Financial Analysis and Reporting
To illustrate how a business is structured to provide a
“Introduction in Accounting”
09/05/2022
Accounting
- (def.) Art of recording, classifying, and analyzing in a
significant manner and in terms of money,
transactions and events which are, in part at
least, of financial character, and interpreting
the results thereof.
- (def.) A service activity. Its function is to provide
information, primarily financial in nature,
about economic entities that is intended to be
useful in making economic decisions.
- Evolved through the demand of the social and
economic needs of the society.
- Helps decision-makers make informed choices
regarding the allocation of scarce resources under
their control.
- Quantifies business operations, therefore the
moniker “language of business” because it tells
something about the business.
- Provides the information “how much am I
spending?”, “how much am I earning?” which helps in
analyzing how the business can improve their
management like minimizing expenses and
maximizing profits.
Businesses
- (def.) An organization or enterprising entity engaged
in commercial, industrial, or professional
activities.
- Can be for profit entities or non-profit organizations.
- Business types range from limited liability
companies to sole proprietorships, corporations, and
partnerships.
Business Model
customer proposition, the fundamental business
model is built on 5 key activities:
1. Investing
- Investors provide the required capital for the
business. Thus, aside from cash, business can
use property or equipment as an investment.
- The cash investment will then be held in a
bank account.
2. Asset Conversion
- From the cash investment, the business can
convert it to bring more assets such as
furniture and fixtures.
3. Product/Service Delivery
- The combination of business resources
provides the basis for producing the products
or services.
- This activity encompasses the actual delivery
of the product/service or when you actually
earn the revenues.
4. Asset Generation
- The sale of a product or service generates an
asset that may be cash or a receivable.
- This asset once collected will produce a cash
inflow for the business.
5. Equity Allocation
- The cash inflow from sale or receivable
collection in excess of those that will be spent
on operating expenses (e.g. salaries, rent,
utilities, inventory) will be allocated to;
• Debt payment and interest on these
debts
• Sent back to the cycle by being
converted to other assets
• Paid back to the owners as a “return on
their investments”
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Types of Businesses
1. Services – provides services to customers
2. Trader/Merchandising – retail selling
3. Manufacturing – use tangible raw materials to
make finished goods
4. Raw Materials Production - creation,
collection, or extraction of raw material for the
production of goods and services, especially
directly from the natural environment.
5. Infrastructure – ex: rent, transport vehicles
6. Financial – ex: Banks
7. Insurance – ex: car insurance, life insurance
Business Activities
1. Financing
- Methods an organization uses to obtain
financial resources from financial markets and
how it manages these resources.
- Organizations require financial resources to
obtain other resources used to produce goods
and services
- Primary resources of financing include
owners and creditors (banks and suppliers).
Financing Activities
• When owners bring cash into the
business
• When businesses acquire cash loans
from banks
• When businesses buy assets on credit
• When businesses pay off these loans
and credit purchases
2. Investing
- Selection and management of long-term
resources that will be used to develop,
produce, and sell products or services.
- Managers use the capital from financing
activities to acquire resources used in the
asset conversion process.
Investing Activities
• Buying long-term assets i.e. land,
building, equipment, etc that are
needed in the operation of the
business
• Selling or disposing these resources
when they are no longer needed.
3. Operating
- The use of resources to design, produce,
distribute, and market good and services.
- Basically, all activities encompassing
operations of the business.
Operating Activities
• Purchasing
• Production
• Selling
• Servicing
• Human Resources
• Distribution
• Research and development
• Engineering and design
Basic Principles
To generate information that is useful to the users of
financial information, accountants rely on the
following principles:
1. Objectivity
- Accounting records and statements are based
on the most reliable data available so that it
will be as accurate and as useful and possible.
- Accounting records are based on information
that flows from documented activities by
objective evidence.
- Without this principle, accounting records
would be based on whims and opinions and is
therefore subject to disputes.
2. Historical Cost
- Acquired assets should be recorded at their
actual cost and not at what the management
thinks they are worth at reporting date.
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3. Accrual-Basis

- Also known as the Expense

Recognition/Revenue Recognition Principle.
- Transactions are recorded using the accrual
basis of accounting.

- The recognition of revenues and expenses

arises when earned or used, respectively.

4. Adequate Disclosure or Completeness

- Requires that ALL relevant information that
would affect the users understanding and
assessment of the accounting entity (the
business) be disclosed in the financial
statements.

5. Materiality
- Financial reporting is only concerned with
information that is significant enough to affect
evaluations and decisions.
- Materiality depends on the size and nature of
the item being judged in a particular
circumstance of its omission.

- Depending on the circumstances, either the

nature or the size of the item could be the
determining factor.

6. Consistency

- The same method of accounting will be used

across all accounting practices and accounting
periods, unless it can be replaced by a more
relevant method.
- Ensures that accounting records over several
accounting periods can easily be compared.
- If this assumption is not true, the financial
statements produced over multiple periods
are probably not comparable.

3
 “Introduction in Financial
Reporting”
09/05/2022
GAAP
- Generally Accepted Accounting Principles (GAAP)
- Refer to a common set of accounting rules, standards,
and procedures issued by the Financial Accounting
Standards Board (FASB).
- Public companies in the U.S. must follow GAAP when
their accountants compile their financial statements.
Understanding GAAP
- A combination of authoritative standards (set by
policy boards) and the commonly accepted ways of
recording and reporting accounting information.
- Aims to improve the clarity, consistency, and
comparability of the communication of financial
information.
Outside GAAP
- Contrasted with pro forma accounting, which is a
non-GAAP financial reporting method.
- Internationally, the equivalent to GAAP in the U.S. is
referred to as International Financial Reporting
Standards (IFRS). IFRS is currently used in 166
jurisdictions.
o In the Philippines it is the Philippine Financial
Reporting Standards (PFRS)
GAAP’s Purpose
- Helps govern the world of accounting according to
general rules and guidelines.
- It attempts to standardize and regulate the
definitions, assumptions, and methods used in
accounting across all industries.
- Covers such topics as revenue recognition, balance
sheet classification, and materiality.
GAAP’s Goal
- The ultimate goal of GAAP is to ensure a company's
financial statements are complete, consistent, and
comparable.
- This makes it easier for investors to analyze and
extract useful information from the company's
financial statements, including trend data over a
period of time.
- It also facilitates the comparison of financial
information across different companies.
Criteria for GAAP
The general acceptance of an accounting principle
depends on how well it meets these three criteria:
1. Relevance
- A principle is relevant to the extent that it
results in information that is meaningful and
useful to those who need to know something
about a certain organization/business.
2. Objectivity
- A principle is objective when the resulting
information is not influenced by the personal
bias or judgement by those who issue it.
- Objectivity connotes reliability and
trustworthiness.
- It also connotes verifiability, which means
that there is some way of finding out whether
the information is correct.
3. Feasibility
- “The cost of something should not be greater
that its benefits.”
- It can be implemented without undue
complexity or cost.
These criteria often conflict with one another because
in some cases, the most relevant solution might be the
least objective, and the least feasible.
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EITF
- Emerging Issues Task Force (EITF)
- Organization created by the Financial Accounting
Standards Board (FASB) in 1984.
Accounting Assumptions
- Responsible for developing and implementing a
streamlined set of accounting principles in order to
prevent different practices from becoming accepted.
- Aims to provide assistance and improvements to the
financial reporting system.
EITF’s Rationale and Methods
- Designed to minimize the need for the FASB to spend
time and effort addressing the narrow
implementation, application, or other emerging issues
that can be analyzed within existing GAAP.
- It holds public meetings, which are scheduled several
times each year. This allows the board to identify
emerging accounting issues and resolve them with a
uniform set of practices before divergent methods
arise and become widespread.
FASB
- The Financial Accounting Standards Board (FASB)
- An independent nonprofit organization responsible
for establishing accounting and financial reporting
standards for companies and nonprofit organizations
in the United States, following generally accepted
accounting principles (GAAP).
- Mission: Improve financial accounting and reporting
standards so that the information is useful to investors
and other users of financial reports.
3 Principles in Accounting
1. Relevance – results must be useful and
necessary.
2. Objectivity – financial information must be
evidenced-based, which means free from
bias.
3. Feasibility – the benefits of getting the
financial information must be greater than
the cost of going through all the process.
1. Accrual Assumption
- Also known as the Expense
Recognition/Revenue Recognition Principle.
- Transactions are recorded using the accrual
basis of accounting.
- The recognition of revenues and expenses
arises when earned or used, respectively.
o Transactions must be recorded when
they are incurred regardless of when
they are paid.
- If this assumption is not true, a business
should instead use the cash basis of accounting
to develop financial statements that are based
on cash flows. The latter approach will not
result in financial statements that can be
audited.
2. Conservatism/Prudence
- Requires the exercise a high degree of
verification and utilize solutions that show the
least aggressive numbers when faced with
uncertainty.
- The guideline requires that losses be
recorded as soon as they are quantified
(certain or uncertain), while gains are only
recorded when they are assured of being
realized.
o Revenues and expenses should be
recognized when earned, but there is a
bias toward earlier recognition of
expenses.
- To minimize the overstatement of revenue
and assets and to understate the liabilities and
expenses.
o Overstate = prudence
- sobrang pagkakareport
- this is more suitable in reporting
expenses so the company will not
incur loss, but a gain if overstated.
5
 o Understate = conservatism
- kulang/lowkey reporting
- this is more suitable in reporting
income so the company will not expect
much more and will gain if
understated.
- If this assumption is not true, a business may
be issuing overly optimistic financial results.
3. Consistency Assumption
- The same method of accounting will be used
across all accounting practices and accounting
periods, unless it can be replaced by a more
relevant method.
- Ensures that accounting records over several
accounting periods can easily be compared.
- If this assumption is not true, the financial
statements produced over multiple periods
are probably not comparable.
4. Economic Entity Assumption
- Assumes that the accounting records of a
business and the personal accounting records
of the business’ owner will be kept separate.
- The transactions of a business and those of its
owners are not intermingled.
o This assumption is a particular
problem for small, family-owned
businesses.
- If this assumption is not true, it is impossible
to develop accurate financial statements.
5. Going Concern Assumption
- Assumes that the business will continue to
operate for the foreseeable future.
- It assumes that the company will not go
bankrupt and will be able to meet its
obligations and objectives
- Presumes that the business will be operating
beyond its next fiscal period, will complete its
expected plans, and meet its projected goals.
- If this assumption is not true (such as when
bankruptcy appears probable), deferred
expenses should be recognized at once.
6. Reliability/Objectivity Assumption
- Only those transactions that can be
adequately proven should be recorded.
- Businesses must be able to prove
transactions through such things as receipts,
billing statements, invoices, and bank
statements.
- If this assumption is not true, a business is
probably artificially accelerating the
recognition of revenue.
7. The Period Assumption / Periodicity
- The financial results reported by a business
should cover a uniform and consistent period
of time.
- These periods should also be consistent each
year that the business is in operation. It can be
monthly, quarterly, biannually, or annually but
must be consistent so that records can be
compared over set time periods.
- If this is not the case, financial statements will
not be comparable across reporting periods.
8. Stable Monetary Unit Concept
- Assumes that the Philippine peso (or the
currency you are reporting) is a reasonable
unit of measure and that its purchasing power
is relatively stable.
- Allows to add and subtract peso amounts as
though each peso has the same purchasing
power as any other peso at any time.
- Ignores the effects of inflation.
Importance of Different Assumptions
- Enhances the reliability, verifiability, and objectivity
of financial statements; establishes credibility.
- Enable the users of the financial statements to
evaluate and confirm the genuineness of an
organization’s financial records and assess economic
well-being.
- Offers a systematic structure concerning how the
accounting transactions of an organization for a
6
particular financial period must be recorded and
reported in the financial statements.

Forms of Business Entities

A business generally assumes on of the three types of
a business organization. The accounting procedures
depend on which form the organization takes.
1. Sole Proprietorship
- Run by one individual for his or her own
benefit. It is the simplest form of business
organization.
- Although a sole proprietorship is not a
separate legal entity from its owner, it is a
separate entity for accounting purposes.
- Financial activities of the business (e.g.,
receipt of fees) are maintained separately
from the owner’s financial activities.

2. Partnership
- Owned and operated by two or more
persons who bind themselves together to
contribute money, property, or industry to
a common fund, with the intention of
dividing the profits amongst themselves.
- In a general partnership, each partner is
liable for any debt incurred by the
partnership.
- Limited partnerships limit the personal
liability of individual partners for the
debts of the business (ex: Hybrid Entity).

3. Corporation
- Owned by shareholders/stockholders.
- An artificial being created by the
operation of law (a separate legal entity),
having the rights of succession, and the
powers, attributes, and properties
expressly authorized by law or incident to
its existence.
- Stockholders' are not personally liable
for the corporation’s debts.

7
 “The Accounting Equation”
09/19/22
Objective of General-Purpose Financial Reporting
Accounting Standards
- Authoritative statements of how particular types of
transactions and other events should be reflected in
financial statements.
- Accordingly, compliance with accounting standards
will normally be necessary for the fair presentation of
the financial statements.
IFRS
- International Financial Reporting Standards
- IFRS is the international accounting framework
within which to properly organize and report financial
information.
- Derived from the pronouncements of the London-
based International Accounting Standards Board
(IASB).
GAAP vs IFRS
- The primary difference between the two systems is
that GAAP is rules-based and IFRS is principles-based.
- This disconnect manifests itself in specific details and
interpretations.
- IFRS guidelines provide much less overall detail than
GAAP.
Objective of Reporting
- The objective of general-purpose financial reporting
is to provide financial information about the reporting
entity that is useful to present and to users of financial
information in making decisions.
Users of Financial Information
• External Users
- Individuals and others that have current or
potential financial interest in the reporting
entity but are not involved in the daily
operations of the entity.
- The information needed by these users are so
diverse that only the primary of the general-
purpose financial statements is provided.
- Need/Use the information about the
resources and claims against the resources of
the entity to assess the entity’s prospects for
future net cash inflows
- Their decision involves the assessment of
costs, benefits, and risks of their own interest.
- The information is used to make the best
decision for the oneself.
- Their information needs are served by
financial accounting (external and
independent).
1. Creditors
2. Potential Investors
3. Suppliers
4. Employees
5. Customers/Clients
6. Government
7. Labor unions
8. Stockholders/Owners
• Internal Users
- Users that are involved in the daily
operations of the entity and in most cases,
involved in decision making.
- The information needed by these users are
usually specific and are designed to help the
entity attain its overall strategies and mission .
- Need/Use the information about how
effectively and efficient the management has
discharged the responsibilities to use the
entity’s existing resources.
- Their decision involves the assessment of
costs, benefits, and risks of the reporting
entity.
- The information is used to make the best
decision for the reporting company.
- Management Accountants design and use an
information system that primary helps in
planning and control decisions.
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 1. Directors
2. CEOs and CFOs
3. Vice Presidents
4. Managers
5. Supervisors
6. Owners
Limitations
- The IFRS Framework notes that the general-purpose
financial reports cannot provide all the information
that the users might need to make economic decisions.
• Statement of Financial Performance/ Income
- They will need to consider pertinent information
from the other sources, for example, general economic
conditions and expectations, political events and
political climate, and industry and company outlooks.
The Accounting Equation
Information Flow
Elements of Financial Statements
• Statement of Financial Position/ Balance Sheet
1. Assets
- Resources controlled by the
enterprise because of past events from
which future economic benefits are
expected to flow to the enterprise.
- The future economic benefits
embodied in the asset may flow to the
enterprise in a number of ways.
2. Liabilities
- Obligations of an entity to outside
parties who have furnished resources.
- A present obligation of the enterprise
arising from past events, the
settlement of which is expected to
result in an outflow of from the
enterprise of resources embodying
economic benefits.
3. Equity
- Residual interest in the assets of the
enterprise after deducting all the
liabilities.
Statement
1. Income
- Increases in economic benefits during the
accounting period in the form of inflows or
enhancements of assets or decreases of
liabilities that result in increases in equity,
other than those relating to contributions
from equity participants. (encompasses
both revenues and gains.)
o Revenue
- Arises from the course of the
ordinary activities of an enterprise.
- Referred to by a variety of different
names including sales, fees, interest,
dividends, royalties, and rent.
o Gains
- Represent other items that meet the
definition of income and may or may
not arise in the ordinary course of the
activities in the enterprise.
2. Expenses
- Decreases in economic benefits during
the accounting period in the form of
outflows or depletions of assets or
incurrences of liabilities that result in
decreases in equity, other than those
relating to distributions to equity
participants (owners). (definition
encompasses losses as well.)
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 o Expenses Debit-Credit
- Arises from the course of the
ordinary activities of an enterprise.
- There are various classes of expenses,
but they are generally classified as cost
services rendered or good sold,
distribution or selling expenses, admin
expensive or other operating Account Titles
expenses.
o Losses 1. Assets
- Represent other items that meet the • Current Assets
definition of income and may or may - It expects to realize the asset, or intends to
not arise in the ordinary course of the sell or consume it, in its normal operating cycle
activities in the enterprise. It holds the asset primarily for trading.
- It expects to realize the asset within 12
months.
Relation Between Accounting and Financial
- The asset is cash or cash equivalent unless
Statements
restricted.
- Financial Statements tell us how a business is o Cash
performing. They are final products of the accounting o Cash Equivalents
process. o Notes Receivable
- The most basic tool in making up the financial o Accounts Receivable
statements is the accounting equation and o Inventories
understanding the nature and different types of o Prepaid Expenses
accounts.
• Non-current Assets
- All other assets not falling under the
The Account definition of Current.
o Property, Plant, and Equipment
- Basic summary device of accounting.
o Accumulated Depreciation
- A separate account is maintained for each element o Intangible Assets
that appears in the balance sheet and income
statement. 2. Liabilities

- Detailed record of increases and decreases, and the • Current Liabilities

balance for each element that appears in the financial o Accounts Payable
statements. o Notes Payable
o Accrued Liabilities
- The simplest form of account is known as the T-
o Unearned Revenues
account.
o Current Portion of Long-Term Debt

• Non-current Liabilities
o Mortgage Payable
o Bonds Payable
o Notes Payable

10
3. Owner’s Equity NOTE:
o Capital • Debits does not mean Increases and Credits
o Withdrawals does not mean decreases.
o Income Summary • The effect of the transactions of the Equity
accounts depend on the nature of the accounts.
• Income • The accounting equation is the most
o Service Income/Service Revenue fundamental concept of Accounting.
o Sales • Rent is always prepaid, and Sales is always
• Expenses accrued.
o Cost of Sales/Cost of Goods Sold
o Salaries or Wages Expenses
o Utilities Expenses (may be T-Accounts
telecommunications facilities, Debit Credit
electricity, water, and fuel)
o Rent Expense
o Supplies Expense
o Insurance Expense
o Depreciation Expense
o Uncollectible Accounts Expense
o Interest Expense

Equity

Double-Entry System

- Accounting is based on a double-entry system which

means that the dual effects of a business transaction is
recorded.

- It states that every debit side entry has a

corresponding credit side entry.
- And that the total debits must equal total credits
- It means that for every transaction there is one or
more accounts debited and one or more accounts
credited.

11
 “Accounting for Business
Transactions”
09/20/2022

Financial Transaction

The Accounting Cycle

1. Identify Events to be Recorded

2. Journalize
3. Post Entries to the Ledger

4. Prepare Trial Balance

5. Worksheet and Adjustments

6. Prepare Financial Statements
7. Journalize and Post Adjustment
Example: 8. Journalize and Post Closing

9. Prepare Post Closing Trial Balance

10. Reverse

Journalizing
- Financial Transactions Recorded in the Journal

Journal Entries

1. Record - A journal is a chronological record of the

entity's transactions.
2. Effects - A journal shows the effects of a business
transaction in terms of debits and credits
3. Double-entry - An accounting transaction affects the
company's finances in two ways.
Example of a Journal:

12
Parts of a Journal

Journalizing Business Transactions

- After the event or the transaction has been identified
and measured, it is recorded in the journal using the
double-entry system.

Example of Journalizing Entries:

13
NOTE:

• The accounting cycle does not start with

journalizing.
• Although the FS is the output of the accounting
process, the cycle does not end with it.

14
 ADDITIONAL INFOS ONLY
“Chapter 1: Introduction to
Financial Reporting”
Ref. Book: Financial Reporting and
Analysis
Financial Reports
• Demand for financial reports exists because
users believe that the reports help them in
decision making.
• financial statements are to be useful, they
must report economic activity without
coloring the message to influence behavior in
a particular direction. They must not
intentionally favor one party over another.
• Financial statements must provide a neutral
scorecard of the effects of transactions
AICPA
- American Institute of Certified Public Accountants
- a professional accounting organization whose
members are CPAs.
Different Kinds of Accounts
10 Elements of Financial Statements
1. Assets - are probable future economic benefits
obtained or controlled by a particular entity as a result
of past transactions or events.
2. Liabilities - are probable future sacrifices of
economic benefits arising from present obligations of
a particular entity to transfer assets or provide
services to other entities in the future as a result of
past transactions or events.
3. Equity - is the residual interest in the assets of an
entity that remains after deducting its liabilities:
Equity = Assets – Liabilities
4. Investments by owners - are increases in equity of a
business enterprise resulting from transfers to the
enterprise from other entities of something of value to
obtain or increase ownership interests (or equity) in
it. Assets, most commonly received as investments by
owners, may also include services or satisfaction or
conversion of liabilities of the enterprise.
5. Distribution to owners - is a decrease in equity of a
particular business enterprise resulting from
transferring assets, rendering services, or incurring
liabilities by the enterprise to owners. Distributions to
owners decrease ownership interest (or equity) in an
enterprise.
6. Comprehensive income - is the change in equity (net
assets) of a business enterprise during a period from
transactions and other events and circumstances from
nonowner sources. It includes all changes in equity
during a period except those resulting from
investments by owners and distributions to owners.
7. Revenues - are inflows or other enhancements of
assets of an entity or settlements of its liabilities (or a
combination of both) from delivering or producing
goods, rendering services, or other activities that
constitute the entity’s ongoing major or central
operations.
8. Expenses - are outflows or other consumption or
using up of assets or incurrences of liabilities (or a
combination of both) from delivering or producing
goods, rendering services, or carrying out other
activities that constitute the entity’s ongoing major or
central operations.
9. Gains - are increases in equity (net assets) from
peripheral or incidental transactions of an entity and
from all other transactions and other events and
circumstances affecting the entity during a period
except those that result from revenues or investments
by owners.
10. Losses - are decreases in equity (net assets) from
peripheral or incidental transactions of an entity and
from all other transactions and other events and
circumstances affecting.
15
 “Chapter 3: Balance Sheet” Example of Balance Sheet in Account Form:
Ref. Book: Financial Reporting and
Analysis

Financial Statements:

1. Balance Sheet / Statement of Financial Position /

Statement of Financial Condition

- shows the financial condition of an accounting entity

as of a particular date.

- most basic financial statement, and it is read by

various users as part of their decision-making process.
Example of a Summarized Balance Sheet:
- balance sheet formats differ across nations.

- consists of three major sections:

• Assets - resources of the firm;

• Liabilities - the debts of the firm;
• Stockholders’ equity - the owners’ interest in
the firm.

- total assets amount must equal the total amount of

Accumulated Depreciation Formula:
the contributions of the creditors and owners. This is
expressed in the accounting equation: • Straight-Line Method = recognizes
depreciation in equal amounts over the
Assets = Liabilities + Stockholders’ Equity
estimated life of the asset. (best choice :>)
Example of Balance Sheet in Report Form:

Note: Do not depreciate the salvage value.

Salvage value is the amount for which the
asset can be sold at the end of its useful life.

Problems in Balance Sheet Presentation

- may cause difficulty in analysis

1. many assets are valued at cost, so one cannot

determine the market value or replacement cost of
many assets and should not assume that their balance
sheet amount approximates current valuation.

2. varying methods are used for asset valuation.

similar problems exist with long-term asset valuation
and the related depreciation alternatives.

16
- These problems do not make statement analysis
impossible. They merely require that qualitative
judgment be applied to quantitative data in order to
assess the impact of these problem areas.

Single-Step Income Statement

“Chapter 4: Income Statement”

Ref. Book: Financial Reporting and
Analysis

2. Income Statement / Statement of Comprehensive

Income

-the most important financial statement

- summarizes revenues and expenses and gains and
losses, ending with net income.
Example of a Single-Step:
- summarizes the results of operations for a particular
period of time.

- net income is included in retained earnings in the

stockholders’ equity section of the balance sheet. (This
is necessary for the balance sheet to balance.)

Multiple-Step Income Statement

Example of a Multiple-Step:
3. Statement of Cash flows
17
 “Chapter 5: Basics of Analysis”
Ref. Book: Financial Reporting and Analysis
The analysis of financial data employs various
techniques to emphasize the comparative and relative
importance of the data presented and to evaluate the
position of the firm.
Financial Statement Analysis
- a judgmental process. One of the primary objectives
is identification of major changes (turning points) in
trends, amounts, and relationships and investigation
of the reasons underlying those changes. Often, a
turning point may signal an early warning of a
significant shift in the future success or failure of the
business. The judgment process can be improved by
experience and using analytical tools.
- consists of the quantitative and qualitative aspects of
measuring the relative financial position among firms
and industries.
- analysis can be done in different ways, depending on
the type of firm or industry and the specific needs of
the user.
- financial statements will vary by size of firm and
among industries.
Techniques in Analyzing Financial Statements
- The information derived from these types of analysis
should be blended to determine the overall financial
position. No one type of analysis supports overall
findings or serves all types of users.
1. Ratio Analysis
- usually expressed as a percent or as times per period.
• Liquidity ratios measure a firm’s ability to
meet its current obligations. They may include
ratios that measure the efficiency of the use of
current assets and current liabilities.
• Borrowing capacity (leverage) ratios measure
the degree of protection of suppliers of long-
term funds.
• Profitability ratios measure the earning ability
of a firm. Discussion will include measures of
the use of assets in general.
• Investors are interested in a special group of
ratios, in addition to liquidity, debt, and
profitability ratios.
• Cash flow ratios can indicate liquidity,
borrowing capacity, or profitability.
- Ratios are interpretable in comparison with;
(1) prior ratios,
(2) ratios of competitors,
(3) industry ratios, and
(4) predetermined standards.
- Comparison of income statement and balance sheet
numbers, in the form of ratios, can create difficulties
due to the timing of the financial statements.
2. Common-size Analysis (Vertical and Horizontal)
- expresses comparisons in percentages.
- use of common-size analysis makes comparisons of
firms of different sizes much more meaningful.
- care must be exercised in the use of common-size
analysis with small absolute amounts because a small
change in amount can result in a very substantial
percentage change.
• Vertical Analysis - compares each amount with
a base amount selected from the same year.
• Horizontal Analysis - compares each amount
with a base amount for a selected base year.
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3. Year to Year Change Analysis
- aids in keeping absolute and percentage changes in
perspective.
Rules in Performing Year to Year Change Analysis
1. When an item has value in the base year and none in
the next period, the decrease is 100%.
2. A meaningful percent change cannot be computed
when one number is positive, and the other number is
negative.
3. No percent change is computable when there is no
figure for the base year
4. Trend Analysis
- studies the financial history of a firm for comparison.
By looking at the trend of a particular ratio, one sees
whether that ratio is falling, rising, or remaining
relatively constant.
- this helps detect problems or observe good
management.
Standard Industrial Classification (SIC) Manual
- we use the Philippine Standard Industrial
Classification (PSIC).
- a detailed classification of industries prevailing in the
country according to the kind of productive activities
undertaken by establishments.
- the PSIC was revised to (1) reflect changes in
economic activities, emergence of new industries, and
the structure of the economy (2) to take into account
the new technologies employed which affect the
organization of production and shifting of economic
activities and (3) to realign with the ISIC revisions for
purposes of international comparability.
- statistical classification of business by industry.
- determining a company’s SIC is a good starting point
in researching a company, an industry, or a product.
Many library sources use the SIC number as a method
of classification
Financial Statement Variation by Type of Industry
• Merchandising Firm
- (retail-wholesale) firms sell products
purchased from other firms.
- A principal asset is inventory, which consists
of merchandise inventories.
- For some merchandising firms, a large
amount of sales may be for cash.
• Service Firm
- generates its revenue from the service
provided. Because service cannot typically be
stored, inventory is low or nonexistent.
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 • Manufacturing Firm
- will usually have large inventories composed
of raw materials, work in process, and finished
goods, as well as a material investment in
property, plant, and equipment.

Industry Norms and Key Business Ratios

1.Agriculture/Mining/Construction/Transportation/
Communication/Utilities

2. Manufacturing
3. Wholesaling

4. Retailing
5. Finance/Real Estate/Services

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