FINANCIAL STATEMENT ANALYSIS

AROCENA, GIRANO V.
CANLAS, JONAS C.
EBBAH, ROBI ANGELO B.
PRE-MBA 102
Financial Statement
Analyzing Financial Statements
Interpret Financial Ratios
Statement of Cash Flows
What is a financial statement?
 These are documents which show where the money came from, where it went,
and where it is now
 The four basic financial statements:
A.) Balance Sheet
B.) Income Statement
C.) Cash Flow Statement
D.) Statement of Shareholder’s Equity
https://www.sec.gov/reportspubs/investor-publications/investorpubsbegfinstmtguidehtm.html
BALANCE SHEET

 It Shows the company’s assets, and liabilities

 It has 2 parts:
- Assets: things that a company owns that
have value
-Liabilities: amount of money that a
company owes to others
 INCOME STATEMENT

 is a report that shows how much revenue a company earned over a specific time
period 
 This report also shows the costs that are associated in earning that revenue
CASH FLOW STATEMENT

 It reports inflows and outflows of company’s cash

 Reports the effect of operating, investing,
and financing activities on cash flows
STATEMENT OF SHAREHOLDER’S EQUITY

 It reports the changes in stockholder’s equity

Advantages of Financial Statement Analysis

 Through Financial Statement Analysis, the company can determine its strengths and weakneses,
 Can help the company can realize if it has adequate liquidity to meet upcoming debts
 Can help reduce production cost and increase “Bottom line”
 Helps determine wether you have enough inventory to meet projected sales figures
 Compare your financial statement analysis values to spot trends and changes that affect the business
Limitations of Financial Statement Analysis

Dependence on historical costs

Differentaccounting methods and techniques in financial statement analysis
Financial statement analysis does not project the actual problems of a
company
Based on specific time period
Subject to fraud.
No discussion of non-financial issues
No predictive value
Analyzing Financial Statements
 There are a number of techniques you can use to perform
financial statement analysis for your business firm, depending
on what you are trying to find out. The financial statements
you want to use in your analysis is the balance sheet, 
income statement, and statement of cash flows. First, you
need to know how to prepare the financial statements. After
learning preparation, financial analysis comes next.

Source: https://www.thebalance.com
Trend Analysis
 Trend analysis is also called time-series analysis. Trend analysis helps a firm's financial manager
determine how the firm is likely to perform over time. Trend analysis is based on historical data from
the firm's financial statements and forecasted data from the firm's pro forma, or forward-looking,
financial statements.
Common Size Financial Statement Analysis
 Common size financial statement analysis, also called a vertical analysis, is just one technique that
financial managers use to analyze their financial statements. It is not another type of income statement, but
is rather a tool used to analyze the income statement.
Interpreting Financial Ratios
 Ratio Analysis compares one indicator to another. Ratios can give you significant
insight into the performance and relative importance of two indicators. A ratio,
which may either, be a percentage, a rate, or simple proportion, expresses the
mathematical relationship between one quantity and another.
 Managers and investors can use ratio analysis to understand the health of an
entity. Ratios lend insight into many critical aspects such as present and future
profit potential, expense control , and solvency.
 Classified into three major groupings: Liquidity, profitability and solvency ratios.

Reference: Ballada, W and Ballada, S. (2016). Accounting Fundamentals Made Easy. Manila: Dynasty Booksource Asia.
Liquidity Ratios
 Creditors and potential creditors are interested in continuously monitoring an entity’s ability to pay interest as it
comes due and to repay the principal of the debt at maturity. An analysis of a firm’s liquid position provides
indicators of its short-term debt-paying ability. It is also used to evaluate management’s current operating
efficiency.
 Measuring the Ability to Pay Current Liabilities.
 Working Capital
 Current Ratio
 Quick Ratio
 Measuring the Ability to Sell Inventory and Collect Receivables
 Account Receivable Turnover
 Average Age of Receivables
 Inventory Turnover
 Average Age of Inventory
 Operating Cycle
Liquidity Ratio
 Working Capital
 Formula: Current Assets - Current Liabilities
 Meaning: This equation describes the amount of capital used to run day to day
business operations. It is necessary to finance an entity’s cash conversion cycle.
 Improved by: Increasing current assets (increase turnaround on accounts
receivable), decrease current liabilities (reduce short term debt), increase net
income to improve cash flow
Liquidity Ratio
 Current Ratio
 Formula: Current Assets / Current Liabilities
 Meaning: Measures the ability of an entity to meet current debt obligations with
assets that are readily available. It is used to evaluate an entity’s liquidity and
short-term debt-paying capacity. A healthy current ratio should be or in excess the
value of 2.0.
 Improve by: Increase current assets by increasing profit, selling additional capital
stock, borrowing additional long term debt, or disposing of unproductive fixed
assets and retaining proceeds. Reduce current liabilities by retaining a greater
portion of allocated savings. Avoid financing non-current assets with current
liabilities.
Liquidity Ratio
 Quick Ratio.
 Formula: Quick Assets / Current Liabilities
 Meaning: Tells whether the entity could pay all its current liabilities even if
none of the inventory is sold. Quick assets are those that may be converted
directly into cash within a short period of time. Creditors generally use the
rule of thumb that a quick ratio of at least 1:1 is satisfactory.
Liquidity Ratio
 Accounts Receivable Turnover
 Formula: Net Credit Sales / Average Net Account Receivable
 Meaning: Measures the entity’s ability to collect from credit customers. It
indicates the number of times that the average balance of accounts receivable
is collected during the period. In general, the higher the ratio, the more
successfully the business collects cash.
 Improve by: Tightening credit policies and by more proactively seeking
payment of outstanding accounts.
Liquidity Ratio
 Average Age of Receivables.
 Formula: 365 days / Accounts Receivable Turnover
 Meaning: Provides a rough approximation of the average time that it takes to
collect receivables. The general rule is that the collection period should not
materially exceed the credit period.
Liquidity Ratio
 Inventory Turnover
 Formula: Cost of Goods Sold / Average Merchandise Inventory
 Meaning: Is a measure of the number of times an entity sold its average level
of inventory during the period. A high rate of turnover indicates relative ease
in selling inventory. Cost of goods sold is used instead of net sales because
both cost of goods sold and merchandise inventory are stated at cost. Higher
inventory turnover ratios generally increase profitability since an entity can
use the cash normally tied up in inventory for higher return investments.
Liquidity Ratio
 Average Age of Inventory
 Formula: 365 days / Inventory Turnover
 Meaning: Provides a rough measure of the length of time it takes to acquire,
sell and replace inventory.
Liquidity Ratio
 Operating Cycle
 Formula: Average age of inventory + Average Age of Receivables
 Meaning: Measures the average time period between buying the inventory and
receiving cash form its sales.
Profitability Ratios
 Profitability ratios are a class of financial metrics that are used to assess a
business's ability to generate earnings compared to its expenses and other relevant
costs incurred during a specific period of time. For most of these ratios, having a
higher value relative to a competitor's ratio or relative to the same ratio from a
previous period indicates that the company is doing well.
 Return on Total Assets
 Return on Ordinary Equity
 Basic Earning Per Ordinary Share
 Price-Earning Ratio
 Dividend Yield
Profitability Ratios

 Return on Total Assets

 Formula: (Profit + Interest Expense) / Average Total Assets
 Meaning: Is a measure of managements’ efficiency in using its assets to earn
profits
Profitability Ratios

 Return on Ordinary Equity

 Formula: (Profit – Preference Dividends) / Average Ordinary Equity
 Meaning: Shows the relationship between profit and ordinary shareholder’s
investment in the entity. Average ordinary equity is an approximation of the
amount invested by group of owners throughout the year.
Profitability Ratios

 Basic Earnings Per Ordinary Share

 Formula: (Profit – Preference Dividends) / Average Number of Ordinary Shares
Outstanding
 Meaning: Is a measure of the profit earned on each ordinary share.
 Improve by: increasing profit can directly increase earnings per share by
providing highly demanded products or services in a cost-effective manner.
Profitability Ratios
 Price – Earning Ratio (P/E)
 Formula: Market Price Per Ordinary Share / Basic Earning Per Ordinary Share
 Meaning: Indicates the degree to which investors value an entity. When
investors pay a high price for a given amount of corporate earnings, they
increase the entity’s P/E ratio.
 The higher the P/E ratio, the more potential investors typically see in the
particular entity. Corporations with higher P/E ratios tend to have higher growth
rates and deliver products and services that will probably be in demand for a
significant time into the future.
Profitability Ratios

 Dividend Yield
 Formula: Cash Dividends Per Ordinary Share / Market Price per Ordinary Share
 Meaning: The ratio of dividends per share to the share’s market price. Measures
the percentage of a share’s market value that is returned annually as dividends.
Solvency ratios
 Solvency Ratios measure the ability of an entity to survive over a long period of
time. Long term creditors and shareholders are interested in the long-run
solvency, particularly its ability to pay interest as it comes due and repay the
principal of the debt at maturity.
 Time Interest Earned ratio
 Debt to Total Assets Ratio
 Equity to Total Assets ratio
Solvency Ratios

 Time Interest Earned Ratio

 Formula: Profit Before Interest Expense and Income taxes / Annual Interest
Expense
 Meaning: Is a measure how readily an entity can meet interest payments with
profit earned from operations. The times interest earned ratio indicates the margin
of safety provided by current earnings in meeting the entity’s interest
responsibilities.
 Improve by: Paying off debt and reducing interest expense and/or increasing
operations profitability.
Solvency Ratios

 Debt to Total Assets Ratio / Debt Ratio

 Formula: Total Liabilities / Total Assets
 Meaning: Shows the percentage of the entity’s assets financed by debt. Higher
ratios indicate that an entity has financed a large portion of assets with debt.
Solvency Ratios

 Equity to Total Assets Ratio / Equity Ratio

 Formula: Total Equity / Total Assets
 Meaning: Shows the percentage of the firm’s assets financed by shareholders.
The higher the ratio, the smaller the risk that the entity will be unable to meet
its obligations when due.
Statement of Cash Flows

 The cash flow statement is distinct from the income statement and balance sheet
because it does not include the amount of future incoming and outgoing cash that
has been recorded on credit. Therefore, cash is not the same as net income, which
on the income statement and balance sheet, includes cash sales and sales made on
credit.
 Cash flow is determined by looking at three components by which cash enters and
leaves a company: core operations, investing and financing,
 Operations. Measuring the cash inflows and outflows caused by core business operations, the operations
component of cash flow reflects how much cash is generated from a company's products or services.

 Example of Operating Activities

Cash Inflow
Receipts from sales of goods and performance of services
Receipts from royalties, fees, commissions and other revenues
Cash Outflow
Payments to suppliers of goods and services
Payment to employees
Payment for taxes
Payment for interest expense
Payment for another operating expenses

Source : http://www.investopedia.com
 Investing. Changes in equipment, assets, or investments relate to cash from investing. Usually, cash
changes from investing are a "cash out" item, because cash is used to buy new equipment, buildings, or
short-term assets such as marketable securities.

 Example of Investing Activities

 Cash Inflows
 Receipts from sale of property and equipment
 Receipts from sale of investments in debt or equity securities
 Receipts from collection on notes receivable
 Cash Outflow
 Payments to acquire property and equipment
 Payments to acquire dept or equity securities
 Payments to make loans to others generally in the form of notes receivable
 Financing. Changes in debt, loans or dividends are accounted for in cash from financing. Changes in
cash from financing are "cash in" when capital is raised, and they're "cash out" when dividends are
paid.

 Examples of Financing Activities

 Cash Inflows
 Receipts from investments by owners
 Receipts from issuance of notes payable
 Cash Outflow
 Payment to owners in the form of withdrawals
 Payments to settle notes payable
A company can use a cash flow statement to predict future cash
flow, which helps with matters in budgeting. For investors, the
cash flow reflects a company's financial health: basically, the
more cash available for business operations, the better. However,
this is not a hard and fast rule. Sometimes a negative cash flow
results from a company's growth strategy in the form of
expanding its operations