FINANCIAL STATEMENT ANALYSIS

Different methods and techniques are used in analyzing financial statements. There are two
phases involves, namely, the computation phase and the interpretation phase. In the first phase,
we compute for differences, percentages, or ratios. In the second stage, we interpret the results of
the figures we get from the first phase. The second phase, although more difficult that the first
phase, makes the analysis of financial statements more meaningful because it communicates to
the users the significance of the results.
Using the statement of financial position and the income statement, financial statements can be
analyzed using the following techniques. These are considered the tools in analyzing the
financial data provided by the financial statements.

HORIZONTAL ANALYSIS compares the same account in the financial statements of two
periods (current and past year) determining the amount of changes and computing its percentage
change using a base year as comparison. It should be noted that for accounts in the base year
with zero or negative balances, the computation of percentage of change will not apply.

VERTICAL ANALYSIS shows the relationship of each part to the whole in a single financial
statement. In the statement of financial position or balance sheet, each item is expressed as a
percentage of total assets or total liabilities and owner’s equity. In the income statement, each
item is presented as percentage of net sales.

TREND ANALYSIS compares not only two years but covers three, four or five year’s financial
statements. This is to determine the trends in the industry.

FINANCIAL RATIO ANALYSIS describes the significant relationship between the numbers
presented in the financial statements. Ratio can be expressed either as a rate, percentage, or a
proportion.
HORIZONTAL ANALYSIS IN FINANCIAL STATEMENTS

Horizontal analysis, otherwise known as comparative analysis, helps management analyze

increase and decreases in balance sheet and income statement accounts. For example, in the
balance sheet, a significant increase in property, plant and equipment will indicate purchase of
land, equipment, machinery, or other plant assets necessary for use I the business. On the other
hand, a significant decrease will reveal disposal of such assets as management may have deemed
necessary. Comparing two consecutive years and noting magnanimous increases or decreases in
other balance sheet items may also be used by management for decision making purposes.

For income statement accounts, horizontal analysis also helps management analyze significant
increases or decreases in sales, cost of sales and expenses. For example, an alarming decrease in
net income may call management’s attention as the generation of net income is the company’s
main goal in doing business. This may lead management to evaluate other income statement
items such as sales, cost of sales, and expenses which are crucial components in arriving at a
company’s net income.

In conclusion, getting the amount of increase and decreases and their percentages, is just the first
step of the analysis. The difficult part is the interpretation of the results. In the real world, this is
subjective as there are no strict and fast rules to follow. Experience and industry trends are
considered in the picture.
The following are the steps in performing a horizontal analysis:

1. Prepare comparative financial statements of two consecutive years.

FIDAS MERCHANDISING
STATEMENT OF FINANCIAL POSITION
AS OF DECEMBER 31
(in millions)

Assets 2017 2016

Current assets
Cash 222.9 330.2
Accounts receivable (net) 282.5 172.1
Inventory 146.3 92.8
Prepaid expenses 74.1 70.3
Total current assets 725.8 665.4
Property, plant and equipment 1866.4 556.2
Total assets 2592.2 1221.6

Liabilities and Owner’s Equity

Current Liabilities 551.9 620.6

Non-current Liabilities 1822.4 376.6
Total liabilities 2374.3 997.2
Owner’s Equity 217.9 224.4
Total Liabilities and Owner’s Equity 2592.2 1221.6

2. Add a third column for the increase or decrease in amount and a fourth column for
the percentage of the increase or decrease.
3. Get the percent of increase or decrease for each account.
a. Choose a base year which is usually the initial year of analysis.
b. Deduct the amount of the current year from the base year
c. Divide the difference above by the amount of the base year.
d. Multiply the quotient by 100 to get the percentage of change.

This is represented by the following formula:

% change = Current year amount – Base year amount x 100%

Base year amount
% change in current assets = 665.4 - 725.8 x100%
665.4
= 9.1%

Note: for accounts with zero balance in the earlier or initial year, the formula for the percentage
of change will not apply.
 FIDAS MERCHANDISING
STATEMENT OF FINANCIAL POSITION
AS OF DECEMBER 31
(in millions)

Assets 2017 2016 INCREASE/DECREASE

Amount Percent

Current Assets
Cash 229.9 330.2 (107.3) (32.5)
Accounts Receivable (net) 282.5 172.1 1104 64.1
Inventory 146.3 92.8 53.5 57.7
Prepaid expenses 74.1 70.3 3.8 5.4
Total Current Assets 725.8 665.4 60.4 9.1
Property, Plant and Equipment (net) 1866.4 556.2 1310.2 235.6
Total Assets 25923.2 1221.6 1370.6 112.2

Liabilities and Owner’s Equity

Current Liabilities
Trade and Other Payables 551.9 620.6 (68.7) (11.1)
Non-Current Liabilities
Loan Payable 1882.4 376.6 1445.8 383.9
Total Liabilities 2374.3 997.2 1377.1 138.1
Owner’s Equity 217.9 224.4 (6.5) (2.9)
Total Liabilities and Owner’s Equity 2592.2 1221.6 1370.6 112.2
VERTICAL ANALYSIS IN THE STATEMENT OF FINANCIAL POSITION

In the statement of financial position, vertical analysis, otherwise known as common-size

analysis, helps management analyze the components of the total assets as well as the components
of the total liabilities and owner’s equity. It helps management answer certain questions as
follows:

1. Of the total assets, what percent is classified as current? Non-current?

2. Of the total assets, what percent is accounts receivable? Merchandise inventory?
3. Of the total liabilities, what percent is classified as current? Non-current?
4. Of the total liabilities and owner’s equity, what percent is liabilities? What percent is
owner’s equity?

The answer to the above questions may lead to other questions such as when accounts receivable
occupy a bug percentage of current assets, are these receivables collectible? This may reflect on
the company’s credit and collection policy. This indicates the leniency of a company in
extending credit to its customers and the terms and policies for collection. If a big percentage of
the total assets is allocated to merchandise inventory, this raises a question as to the whether the
inventory is saleable of obsolete. For the percentage of total liabilities versus owner’s equity, this
indicates the part of the company financed by creditors and the part of the company financed by
the owner. In short, what part of total assets is financed by the creditor and what part of the total
assets is financed by the owner?

VERTICAL ANALYSIS IN THE INCOME STATEMENT

In the income statement, vertical analysis helps management analyze the components of the
income statement in relation to its revenue account which is sales. It help management answer
certain questions as follows:

1. What percentage of net sale is cost of sales or cost of goods sold? Gross profit? Operating
Expenses?
2. If operating Expenses were divided between selling and administrative expenses, what percent
of net sales is absorbed by selling expenses? Administrative expenses?
3. What is the percentage of net income to sales?

The following are the steps in performing a vertical analysis.

1. Prepare comparative financial statement of two consecutive years.

2. Add one addition column on the right side of each year.
3. For the comparative financial statement, express each account as a percentage of the total
assets. The total assets is automatically 100%. Likewise, total liabilities and owner’s equity is
automatically 100%.

Example:

% of current assets = 725.8 x 100% = 28%

2, 592.2

% of non-current liabilities= 1, 822.4 x 100% = 70.3%

2592.2

4. For the comparative income statement, express each account as a percentage of net sales. Net
sales is automatically 100%.

Example:
% of cost of goods sold= 1,032.1 x 100% = 46.6%
2, 213.3
 Fidas Merchandising
Statement of Financial Position
As of December 31

Assets 2017 Percent 2016 Percent

Current Assets 222.9 8.6 330.2 27.0

Cash
Accounts Receivable 2852.5 10.9 172.1 14.1
Inventory 146.3 5.6 92.8 7.6
Prepaid Expenses 74.1 2.9 70.3 5.8
Total Current 725.8 28.0 665.4 54.5

Property, Plant and Equipment 1866.4 72.0 556.2 45.5

Total Assets 2592.2 100 1221.6 100

Liabilities and Equity

Current Liabilities 551.9 21.3 620.6 50.8

Non-current Liabilities
Loan Payable 1822.4 70.3 376.6 30.8
Total Liabilities 2374.3 91.6 997.2 81.6
Equity 217.9 8.4 224.4 18.4
Total Liabilities and Equity 2592.2 100 1221.6 100

Note: Notice that for assets each asset type is expressed as a percentage of the total assets while the
liabilities and the owner’s equity are expressed as a percentage of the total liabilities and owner’s equity.

Fidas Merchandising
Income Statement
For the year ended December 31
(in millions)

2017 Percent 2016 Percent

Net Sales 2213.3 100 1738.7 100

Cost of Goods Sold 1032.1 46.6 831.8 47.8
Gross Profit 1171.2 53.4 906.9 52.2
Selling and Administrative Expenses 889.2 40.2 659.5 38.0
Operating Income 292.0 13.2 247.4 14.2
Interest Expense 90.9 4.1 30.5 1.8
Income before Income Taxes 201.1 9.1 216.9 12.4
Income Tax Expense 60.3 2.7 65.0 3.7
Net Income 140.8 6.4 151.9 8.7
TREND ANALYSIS

In trend analysis, a base year is established which is labeled as the 100% thereby expressing
figures of all other years as a percentage of the base year. The amount under each year is divided
by the amount in base year thereby determining the amount of the other years in relation to the
base year.

Steps in performing a Trend Analysis

1. Prepare comparative financial statements for three, four or five consecutive years.
2. Choose a base year. Usually the first year is the base year.
3. Calculate the trend percentage for each item by dividing the amount of each item
by the base year. The base year is automatically 100%.

Trend % = Chosen year x 100%

Base Year

Example
Current Asset Trend % 2016 = 665.40 x 100% = 111.3%
597.60