short
term) 150 300 0.95% 2.07%
Total Current Liabilities 3500 2500 22.22% 17.26%

Non-Current Liaibilities
Mortgage Payable 2750 2000 17.46%
Bonds, payable, 5% 1000 2000 6.35% 13.81%
Total Non-Current Liabilities 3750 4000 23.81% 27.61%
0.00% 0.00%
Total Liabilities 7250 6500 46.03% 44.87%

Stockholder's Equity

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Preferred Stock,
P100, 6% 1000 1000 6.35% 6.90%
Common Stock, P12
par 3000 3000 19.05% 20.71%
Additional Paid in
Capital 500 500 3.17% 3.45%
Total Paid in Capital 4500 4500 28.57% 31.07%
Retained Earnings 4000 3485 25.40% 24.06%
Total Stockholder's Equity 8500 7985 53.97% 55.13%

Total Liabilities and

Stockholder's Equity 15750 14485 100.00% 100.00%

Illustrative Example 2: Common Size Comparative Income Statement

Ka ja 's Retai l Corpora ti on

Common Si ze Compa ra ti ve Statement of Fi na nci a l Pos i ti on
December 31, 2018 a nd 2017
(In thous a nd P)
Common Si ze
2018 2017 2018 2017
Sa l es , net 26000 24000 100.00% 100.00%
Les s : Cos t of Sa l es 18000 15750 69.23% 65.63%
Gros s Ma rgi n 8000 8250 30.77% 34.38%

Les s : Sel l i ng a nd Admi ni s tra ti ve Expens es

Sel l i ng Expens es 3500 3250 13.46% 13.54%
Admi ni s tra ti ve Expens e 2930 3050 11.27% 12.71%
Total S & A Expens es 6430 6300 24.73% 26.25%
Net Opera ti ng Income 1570 1950 6.04% 8.13%
Les s : Interes t Expens e 320 350 1.23% 1.46%
Net Income Before Ta xes 1250 1600 4.81% 6.67%
Les s : Income Ta xes (35%) 375 480 1.44% 2.00%
Net Income 875 1120 3.37% 4.67%

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CHAPTER 2
INVESTING IN STOCK MARKET

What are Stocks?

- Shares of ownership in a company
- One who owns a stock is called the stockholder or shareholder

How do we earn from stock investment?

1. Thru dividends or the company’s way of sharing its earnings to its
stockholders.
*It is important to watch out for the EXDATE (deadline) – buy stocks
before the EXDATE for you to be entitled for the dividends. Buying stocks
ON the EXDATE will give an otherwise result.

2. Price appreciation – buy low/sell high

How did the stocks reach the stock market?

- When company wants to expand their business, it would need huge amount of
capital. The company will open the ownership of the business.
- Initial Public Offering – the company is selling stocks to the public for the first
time.

Two Types of Stock Market

- Primary Market (for IPO)
- Secondary Market (best example is PSE)
How to invest?
- Open a trading account
- Fund your account
- Start buying/selling

Why Invest?
- Wealth generation
- Liquidity – relatively can buy and sell stocks quickly

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- Ownership of big businesses. Could buy small portions of big businesses.

What are Blue Chips?

- 30 Biggest and Most Traded Companies

Index
- indicator of overall performance of the stock market
- Bullish Market – the trend is going up
- Bearish Market – the trend is going down

The Ticker Board

• SYMBOL - code/ short names of the companies
• BID - highest buying price for that particular stock
• ASK - lowest selling price for that particular stock
• VALUE - multiply price and the volume=value, the peso amount of your
transaction
• VOLUME - number of shares, unit or quantity
• LTP (LAST TRADED PRICE) - current market value/ market value

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