FINANCIAL MANAGEMENT
CHAPTER III
FINANCIAL STATEMENT AND ANALYSIS
SUBMITTED TO:
GIMELYN B. TANQUERIDO, MBA
SUBMITTED BY:
CHAPTER 3
FINANCIAL STATEMENT AND ANALYSIS
OBJECTIVE:
a) identify the various information provided by the basic financial statement;
b) appreciate the relevance and importance and financial statement analysis;
c) perform vertical and horizontal methods of financial statement analysis; and
d) Compute, Analyse and interpret financial ratios and in terms of liquidity, solvency,
profitability and solvency.
UNDERSTANDING THE BASIC FINANCIAL STATEMENTS
1. The Statement of Financial Position (Balance Sheet)
It is a financial “snapshot” of your business at given date in time. It provides information
about the financial condition, position and structure of the company in terms of its
assets, liabilities, and the difference between the two, which is the equity or net worth.
Assets = liabilities + owner’s equity
The statement of financial position usually presented in comparative form. Comparative
financial statement include the current year’s statement and statements of one or more
of the preceding accounting periods.
Example of the Corporation Statement of Financial Position:
a. Report Form – The statement of financial position can be presented in vertical
format with Assets Section above the Liabilities and Equities sections that,
together, balance it.
b. Account Form – The entire statement of financial position is normally presented
in horizontal layout, with Assets Page on left, and a page for Liabilities and
Equities on the right.
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Report Form
Account Form
2. Statement of Comprehensive Income
The income statement summarizes a company’s revenues (sales) and expenses
quarterly and annually for its fiscal year. Also called as “statement of income”,
“statement of earnings”, “statement of operations”, “statement of operating results”,
and “profit and loss statement”. In addition, the terms “profits”, “earnings”, and
“income” all mean the same thing and are used interchangeably.
Gross profit = net sales – cost of goods sold
Forms and Presentation of the Statement of Comprehensive Income
a. Multi-Step Approach – It shows the various profitability stages from gross profit,
operating profit up to the net profit which is essential in terms of cost control and
management.
b. Single Step Approach – It simply identifies the income that comes from
professional fee and all expenses grouped together to arrive to a net profit.
3. Statement of Changes in Equity
It shows all changes in owner’s equity for a period of time to provide readers with the
useful information on how the capital or fund of an entity is utilized and used.
Opening Balance of Equity + Net Income
- Dividends +/- Other Changes
= Closing Balance of Equity
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OVERVIEW ON FINANCIAL STATEMENT ANALYSIS
Financial statement analysis is the process of identifying financial strengths and
weaknesses of the firm by properly establishing relationship between the items of the
balance sheet and the income statement account. The method/techniques that are used
in analysing financial statement such as, comparative statement, schedule of changes
in working capital, common size percentages, fund analysis, trend analysis and ratios
analysis. Financial statements are prepared to meet external reporting obligations and
also for decision making purposes.
Trends – The results given in generally cover at least the previous three full accounting
years therefore any fluctuations in any area can be easily pinpointed.
Benchmarks – The average results for each ratio together with the industry profile of
the average company in the sector can both be used as benchmarks to compare
individual company performance.
Size – all the major companies in the sector are ranked on the basis of sales, profits,
total assets and employee numbers.
Growth – the average annual growth of each company’s sales, profits, total assets and
number of employees over the three-year period being analysed is calculated and
ranked.
Advantage of Financial Statement Analysis
1. Investors get enough idea to decide about the investments of their funds in the
specific company.
2. Regulatory authorities like International Accounting Standards Board can ensure
whether the company is following accounting standards or not.
3. Can help the government agencies to analyse the taxation due of the company.
Moreover, company can analyse its own performance over the period of time.
Limitations of Financial Statement Analysis
1. Comparison of Financial Data
2. The Need to Look Beyond the Ratios
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Tools and Techniques of Financial Statement Analysis
1. Horizontal Analysis or Trend Analysis – comparison of two or more year’s
financial data. It is facilitated by showing changes between years in both peso
and percentage form.
Year 2−Year 1
¿ x 100
Year 1
110000 90000
= x 100
90000
20000
= x 100
90000
= 22%
a. Trend Percentage – it states several years’ financial data in terms of a base
year. The base year equals 100% with all other years stated in some
percentage of this base.
2. Vertical Analysis – is the procedure of preparing and presenting common size
statements. Common size statement is one that shows the items appearing on it
in percentage form as well as in peso form.
current year
= x 100
based amount
110,000
= x 100
250,000
= 0.44 x 100
= 44%
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3. Ratio Analysis – the most powerful tool, it simply means one number expressed
in terms of another. It is a statistical yardstick by means of which relationship
between two or various figures can be compared or measured.
i. Profitability Ratios – measure the results of business operations or overall
performance and effectiveness of the firm.
Gross Profit
a) Gross Profit Ratio = x 100
Net Sales
Net Profit
b) Net Profit Ratio = x 100
Net Sales
Cost of Goods Sold +Operating Expenses
c) Operating Ratio = x 100
Net Sales
d) Return on shareholders investment or net worth =
Net Profit after interest ∧tax
'
x 100
Shareholde r s funds
e) Return on equity capital =
Net Profit after tax−Preference dividend
x 100
Equity Share Capital
ii. Liquidity Ratios – measure the short-term solvency of financial position of a
firm.
a) Working Capital = Current assets – Current liabilities
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b) Current ratio = Current Assets / Current Liabilities
c) Liquid/Acid test/Quick ratio = Liquid Assets / Current Liabilities
iii. Activity Ratios or Turn-over Ratio – are calculated to measure the
efficiency with which the resources of a firm have been employed.
a) Inventory turnover ratio = Cost of Goods Sold / Average Inventory
b) Average collection period = 360 days / Receivable Turnover
iv. Long-term Solvency or Leverage Ratios – conveys a firm’s ability to meet
the interest cost and payment schedule of its long-term obligations.
a. Debt-to-equity ratio = Total Liabilities / Total Shareholders Equity
b. Proprietary or Equity ratio = Shareholders Equity / Total Assets
Data for Profitability Ratio and Activity Ratio
Data for Liquidity Ratio and Leverage Ratio
