0% found this document useful (0 votes)
227 views

Three Kinds of FS Analysis Techniques

The document discusses various techniques for analyzing financial statements: 1) Horizontal analysis compares financial statement items over multiple periods to analyze changes in amounts and percentages. 2) Vertical analysis expresses each financial statement item as a percentage of a total to analyze composition and trends. 3) Ratio analysis uses relationships between financial statement items expressed as percentages or proportions to evaluate performance, efficiency, profitability, and other financial metrics.
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
0% found this document useful (0 votes)
227 views

Three Kinds of FS Analysis Techniques

The document discusses various techniques for analyzing financial statements: 1) Horizontal analysis compares financial statement items over multiple periods to analyze changes in amounts and percentages. 2) Vertical analysis expresses each financial statement item as a percentage of a total to analyze composition and trends. 3) Ratio analysis uses relationships between financial statement items expressed as percentages or proportions to evaluate performance, efficiency, profitability, and other financial metrics.
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
You are on page 1/ 4

Fundamentals of Accounting, Business and Management II

ANALYSIS AND INTERPRETATION OF FINANCIAL STATEMENTS

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

✓Peso change = P250,000 - P175,000 = P75,000


✓Percentage change = (P250,000 - P175,000) / P175,000 = 42.86%
✓This is evaluated as follows: Sales increased by P75,000. This represents growth of 42.86% from 2015 levels.

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.

Cash P 200,000 200,000/1,400,000 = 14.3%


Accounts Receivable 400,000 400,000/1,400,000 = 28.6%
Inventory 250,000 250,000/1,400,000 = 17.9%
Equipment 550,000 550,000/1,400,000 = 39.3% 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

ASSETS LIABILITIES AND STOCKHOLDERS’ EQUITY

Cash P 120,000.00 Accounts Payable P 70,000.00


Marketable Securities P 35,000.00 Short-term notes P 55,000.00
Accounts Receivable P 45,000.00 Current Liabilities P 125,000.00
Inventories P 130,000.00 Long-term debt P 2,700,000.00
Current Assets P 330,000.00 Total Liabilities P 2,825,000.00

Equipment P 2,970,000.00 Common stock P 500,000.00


Buildings P 1,600,000.00 Retained earnings P 1,575,000.00
Fixed Assets P 4,570,000.0 Stockholders’ equity P 2,075,000.00
Total Assets P 4,900,000.00 Total liabilities and equity P 4,900,000

ABM Company
Statement of Financial Performance
for the Year Ended December 31, 2016

Sales Revenue P 2,000,000.00


Cost of Sales/Service P (1,300,000.00)
Gross Profit P 700,000.00
A.Return on equity = 16.98% = 352,240/2,075,000
Operating Expenses P (199,000.00) B. Return on assets = 10.22% = 501,000/4,900,000
Operating Profit P 501,000.00 C. Gross profit margin = 35% = 700,000/2,000,000
Other Income P 5,000.00 D. Operating profit margin = 25.05% = 501,000/2,000,000
Other Expenses P (2,800.00) E. Net profit margin = 17.61% = 352,240/2,000,000
Net Income before Tax P 503,200.00
Income Tax P (150,960.00)
Net Income after Tax P 352,240.00

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.

 Accounts Receivable Turnover = Sales/Accounts Receivable


o Average Collection Period = 365/Accounts Receivable Turnover

 Inventory Turnover = Cost of Goods Sold/Inventory


o Average Age of Inventory = 365/ Inventory Turnover

 Accounts Payable Turnover = Purchases/Accounts Payable


o Average Payment Period = 365/Accounts Payable Turnover

 Operating Cycle = Average Collection Period + Average Age of Inventory


 Cash Conversion Cycle = Operating Cycle - Average Age of Payables
Sample Company
Statement of Financial Position
as of December 31, 2014
ASSETS LIABILITIES AND STOCKHOLDERS’ EQUITY

Cash P 120,000.00 Accounts Payable P 70,000.00


Marketable Securities P 35,000.00 Short-term notes P 55,000.00
Accounts Receivable P 45,000.00 Current Liabilities P 125,000.00
Inventories P 130,000.00 Long-term debt P 2,700,000.00
Current Assets P 330,000.00 Total Liabilities P 2,825,000.00
Equipment P 2,970,000.00 Common stock P 500,000.00
Buildings P 1,600,000.00 Retained earnings P 1,575,000.00
Fixed Assets P 4,570,000.00 Stockholders’ equity P 2,075,000.00
Total Assets P 4,900,000.00 Total liabilities and equity P 4,900,000.00

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

ASSETS LIABILITIES AND STOCKHOLDERS’ EQUITY

Cash P 120,000.00 Accounts Payable P 70,000.00


Marketable Securities P 35,000.00 Short-term notes P 55,000.00
Accounts Receivable P 45,000.00 Current Liabilities P 125,000.00
Inventories P 130,000.00 Long-term debt P 2,700,000.00
Current Assets P 330,000.00 Total Liabilities P 2,825,000.00
Equipment P 2,970,000.00 Common stock P 500,000.00
Buildings P 1,600,000.00 Retained earnings P 1,575,000.00
Fixed Assets P 4,570,000.00 Stockholders’ equity P 2,075,000.00
Total Assets P 4,900,000.00 Total liabilities and equity P 4,900,000.00

Sample Company
Statement of Financial Performance
for the Year Ended December 31, 2014

Sales Revenue P 2,000,000.00 Note:


Cost of Sales/Service P (1,300,000.00)
Gross Profit P 700,000.00 “Other expenses” in the Statement of
Operating Expenses P (199,000.00) Financial Performance is composed only
Operating Profit P 501,000.00 of interest expense.
Other Income P 5,000.00
Other Expenses P (2,800.00) Debt ratio = 57.65%
Net Income before Tax P 503,200.00 Debt-to-equity ratio = 1.3614
Income Tax P (150,960.00) Interest coverage ratio = 180.71
Net Income after Tax P 352,240.00

Liquidity refers to the company’s ability to satisfy its short-term obligations as they come due.

a. Current Ratio = Current Assets/Current Liabilities


b. Quick Ratio = Cash + Marketable Securities + Accounts Receivable/Current Liabilities
• Marketable securities are short-term investments.

ABMCompany
Statement of Financial Position
as of December 31, 2016

Assets Liabilities and Stockholders’ Equity

Cash P 120,000.00 Accounts Payable P 70,000.00


Marketable Securities P 35,000.00 Short-term notes P 55,000.00
Accounts receivable P 45,000.00 Current liabilities P 125,000.00
Inventories P 130,000.00 Long-term debt P 2,700,000.00
Current assets P 330,000.00 Total liabilities P 2,825,000.00

Equipment P 2,970,000.00 Common stock P 500,000.00


Buildings P 1,600,000.00 Retained earnings P 1,575,000.00
Fixed Assets P 4,570,000.00 Stockholders’ equity P 2,075,000.00

Total Assets P 4,900,000.00 Total Liabilities and Stockholders’ Equity P 4,900,000.00

Current ratio = P330,000/125,000 = 2.64


Quick Ratio = P200,000/125,000= 1.60

You might also like