FINMA 113 – FINANCIAL ANALYSIS AND REPORTING

Financial Statement Analysis – it is the process of analyzing
a company's financial statements for decision-making
purposes. It involves data collection from financial statement
to assess and evaluate the firm’s past performance, present
condition, and future potential of the business.
Users of Financial Statement Analysis
● Investors – look at the risk and performance of their
investments and the possibility of growth in the future.
● Managers/Employees – look at how the company is
performing and its stability in providing job security and
additional benefits.
● Creditors – are interested in the liquidity of the company to
ascertain if they will be paid on time.
● Banks/Bond Holders – are interested in the performance and
solvency of the company for lending purposes.
● Government – interest in the companies to determine
general economic conditions and possible incentives to be
given.
Different users can use financial statement analysis to
achieve the following objectives:
1) Assessment of Past Performance and Current Position
2) Prediction of Net Income and Growth Prospects
3) Prediction of Bankruptcy and Failure
4) Loan Decision by Financial Institutions and Banks
Steps in Performing Financial Statement Analysis
1) Ascertain General Economic Conditions (industry
Performance)
2) Establish Company Objectives and Strategies
3) Determine Financial Reporting Standard Provision and
Requirements
4) Develop Expected Trends, Components, and Ratios
5) Compute Trends and Ratios
6) Compare Expected and Computed Trends and Ratios and
make a conclusion
Limitations of Financial Statement Analysis
● The financial analysis does not contemplate cost price level
changes
● The financial analysis might be ambiguous without the prior
knowledge of the changes in accounting procedure followed
by an enterprise
● Financial analysis is a study of reports of the enterprise
● Monetary data alone is contemplated in financial analysis
while non-monetary factors are overlooked
● The financial statements are outlined on the ground of
accounting concept, as such, it does not mirror the current
position
● Changes or trends are measured by comparing the current
year’s values against those of the base year.
● A percentage or an absolute comparison may be used in
horizontal analysis.
● It can be used to evaluate the company’s effort to improve
operations or its financial status.
FORMULA:
Peso amount Current Year – Base
=
increase/Decrease Year
Percentage Current Year – Base
Increase or = Year X100
Decrease BY Base Year
Percentage Current Year
Increase or = X100
Base Year
Decrease TO
Limitations of Horizontal Analysis
a) The comparison (current) period can be made to look
unusually bad or good. It depends on the selection of the base
year and the chosen accounting periods on which the analysis
starts.
b) The compilation of financial information may differ over time
leading to variation when account balances for each
accounting period are compared.
Vertical or Common Size Analysis - is a technique of
financial statement analysis in which each line item is listed as
a percentage of a base figure within the statement.
● It makes it easier to comprehend the correlation between
single items on a balance sheet and the bottom line,
expressed in a percentage.
● There will always be a line in the statement that shows as
the base figure at 100%, with each following line item
representing a percentage of the whole.
● Generally there are three common base amount, Total
Assets for the Asset Group, Total Liabilities and Equity for the
Liabilities and Equity Group and Total Sales for the Income
Statement Group
● However, other base amount may be used like total current
assets, total operating expenses, etc.
● It makes the data more meaningful because the vertical
analysis uses percentages to represent each line item, you
can proportionately compare a company's relative account
balances to those of another company or the company's
industry average regardless of whether the total sales for the
other company or industry average are higher or lower than
the company you are analyzing.

Types of Financial Statement Analysis

1) Vertical Analysis or Common Size Financial Statement FORMULA:
2) Horizontal Analysis or Trend Analysis
3) Ratio Analysis Statement Line Item
X100
Base Line Item

Horizontal or Trend Analysis - approach used to analyze

financial statements by comparing specific financial
information for a certain accounting period with information
from other periods
The first (earliest) year is generally the BASE YEAR, and
amounts for subsequent years are presented not as amounts
but as percentages of the base year amount, with the base
year assigned a value of 100%, or 100.
 FINMA 113 – FINANCIAL ANALYSIS AND REPORTING
EXAMPLE: b.) Liquidity Ratios – measure the ability of the firm’s
cash resources to meet its short-term cash
Sales (Base Line Item) 20,000 100% obligations
Cost of Goods Sold (4,000) 20%
GROSS PROFIT 16,000 80% ▪ Net Working Capital - the difference between current assets
General and Admin Expenses 8,000 40% and current liabilities. It bridges the gap between the
OPERATING INCOME 8,000 40% production process and the collection of cash from the sale of
Taxes (30%) 2,400 12% the item.
NET INCOME 5,600 28%
NET WORKING CAPITAL = Total Current Asset – Total
Current Liabilities
Limitations of Vertical Analysis
a) Since percentage values are examined in place of actual
financial figures, it is quite easier to get away with the window ▪ Current Ratio - it relates current assets to the claims of short-
dressing of financial statements. term creditors. Whereas net working capital expresses this
b) This method is not very useful for businesses that are relationship as a net amount, the current ratio expresses the
inherently impacted by seasonal fluctuations. relationship as a ratio.

CURRENT Current Asset

Ratio Analysis - The process of looking at the relationships
between different account balances in the financial statements
to see if they indicate positive or negative trends developing
within a company.
- The main purpose is to enable evaluation of risk and return
of a company by different users needing different information.
=
RATIO Current Liabilities
▪ Acid Test (Quick) Ratio - is a more conservative version of
the current ratio. The quick ratio measures the firm’s ability to
pay its short-term debts using its most liquid assets.

Major Categories in Financial Ratio Analysis Cash + Marketable Securities +

ACID TEST
= Accounts Receivable
1) Risk Analysis RATIO
Current Liabilities
a) Capital Structure Ratio
b) Liquidity Ratio c.) Solvency Ratio - the ability of the company to pay its
c) Solvency Ratio long-term obligations as they come due.
d) Activity Ratio
● Times Interest Earned - compares the funds available to pay
2) Return Analysis interest with the amount of interest expense on the income
a) Profitability Ratio statement.
b) Market Prospect Ratio
Earnings Before Interest and
TIME INTEREST
Risks Analysis: The general objective is to determine the = Taxes
EARNED
probability of a company’s bankruptcy Interest Expense
a.) Capital Structure Ratios - refers to the way a firm
chooses to finance its business. d.) Activity Ratios - provide information about a firm's
ability to manage its resources efficiently, specifically
▪ Debt Ratio - measures the proportion of the company’s total the current assets of accounts receivable and
assets that are financed by creditors and thus the firm’s long- inventory, and its ability to manage its accounts
term debt payment ability. payable effectively.

Total Liabilities
DEBT RATIO = ● Receivable Turnover - it tracks the efficiency of a firm’s
Total Asset
accounts receivable collections and indicates the amount of
investment in receivables that is needed to maintain the firm’s
▪ Equity Ratio – measures the proportion of the company’s
level of sales.
total assets that are financed by stockholders and past
earnings of the firm.
RECEIVABLE Total Credit Sales
=
TURNOVER Average Receivable
Total Equity
EQUITY RATIO =
Total Asset
● Days Sales Outstanding/Average Collection Period/Days in
Receivables - It tells how many days an average receivable is
▪ Debt-to-Equity Ratio - This ratio is a comparison of how much held before it is collected.
of the financing of assets comes from creditors and how much
comes from owners, in the form of equity.
DAYS IN 360 or 365 days
=
RECEIVABLE Receivable Turnover
DEBT TO Total Liabilities
=
EQUITY RATIO Total Equity
 FINMA 113 – FINANCIAL ANALYSIS AND REPORTING
EARNING PER Net Income
=
● Inventory Turnover - calculates how many times during the SHARE No. of Shares Outstanding
year the company sells its average level of inventory.
Or
INVENTORY Total Cost of Sales
= Net Income – Preferred
TURNOVER Average Inventory EARNING PER
Dividends
COMMON =
No. of Common Shares
● Days in Inventory/Average Holding Period - calculates the SHARE
Outstanding
number of days that the average inventory item remains in
stock before it is sold, or the average number of days it takes
to sell an item of inventory. ● Profit/Sales margin - the ratio of profit remaining from sales
after all expenses have been paid.
DAYS IN 360 or 365 days
= PROFIT/SALES Net Income
INVENTORY Inventory Turnover =
MARGIN Net Sales
● Payable Turnover - It represents the number of times
payables “turn over” during a year’s time.
● Basic Earning Power (BEP) Ratio - is a measure that
PAYABLE Total Purchases calculates the earning power of a business before the effect of
= the business' income taxes and its financial leverage.
TURNOVER Average Payable
BASIC EARNING Taxes
● Days in Payable (Payable Deferral Period) - represents the =
POWER RATIO Total Assets
average number of days the company takes to pay its
payables. b.) Market Ratios
● Price Earnings Ratio - gives an indication of what
DAYS IN 360 or 365 days shareholders are paying for continuing Earnings per Share.
=
PAYABLE Payable Turnover Investors view it as an indication of what the market considers
to be the firm’s future earning power.
● Operating Cycle - is the length of time it takes to convert an
investment of cash in inventory back into cash. PRICE Market Value of Each Share
EARNINGS =
Earnings Per Share
OPERATING CYCLE = Days in Receivable + Days in RATIO
Inventory
● Earnings Yield - measures the income-producing power of
● Cash Conversion Cycle - the length of time it takes to convert one share of common stock at the current price. It is the
an investment of cash in inventory back into cash recognizing inverse of the P/E Ratio.
that some purchases are made on credit.
EARNINGS Earnings Per Share
=
CASH CONVERSION CYCLE = Operating Cycle – Days in YIELD Market Value of Each Share
Payables
● Dividend Yield - Thus, it is the cash return received by a
2. Return Analysis: The general objective is to ascertain the
shareholder on one share of stock, based on the stock’s
company’s gains and wealth built in relation to the risks taken.
current price and current dividend.
a.) Profitability Ratios - These ratios convey how well
DIVIDEND Dividend per Share
a company can generate profits from its operations. =
YIELD Market Value of Each Share
● Return on Assets - measures a company’s success in using
financing to generate profits and is also a good measure of the ● Dividend Pay-out - measures the proportion of earnings paid
company’s solvency risk. out as dividends to common stockholders.

RETURN ON Net Income DuPont Analysis - Useful method used to decompose the
=
ASSET Average Total Assets different drivers of return on equity (ROE). The decomposition
of ROE allows investors to focus on the key metrics of financial
performance individually to identify strengths and
weaknesses.
● Return on Equity - measures the return that is received from
the business on the equity
● A company’s Return on Equity is affected by three things,
RETURN ON Net Income which are:
= ● Efficiency of operations (measured by the profit margin on
EQUITY Average Total Asset
sales),
● Earnings per Share - is essentially the measure of the ● Effectiveness in asset utilization (measured by the asset
amount of income that each share of common stock would turnover ratio),
have earned if the profit of the company had been “paid” ● Financial leverage (measured by the equity multiplier).
(distributed) to all of the common shares outstanding.
 FINMA 113 – FINANCIAL ANALYSIS AND REPORTING
FORMULA: (Horizontal Analysis): The Asset Section of the comparative
Statement of Financial Position of New York Corporation
● Profit/Sales Margin - measures the percentage of sales that follow:
actually becomes profit for a company. Also called Sales
Margin and Return on Sales. ASSETS 2021 2022 % 2023 %
Cash 148,000 100,000 90,000
PROFIT/SALES Net Income AR 283,000 410,000 394,000
= Inventory 322,000 616,000 696,000
MARGIN Net Sales
Other
Current 10,000 14,000 15,000
● Asset Turnover - tells us how much of sales we are getting Assets
from our total assets. Total
Current 763,000 1,140,000 1,195,000
ASSET Total Sales Assets
=
TURNOVER Average Total Asset PPE 460,000 904,000 974,000
Total
1,223,000 2,044,000 2,169,000
● Equity Multiplier - a risk indicator that measures the portion Assets
of a company’s assets that is financed by stockholder's equity
rather than by debt. Required: Using 2021 as base year, perform trend/horizontal
analysis.
EQUITY (Average) Total Asset
= Below are the comparative income statement of XXX
MULTIPLIER (Average) Total Equity
Corporations:

XXX Corporation
ROE under DuPont Analysis = Profit Margin x Asset Income Statement
Turnover x Equity Multiplier Years Ended December 31
Or: 20xx 20xy
Net Average Net Sales 75,000 70,000
Total Sales
Income Total Asset
COGS (24,500) (22,000)
ROE x x Average
Total Ave. Total Gross Margin 50,500 48,000
Total
Sales Assets Selling and Admin Expense (16,000) (15,000)
Equity
Other Operating Expense (1,600) (3,000)
Operating Income 32,900 30,000
● Alternatively, Return on Asset can be computed under Interest Expense (5,000) (4,500)
DuPont Analysis as follows: Income Before Taxes 27,900 25,500
Income Tax Expense (8,370) (7,650)
ROA under DuPont Analysis = Profit Margin x Asset Net Income 19,530 17,850
Turnover
Or: Prepare a trend analysis to show the peso amount of change
Net and percentage increase or decrease.
Total Sales
Income
ROA x
Total Ave. Total (Vertical Analysis): The comparative income statement of Di
Sales Assets Matuto Corporation follows:

Inherent Limitations of Financial Ratios 2021 % 2022 % 2023 %

a) A ratio by itself is not significant. It must be interpreted in Net Sales 1,235,000 100 2,106,000 100 2,211,000 100
comparison with prior ratios, predetermined benchmarks, or COGS 849,000 1,501,000 1,599,000
ratios of competitors. Gross
386,000 605,000 612,000
b) Financial statements are not exact and incomplete. Profit
Qualitative information should also be gathered to support the OPEX 180,000 383,000 402,000
information derived from the financial statements. Operatin
206,000 222,000 210,000
c) Ratio analysis is backward-looking since financial g Income
Interest
statements are based on historical data and amounts. Expense
20,000 51,000 59,000
d) Different accounting practices can distort comparisons. This EBT 186,000 171,000 151,000
is due to the existence of assumptions and estimation, and Income
other optional treatment provided in the accounting standards. 74,000 68,000 60,000
Tax Exp
e) It is difficult to generalize about whether a ratio is good. EAIT 112,000 103,000 91,000

Required: Construct the Common-Size Income Statement for

the three years presented.
 FINMA 113 – FINANCIAL ANALYSIS AND REPORTING
Shu Nga Company’s comparative balance sheet is presented (Liquidity): Determine the missing items:
below. Provide a common size balance sheet to understand COMPANY COMPANY COMPANY
how much of the line items contribute to the total assets. A B C
ASSETS 2022 2023 Current Asset 200,000 120,000
Current Assets 1,100,000 1,066,000 Current Liabilities 80,000
Long Term Investment 190,000 355,000 Inventory 40,000 20,000
Plant Asset 889,000 940,000 Current Ratio 1.2:1 1.5:1
Intangibles 100,000 100,000 Acid Test Ratio 0.8:1 1.2:1
TOTAL ASSETS 2,279,000 2,461,000 Working Capital

LIABILITIES (Solvency): Determine the missing items.

Current Liabilities 420,000 486,000
Long-term Liabilities 200,000 400,000 COMPANY COMPANY COMPANY
TOTAL LIABILITIES 620,000 886,000 A B C
Operating Income 80,000
EQUITY Interest Expense 20,000 10,000
6% Preferred Stock 300,000 300,000 Income Before tax 60,000
Common Stock 1,000,000 1,000,000 Tax (40%) 24,000
Retained Earnings 359,000 275,000 Net Income 12,000
TOTAL EQUITY 1,659,000 1,575,000 Times Interest
5 4
Earned
TOTAL LIAB & EQUITY 2,279,000 2,461,000
“Kaya Pa Ba” Corporation has P800,000 of debt outstanding,
and it pays an interest rate of 10 percent annually on its bank
(Comprehensive Horizontal and Vertical Analysis): The loan. “Kaya Pa Ba” annual sales are P3,200,000, its average
asset section “Lodi” Corporation’s balance sheet is composed tax rate is 40 percent, and its net profit margin on sales is 6
of cash, accounts receivable, inventory, and Property, Plant percent. If the company does not maintain a TIE ratio of at
and Equipment. In its common size balance sheet for the least 4 times, its bank will refuse to renew its loan, and
current year, cash is 20% of total assets which is the same bankruptcy will result.
percentage in the previous year. Accounts Receivable and
Inventory currently have account balances of P180,000 and P What is “Kaya Pa Ba’s” current TIE ratio?
360,000, respectively. In analyzing the trend of accounts
receivable and inventory balances, it was determined that (Activity Ratios): The following data were taken from the
accounts receivable decreased by 40% while inventory accounting records and financial statements of “Suko Na”
increased to 180% as compared in the previous year. Total Corporation:
Current Assets were 70% of total assets in the previous year
while Laguna’s Property, Plant and Equipment increased by 2022 2023
40% in the current year. Accounts Receivable 40,000 50,000
Inventory 50,000 30,000
Required: Reconstruct the asset section of Lodi Corporation Accounts Payable 15,000 30,000
for both the previous and current year. Sales 450,000
Cost of Sales 200,000
(Capital Structure): Determine the missing items: Purchase 180,000

TOTAL COMPANY COMPANY COMPANY Required: Compute the following:

A B C 1. Inventory Turnover and Days in Inventory
ASSETS 500,000 200,000 2. Receivable Turnover and Days in Receivable
LIABILITIES 200,000 3. Payable Turnover and Payable Deferral Period
EQUITY 300,000 90,000 4. Operating Cycle and Cash Conversion Cycle
DEBT RATIO 40%
EQUITY RATIO
DEBT TO
80%
EQUITY RATIO
CAPITAL
MULTIPLIER
 FINMA 113 – FINANCIAL ANALYSIS AND REPORTING
(Activity Ratios): Determine the missing items. (Dupont): The Winston Corporation has the following
relationships:
COMPANY COMPANY COMPANY
A B C Sales/Total assets 2.0×
Return on assets (ROA) 4.0%
Sales 800,000 400,000
Return on equity (ROE) 6.0%
Cost of Sales 500,000 250,000
Purchases 400,000 180,000
Required: What is Winston’s profit margin and debt
Accts. Receivable 40,000 80,000 ratio?
Inventory 50,000 100,000
Accounts Payable 80,000 50,000 (Dupont): Noli Enterprises has an ROE of 15 percent, a debt
Inventory ratio of 40 percent, and a profit margin of 5 percent. The
5 times
Turnover company’s total assets equal P800 million.
Days in Inventory 144 days Required: What are the company’s sales? (Assume that the
Receivable company has no preferred stock.)
12 times
Turnover
Days in
180 days
Receivable
Payable Turnover
Deferral Period 60 days
Operating Cycle
Cash Conversion
72 days
cycle

(Performance Ratio): Determine the missing items.

COMPANY COMPANY COMPANY

A B C
Net Income 50,000 12,000
Total Asset 400,000
Total Liabilities 250,000 100,000
Total Equity 150,000
Total Sales 800,000
Return on Asset 20%
Return on Equity 25% 40%
Asset Turnover 2 times 4 times
Profit Margin 7.5 %
Capital Multiplier
Debt Ratio

(Return on Assets): “Laban Pa” company currently has total

operating income at P100,000 while interest expense
amounted to P 10,000. Average operating assets were
determined to be P 1,000,000 for the year. The company is
subject to 40% income tax rate.

(Changes in ROA & ROE): The Board of Directors is

dissatisfied with last year's ROE of 15%. If the profit margin
and asset turnover remain unchanged at 8% and 1.25
respectively.

Required: By how much must the total debt ratio increase

to achieve 20% ROE?

(Dividend Ratio): Determine the missing items.

COMPANY COMPANY COMPANY
A B C
Earnings per
P10 P25
share
Market value per
P20 P80
share
Dividend Per
P5 P5
share
Dividend Payout 60%
Dividend Yield 10%
Price-earnings
3 times
Ratio