What I Need to KNOW

This module contains one (1) lesson:

LESSON 5: FINANCIAL STATEMENT

At the end of this module, the student is expected to:
 solve exercises and problems that require computation and interpretation using
horizontal analysis and vertical analysis; and
 using the downloaded sample financial statements, learner computes various
financial ratios and interprets the level of profitability, efficiency and financial
health (liquidity and solvency) of the business.

General Instructions: Answer all the activities on this module. Use separate sheets of
paper for your answers

Activity I. Think of yourself as a business owner and share what you have in mind
seeing yourself as an owner. What are the things you want to know as business
owners, which are not available on the face of FS? You may consider the growth
(whether in assets, revenue or net income), asset components, financing mix and
profitability (specifically the portion of revenue that will eventually go to the owner).

Financial Statement (FS)

- analysis is the process of evaluating risks, performance, financial health, and future
prospects of a business by subjecting financial statement data to computational and
analytical techniques with the objective of making economic decisions (White et.al
1998).
There are three kinds of FS analysis techniques:
- Horizontal analysis
- Vertical analysis
- Financial ratios

A. Horizontal analysis, also called trend analysis, is a technique for evaluating a series
of financial statement data over a period of time with the purpose of determining the
increase or decrease that has taken place (Weygandtet.al 2013). This will reveal the
behavior of the account over time. Is it increasing, decreasing or not moving? What is
the magnitude of the change? Also, what is the relative change in the balances of the
account over time?
-Horizontal analysis uses financial statements of two or more periods.
-All line items on the FS may be subjected to horizontal analysis.
-Only the simple year-on-year (Y-o-Y) grow this covered in this lesson.
-Changes can be expressed in monetary value (peso) and percentages
computed by using the following formulas:
•Peso change=Balance of Current Year-Balance of Prior Year
•Percentage change=(Balance of Current Year-Balance of Prior Year)/(Balance of Prior Year)
Example:

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Subject: Fundamentals of Accountancy, Business and Management II – Module 5
B. Vertical analysis, also called common-size analysis, is a technique that expresses
each financial statement item as a percentage of a base amount (Weygandt et.al.
2013).
-For the SFP, the base amount is Total Assets.
•Balance of Account / Total Assets.
•From the common-size SFP, the analyst can infer the composition of
assets and the company’s financing mix.

Example:

C. Financial Ratio. Ratio analysis expresses the relationship among selected items of
financial statement data. The relationship is expressed in terms of a percentage, a rate,
or a simple proportion (Weygandtet.al. 2013). A financial ratio is composed of a
numerator and a denominator. For example, a ratio that divides sales by assets will find
the peso amount of sales generated by every peso of asset invested. This is an
important ratio because it tells us the efficiency of invested asset to create revenue.
This ratio is called asset turnover. There are many ratios used in business.

These ratios are generally grouped into three categories:

(a) profitability, (b) efficiency, and (c) financial health.

Profitability ratios measure the ability of the company to generate income from the use
of its assets and invested capital as well as control its cost. The following are the
commonly used profitability ratios:
-Gross profit ratio reports the peso value of the gross profit earned for every peso
of sales. We can infer the average pricing policy from the gross profit margin.
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Subject: Fundamentals of Accountancy, Business and Management II – Module 5
 -Operating income ratio expresses operating income as a percentage of sales. It
measures the percentage of profit earned from each peso of sales in the company’s
core business operations (Horngren et.al. 2013). A company with a high operating
income ratio may imply a lean operation and have low operating expenses. Maximizing
operating income depends on keeping operating costs as low as possible (Horngren
et.al. 2013).
-Net profit ratio relates the peso value of the net income earned to every peso of
sales. This shows how much profit will go to the owner for every peso of sales made.
-Return on asset (ROA) measures the peso value of income generated by
employing the company’s assets. It is viewed as an interest rate or a form of yield on
asset investment. The numerator of ROA is net income. However, net income is profit
for the shareholders. On the other hand, asset is allocated to both creditors and
shareholders. Some analyst prefers to use earnings before interest and taxes instead
of net income. There are also two acceptable denominators for ROA – ending balance
of total assets or average of total assets. An average asset is computed as beginning
balance + ending balance divided by 2.
-Return on equity (ROE) measures the return (net income) generated by the
owner’s capital invested in the business. Similar to ROA, the denominator of ROE may
also be total equity or average equity.

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Subject: Fundamentals of Accountancy, Business and Management II – Module 5
Activity II. Describe the different ratio analysis below.
1. Profitability
2. Efficiency
3. Financial Health
4. Vertical Analysis
5. Horizontal Analysis

Activity III. Consider the given SFP of C&F Store and complete the table below:

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Subject: Fundamentals of Accountancy, Business and Management II – Module 5
 Your Answer Your Answer

Your Answer

Activity IV. Compute what are needed in the requirement below.

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Subject: Fundamentals of Accountancy, Business and Management II – Module 5