FINANCIAL STATEMENT
-The financial statement is the
summarized data of a company’s
assets, liabilities, and equities in the
balance sheet and its revenue and
expenses in the income statement.
Its objective is to provide information
about the financial position, result of
operations, and cash flows of an
enterprise that is useful for
decision-making to a wide range of
users.
COMPONENTS OF FINANCIAL
STATEMENT
1. BALANCE SHEET
● A statement showing the
financial position of the
company at a particular time.
● It composed of the company’s
assets and liabilities and
stockholder’s equity.
2.INCOME STATEMENT
● It is a formal statement that
shows the result of the
operations for a certain period
of time.
● It presents the revenues
generated during the
operating period, the
expenses incurred, and the
company’s net earnings.
3. STATEMENT OF
STOCKHOLDERS EQUITY
● required basic statement that
shows the movements in the
● components of the equity.
● The major elements of the
statement equity include:
● Issuance of stocks. These are
the common or preferred
stocks issued during the year.
● Retained earnings.
Accumulated income or loss
of the company for the past
years of operations.
● Declaration of cash dividends.
Deduction from retained
earnings.
● Distribution of stock
dividends. It discloses the
stock dividend rate and the
amount of stock dividends
distributed to stockholders.
● Purchase and sale of treasury
stock. Firm’s stocks originally
issued but were bough back
and were not retired.
● Shown as addition to
stockholders’ equity while the
purchase is shown as
deduction.
● Accumulated other
comprehensive income.
Includes unrealized gains and
losses on available-forsale
investment and
foreign-currency translation
adjustments.
● Correction of errors. It lists
errors in the past but
corrected in the coming year.
4. CASH FLOW STATEMENT
● It is the financial
statement that shows
the firm’s cash
receipts and
payments during a
specified period of
time.
Statement of cash flows shows how
much cash the firm is generating. The
statement is divided into four sections
as follows:
1.Operating Activities
– deals with items that occur and part
of normal ongoing operations.
a. Net income – the first operating
activity is the net income, which is the
first source of cash. If all sales were
for cash, if all costs required
immediate cash payments, and if the
firms were in a static situation, net
income would equal cash from
operations.
b. Depreciation and amortization – the
first adjustment relates to the
depreciation and amortization.
Accountants subtracted depreciation,
which is a noncash charge, when they
calculated net income. Therefore,
depreciation must be added back to
net income when cash flow is
determined.
c. Increase in inventories – to make or
buy inventory items, the firm must use
cash. It may receive some of this cash
as loans from its suppliers and
workers (payables and accruals); but
ultimately, any increase in inventories
requires cash.
d. Increase in accounts receivable – if
a company choose to sell on credit
when it makes a sale, it will not
immediately get the cash that it would
have received had it not extended
credit. It must replace the inventory
that is sold on credit.
e. Increase in accounts payable –
accounts payable represent a loan
from suppliers if a company bought
goods in credit.
f. Increase in accrued wages and
taxes – same logic applies to accruals
as to accounts payable.
g. Net cash provided by operating
activities- all of the previous items are
part of the normal operations-they
arise as a result of doing business.
When we sum them, we obtain the net
cash flow from operations.
2. Long-Term Investing Activities
- all activities involving long-term
assets are covered in this section, for
example, acquisition of some fixed
assets.
a. Additions to property, plant and
equipment
– if a company spend on fixed assets
during the current year, this is an
outflow but if a company sold some of
its fixed assets, this would have been
a cash inflow.
b. Net cash used in investing activities
– sum of the investing activities.
Iii. Financing Activities
a. Increase in notes payable
– if a company borrowed from the
bank for this purpose its cash inflow, if
the company repays the loan, this will
be an outflow.
b. Increase in bonds (long-term debt)
– if the company borrowed from
long-term investors, issuing bonds in
exchange for cash, this is an inflow.
When bonds are repaid by the firm, it
is an outflow.
c. Payment of dividends to
stockholders - paid to stockholders
and to be shown as negative
amounts.
d. Net cash provided by financing
activities -sum of the financing
activities
IV. Summary -this section
summarizes the change in cash
and cash equivalents over the year.
a. Net decrease in cash (I,II,III) – net
sum of the operating activities,
investing activities and financing
activities is shown here.
b. Cash and equivalent at the
beginning of the year.
c. Cash and equivalent at the end of
the year.
5. Accounting Policies and Notes to MODULE 3:
Financial Statements
TOOLS & TECHNIQUES IN
- guidelines used in the preparation of FINANCIAL ANALYSIS
the financial statements. Detailed
information not appearing in the 1. Horizontal Analysis
financial statements is also located in
this part for clarification, for instance, - This is used to evaluate the trend in
the method used in depreciating the the accounts over the years. It is
assets (straight-line method, usually shown in comparative financial
sum-of-the-years’ digit method, statements.
declining method), valuation of
inventory (FIFO, LIFO, average), and a. Comparative statements
issuance of capital stocks.
- compared are financial data of two
Limitations of Financial Statement years showing the increases or
decreases in the account balances
1. There are variations in the with their corresponding percentages
application of accounting principles. which evaluate the changes or
There are general standards followed behavior patterns of different accounts
in the application of accounting in financial statement for two or more
principles. The applications vary years.
because of the different methods and
procedures used. For instance, in the
computation of depreciation
expenses, the firm may use the
straight-line method, the sum-of-the
years' digit method or the replacement
method.

2. Financial statements are interim in

nature The financial position and
results of the operation of the
company prepared at every interval,
normally one year, are mere estimates
of what the performance of that firm in
that particular period. Thus, the true
performance of the company will only
be determined upon its liquidation.
3. Financial statements do not reflect
changes in the purchasing power of
the peso. Financial statements are
prepared based on the historical cost
and do not reflect the current market
value of the assets.
B. TREND RATIO
- a firm’s 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.
- It is similar to comparative
statements except that several
consecutive years were used showing
the behavior of the financial data

4. Financial statements do not contain

all the significant facts about the
business. Investors do not rely only on
quantitative factors presented in the
financial statement. They also depend
heavily on other pieces of information
about the company such as the
stockholders, composition of the
board of directors, projects
undertaken, and the overall
performance of the company relative
to the industry, among others.
2. VERTICAL ANALYSIS
- It uses a significant item on the
financial statement as a base value.
All other financial items on the
statements are compared with it.
In a common – size statement, a
significant item on a financial
statement is used as the base value,
and all other items in the financial
statement are compared with it. In
performing common-size analysis for
the balance sheet, total assets are
assigned as the based account with
the percentage of 100.
FORMULA:
Common Size Ratio = (Comparison
Amount/Base Amount) x 100
deciding the actions that a company
should take in the future.
LIQUIDITY RATIO
- It is a company’s ability to meet its
maturing short-term obligations. A
company with poor liquidity may have
a poor credit risk, perhaps because it
is unable to make timely interest and
principal payments

B. FINANCIAL RATIOS - The firm's liquidity also affects its

capacity to borrow.
• Liquidity ratio – is a company’s
ability to meet its maturing short-term - A low liquidity position of a firm will
obligations. A company with poor make loan applications difficult due to
liquidity may have a poor credit risk, poor credit risk.
perhaps because it is unable to make
timely interest and principal payments.

• Activity or asset utilization ratio –

is used to determine how quickly
various accounts are converted into
sales or cash.

• Leverage ratio (solvency) - is the

company’s ability to meet its long-term
obligations as they become due.

• Profitability ratio – shows the

profitability of the operations of the
company. It highlights the firm’s
effectiveness in handling its
operations. Investors will be reluctant
to invest in a company that has poor
earning capacity.

• Market value ratio -related the firm's

stock price to its earnings.

FINANCIAL RATIOS PROVIDE TWO

TYPES OF COMPARISONS:

1. Industry Comparison

Financial ratios are computed and

compared with the industry average.
Through industry comparison, the
company may be able to compare
their performance against their
competitors' and how they fare with
them

2. Trend Analysis

The firm's 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
ACTIVITY RATIO

- Activity ratio or asset management

ratios measure the firm's efficiency in
managing its assets.

- These activity ratios are used to

determine how rapid various accounts
are converted into sales or cash.

- Generally, a high turnover ratio is

associated with good asset
management and low turnover ratio
with bad asset management.

Accounts receivable turnover –

estimates how fast the accounts
receivable is converted into cash
during the year.

- Accounts receivable turnover is

computed by dividing net credit sales
by the average of the beginning and
ending balance of the accounts
receivable.

- Average accounts receivable is

obtained by adding the beginning and
ending accounts receivable and then
dividing the sum by two.

- If there is no net credit sales

information, net sales can be use
RISK AND RETURN TRADE-OFF - Firms with high debt ratio are more
BETWEEN LIQUIDITY AND likely to encounter difficulty in securing
ACTIVITY RATIOS additional funds.

- A trade-off exists between liquidity - Financial institutions that grant loan

risk and return.
- Holding a high amount of current
assets means less liquidity risk and
less returns to the firm.
to firms with a high debt ratio would
like to be compensated for the risk
they are willing to take by charging a
higher interest rate.

- Maintaining a high level of current

assets that productive fixed assets is
a sign of risk aversion of the firm.

- The firm would rather have a small

return on short-term investments on
current assets rather than generate
more income in fixed assets.

- On the other hand, firms invest more

on fixed assets are more exposed to
liquidity risk due to funds tied. Firms
which succeed with fixed asset
investments enjoy more economic
returns to the firm.

- Maintaining a proper balance

between liquidity and return is
important to the overall financial
health of business.

LEVERAGE RATIO

- Leverage ratios indicate up to what

extent the firm has financed its
investments by borrowing.

- Firms that use debt financing rather

than equity financing increase the risk
of the firm.

- The more debt they incur, the higher

their leverage ratio is and the higher
the financial risk they face.

a. Debt Ratio

- It is computed by dividing the total

liabilities of the firm by its total assets.

- This ratio shows the portion of the

total assets financed by the creditors.

- The provider of funds other than the

stockholders prefers to see a low debt
ratio because there is a greater
chance for creditors to collect their
receivables when the firm goes
bankrupt.
MODULE 5