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ANALYSIS AND INTERPRETATION OF FINANCIAL

STATEMENT
FINANCIAL STATEMENT ANALYSIS

 A process of evaluating and interpreting an entity’s financial statements


to assess its financial health for the purpose of making better economic
decisions.
 Analysis depends on the objective, it may analyze one or more of the
following:
 Industry and economic trend
 Solvency and capital structure
 Operational efficiency
 Profitability
INDUSTRY AND ECONOMIC TREND - THIS INVOLVE THE ANALYSIS OF
THE ECONOMIC ENVIRONMENT WHERE BUSINESS OPERATES.

Economic ETC.
competition
Climate

Business
Market Supply and
Rates demand
Government
Regulation
BUSINESS

 Published industry averages


 Current events
 Statistical data
 Research paper
 Financial data from key planners in the industry
Financial statement * one of the many inputs needed in the analysis*
SOLVENCY AND CAPITAL STRUCTURE

The ability of the business to pay its debts


and remains as a going concern.

Solvency
Solvency Liquidity
(long-term) (short-term)
CAPITAL STRUCTURE

Refers to how a business efficiently finances its operations


using different sources of funds (debt or equity)

Capital
Solvency
Structure
Stability of
business
OPERATIONAL EFFICIENCY

Refers to how well a business is


managing its resources to maximize
earnings
PROFITABILITY

Refers to the ability of a business to


generate profit
METHODS OF FINANCIAL STATEMENT ANALYSIS

Horizontal and vertical analyses


Financial ratio analysis
HORIZONTAL ANALYSIS

 It is the comparison of financial information over two or more


reporting periods.
 To analyze if changes in amounts are unusually high or low,
which may entail investigation of the reason for the unusual
change.
STEPS IN HORIZONTAL ANALYSIS

1. Compute for the change in the amounts in a baseline year


(earlier period) and a later period
Earlier Period – Later Period =( + )increase/ (-) decrease *difference*
2. Divide the change bye amount in the baseline year.
Difference ÷ Later period = percent
ABC Co.
Statement of Financial Position
As of December 21, 2011
ASSETS 2011 2010 Increase/ Percent
(Decrease)
Cash and cash equivalents P 30 000 P80 000 P(50 000) -62.5%
Accounts receivable – net 1 672 000 304 000 1 368 000 450%
Inventory 500 000 300 000 200 000 66.67%
Prepaid assets 48 000 50 000 (2 000) -4%
Total current assets 2 250 000 734 000 1 516 000 206.54%
Property, Plant and Equipment 780 000 720 000 60 000 8.33%
Total non-current assets 780 000 720 000 60 000 8.33%
Total Assets P3 030 000 P1 454 000 P1 576 000 108.39%
SOLVENCY AND CAPITAL STRUCTURE (SOLVENCY)

 Liquidity (short-term solvency) – Look at total current assets and


liabilities.
There is and increase in total assets compared to total current liabilities.
However, the main cause of the increase in total current assets is the
increase in accounts receivable (450%) which means that the ability of the
business to pay its current liabilities is dependent on its ability to collect
the account receivable. Despite the increase in total current assets, cash
has decreased (-62.5%).
SOLVENCY (LONG TERM)

 The solvency of the business has also improved in 2017. this is reflected
by the decrease in non current liabilities (-50%). The business was able to
settle in 2017 the current maturing loan of P180 000 from 2016.
Liabilities 2017 2016 (decrease) Percent

Current portion
180 000 180 000 - 0%
Noncurrent
portion 180 000 360 000 (180 000) -50%
Total notes payable
360 000 540 000 (180 000) -33.33%
CAPITAL STRUCTURE

 The main source of the business financing in 2017 is equity,


primarily from retained profits. These are reflected by the
following:
 A. the increase in equity is higher compared to the increase on total
liabilities (242.11% vs 39.58%)
 B. the main cause of the increase in equity is retained profit, rather than
additional contribution by the owner
PROFITABILITY.

The profitability of the business has greatly improved in 2017. (516.49% owners capital .as
profit of the year)
a. Sales have increased at a higher rate than cost of goods sold (66.67% vs 55.56%). This
means that unit cost have either decreased or sales prices have increased.
b. Depreciation expense increased. which could have been brought about by the acquisition
of additional depreciable assets during 2017 .
c. Bad debts expense increased with the increase in accounts receivable . This reflects the
higher risk that the business assumes as a consequence of extending more credit to
customers.
d. Interest expense decreased mainly because of the decrease in notes payable.
TREND ANALYSIS

A variation to the horizontal analysis is trend


analysis. Under a trend analysis, the comparison of
financial information extends beyond two periods,
normally five or more. The computational
procedures in trend analysis are similar to a
horizontal analysis.
FINANCIAL RATIO ANALYSIS

 - computation of percentages, fractions or proportions using


certain formulas. This analysis is designed to emphasize the
meaningful relationships between financial data.
1. Liquidity ratios
2. Activity ratios (asset management ratios)
3. Leverage ratios (Debt management ratio)
4. Profitability ratios.
LIQUIDITY RATIOS

A current ratio – most commonly used ratio in


measuring ability of a business to pay its short-term
debts.
𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑒𝑡𝑠
𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑟𝑎𝑡𝑖𝑜 =
𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
QUICK RATIO (ACID-TEST RATIO)

 Much stricter ratio used to measure the ability of a business to


pay its short-term debts.

𝑞𝑢𝑖𝑐𝑘 𝑟𝑎𝑡𝑖𝑜 𝑎𝑐𝑖𝑑 − 𝑡𝑒𝑠𝑡 𝑟𝑎𝑡𝑖𝑜


𝑄𝑢𝑖𝑐𝑘 𝑎𝑠𝑠𝑒𝑡𝑠
(𝑐𝑎𝑠ℎ + 𝑚𝑎𝑟𝑘𝑒𝑡𝑎𝑏𝑙𝑒 𝑠𝑒𝑐𝑢𝑟𝑖𝑡𝑖𝑒𝑠 + 𝑎𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑟𝑒𝑐𝑖𝑒𝑣𝑎𝑏𝑙𝑒, 𝑛𝑒𝑡)
=
𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
WORKING CAPITAL

 -similar to current ratio but measures the ability of a business


to pay its short-term debts by the excess or deficiency of
current assets over current liabilities.

𝑤𝑜𝑟𝑘𝑖𝑛𝑔 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 = 𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑒𝑡𝑠 − 𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠


ACTIVITY RATIOS- HOW EFFICIENT A BUSINESS IS UTILIZING ITS
RESOURCES.

 A. inventory turnover – measure of the number of times inventory is sold


and replenished during a period. Generally the higher the ratio, the better.
However, an usually high inventory turnover could also indicate inventory
shortages.

𝑐𝑜𝑠𝑡 𝑜𝑓 𝑔𝑜𝑜𝑑𝑠 𝑠𝑜𝑙𝑑


𝑖𝑛𝑣𝑒𝑡𝑜𝑟𝑦 𝑡𝑢𝑟𝑛𝑜𝑣𝑒𝑟 =
𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦
𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦,𝑏𝑒𝑔+𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦,𝑒𝑛𝑑
Average inventory =
2
DAYS OF INVENTORY (AVERAGE SALE PERIOD) – IS A MEASURE OF
THE NUMBER OF DAYS BEFORE IT IS SOLD.

365 𝑑𝑎𝑦𝑠 𝑖𝑛 𝑎 𝑦𝑒𝑎𝑟


𝑑𝑎𝑦𝑠 𝑜𝑓 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 =
𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑡𝑢𝑟𝑛 𝑜𝑣𝑒𝑟
ACCOUNTS RECEIVABLE TURNOVER – A MEASURE OF THE NUMBER OF
TIMES ACCOUNTS RECEIVABLE HAVE BEEN COLLECTED DURING A PERIOD.

𝑎𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑟𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒 𝑡𝑢𝑟𝑛𝑜𝑣𝑒𝑟


𝑐𝑟𝑒𝑑𝑖𝑡 𝑠𝑎𝑙𝑒𝑠
=
𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑎𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑟𝑒𝑐𝑖𝑒𝑣𝑎𝑏𝑙𝑒
Where:
𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑎𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑟𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒
𝑎𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑟𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒, 𝑏𝑒𝑔 + 𝑎𝑐𝑐𝑜𝑢𝑛𝑡 𝑟𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒 , 𝑒𝑛𝑑
=
2
DAYS OF RECEIVABLE(AVERAGE COLLECTION PERIOD)

365 𝑑𝑎𝑦𝑠 𝑖𝑛 𝑎 𝑦𝑒𝑎𝑟


𝑑𝑎𝑦𝑠 𝑜𝑓 𝑟𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒 =
𝑎𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑟𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒 𝑡𝑢𝑟𝑛𝑜𝑣𝑒𝑟
LEVERAGE RATIOS (DEBT MANAGEMENT RATIOS) PROVIDE A MEASURE OF
EXTENT A BUSINESS USES A DEBT FINANCING OR “LEVERAGE”

 Debt ratio (debt-to-asset ratio) – measures the proportion of


assets financed through debt.

𝑇𝑜𝑡𝑎𝑙 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
𝑑𝑒𝑏𝑡 𝑟𝑎𝑡𝑖𝑜 =
𝑡𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠
EQUITY RATIO – PROPORTION OF ASSETS FINANCED THROUGH
EQUITY

𝑡𝑜𝑡𝑎𝑙 𝑒𝑞𝑢𝑖𝑡𝑦
𝑒𝑞𝑢𝑖𝑡𝑦 𝑟𝑎𝑡𝑖𝑜 =
𝑡𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠
DEBT TO EQUITY RATIO- HOW MUCH DEBT IS USED TO FINANCE THE
ASSETS RELATIVE TO THE AMOUNT PERTAINING TO THE OWNERS

𝑡𝑜𝑡𝑎𝑙 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
𝑑𝑒𝑏𝑡 𝑡𝑜 𝑒𝑞𝑢𝑖𝑡𝑦 𝑟𝑎𝑡𝑖𝑜 =
𝑡𝑜𝑡𝑎𝑙 𝑒𝑞𝑢𝑖𝑡𝑦
PROFITABILITY RATIOS – MEASURE PERFORMANCE OF A BUSINESS IN TERMS
OF ITS ABILITY TO GENERATE PROFIT FROM OTS RESOURCES.

Gross profit ratio – shows relationship between sales and cost of


goods sold.

𝑔𝑟𝑜𝑠𝑠 𝑝𝑟𝑜𝑓𝑖𝑡
𝑔𝑟𝑜𝑠𝑠 𝑝𝑟𝑜𝑓𝑖𝑡 𝑟𝑎𝑡𝑖𝑜 =
𝑛𝑒𝑡 𝑠𝑎𝑙𝑒𝑠
NET – PROFIT RATIO – MEASURES PROFITABILITY AFTER
CONSIDERING ALL INCOME AND EXPENSES.

𝑝𝑟𝑜𝑓𝑖𝑡 𝑓𝑜𝑟 𝑡ℎ𝑒 𝑦𝑒𝑎𝑟


𝑛𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡 𝑟𝑎𝑡𝑖𝑜 =
𝑛𝑒𝑡 𝑠𝑎𝑙𝑒𝑠
RETURN ON ASSETS – MEASURES THE PROFIT GENERATED IN
RELATION TO THE TOTAL RESOURCES AVAILABLE TO THE BUSINESS.

𝑝𝑟𝑜𝑓𝑖𝑡 𝑓𝑜𝑟 𝑡ℎ𝑒 𝑦𝑒𝑎𝑟


𝑟𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝑎𝑠𝑠𝑒𝑡𝑠 =
𝑡𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠
RETURN ON EQUITY – MEASURES THE PROFIT GENERATED IN RELATION
TO THE RESOURCES INVESTED BY THE OWNER OF THE BUSINESS.

𝑝𝑟𝑜𝑓𝑖𝑡 𝑓𝑜𝑟 𝑡ℎ𝑒 𝑦𝑒𝑎𝑟


𝑟𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝑒𝑞𝑢𝑖𝑡𝑦 =
𝑇𝑜𝑡𝑎𝑙 𝑒𝑞𝑢𝑖𝑡𝑦

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