Three Kinds of FS Analysis Techniques
Three Kinds of FS Analysis Techniques
Financial statement (FS) analysis is the process of evaluating risks, performance, financial health, and future prospects of a
business by subjecting financial statement data to computational and analytical techniques with the objective of making
economic decisions.
Three kinds of FS analysis techniques:
1) Horizontal analysis
2) Vertical analysis
3) Financial ratios
Horizontal Analysis-Also called trend analysis, is a technique for evaluating a series of financial statement data over a period of
time with the purpose of determining the increase or decrease that has taken place.
o Horizontal analysis uses financial statements of two or more periods.
o All line items on the FS may be subjected to horizontal analysis.
o Only the simple year-on-year (Y-o-Y)grow this covered in this lesson.
o Changes can be expressed in monetary value (peso) and percentages computed by using the following
formulas:
Peso change=Balance of Current Year-Balance of Prior Year
Percentage change= (Balance of Current Year-Balance of Prior Year)/(Balance of Prior Year
2015 2016
Sales P175,000.00 P250,000.00
Vertical analysis-Also called common-size analysis, is a technique that expresses each financial statement item as a percentage of
a base amount.
For the SFP, the base amount is Total Assets.
Balance of Account / Total Assets.
Ratio analysis expresses the relationship among selected items of financial statement data. The relationship is
expressed in terms of a percentage, a rate, or a simple proportion (Weygandtet.al. 2013). A financial ratio is
composed of a numerator and a denominator.
Profitability refers to the company’s ability to generate earnings. It is one of the most important goals of businesses.
Profitability Ratios:
a. Return on equity measures the amount of net income earned in relation to stockholders’ equity.
ROE (return on equity) = Net income ÷ Stockholders’ equity
b. Return on assets measures the ability of a company to generate income out of its resources/assets.
ROA (return on asset) = Operating income ÷ Total assets
c. Gross profit margin shows how many pesos of gross profit is earned for every peso of sale. It provides
information regarding the ability of a company to cover its manufacturing cost from its sales.
Gross profit margin = Gross profit ÷ Sales
d. Operating profit margin shows how many pesos of operating profit is earned for every peso of sale. It measures
the amount of income generated from the core business of a company.
Operating profit margin =Operating profit ÷ Sales
e. Net profit margin measures how much net profit a company generates for every peso of sales or revenues that
it generates.
Net profit margin = Net income ÷ Sales
ABM Company
Statement of Financial Position
as of December 31, 2016
ABM Company
Statement of Financial Performance
for the Year Ended December 31, 2016
Efficiency refers to a company’s ability to be efficient in its operations. Specifically, it refers to the speed with which
various current accounts are converted into sales, and ultimately, cash.
Sample Company
Statement of Financial Performance
for the Year Ended December 31, 2014
Sales Revenue P 2,000,000.00
Cost of Sales/Service P (1,300,000.00)
Accounts receivable turnover: 44.4x
Gross Profit P 700,000.00 Average collection period: 8.2 days
Operating Expenses P (199,000.00) Inventory turnover: 10x
Operating Profit P 501,000.00 Average age of inventory: 36.5 days
Other Income P 5,000.00 Accounts payable turnover: 18.57x
Other Expenses P (2,800.00) Average payment period: 19.65 days
Net Income before Tax P 503,200.00 Total asset turnover: 0.41x
Income Tax P (150,960.00) Operating cycle: 44.7 days
Net Income after Tax P 352,240.00
Cash conversion cycle: 25.05 days
Notes:
For purchases, if there is no beginning inventory given, it is sufficient to use cost of goods sold as a substitute number, if
there is no other information given; For the number of days in a year, 365 or 360 maybe used.
Financial leverage refers to the company’s use of debt. It defines the company’s capital structure which indicates how
much of the total assets are financed by debt and equity.
Debt ratio – This ratio measures the proportion of total assets finance by total liabilities or money provided
by creditors (not by the business owners).
Debt Ratio = Total Liabilities/Total Assets
Debt-to-equity ratio – A variation of debt ratio, shows the proportion of debt to equity.
Debt-to-Equity Ratio = Total Liabilities/Total Equity
• Interest coverage ratio – This ratio shows the company’s ability to pay its fixed interest charges in relation
to its operating income or earnings before interest and taxes.
Interest coverage ratio= Earnings before interest and taxes/Interest Expense
Sample Company
Statement of Financial Position
as of December 31, 2014
Sample Company
Statement of Financial Performance
for the Year Ended December 31, 2014
Liquidity refers to the company’s ability to satisfy its short-term obligations as they come due.
ABMCompany
Statement of Financial Position
as of December 31, 2016