Financial Statement Analysis
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FS Analysis
FS Analysis involves careful selection of data from financial statements in order to assess and evaluate the
firm’s past performance, its present condition and future business potentials.
Objectives of FS Analysis
The primary objective of FS Analysis is to determine the extent of firm’s success in attaining its financial
goals in the following areas:
(1) Maximizing profitability
(2) Ability of the firm to pay its obligations
(3) Safety of the investment in the business
(4) Effectiveness and efficiency of management in utilizing the resources entrusted to them
(5) Attain stability in operations.
Problems and Limitations of FS Analysis
Problems and Limitations of FS Analysis
(1) The nature of the information
– The use of estimates in allocating costs to each period.
– Financial data is not adjusted for price changes or inflation/deflation because of cost principle.
– Companies have a choice of accounting methods. These differences impact ratios and make it
difficult to compare companies using different methods.
– Companies may have different fiscal year ends making comparison difficult if the industry is cyclical.
(2)The need to look beyond ratios
Ratios or any information generated by FS analysis are not the ultimate goal. The company must
interpret and look beyond this results for a more proper evaluation.
TECHNIQUES IN FS ANALYSIS
HORIZONTAL ANALYSIS
It is the process of analyzing the firms’ financial data across two or more consecutive periods. This is done
through either:
(a) Comparative FS (b) Trend Analysis
TREND PERCENTAGES – are index numbers showing relative changes in financial data resulting to passage of time.
In horizontal analysis, the amount of change and percentage of change should be shown.
PERCENTAGE CHANGE (%) = AMOUNT OF CHANGE / BASE
CAUTION ABOUT THE BASE:
(1) The base may be last year’s or earlier period data, average industry data or even chief competitors’ data.
(2) The percentage change is NOT computed if the base is ZERO or NEGATIVE.
TECHNIQUES IN FS ANALYSIS
VERTICAL ANALYSIS
Vertical analysis is a method of financial statement analysis in which each line item is listed as a percentage of a base figure within the
statement. Vertical analysis is the process of comparing figures in the FS of a single period only.
Proper application of vertical will generate a COMMON-SIZE FINANCIAL STATEMENTS. Common size financial statements are financial
statements that translate peso amounts to percentages in relation to a chosen base.
NOTE: In vertical analysis, only percentages are shown.
What base to use?
Financial Statement Proper Base
Income Statement Net Sales
Balance Sheet Total Assets
Statement of Cash Flows Total Cash Available
TECHNIQUES IN FS ANALYSIS
FINANCIAL RATIOS
It is a comparison in fraction, decimal or proportion of two significant figures taken from the financial
statements.
REMINDER IN USING FINANCIAL RATIOS: In comparing balance sheet items with income statement items in a
single ratio, the balance sheet items are being averaged if the beginning and ending balances are available.
Cautions in using ratios:
(1) Ratios have great disparities from one industry to another.
(2) Conservatism has a bias towards diminishing value of the firm.
(3) Historical cost principle may significantly contribute to a distorted FS Analysis.
SUMMARY OF COMMONLY USED FINANCIAL RATIOS
Activity ratios: are ratios that
measure the liquidity of specific
assets and efficiency in managing
assets.
SUMMARY OF COMMONLY USED FINANCIAL RATIOS
Solvency ratios: are ratios that
measure the ability of the firm to
pay its long-term financing and
the extent of a firm’s financing.
SUMMARY OF COMMONLY USED FINANCIAL RATIOS
Profitability ratios: are ratios that
measure the overall performance
of the firm.
SUMMARY OF COMMONLY USED FINANCIAL RATIOS
Market-test ratios: these ratios
are concerned with the return on
investment for shareholders, and
with the relationship between
return and the value of an
investment in company's shares.
DISCUSSION EXERCISE
Requirements:
1. Prepare a vertical and
horizontal analysis for the year
2019.
DISCUSSION EXERCISE
