MANAGEMENT ACCOUNTING

1
FINANCIAL STATEMENTS ANALYSIS

PREPARED BY: PROF. DAISY DIAN O. MAGLANGIT

FINANCIAL STATEMENT ANALYSIS

Involves careful selection of data from financial statements for the primary
purpose of forecasting the financial health of the company.
Expected conditions maybe represented by:
a. Predetermined standards
b. Past performance
c. Competitors’ performance or industry average
OBJECTIVES OF FINANCIAL STATEMENT
ANALYSIS

• Managers, investors and lenders analyze financial statements to identify an

organization’s financial strength and weakness.
• Financial statements are essentially historical documents and they tell what
has happened during a particular period of time.
• Most users are concerned about what will happen in the future.
GENERAL APPROACH TO FINANCIAL
STATEMENTS ANALYSIS
1. Background study and evaluation of firm industry, economy and outlook
2. Short-term Solvency Analysis
 refers to the analysis of the company’s ability to meet near term demand for cash and normal operating
requirements.
Some indications:
a. Favorable credit position
b. Satisfactory proportion of cash to the requirements of the current volume
c. Ability to pay current debts in the regular course of business
d. Ability to extend more credit to customers
e. Ability to replenish inventory promptly
3. Capital Structure and Long-Term Solvency Analysis
Pertains to the evaluation of the amount and proportion of debt in a firm’s capital structure to
assess its ability to service debt.
a. Maintain a well-balanced relationship between borrowed funds and equity.
b. Effectively employ borrowed funds and equity.
c. Declare satisfactory amount of dividends to shareholders.
d. Withstand adverse business conditions.
e. Engage in research and development to provide new products or improve method or
processes.
f. Meet their commitment to borrowers and owners.
4. Operating Efficiency and Profitability Analysis
Involves the evaluation of how well assets have been employed by management in terms of
generating revenues and maximizing returns on such resources.
a. Ability to earn satisfactory return on its investment of borrowed funds and equity
b. Ability to control operating costs within reasonable limits
c. Optimum level of investment in assets
5. Other Considerations
I. Quality of Earnings.
a. Meet Internal Earnings Target—represents an important tool in motivating managers to
increase sales and efforts, control costs and use resources more efficiently.
b. Meet External Expectations—companies have the tendency to manage earnings to make
sure that the announced number is at least equal to the earnings expected by analysts.
c. To Even-out Income—the practice of carefully timing the recognition of revenues and
expenses.
d. Provide “window dressing” for an IPO or a loan—window dressing are measures taken by
the management to make the company appear as strong and profitable.
COMMON TECHNIQUES USED TO MANAGE
EARNINGS
1. Strategic Matching: involves timing its transactions so that the large one-time
gains and losses occur in the same period resulting in a smooth upward trend in
reported earnings.
2. Change in methods or estimates with little or no disclosure: some users evaluate
the reported earnings under the incorrect assumption
3. Departure from accounting periods: show more favorable results is” fraudulent
reporting” or deliberate violation of accounting rules.
4. Fictitious Transactions: involves deliberate recording of non-existent revenue
transactions and customers or reporting sales
II. Quality of Assets and relative amount of debt—a financial analyst or user
must look at the composition of assets, their condition or liquidity
III. Transparent Financial Reporting: The Best Practice—better decision
making that reduces the risk to potential investors can place in that
information.
STEPS IN FINANCIAL STATEMENT
1. Establish objectives of the analysis
2. Study the industry in which firm operates and relate industry climate to current and
projected economic development
3. Develop knowledge of the firm and quality of management
4. Evaluate financial statements
a. Horizontal analysis of comparative statements
b. Trend Percentages
c. Common size financial statements
d. Financial ratios

5. Summarize findings based on analysis and reach conclusions

LIMITATIONS OF FINANCIAL STATEMENT

1. Informed derived by the analysis are not absolute measures of performance in any
and all of the areas of business operations.
2. Limitations inherent in the accounting data the analyst works with.
3. Limitations of the performance measures or tools and techniques used in the
analysis.
4. Analysts should be alert to the potential for management to influence the outcome
of financial statements in order to appeal to creditors, investors, and others.
HORIZONTAL ANALYSIS OF COMPARATIVE
STATEMENTS
The study of percentage
changes in comparative
statements.
1. Compute the peso
amount of the change
from the
base(earlier)period to the
later period
TREND PERCENTAGES

• Are index numbers showing

relative changes in financial data
resulting with the passage time.
• Percent change=(current year
amount-base year amount) ÷ base
year amount