FINANCIAL STATEMENTS

ANALYSIS
Pamantasan ng Lungsod ng Valenzuela
College of Business & Accountancy
Department of Accountancy
 FINANCIAL STATEMENTS ANALYSIS

 - is largely a study of the relationship among the various financial factors in

a business as disclosed by a single set of statements and a study of a trend
of these factors as shown in a series of statements.

Creditors Investors
• are very interested in the • are very interested in the
business enterprise’s debt current and future level of
paying ability return (earnings) and risk
(liquidity, debt and activity).
 THE VALUE OF FINANCIAL STATEMENT
INFORMATION
 General-purpose financial statements are distributed to a wide range of potential users,
providing each group with valuable information about a company’s economic
performance and financial condition.
Users typically evaluate this information along three dimensions:
LIQUIDITY SOLVENCY PROFITABILITY
Short-term creditors such as Long-term creditors, such as Investors, such as
banks and financial institutions bondholders, loan money for stockholders, are interested
are primarily concerned with
whether a company will be long periods of time. in evaluating the potential
able to repay short-term for the price of the
borrowings such as loans and Thus, they are interested in company’s stock to
notes. evaluating a company’s increase.
ability to make its periodic
As such, they are most interest payments and repay As such, investors focus on
interested in evaluating a evaluating a company’s
company’s ability to convert the face amount of debt at
assets into cash, which is maturity, which is called ability to generate earnings,
called liquidity solvency. which is called profitability.
 TECHNIQUES IN ANALYZING FINANCIAL
STATEMENTS
 Analytical methods
examine changes in the
amount and percentage
of financial statement
items within and across
periods.
 Ratios express a financial
statement item or set of
financial statement items
as a percentage of
another financial
statement item, in order to
measure an important
economic relationship as
a single number.

 Comparisons Over Time: The comparison of a financial statement item or ratio with
the same item or ratio from a prior period often helps the user identify trends in a
company’s economic performance, financial condition, liquidity, solvency, and
profitability.
 Comparisons Between Companies: The comparison of a financial statement item or
ratio to another company in the same industry can provide insight into a company’s
economic performance and financial condition relative to its competitors.
 ANALYTICAL REVIEW
HORIZONTAL ANALYSIS
 - comparison of two or more years’
financial data.
 - concentrates on trends in the accounts
in peso value and percentage terms.
 - it helps to pinpoint areas of wide
divergence that require investigation.
VERTICAL ANALYSIS
 - it measures the quantities relationship of the
various items in the financial statement`s on
a particular period.
 - it helps to determine the relationship with
various items appeared in the financial
statement.
 In a vertical analysis of the balance sheet,
the percentages are computed as follows:
 Each asset item is stated as a percent of the
total assets.
 Each liability and stockholders’ equity item is
stated as a percent of the total liabilities and
stockholders’ equity.
 In a vertical analysis of the income
statement, each item is stated as a percent
of sales.
HORIZONTAL ANALYSIS (INCOME STATEMENT)
VERTICAL ANALYSIS (INCOME STATEMENT)
R15 Company provided the following income statements for the year
2020.

2019 2020
Net Sales P 2,000,000 P 2,200,000

Cost of Sales 1,500,000 1,800,000

Gross Profit 500,000 400,000

Operating Expenses 300,000 150,000

Profit (Loss) 200,0000 250,000

 Horizontal Analysis-Solution
2019 2020 Peso Percentag
Change e Change

Net Sales P 2,000,000 P 2,200,000 200,000 10%

Cost of Sales 1,500,000 1,800,000 300,000 20%

Gross Profit 500,000 400,000 (100,000) (20%)

Operating 300,000 150,000 (150,000) (50%)

Expenses

Profit (Loss) 200,0000 250,000 50,000 25%

 Vertical Analysis
2019 2020 2019 2020

Net Sales P 2,000,000 P 2,200,000

100% 100%
Cost of Sales 1,500,000 1,800,000
75% 82%
Gross Profit 500,000 400,000
25% 18%
Operating 300,000 150,000
Expenses 15% 7%
Profit (Loss) 200,000 250,000
10% 11%
RATIO ANALYSIS

 - it shows the mathematical relationship between two figures, which have

meaningful relation with each other.
 TESTS OF LIQUIDITY
Liquidity – refers to the company’s ability to pay its current
liabilities as they fall due

WORKING QUICK RATIO

CURRENT RATIO (ACID TEST RATIO)
CAPITAL RATIO
𝐶𝑈𝑅𝑅𝐸𝑁𝑇 𝐴𝑆𝑆𝐸𝑇𝑆 𝑄𝑈𝐼𝐶𝐾 𝐴𝑆𝑆𝐸𝑇𝑆
CURRENT ASSETS – CURRENT LIABILITIES
𝐶𝑈𝑅𝑅𝐸𝑁𝑇 𝐿𝐼𝐴𝐵𝐼𝐿𝐼𝑇𝐼𝐸𝑆 𝐶𝑈𝑅𝑅𝐸𝑁𝑇 𝐿𝐼𝐴𝐵𝐼𝐿𝐼𝑇𝐼𝐸𝑆

• The working capital is • It measures the number

used to evaluate a
company’s ability to pay
current liabilities
• However, it is difficult to
use working capital to
compare companies of
different sizes.
• It is a measure of
adequacy of working
capital. It is the primary
test of liquidity to meet
current obligations from
current assets.
of times that the current
liabilities could be paid
with the available cash
and near-cash assets
(cash, current
receivables and
marketable securities)
 WORKING CAPITAL ACTIVITY RATIOS
𝐼𝑁𝐶𝑂𝑀𝐸 𝑆𝑇𝐴𝑇𝐸𝑀𝐸𝑁𝑇 𝐴𝐶𝐶𝑂𝑈𝑁𝑇 𝑁𝑂. 𝑂𝐹 𝐷𝐴𝑌𝑆 𝐼𝑁 𝐴 𝑌𝐸𝐴𝑅
TURNOVER AVERAGE AGE
𝐴𝑉𝐸. 𝐵𝐴𝐿𝐴𝑁𝐶𝐸 𝑆𝐻𝐸𝐸𝑇 𝐴𝐶𝐶𝑂𝑈𝑁𝑇 𝑇𝑈𝑅𝑁𝑂𝑉𝐸𝑅

- It measures the number of

𝑁𝐸𝑇 𝐶𝑅𝐸𝐷𝐼𝑇 𝑆𝐴𝐿𝐸𝑆 times receivables are
RECEIVABLES
𝐴𝑉𝐸𝑅𝐴𝐺𝐸 𝑅𝐸𝐶𝐸𝐼𝑉𝐴𝐵𝐿𝐸𝑆 recorded and collected
TURNOVER during the period.

AVERAGE AGE OF - It indicates the average

360 𝐷𝐴𝑌𝑆 number of days during the
RECEIVABLES (AVERAGE company must wait before
𝑅𝐸𝐶𝐸𝐼𝑉𝐴𝐵𝐿𝐸𝑆 𝑇𝑈𝑅𝑁𝑂𝑉𝐸𝑅
COLLECTION PERIOD) receivables are collected.
(DAYS’ SALES IN
RECEIVABLE)

Collecting accounts receivable as quickly as possible does the following:

- Improves a company’s liquidity
- Provides cash to improve or expand operations
- Reduces the risk of uncollectible accounts
 WORKING CAPITAL ACTIVITY RATIOS

- It measures the number of times

𝐶𝑂𝑆𝑇 𝑂𝐹 𝐺𝑂𝑂𝐷𝑆 𝑆𝑂𝐿𝐷 that the inventory is replaced
INVENTORY TURNOVER 𝐴𝑉𝐸𝑅𝐴𝐺𝐸 𝑀𝐸𝑅𝐶𝐻𝐴𝑁𝐷𝐼𝑆𝐸 𝐼𝑁𝑉𝐸𝑁𝑇𝑂𝑅𝑌 during the period.

AVERAGE AGE OF INVENTORY - It indicates the average number

(INVENTORY CONVERSION PERIOD) 360 𝐷𝐴𝑌𝑆 of days during which the company
(DAYS’ SALES IN INVENTORY 𝐼𝑁𝑉𝐸𝑁𝑇𝑂𝑅𝑌 𝑇𝑈𝑅𝑁𝑂𝑉𝐸𝑅 must wait before the inventories
are sold

Excess inventory does the following:

- Decreases liquidity by tying up funds (cash) in inventory
- Increases insurance expense, property taxes, storage costs, and other
related expenses
- Increases the risk of losses because of price declines or obsolescence
of the inventory
SOLVENCY RATIOS
It refers to the ability of company to pay its debts.
These ratios involve leverage ratios. Leverage refers to how much of company’s
resources are financed by debt and/or preferred equity, both of which require fixed
payment of interests and dividends

𝐸𝐵𝐼𝑇 - It determines the extent to

TIMES INTEREST EARNED which operations cover
𝐼𝑁𝑇𝐸𝑅𝐸𝑆𝑇 𝐸𝑋𝑃𝐸𝑁𝑆𝐸 interest expense
- The higher the ratio, the
more likely interest
payments will be paid if
earnings decrease.

𝑇𝑂𝑇𝐴𝐿 𝐿𝐼𝐴𝐵𝐼𝐿𝐼𝑇𝐼𝐸𝑆 - Proportion of assets

DEBT-EQUITY RATIO provided by creditors
𝑇𝑂𝑇𝐴𝐿 𝐸𝑄𝑈𝐼𝑇𝑌 compared to that provided
by owners
SOLVENCY RATIOS

DEBT RATIO 𝑇𝑂𝑇𝐴𝐿 𝐿𝐼𝐴𝐵𝐼𝐿𝐼𝑇𝐼𝐸𝑆 - Proportion of total assets

provided by creditors
𝑇𝑂𝑇𝐴𝐿 𝐴𝑆𝑆𝐸𝑇𝑆

EQUITY RATIO 𝑇𝑂𝑇𝐴𝐿 𝐸𝑄𝑈𝐼𝑇𝑌 - Proportion of total assets

provided by owners
𝑇𝑂𝑇𝐴𝐿 𝐴𝑆𝑆𝐸𝑇𝑆
PROFITABILITY RATIOS
are a set of measurements used to determine the ability of a business to
create earnings.

𝐼𝑁𝐶𝑂𝑀𝐸 - Determines the portion of sales

RETURN ON SALES that went into company’s
𝑁𝐸𝑇 𝑆𝐴𝐿𝐸𝑆 earnings

RETURN ON ASSETS 𝐼𝑁𝐶𝑂𝑀𝐸 - Efficiency with which assets are

used to operate the business
𝐴𝑉𝐸𝑅𝐴𝐺𝐸 𝐴𝑆𝑆𝐸𝑇𝑆

𝐼𝑁𝐶𝑂𝑀𝐸 - Measures the amount earned on

RETURN ON EQUITY the owners’ or stockholders’
𝐴𝑉𝐸𝑅𝐴𝐺𝐸 𝐸𝑄𝑈𝐼𝑇𝑌 investment

- Measures the amount of net

𝑁𝐸𝑇 𝐼𝑁𝐶𝑂𝑀𝐸 − 𝑃𝑅𝐸𝐹𝐸𝑅𝑅𝐸𝐷 𝐷𝐼𝑉𝐼𝐷𝐸𝑁𝐷𝑆
EARNINGS PER SHARE income earned by each common
𝑊𝑇𝐷. 𝐴𝑉𝐸. 𝐶𝑂𝑀𝑀𝑂𝑁 𝑆𝐻𝐴𝑅𝐸𝑆 𝑂𝑈𝑇𝑆𝑇𝐴𝑁𝐷𝐼𝑁𝐺
share
MARKET RATIOS
are used to evaluate the current share price of a publicly-held company's stock. These ratios are
employed by current and potential investors to determine whether a company's shares are
overpriced or underpriced.

PRICE-EARNINGS RATIO 𝑃𝑅𝐼𝐶𝐸 𝑃𝐸𝑅 𝑆𝐻𝐴𝑅𝐸 -it indicates the number of pesos
required to buy P1 share.
𝐸𝐴𝑅𝑁𝐼𝑁𝐺𝑆 𝑃𝐸𝑅 𝑆𝐻𝐴𝑅𝐸

- Measures the extent to which

DIVIDENDS PER SHARE 𝐷𝐼𝑉𝐼𝐷𝐸𝑁𝐷 𝑂𝑁 𝐶𝑂𝑀𝑀𝑂𝑁 𝑆𝑇𝑂𝐶𝐾𝑆 earnings are being distributed to
𝑆𝐻𝐴𝑅𝐸 𝑂𝐹 𝐶𝑂𝑀𝑀𝑂𝑁𝑆𝑇𝑂𝐶𝐾 𝑂𝑈𝑇𝑆𝑇𝐴𝑁𝐷𝐼𝑁𝐺 common shareholders.

𝐷𝐼𝑉𝐼𝐷𝐸𝑁𝐷 𝑃𝐸𝑅 𝑆𝐻𝐴𝑅𝐸 - Measures the rate of return in the

DIVIDEND YIELD RATIO investor’s common stock
𝑃𝑅𝐼𝐶𝐸 𝑃𝐸𝑅 𝑆𝐻𝐴𝑅𝐸 investments.

DIVIDEND PAY-OUT 𝐷𝐼𝑉𝐼𝐷𝐸𝑁𝐷 𝑃𝐸𝑅 𝑆𝐻𝐴𝑅𝐸 - It indicates the proportion of

earnings distributed as dividends.
𝐸𝐴𝑅𝑁𝐼𝑁𝐺𝑆 𝑃𝐸𝑅 𝑆𝐻𝐴𝑅𝐸
 ILLUSTRATIVE EXAMPLE
Following are the financial statements of Anne Company:

Determine the following:

VERTICAL ANALYSIS HORIZONTAL ANALYSIS RATIO ANALYSIS
(Year 2018) Net Sales Current ratio
Gross Profit Margin EBIT Debt ratio
Operating Profit Margin Net Income Equity ratio
Net Profit Margin Debt-equity ratio
ILLUSTRATIVE EXAMPLE
VERTICAL ANALYSIS (2018)

 Gross Profit Margin

Gross profit / Sales
700 / 2,000
Ans: 35%

 Operating Profit Margin

Operating profit / Sales
400 / 2,000
Ans: 20%

 Net Profit Margin

Net profit / Sales
400 / 2,000
Ans: 9%
ILLUSTRATIVE EXAMPLE
HORIZONTAL ANALYSIS

 Net Sales
2000-1600 = 400
400 / 1,600
Ans: 25%

 EBIT
400-300 = 100
100 / 300
Ans: 33.33%

 Net Income
180-100 = 80
80 / 100
Ans: 80%
ILLUSTRATIVE EXAMPLE
RATIO ANALYSIS

 Current ratio
current assets/ current liabilities
2,500 / 500
Ans: 5:1
 Debt ratio
total liabilities/ total assets
1,500 / 5,000
Ans: 30%
 Equity ratio
total equity/ total assets
3,500 / 5,000
Ans: 70%
 Debt-equity ratio
total liabilities/ total equity
1,500 / 3.500
Ans: 42.86%
 ILLUSTRATIVE EXAMPLE
 LYN MERCHANDISING HAS 1,000,000 COMMON SHARES
OUTSTANDING, WITH EACH SHARE PRICED AT P 8.00. IN
2018, THE COMPANY DECLARED DIVIDENDS OF 0.10 PER
SHARE. THE BALANCE SHEET AT THE END OF 2018
SHOWED APPROXIMATELY THE AMOUNTS (IN
THOUSAND PESO) AS THAT THE END OF 2017. THE
FINANCIAL STATEMENTS FOR LYN MERCHANDISING ARE
AS FOLLOWS:

 COMPUTE FOR THE FOLLOWING:

CURRENT RATIO RETURN ON SALES

ACID-TEST RATIO RETURN ON EQUITY
ACCOUNTS RECEIVABLE TURN OVER
EPS
AVERAGE AGE OF RECEIVABLES
INVENTORY TURN OVER
P/E RATIO
AVERAGE AGE OF INVENTORY DEBT RATIO
GROSS PROFIT MARGIN DEBT-EQUITY RATIO
OPERATING PROFIT MARGIN TIME-INTEREST EARNED
 CURRENT RATIO
ACID-TEST RATIO
current assets / current liabilities
quick assets / current liabilities
1,070/370
660/370
2.89:1
1.78:1

ACCOUNTS RECEIVABLE TURNOVER AVERAGE AGE OF RECEIVABLES

net credit sales / average receivables 360 days / receivables turnover
4,700/440 360/10.68
10.68 times 33.71

INVENTORY TURN OVER AVERAGE AGE OF INVENTORY

cost of goods sold / average inventory 360 days / inventory turnover
2,300/410 360/5.61
5.61 times 64.17

GROSS PROFIT MARGIN OPERATING PROFIT MARGIN

gross profit / sales operating profit / sales
2,400/4,700 850/4,700
51.06% 18.09

RETURN ON SALES
net income / sales
420/4,700
8.94%
 EARNINGS PER SHARE PRICE-EARNINGS PER SHARE RATIO
net income - preferred dividends /
price per share / earnings per share
average commonshare outstanding
420/1,000,000
8/0.42
0.42 19.05

DEBT RATIO
total liabilities / total assets
2,330/4,570
50.98%

TIME-INTEREST EARNED
EBIT / interest expense
850/150
5.67