Basic Financial Statement Analysis

Financial Statement Analysis

• Is the process which examines past and current financial data for the
purpose of evaluating financial position and performance and
estimating future risks and potential.

• Is an exceptionally powerful tool for a variety of users of financial

statements, each having different objectives in learning about the
financial circumstances of the entity.
Financial Statement Analysis
FINANCIAL POSITION

RESULTS OF OPERATIONS

Financial Statements inform the

CASH FLOWS
readers of a company’s
CHANGES IN EQUITY

However, these information are not sufficient to help readers make decisions about the business. That is
why we need tools or techniques on financial statements in order to have a better understanding of the
business.
Financial Statement Analysis is the process of evaluating risks, performance, financial health and future
prospects of a business using computational and analytical techniques with the objective of making
economic decisions.
Uses of Financial Statement Analysis
• Identify major changes or turning points in trends, amounts, and relationships.
• Assist investors and creditors in finding the type of information they require for
making decisions relating to their interests in a particular company
• Assessment of past performance and current position
• Assessment of future potential and related risk
Users of Financial Statement Analysis
There are a number of users of financial statement analysis. They are:
• Creditors. Anyone who has lent funds to a company is interested in its ability to pay back the debt,
and so will focus on various cash flow measures.
• Investors. Both current and prospective investors examine financial statements to learn about a
company's ability to continue issuing dividends, or to generate cash flow. To determine whether to
buy, hold or sell their investments in the business.
• Employees. To determine the stability and profitability of employers
• Lenders. To determine the ability of the borrowers to pay loans granted to them on time.
• Suppliers. To determine the ability of the customer to remain as a continuing buyer.
Users of Financial Statement Analysis
There are a number of users of financial statement analysis. They are:
• Management. To determine the activities of the enterprise for planning, organizing, leading and
controlling.
• Customer. To determine the ability of the enterprise to be a continuing source of supply.
• Regulatory authorities. If a company is publicly held, its financial statements are examined by the
Securities and Exchange Commission to see if its statements conform to the various accounting
standards and the rules of the SEC.
• Government Agencies. To determine the capacity of the enterprise to pay taxes and its tax
compliance.
Methods of Financial Statement Analysis

• Horizontal and Vertical Analysis

• Ratio methods
Horizontal Analysis/Trend Analysis
The comparison of historical financial information over a series of reporting periods
Horizontal Analysis
It is a technique for evaluating a series of financial statement data over a period of time.
Horizontal Analysis involves sidewise comparison.
Horizontal Analysis uses financial statements of two or more periods. It may be performed on all
financial statements, specifically for both SFP and SCI
Changes can be expressed in monetary value (PESO) or percentages computed by using the
following formulas;
Peso Change = Balance of Current Year – Balance of Prior Year
Percentage Change = Peso Change____
Balance of Prior Year
Horizontal Analysis of the Balance Sheet
20x4 20x3 Variance Percent
Cash P205,000 P182,500 P22,500 12%
Accounts Receivable 410,000 485,000 (75,000) (15%)
Inventory 886,000 575,000 311,000 54%
Prepaid Expenses 139,000 112,500 26,500 24%
T. Current Assets 1,640,000 1,355,000 285,000 21%
Fixed Assets 2,460,000 2,395,000 65,000 3%
Total Assets P4,100,000 P3,750,000 P350,000 9%

Accounts Payable P347,500 P455,000 (P107,500) (24%)

Taxes Payable 202,500 145,000 57,500 40%
T. Current Liab 550,000 600,000 (50,000) 8%
T. Non Current Liab. 1,500,000 1,500,000 -0- -0-
T. Liabilities 2,050,000 2,100,000 (50,000) (2%)
114%
Owner’s Equity 2,050,000 1,650,000 400,000 24%
Total Liab & Equity P4,100,000 P3,750,000 P350,000 9%
Horizontal Analysis of the Income Statement
20x4 20x3 Variance Percent
Net Sales P4,000,000 P3,500,000 P500,000 14%
Cost of goods sold 2,400,000 2,170,000 230,000 11%
Gross Income from 1,600,000 1,330,000 270,000 20%
Sales

Selling Expenses 800,000 735,000 65,000 9%

Admin. Expenses 435,000 420,000 15,000 4%
T. Operating Exp 1,235,000 1,155,000 80,000 7%

See other line Items on your textbook

Net income after Tax P300,000 P168,375 P131,625 78%

Interpretations
By reading the result of Horizontal Analysis, the user is able to note significant changes
*Accounts receivable decreased by 15% in 20X4, whereas Net sales increased by 14%
Reduction in AR may mean increased collection effort; it may also mean that less customers
purchased on credit. (FAVORABLE)
*Inventories increased by 54% in 20x4, whereas the COGS increased by only 11%
It is FAVORABLE, if the reason for building up inventories is due to expectation of an increase
in sales in the following year.
It is UNFAVORABLE, if the change is due to over purchasing.
Vertical Analysis/
Common Size Analysis
The proportional analysis of a financial statement, where each line item on a financial
statement is listed as a percentage of another item.
Vertical Analysis

Vertical analysis is a technique that expresses each common size financial statement line item as a
percentage of a base amount. This means that every line item on an income statement is stated as a
percentage of sales, while every line item on a balance sheet is stated as a percentage of total assets.
For the SFP, the base amount used is the total assets. On the other hand, sales or net sales is used as
base amount for the SCI.
JC Trading Company
Statement of Financial Position
As of Decemebr 31
2014 % 2013 %
Cash and Cash Equivalents 470,310.00 5.46 519,860.00 6.42
Accounts Receivable 660,110.00 7.66 565,170.00 6.98
Inventory 653,060.00 7.58 555,480.00 6.86
Prepaid Expenses 173,740.00 2.02 228,820.00 2.83
Total Current Assets 1,957,220.00 22.72 1,869,330.00 23.10
Property, Plant and Equipment, net 5,910,530.00 68.62 5,501,660.00 67.98
Intangible Assets 745,200.00 8.65 721,900.00 8.92
Total Assets 8,612,950.00 100 8,092,890.00 100

Current Liabilities 1,273,050.00 14.78 1,123,700.00 13.89

Long-Term Liabilities 577,580.00 6.71 541,540.00 6.69
Total Liabilities 1,850,630.00 21.49 1,665,240.00 20.58
JC, Capital 6,762,320.00 78.51 6,427,650.00 79.42
Total Liabilities and Owner's Equity
8,612,950.00 100 8,092,890.00 100
JC Trading Company
Statement of Comprehensive Income
For the year ended
2014 % 2013 %
Sales Revenue 5,385,860.00 100 4,921,850.00 100
Cost of Goods Sold 1,374,790.00 25.5 1,254,860.00 25.5
Gross profit 4,011,070.00 74.50 3,666,990.00 74.5
Selling and Administrative Expense 3,406,460.00 63.20 3,127,150.00 63.5
Operating Income 604,610.00 11.20 539,840.00 11
Interest Expense 11,820.00 0.20 23,040.00 0.5
Net Income 592,790.00 11.00 516,800.00 10.5
Interpretation
A trading company is one that buys and sells inventory with minimal processing.
• Total current assets composed of 22.7% of total assets.
• The largest asset is PPE at 68.6% of total assets. This could be delivery equipment or store
facilities.
• The company’s financing mix is 21% liability and 79% equity.
• The largest expense is selling and administrative expense at 63% of sales mainly because their
operation is largely about selling activities.
• Net income is consistently at 11% of sales.