Financial Analysis and Reporting

Day 1 Lecture

I. The Four Basic types of Business

II. Review of Financial Statements
A. Statement of Financial Position
B. Comprehensive Statement of Income and Expenses
C. Cash Flow Statement
D. Owner’s/Stockholders’ Equity Statement
III. Uses of Financial Analysis
IV. Common Danger Signals
V. Fundamental Concept in Financial Statement Analysis

Assignment: In a yellow sheet, prepare

neatly written, a typical example of
each of the financial statements.
Discuss the order of appearance of
account titles. Define each title and
The discuss
Four Basic Types of Business
its nature. Submission, next
meeting
Manufacturing
Wholesaling
Retaling Trading, merchandising
Services

Traditional flow of goods and materials from their source, the manufacturer, to the wholesale
distribution, then to the eventual consumer outlet, the retailer.

Service organizations such as bus lines, taxi companies, theaters, tailors, dry cleaners,
consultants, etc., do not sell merchandise, but offer their services. In other respects, service
organizations are much like retailers in that they are retailers of service to the consumer.

Distinct Features of Businesses

Manufacturing
• Large investment in property, plant and equipment
• Large accounts receivables
• There are three types of inventories: Raw materials, work in process, finished goods
• The large cost components are: raw materials direct labor
• Large capitalization and/or heavy long-term debt

Wholesaling
• Small profit margin, large volume operation
• Small investment in property and equipment
• Large accounts receivables
• Large finished goods inventory
• Low labor cost
• Potential credit problems

Retailing
• Heavy investment in store fixtures, counters, signages
• Expensive store location

1|P age – L ectur e on Financial Analys is and Reporting: Prof. C.

 • Large mark up on cost
• Large finished goods inventory
• Minimal accounts receivables

Services
• Either minimal or large investment in property and equipment
• Negligible inventory
• Varying profit margin based on services provided
• Value of service less tangible

Module 2

Assignment: In a yellow sheet, copy audited financial statements of any Philippine companies…..

Review of Financial Statements

• Financial statements are important for financial managers to understand financial
statements.
• Financial statements serve as windows through which outsiders-investors, lenders, and
others view firm’s financial performance and position.

1. Statement of Financial Position

➢ A statement showing the company’s financial position AS OF GIVEN DATE.
➢ Presents the company’s assets, liabilities and equity accounts
➢ Components/Format: Assets = Liabilities + capital
➢ Static
➢ Cumulative
➢ Figures based on historical cost
➢ No information on cash generation
➢ Tells little about sales – the main source of cash flows

2. Comprehensive Statement of Income and Expenses

➢ Statement summarizing the results of a company’s operations for a PARTICULAR
PERIOD.
➢ Presents the income/revenues from operations, the cost incurred in producing the
revenues, expense items, income tax provisions, and other items affecting the
operations of the period.
➢ Components/Format:
Sales (Manufacturing/Merchandising)
Less: Cost of Goods Sold
Gross Profit Margin
Less: Operating Expenses
Operating Income
Add/Less: Other income/expenses
Income before tax
Less: Tax provision
Income from continuing operations
Add/Less: After-taxes extraordinary items
Add/Less: Cumulative effect of change in accounting procedure

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 Net Income
Earnings per share *
-Or-
Operating Revenues (services)
Less: Operating costs and expenses
Gross Profit Margin/Operating income
Add/Less: Other income/expenses
Income before tax
Less: Tax provision
Income from continuing operations
Add/Less: After-taxes extraordinary items
Add/Less: Cumulative effect of change in accounting procedure
Net Income
Earnings per share*
*EPS = Net Income – Due to Preferred shares / # of common shares

3. Cash Flow Statement

➢ Statement showing the sources and uses of cash DURING THE PERIOD.
➢ In its most refined forms, it is a state of changes in financial position where the flows
of cash are explained and accounted for.
➢ Components/Format
Operating activities
Investing activities
Financing activities

4. Statement of Change in Owner’s/Stockholders’ Equity

➢ Statement reflecting the changes in the value of owner’s or membership equity
during the period.
➢ Components/format:

Preferred Stock
Convertible
Non-Convertible
Common Stock
Additional Paid-in Capita
Equity Adjustment in Foreign Currency Translation
Equity in Net Unrealized Loss on Investment Securities
Retained Earnings
Appropriated
Unappropriated
Net income (loss)
Cash Dividends
Stock Dividends
Total Stockholders’ Equity

Other Financial Statements

Notes to Financial Statements

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 ➢ Explanatory data that follows the financial statements and are integrally related to
them.
➢ These notes help the reader understand financial statement figures and any other
matters essential in gauging the company’s financial position.

Report of Independent Public Accountants

➢ A report rendered by the independent CPA at the end of the audit engagement.
➢ The auditor reports on the nature of the work done and the degree of the
responsibility taken.

Cash versus Accrual Basis Accounting

Cash basis of accounting

➢ Cash Basis of accounting recognizes revenues when cash is received and recognizes
expenses when cash is paid out.
➢ For example, under the cash basis, services rendered in 2011 for which cash is collected
in 2012 would be treated as 2012 revenue. Expenses incurred in 2011 for which cash is
disbursed in 2012 would be treated as 2012 expenses.
➢ Generally considered unacceptable, HOWEVER, financial managers focus primarily on
cash flows than on accrual-based accounting data.
➢ Some relatively small business firms and professional persons, such as physicians,
lawyers, and accountants, may account for their revenues and expenses on a cash basis.
➢ FI

Accrual basis of accounting

➢ Accrual basis of accounting recognizes revenues when sales are made or services are
performed, regardless of when cash is received.
➢ Expenses are recognized as incurred, whether or not cash is paid out.
➢ For example, when services are performed for a customer on account, the revenue is
recorded at that time even though cash has not been received. Later, when the cash is
received. Later, when the cash is received, no revenue is recorded because it has
already been recorded.

Uses of Financial Statements

1. Investors information that will help them determine whether they should buy, hold or
sell their equity.
2. Employees are interested in information about the stability and profitability of their
employers in order to assess the ability of their employers to provide remuneration,
retirement benefits and employment opportunities.
3. Lenders are interested in information that enable them to determine whether the loan
and the related interest will be paid when due.
4. Suppliers and other trade creditors are interested in information that enable them to
determine whether amounts owing to them will be paid when due.
5. Customers have interest in information about the continuance of an enterprise
especially when they have a long-term involvement with, and are dependent on, the
enterprise.

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 6. Government and their agencies are interested in the allocation of resources and to
regulate the activities of the enterprise, determine taxation polices and as the basis for
national income and similar statistics.
7. Financial statements may assist the public by providing information about the trends
and recent developments in the prosperity of the enterprise and the range of its
activities.

Objectives of Financial Statements

• To provide information about the financial position, performance and changes in

financial position of an enterprise.
• To meet the common needs of users
• To show the result of the stewardship of the management

Common Danger Signals

➢ Rapidly depreciating operating cash balance
➢ Insufficient working capital
➢ Potential violations of debt covenants
➢ Extensive and/or material transactions with related parties
➢ Significant quarter-end or year-end transactions
➢ Use of “creative accounting”
➢ Changes in independent auditors
➢ Delays in submission of requested financial information
➢ Evasive responses by management to auditor’s findings

Module 3

Fundamental Concept in Financial Statement Analysis

1. Basic financial statement analysis involves examining relationships between items on

the statements [ratio and percentage analysis] and identify trends in these relationships
[comparative analysis]
2. Analysis is used to predict the future, but ratio analysis is limited because the data are
from the past. Also, ratio analysis identifies present strengths and weaknesses of a
company but it may not reveal why they are as they are. Although single ratios are
helpful, they are not conclusive; they must be compared with industry averages, past
years, planned amounts, and the like for maximum usefulness.
3. Ratios are classified as liquidity ratios, activity ratios, profitability ratios, coverage ratios,
and growth ratios.
4. Liquidity ratio analysis measures the short-run ability of the enterprise to pay its current
maturing obligations.
5. Activity ratio analysis measures how effective the enterprise is using its assets.
6. Profitability ratio analysis measures the degree of success or failure of an enterprise to
generate revenues adequate to cover its costs of operation and provide a return to its
owners.
7. Coverage ratio analysis measures the degree of protection afforded long-term creditors
and investors.

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 8. Horizontal analysis, indicates the proportionate change in financial statement items over
a period of time; such analysis is most helpful in evaluating trends.
9. Vertical analysis [common-size analysis] is an expression of each item on the financial
statements in a given period to a base amount; it is an analysis of the composition of
each of the financial statements from different years [a] to detect trends not evident
from the comparison of absolute amounts and [b] to make intercompany comparison of
different size enterprise.

Module 3

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