A N A LY S I S A N D I N T E R P R E TAT I O N

O F F I N A N C I A L S TAT E M E N T S 1
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 (White et.al
1998)
THERE ARE THREE KINDS OF FS
ANALYSIS TECHNIQUES
• : - Horizontal analysis
• - Vertical analysis
• - 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 This will
reveal the behavior of the account over time. Is it
increasing, decreasing or not moving? What is the
magnitude of the change? Also, what is the relative
change in the balances of the account over time? -
• - Horizontal analysis uses financial statements of two or more periods.
- All line items on the FS may be subjected to horizontal analysis.
- Only the simple year-on-year (Y-o-Y)grow this covered in this lesson. -
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) • Example:
• Vertical anaylsis, 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.
• From the common-size SFP, the analyst can infer the
composition of assets and the company’s financing
mix.
• Example:
• For the SCI, the base amount is Net Sales.
• Balance of Account / Total Sales.
• This will reveal how “Net Sales” is used up by the various
expenses.
• Net income as a percentage of sales is also known as the net
profit margin.
• Example
• 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(White et.al 1998).
• There are three kinds of FS analysis techniques:
- Horizontal analysis
- Vertical analysis
- Financial ratios
 FINANCIAL RATIO ANALYSIS

• 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. A financial ratio is
composed of a numerator and a denominator.
• For example, a ratio that divides sales by assets will find the peso
amount of sales generated by every peso of asset invested. This is
an important ratio because it tells us the efficiency of invested asset
to create revenue. This ratio is called asset turnover. There are
many ratios used in business.
• These ratios are generally grouped into three categories:
(a) profitability, (b) efficiency, and (c) financial health.
 1. PROFITABILITY RATIO

• Profitability ratios measure the ability of the

company to generate income from the use of its
assets and invested capital as well as control its
cost. The following are the commonly used
profitability ratios:
• -Gross profit ratio reports the peso value of the
gross profit earned for every peso of sales. We can
infer the average pricing policy from the gross
profit margin.
• Operating income ratio expresses operating income as a
percentage of sales. It measures the percentage of profit earned
from each peso of sales in the company’s core business operations
(Horngren et.al. 2013). A company with a high operating income
ratio may imply a lean operation and have low operating
expenses. Maximizing operating income depends on keeping
operating costs as low as possible (Horngren et.al. 2013).
• Net profit ratio relates the peso value of the net income earned to
every peso of sales. This shows how much profit will go to the
owner for every peso of sales made.
• Return on asset(ROA) measures the peso value of income generated
by employing the company’s assets. It is viewed as an interest rate
or a form of yield on asset investment. The numerator of ROA is
net income. However, net income is profit for the shareholders. On
the other hand, asset is allocated to both creditors and shareholders.
Some analyst prefers to use earnings before interest and taxes
instead of net income. There are also two acceptable denominators
for ROA – ending balance of total assets or average of total assets.
Average assets is computed as beginning balance + ending balance
divided by 2.
• Return on equity(ROE) measures the return (net income) generated
by the owner’s capital invested in the business. Similar to ROA, the
denominator of ROE may also be total equity or average equity.
STUDENTS ARE GROUPED INTO 5 MEMBERS EACH;
THEY ARE GIVEN 5 QUESTIONS TO BE ANSWERED IN
5 MINUTES
• Questions:

1. What is Financial Ratio Analysis?

2. What is the importance of Financial Ratio Analysis?
3. What are the three kinds of Financial statement analysis?
4. Define Profitability Ratio.
5. What are the different Profitability Ratio?
 OPERATIONAL EFFICIENCY RATIO
• Operational efficiency ratio measures the ability of the company to utilize its assets.
Operational efficiency is measured based on the company’s ability to generate sales from the
utilization of its assets, as a whole or individually. The turnover ratios are primarily used to
measure operational efficiency.
• Asset turnover measures the peso value of sales generated for every peso of the company’s
assets. The higher the turnover rate, the more efficient the company is in using its assets.
• Fixed asset turnover is indicator of the efficiency of fixed assets in generating sales.
• Inventory turnover is measured based on cost of goods sold and not sales. As such both the
numerator and denominator of this ratio are measured at cost. It is an indicator of how fast the
company can sell inventory. An alternative to inventory turnover is “days in inventory”. This
measures the number of days from acquisition to sale.
• Accounts receivables turnover the measures the number of times the company was able to
collect on its average accounts receivable during the year. An alternative to accounts
receivable turnover is “days in accounts receivable”. This measures the company’s collection
period which is the number of days from sale to collection.
• Financial Health Ratios look into the company’s solvency
and liquidity ratios. Solvency refers to the company’s
capacity to pay their long term liabilities. On the other
hand, liquidity ratio intends to measure the company’s
ability to pay debts that are coming due (short term debt).
• Debt ratio indicates the percentage of the company’s
assets that are financed by debt. A high debt to asset ratio
implies a high level of debt.
• Equity ratio indicates the percentage of the company’s
assets that are financed by capital. A high equity to asset
ratio implies a high level of capital.
• Debt to equity ratio indicates the company’s reliance to debt
or liability as a source of financing relative to equity. A high
ratio suggests a high level of debt that may result in high
interest expense.
• Interest coverage ratio measures the company’s ability to
cover the interest expense on its liability with its operating
income. Creditors prefer a high coverage ratio to give them
protection that interest due to them can be paid.
• Current ratio is used to evaluate the company’s
liquidity. It seeks to measure whether there are
sufficient current assets to pay for current liabilities.
Creditors normally prefer a current ratio of 2.
• Quick ratio is a stricter measure of liquidity. It does
not consider all the current assets, only those that are
easier to liquidate such as cash and accounts
receivable that are referred to as quick assets.