INTRODUCTION TO

ANALYSIS OF FINANCIAL
STATEMENTS
 Financial Statement Analysis
Is the process of selecting related data
from financial statements to evaluate
the entity’s past financial position and
operating performance and predict the
outcome of future operations.
 Significance of Financial Statement Analysis

Analyzed and User’s Decision

Interpreted Making Process
Financial Statements
 Analysis of Financial Statements
involves the process of evaluating a
particular accounting value in relation
to other accounting values.
Financial Statement analysis involves
the process of relating and
cross-referencing the data with other
accounting information provided in
the financial statements.
Illustration 1: The comparative current assets of JENNY Merchandising is
presented as follows:
2018 2017
Cash and Cash Equivalents 105,000 102,000
Trade and Other Receivables 327,000 276,000
Inventory 334,000 295,000
Prepaid Expenses 100,000 114,000
Total Current Assets 866,000 787,000

a. That there is cash of P105,000 in 2018 which is higher by P3,000 in 2017;

b. That the trade and other receivables is P327,000 at the end of 2018; or
c. That the inventory increased to P334,000 in 2018 from P295,000 in 2017
THIS IS NOT FINANCIAL STATEMENT ANALYSIS
 Type of information provided by the Financial
Statements:
a. Financial Position
b. Result of financial operation
c. Cash flows
d. Management stewardship of resources
 Basic Objective
To assist the different
users in the
decision-making
process.
 PROCEDURES in Analyzing the Financial Statement

1. Establish the objective of the financial statement

analysis
2. Gather complete information about the firm and
study the industry in which the firm operates.
3. Perform mathematical analysis using the
applicable tools
4. Make conclusions relative to the established
objectives.
The different objectives of the analysis are usually directed towards the following
concerns:

1. Liquidity – refers to the ability of the business to pay current maturing financial
obligations.

2. Solvency or stability – refers to the ability of an entity to settle long-term debt

when they mature and still remain stable.

3. Profitability – refers to the ability of an entity to earn an income equal to or above

the industry and also reflects the efficiency of the management in utilizing the
resources entrusted to them.
Highlights in Reading the Financial
Statement
 Statement of Financial Position
1. Contained financial data about the liquidity and solvency or
stability of the business.

2. The SFP presents the 2 major activities: the investing and

financing activity.

3. The structure of the SFP is divided into 2 parts by the following

equation: Assets = Liabilities + Owner’s Equity.
 Statement of Financial Position
4. The left side of the equation refers to the investing activities of the business
like short term investment and non-current assets.

5. The right side represents the financing activities of the business which
includes the short-term debts, long-term debts and the owner’s equity.

6. The assets which are used to operate the company in various investing
activities should equal to the financial obligations and equity of the owners
which represent the financing activities.
 Statement of Financial Position
7. The SFP also reflects the management stewardship of resources to increase
shareholders’ interest.

8. Financial leverage refers to the ability of the business to use debt to finance business
activity, like borrowing money from the banks to finance plant expansion. It aims to
achieve higher results with relatively small amount of investment from owners.

9. Financial leverage may either be positive or negative.

 Statement of Comprehensive Income
1. The SCI contained financial information about the profitability of the business.

2. It reflects the different operating activities of the business.

3. It shows the revenues earned and expenses recognized for a particular period.

4. Revenue represents the single item that reflects the strength of the company in
terms of profitability. Thus, it has been considered that the best way for the
business to improve profitability is by increasing its sales revenue.
 Statement of Comprehensive Income
5. Gross margin evaluation may indicate the margin of profit to cover
operating expenses. Hence, higher gross profit margin is generally
favorable to the company.

6. The data on earnings per share, should be reported on the face of

the SCI, It is the very important barometer for the investors.

7. The operating activities are highly affected by current assets and

current liabilities, therefore, the SCI are generally
cross-referenced to the SFP.
 Statement of Cash Flows
1. The statement of cash flows contained information about the
inflow and outflow of cash during a period.
2. It accounts for the change in cash shown in the statement of
financial position & accounts in the SCI affecting cash and cash
equivalents.
3. The sources and application of cash and cash equivalents are
broken down into investing, financing, and operating activities.
4. It is useful in determining the liquidity of the business, and its
ability to change cash flows in the future.
5. Generally, the net income of the business is considered to be of
high quality if cash from operating activities is higher than the net
income.
Users and Their Interests in
Analyzing The Financial
Statement
 USERS AREAS OF INTEREST
- Primarily interested on the liquidity of the business
- Analysis focuses on the following:
1. Short-term investors a. Current asset
b. Current liabilities; and
c. Cash flows from operation
- Primarily interested on the following:
a. Growth of the business
b. Solvency status
c. Financial leverage
2. Long-term investors d. Risks of investments
- Analysis gives heavier weight on the following:
a. non-current assets;
b. Long-term debt; and
c. Cash from financing activities
 USERS AREAS OF INTEREST
- Primarily interested on the ability of the
business to pay interest
- Analysis focuses on the following:
3. Lenders/Financial institutions
a. Cash position of the business
b. Financial leverage
c. solvency
- Primarily interested on the capacity of
the business to pay amounts owed to
them
4. Suppliers/creditors
- Analysis focuses on the following:
a. Net working capital
b. Cash position
 USERS AREAS OF INTEREST
- Primarily interested on the ability of the business to:
a. Pay proper remuneration;
b. Provide retirement benefits; and
5. Employees c. Extend employees opportunities
- Analysis focuses on the following:
a. Profitability
b. solvency
- Primarily interested on compliance with tax regulations
and reportorial requirements
- Analysis focuses compliance on the following:
a. Tax withheld and remittances
6. Government
b. Interest withheld and paid
c. Mandatory deductions
d. Social responsibility
e. Mandatory wages and benefits
 LIMITATIONS OF
FINANCIAL STATEMENT
ANALYSIS
 1. The results of quantitative analysis are just
only indicators of the company’s liquidity,
solvency and profitability. The results are not
absolute status of entity’s financial performance.
 2. Different thresholds among
companies. An entity may set its
current ratio at a level which may not
be acceptable to another company.
3. Financial data do not reflect changes
in the purchasing power.
 4. Differences in the application of
accounting methods and estimates.
5. Differences in valuation and
measurement.
 6. The tendency for the management
to show favorable financial statements
in order to win the confidence of
investors and creditors.