FINANCIAL

ANALYSIS

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Financial statement analysis is an integral part

of the interpretation of results disclosed by
financial statements. It supplies to decision
makers crucial financial Information and points
out the problem areas which can be
investigated. It is also useful for external
decision makers in the process of making critical
decisions concerning the business firms.

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Objectives:
1. To know how to use financial statements data in the
computation of financial ratios.
2.To know the different types and groups of financial
ratios.
3.To interpret the results of ration analysis.
4.To make financial decisions based on ratio analysis

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Financial analysis is a process of selecting,
evaluating, and interpreting financial data, along
with other pertinent information, in order to
formulate an assessment of a company’s present
and future financial condition and performance.

Financial
Market Data Disclosures

Economic
Data

Financial Analysis

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Financial analysis - is the selection,
evaluation, and interpretation; of financial data,
along with other pertinent information, to assist
in investment and financial decision-making.

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 COMMON-SIZE ANALYSIS
Common-size analysis is the restatement of financial statement information in
a standardized form.
- Horizontal common-size analysis uses the amounts in accounts in a
specified year as the base, and subsequent years’ amounts are stated as a
percentage of the base value.
- Useful when comparing growth of different accounts over time.
- Vertical common-size analysis uses the aggregate value in a financial
statement for a given year as the base, and each account’s amount is
restated as a percentage of the aggregate.
- Balance sheet: Aggregate amount is total assets.
- Income statement: Aggregate amount is revenues or sales.

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 EXAMPLE: COMMON-SIZE ANALYSIS
Consider the CS Company, which reports the following financial information:
Year 2008 2009 2010 2011 2012 2013
Cash P400.00 P404.00 P408.04 P412.12 P416.24 P420.40
Inventory 1,580.00 1,627.40 1,676.22 1,726.51 1,778.30 1,831.65
Accounts receivable 1,120.00 1,142.40 1,165.25 1,188.55 1,212.32 1,236.57
Net plant and equipment 3,500.00 3,640.00 3,785.60 3,937.02 4,094.50 4,258.29
Intangibles 400.00 402.00 404.01 406.03 408.06 410.10
Total assets P6,500.00 P6,713.30 P6,934.12 P7,162.74 P7,399.45 P7,644.54

1. Create the vertical common-size analysis for the CS Company’s assets.

2. Create the horizontal common-size analysis for CS Company’s assets, using
2008 as the base year.

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 EXAMPLE: COMMON-SIZE ANALYSIS
Vertical Common-Size Analysis:
Year 2008 2009 2010 2011 2012 2013
Cash 6% 6% 5% 5% 5% 5%
Inventory 23% 23% 23% 23% 22% 22%
Accounts receivable 16% 16% 16% 15% 15% 15%
Net plant and equipment 50% 50% 51% 51% 52% 52%
Intangibles 6% 6% 5% 5% 5% 5%
Total assets 100% 100% 100% 100% 100% 100%

Graphically:
100%

Proportion 50%
of Assets
0%
2008 2009 2010 2011 2012 2013
Fiscal Year

Cash Inventory Accounts receivable

Net plant and equipment Intangibles
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 EXAMPLE: COMMON-SIZE ANALYSIS
Horizontal Common-Size Analysis (base year is 2008):
Year 2008 2009 2010 2011 2012 2013
Cash 100.00% 101.00% 102.01% 103.03% 104.06% 105.10%
Inventory 100.00% 103.00% 106.09% 109.27% 112.55% 115.93%
Accounts receivable 100.00% 102.00% 104.04% 106.12% 108.24% 110.41%
Net plant and equipment 100.00% 104.00% 108.16% 112.49% 116.99% 121.67%
Intangibles 100.00% 100.50% 101.00% 101.51% 102.02% 102.53%
Total assets 100.00% 103.08% 106.27% 109.57% 112.99% 116.53%

Graphically:
130%
120%
Percentage
of Base 110%
Year 100%
Amount 90%
2008 2009 2010 2011 2012 2013

Fiscal Year

Cash Inventory Accounts receivable Net plant and equipment Intangibles Total assets

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 FINANCIAL RATIO ANALYSIS
• Financial ratio analysis is the use of relationships among financial statement
accounts to gauge the financial condition and performance of a company.
• We can classify ratios based on the type of information the ratio provides:

Liquidity Solvency Profitability

Activity Ratios
Ratios Ratios Ratios
Ability to
efficiently Ability to
leverage Ability to meet manage
Ability to
company short-term, expenses to
satisfy debt
assets to immediate produce
generate obligations.
obligations. profits from
revenue or sales.
cash

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ACTIVITY RATIOS
• Turnover ratios reflect the number of times assets flow into and out of the
company during the period.
• A turnover is a gauge of the efficiency of putting assets to work.
• Ratios:
Inventory turnover = How many times inventory is
created and sold during the
period.

How many times accounts

receivable are created and
collected during the period.

The extent to which total

assets create revenues during
the period.

The efficiency of putting

working capital to work

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OPERATING CYCLE COMPONENTS
• The operating cycle is the length of time from when a company makes an
investment in goods and services to the time it collects cash from its accounts
receivable.
• The net operating cycle is the length of time from when a company makes an
investment in goods and services, considering the company makes some of its
purchases on credit, to the time it collects cash from its accounts receivable.
• The length of the operating cycle and net operating cycle provides information
on the company’s need for liquidity: The longer the operating cycle, the greater
the need for liquidity.
Number of Days of Inventory Number of Days of Receivables

| | | |

Buy Inventory on Pay Accounts Sell Inventory on Collect Accounts

Credit Payable Credit Receivable

Number of Days of Payables Net Operating Cycle

Operating Cycle

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OPERATING CYCLE FORMULAS

Average time it
takes to create
and sell
inventory.
Average
Average time
time it
it
takes to
takes to collect
collect
on
on accounts
accounts
receivable.
receivable.

Average
Average time
time it
it
takes to
takes to pay
pay
suppliers.
suppliers.

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OPERATING CYCLE FORMULAS

Time from investment in

inventory to collection
of accounts.

Time from investment in

inventory to collection
of accounts,
considering the use of
trade credit in
purchases.

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LIQUIDITY
• Liquidity is the ability to satisfy the company’s short-term obligations using
assets that can be most readily converted into cash.
• Liquidity ratios:

Ability to satisfy current

liabilities using current assets.

Ability to satisfy current

liabilities using the most liquid
of current assets.

Ability to satisfy current

liabilities using only cash and
cash equivalents.

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SOLVENCY ANALYSIS
• A company’s business risk is determined,
in large part, from the company’s line of
business. Risk
• Financial risk is the risk resulting from a
company’s choice of how to finance the
business using debt or equity. Business Financial
• We use solvency ratios to assess a Risk Risk
company’s financial risk.
• There are two types of solvency ratios:
component percentages and coverage Sales Risk
ratios.
- Component percentages involve
comparing the elements in the capital
structure. Operating
Risk
- Coverage ratios measure the ability to
meet interest and other fixed financing
costs.

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SOLVENCY RATIOS
Proportion of assets financed with debt.
Proportion of assets financed with long-
term debt.

Debt financing relative to equity

financing.
Reliance on debt financing.
Component-Percentage Solvency Ratios

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PROFITABILITY
• Margins and return ratios provide information on the profitability of a company
and the efficiency of the company.
• A margin is a portion of revenues that is a profit.
• A return is a comparison of a profit with the investment necessary to generate
the profit.

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PROFITABILITY RATIOS: MARGINS
•Each
  margin ratio compares a measure of income with total revenues:

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 PROFITABILITY RATIOS: RETURNS
•  
Return ratios compare a measure of profit with the investment that
produces the profit:

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Using the financial statements below, different ratios were computed as follows:
Bartlett Company Income Statement (P000)
For the Year Ended

  December 31
Sales revenue P3,074.00 P2,567.00
Less: Cost of Goods Sold 2,088.00 1,711.00
Gross Profits P 986.00 P 856.00
Less: Operating Expenses    
Selling expenses 100.00 108.00
General and administrative expenses 194.00 187.00

Lease expense 35.00 35.00

Depreciation expenses 239.00 223.00
Total Operating Expenses P 568.00 P 553.00
Operating Profits P 418.00 P 303.00
Less: Interest expenses 93.00 91.00
Net Profits before Taxes P 231.00 P 148.00
Less: Preferred stock dividends 10.00 10.00
Earnings available for common P 221.00 P 138.00
stockholders
Earnings per Share P 2.90 P 1.81
Dividends per Share P 1.29 P 0.75

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   December 31
Assets 2009 2008
Current Assets    
Cash P 363.00 P 288.00
Marketable securities 68.00 51.00
Accounts receivable 503.00 365.00
Inventories 289.00 300.00

Barttlett Total Current Assets

Gross Fixed Assets
P 1,223.00
 
P 1,004.00
 
Land and Building P2.072.00 P1,903.00

Corporation Machinery and equipment

Furniture and fixtures
1,866.00
358.00
1,693.00
316.00

Balance Vehicles
Others
275.00
98.00
314.00
96.00

Sheet (2008
Total Gross Fixed Assets P4,669.00 P4,322.00
Less: accumulated depreciation 2,295.00 2,056.00
Net Fixed Assets P2,374.00 P2,266.00

& 2009) Total Assets

Liabilities & Stockholders’ Equity
P3,597.00
 
P3,270.00
 
Current liabilities    
Accounts payable P 382.00 P 270.00
Notes payable 79.00 99.00
Accruals 159.00 114.00
Total current liabilities P 620.00 P 483.00
Long-term debt (includes financial leases) P 1,023.00 P 967.00
Total Liabilities P 1,643.00 P 1,450.00
Stockholders’ Equity    
Preferred stock – cumulative 5%, P100 par, 2,000 shares P 200.00 P 200.00
authorized and issued

Common stocks – P2.50 par, 100,000 shares authorized, shares 191.00 190.00
issued and outstanding in 2009; 76,262; 76,244

Paid-In Capital in Excess of Par 428.00 418.00

Retained Earnings 1,135.00 1,012.00
Total Stockholders’ Equity P 1,954.0 P1,820.00
Total liabilities and Stockholders’ Equity P 3,597.00 P3,270.00

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 SUMMARY
• Financial ratio analysis and common-size analysis help gauge the financial
performance and condition of a company through an examination of
relationships among these many financial items.
• A thorough financial analysis of a company requires examining its efficiency in
putting its assets to work, its liquidity position, its solvency, and its profitability.
• We can use the tools of common-size analysis and financial ratio analysis,
including the DuPont model, to help understand where a company has been.
• We then use relationships among financial statement accounts in pro forma
analysis, forecasting the company’s income statements and balance sheets for
future periods, to see how the company’s performance is likely to evolve.

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