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Bicol University
College of Business, Economics and Management
Daraga, Albay

Prof 10
Financial
Management A
Modularized Instruction

by
 Eric Anthony Lorino

MODULE II
Financial Statement Analysis
Welcome to the second module of our course for financial
management subject. Let us
understand more about the financial statements here in the second module.
This module covers the following topics: Analytical Process; Basic Decision Areas; Steps in Analyzing the Financial Statements; Types of
Financial Statement Analysis
Introduction
I

I
Specific Learning Outcomes

At the end of the module you are D

O
expected to:
M

• Know and understand the

analytical process
 • Determine the basic decision areas in financial
statement
analysis

• Enumerate the steps in

financial statement analysis

• Enumerate and describe the

types of financial statement
analysis
deals with the understanding of the relationship between financial concepts and daily decision

both analytical and judgmental process used in the managerial context

end purpose is to help people make sound decisions and judgments

Financial Statements
product of financial accounting, show the results of
operation, financial position, changes in owner’s equity, sources and uses of funds

Basic Financial Statements

• Income Statement/ Statement of Comprehensive
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• Balance sheet/ statement of financial position/ statement of financial condition

Discussion
• Statement of changes in owner’s/partners’/stockholders’ equity

Financial Analysis
• Cash flow statement/ Statement of Cash Flows
making
income
Shows the results of the operations of the business. It
details the operating revenues/ sales and operating expenses, other income and other expenses. It

shows the profitability of the firm Balance Sheet

Shows the assets of the firms, along with its liabilities and equity. It presents the liquidity and solvency of

the firm.
Statement of Changes in Owner’s Equity shows the investments made by the owners of the business decreased by the withdrawals made and increased by the
net profit made Cash Flow Statement

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Details all sources or inflow of cash and expenditures or outflows of cash to show net

income or decrease in cash

Income Statement
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Comparison Matrix of Financial Statements

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When analyzing financial statements the following decision areas are being considered in the process:

Operating Decisions
deal with the day to day operations of the firm include decisions such as pricing, selecting markets,

choosing the appropriate process or technology,

outsourcing payroll, among others
Investment Decisions
deciding on what assets to acquire or projects to Financing Decisions

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refers to decisions that involve funding investments
and operations over the long run
Three Basic Decision Areas
pursue
Understanding the information provided in the financial statements

any reader of the financial statements, especially the financial manager who makes decisions for the firm needs to have a basic knowledge of finance in its

contextual meaning to avoid confusion and misleading or wrong decisions, which are sometimes

fatal to the business

Drawing logical conclusion based on the data managers must be able to make inferences based on the data on the financial statements of which may be
presented in two comparative years
Making the appropriate decision on the course of
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action to take
after conclusions are drawn managers will able to determine the course of action to take to correct

what needs correction and the steps necessary to redirect company efforts toward the goals that the firm has set to achieve

Steps in Analyzing Financial Statements

presented
Current Asset
is one that can be converted into cash in the normal operation of the firm within one year.

Fixed Asset
are permanent assets that will not normally be converted into cash. On the balance sheet, fixed assets are shown at historical cost, which is the amount actually

paid for the asset.

Market Value
is the price the asset could command in the market.
Replacement Cost
is the price that would be required to replace the asset if it had to be acquired today.

Current liabilities
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are those that the firm reasonably expects to pay within the next year

Accounts Payable
Account Concepts
are obligations that the firm has for goods it has received from others

Notes Payable
are short-term debt that the firm must pay-off within the next year

are debts the firm owes because payment has not yet been made, such as salaries owed to Taxes Payable
are taxes that are owned, but that have not yet been paid

Long-term liabilities
are continuing obligations that will not be completely repaid next year

Common Stock
are account that reflects capital that were contributed by the equity holders of the firm.

Retained Earnings
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account shows the amount of net income that the firm has not paid out dividends to its shareholders.

Accruals

employees
Vertical Analysis
Evaluates financial statement by expressing each item in a financial statement as a percent of the base amount (key figure)

Key-figure (such as sales in IS and total assets on BS) are set to 100%

Other items are then expressed as percentage of

Horizontal Analysis
Comparing key figures in financial statement
Evaluates a series of financial statement over a period of time.

Ratio Analysis
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It expresses the relationship among selected items of financial statement data.

Types of Analysis

100
Sales P 800,000 100% Operating Expense 480,000 60% Gross Profit 320,000 40% Other Expense 200,000 25%

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Net Income 120,000 15% In the basic Income Statement shown above,
the Sales Account is the base account. The other account in the statement is being evaluated based from its percentages to the For Balance Sheet, the Total
Asset account will
be the base account and the other accounts
in the statement will be analyzed based on the percentage of its relationship to the Total
Asset accountLDM COMPUTERS
Sample Exercise

Income Statement
December 31, 2019

sales.
In Horizontal analysis the two year period is
shown. This analysis primarily looks into the increase or decrease of the account figures in the financial statements for consecutive

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An positive value of the percentage indicates
that the account in the financial statement
increases while the negative value of the percentage indicates otherwise.

The increase and decrease in the account,

signifies a good or bad signals for the
periods.

organization.
Current Assets P 500,000 400, 000 200,000
Assets 2018 2019 Percentage -20% Equipment
150,000
-25% 50,000 50,000

Total Assets P 750,000 600,000

-20% 250,000 350,000

P 750,000 650,000
Total OE 500,000 300,000 -40% & OE -15%

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In the sample, the percentages are directly shown. The analysis will now be based on the
LDM COMPUTERS
nature of the accounts as to whether the
Balance Sheet
increase or decrease is considered to be
December 31, 2018 & 2019
beneficial for the firm or not.
Property &

Other Assets
Non Current
Assets 0% 40%

Total Liabilities (all are current liabilities)

Total Liabilities
Importance of Ratio Analysis
Quick and easy snapshot of an organization’s Aid for comparisons
Ratio provide benchmark to compare on company with another (inter-firm comparison) or to compare the same company over period of time (intra-firm

comparison).

Types of Ratio Analysis

Profitability Ratio
It measures the income or operating effectiveness of an organization for a given period of time.

A low value of this ratio will affect the company ‘s ability to obtain debt, equity financing and the ability to grow or expand.

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Liquidity Ratio
It measure the short term ability of the organization to pay debt and to meet unexpected need for

Ratio Analysis

Quick Ratio
This ratio indicates whether current liabilities could be paid without having to sell the inventory

achievements
This ratio is useful for companies which cannot
convert inventory into cash quickly if necessary.
cash.
Solvency Ratio
This is to measure the ability of the company to survive over a long period of time The ability to pay interest as it come due/mature Limitations of the Accounting
Information The financial statement contains numerous estimates. Eg. Provision for doubtful debt,
depreciation and contingent loss.
The traditional financial statements are based on historical cost, it is not adjusted for price-level

change. Eg. Inflation affects the sales growth.

Alternative Accounting Method
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A comparison may be misleading as different companies use different accounting method. Eg.

FIFO and LIFO.

Diversification of firms
This diversification of activities of companies limit the usefulness of financial analysis. (no specific industry).

Estimates

Cost
Reminders when using Ratio Analysis
Ratio analysis is a good way to overview an organization’s activities

Ratio analysis must be compared with past result or

industry norms, not in isolation
analysis: treatment
Things to be taken into account in using ratio size of the organization Method used in accounting Same industry

Same country
Copy the sample statement in a separate paper
and provide the answer being required for both Perform the Horizontal Analysis
MODULE II
Accounts 2018 2019 Percentage Sales 3270000 2915000 Cost of Sales 2100000 1900000 Gross Profit 1170000 1015000 Selling Expenses 370000 340000 Administrative Expenses
200000 215000 Total 570000 555000 Operating Income 600000 460000 Interest Expense 100000 100000 Income before tax 500000 360000 Income Tax 150000 108000 Income
after Tax 350000 252000

Application

analysis

LDM COMPUTERS
Income Statement
December 31, 2018 & 2019

Operating Expenses
Perform Vertical Analysis
Assets 2019 Percentage Current Assets P 500,000 Property & Equipment 200,000 Total Assets P 750,000

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Total OE 500,000 Total Liabilities & OE P 750,000
LDM COMPUTERS
Balance Sheet
December 31, 2019

Other Assets Non Current

Assets 50,000
Total Liabilities (all are current

liabilities) 250,000
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Answer:
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Financial statement analysis
takes into consideration basic decision areas as it performs the three basic financial statement
analysis– vertical, horizontal and ratio analysis.

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Synthesis
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Weygandt, Jerry J. et. al (2012).

Managerial Accounting. Sixth Edition.
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Smart, Scott B. and Megginson, William L.

(2011). Financial Management: An
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Cengage Learning Asia Pte Ltd
(Philippines Branch)

Alminar-Mutya, Ruby F. (2010). Basic

Business Finance: Management
S

C
Approach. Mandaluyong,
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E
Medina, Roberto G. (2007). Business
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E
Finance. Second Edition. Manila
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Keown, Arthur J. (2005). Fundamentals of

Financial Management: Investment,
Financing and Asset Management.
Philippine Edition. New Jersey: USA.
Pearson Education Inc.

Melicher, Ronald W. (2005). Finance

Introduction to Institutions, Investments
and Management. New Jersey, USA.
John Wiley & Sons, Inc.

https://www.investopedia.com/terms/e/ exchangerate.asp