Topic 6 Financial Statement Analysis

Intro:

Maximize stockholder’s wealth through the current value of existing stocks.

• Accounting profits should not be discarded as they directly affect the firm’s stock
price.
• Accounting information is presented in the financial statements.
• Financial statement is an important tool to understand why the company is
performing the way it is and as a forecasting device as to where it is going.

is the summarized data of a company’s assets, liabilities, and equities in the balance
sheet and its revenues and expenses in the income statement.

• Objective:
is to provide information about the financial position, result of operations, and cash
flows of an enterprise that is useful in decision-making to a wide range of users.

1. Balance Sheet
2. Income Statement
3. Statement of Stockholder’s Equity
4. Statement of Cash Flows
5. Accounting Policies and Notes to Financial Statements

Importance of Financial Statement Analysis

• determines an entity’s:
profitability,
liquidity, (ability to pay short-term obligations), and
solvency (ability to meet long-term obligations)
• assesses management effectiveness in running the business (operation)
• assesses the safety of investment in the firm. (financing)

1. There are variations in the application of accounting principles.

2. Financial statements are:
- interim in nature.
- do not reflect changes in the purchasing power of the peso.
- do not contain all the significant facts about the business

-is an evaluation of the past and current performance of the firm

and its forecast in the future.
Involves:
-calculations
-tools and techniques
a. Comparative Statements
- compared are financial data of two years showing the increases or decreases in the
account balances with their corresponding percentages.
b. Trend Ratio
- firms present ratio is compared with its past and expected future ratios to
determine whether the company’s financial condition is improving or deteriorating
over time.

-is similar to comparative statements except that several consecutive years were
used showing the behavior of financial data.

Cash Ratio for 2019 = (70,000 / 75,000) = 93.33%

Cash Ratio for 2020 = (65,000 / 75,000) = 86.67%
Common-Size Statement
- significant item on a financial statement is used as the base value, and all other
items on the financial statements are compared with it. It is used to show the
internal structure of an enterprise. It reflects the existing relationship of each
account in the balance sheet and income statement.

* IN BALANCE SHEET
- total assets are assigned as the base account with a 100%.
total liabilities and stockholder’s equity is 100%.

* IN INCOME STATEMENT
- net sales are given the value of 100% and all other
accounts are evaluated in comparison to net sales.
- is a comparison in fraction, proportion, decimal or percentage form of two
significant figures taken from financial statements. It expresses the direct
relationship between two or more quantities in the statement of financial position
and income statement of a business firm.

Financial Ratios provide insight into:

a.) the profitability of the company’s operations
b.) the soundness of the firm’s short-term and long-term financial condition and
c.) the efficiency with which management has utilized the sources entrusted to it.

1. Industry Comparison
- financial ratios are computed and compared with the industry average. Thrugh
industry comparison, the company may be able to compare their performance
against their competitors and how they fare with them.

2. Trend Analysis
- financial ratios are computed and compared with their past performance. By the
trends, the company will know if their financial performance is improving or not
over the years. It is a very powerful tool in deciding the actions that a company
should take in the future.
-are ratios that measure the firm’s ability to meet cash needs as they arise.
1. Working Capital = Current Assets - Current Liabilities
2. Current Ratio = Current Assets / Current Liabilities
3. Quick Ratio = Quick Assets* / Current Liabilities
4. Cash Position Ratio = Cash + Marketable Sec. / Current Liabilities
*(Quick Assets are Cash, Marketable Securities, and Accounts Receivable)

are ratios that measure the liquidity of specific assets and efficiency in managing
assets such as accounts receivable, inventory and fixed assets

1. AR Turnover = Net Credit Sales / Ave. Accounts Receivable

2. Ave. Collection Period = 360 / AR Turnover

3. Inventory Turnover = Cost of Goods Sold / Ave. Inventory

4. Ave. Age of Inventory = 360 / Inventory Turnover

5. Operating Cycle = Ave. Collection Period + Ave. Age of Inventory <--(2+ 4)

6. Fixed Asset Turnover = Net Sales / Ave. net Fixed Assets

7. Total Asset Turnover = Net Sales / Ave. Total Assets

- are ratios that measure the extent of a firm’s financing, with debt relative to equity
and its ability to cover interest and other fixed charges such as rent and sinking fund
payments.
1. Debt Ratio = Total Liabilities / Total Assets
2. Debt-to-Equity Ratio = Total Liabilities / Stockholder’s Equity
3. Times Interest Earned Ratio = Earnings before Interest & Taxes / Interest expense

1. Gross profit margin = Gross Proft / Net Sales

2. Profit Margin = Net Income / Net Sales
3. Return on Total Assets = Net Income / Ave. Total Assets
4. Return on CS Equity = Net Income / Ave. CS Equity
5. Earnings per Share = Net Income - Pref. Stock Dividend /
CS Outstanding
6. Price-to-Earnings per share = Market Price per share /
7. Book Value per Share = Stockholder’s Equity - Preferred Stocks /
Common Stocks Outstanding
8. Market-to-Book Value = Market Price per share /
Book Value per share
9. Dividend Yield = Dividends per share / Market Price per share
10. Dividend Payout = Dividends per share / Earnings per share
SEATWORK
Conduct a horizontal FS analysis on the following data:

Instructions:
1. Prepare the balance sheet
2. Conduct a horizontal analysis

ASSIGNMENT
Explain the relevance of each financial ratios:
1. Liquidity ratios
2. Activity ratios
3. Leverage ratios
4. Profitability ratios
Example: Liquidity ratios are ratios that measure the firm’s ability to meet cash needs
as they arise.
a. Working Capital is the business's ability to meet its payment obligations as they
fall due.

* Market value ratio