FINANCIAL STATEMENT ANALYSIS

Financial statement analysis – involves the assessment and evaluation of the firm’s past
performance, its present condition and future business potential. The analysis serves to provide
information regarding:
1. Profitability of the business firm
2. The firm’s ability to meet its obligations
3. Safety of the investment in the business
4. Effectiveness of management in running the firm
5. Over-all company marketability

Horizontal analysis (Trend analysis) – involves comparing figures shown in the financial
statements of two or more consecutive periods.
o It is used to evaluate trends over a period of several years for a single business. It is
also called variation analysis.
o It can be used to evaluate the company’s effort to improve its operations or its
financial status.

Assets 2019 2020 2021

Cash 12.10% P148,000 P100,000 (32.4%) P90,000 (10%)
Accounts 23.14% 283,000 410,000 44.9% 394,000 (3.9%)
receivable
Inventory 26.32% 322,000 616,000 696,000
Other current 0.82% 10,000 14,000 15,000
assets
Total current 62.39% P763,000 P1,140,000 P1,195,000
assets
PPE 37.61% 460,000 904,000 974,000
TOTAL ASSETS 100% P1,223,000 P2,044,000 P2,169,000

Vertical analysis (Common Size FS) – involves comparing the figures in the financial statements
of a single period. A common-size financial statement is one that shows each item as a percentage
of a total rather than in peso form.
o It covers one year’s operating results and expresses each component as a percentage
of a total called base amount.
o Generally, there are three common base amounts: Total Assets, Total Liabilities and
Equity and Total Sales. However, other base amounts may be used like total current
assets, total operating expenses, etc.

2019 2020 2021

Net sales P1,235,000 100% P2,106,000 P2,211,000
Cost of goods sold 849,000 68.74% 1,501,000 1,599,000
Gross profit 386,000 31.26% 605,000 612,000
Operating expense 180,000 383,000 402,000
Operating income 206,000 222,000 210,000
Interest expense 20,000 51,000 59,000
Earnings before taxes 186,000 171,000 151,000
Income tax expense 74,000 68,000 60,000
Income after taxes 112,000 9.1% 103,000 91,000
Ratio analysis – involves the development of mathematical relationships between accounts in the
financial statements.

Test of Liquidity (the company’s ability to pay short-term current liabilities as they fall
due)
1. Current Ratio = Current Assets/Current Liabilities
2. Acid Test Ratio Quick ratio = Quick Assets (Cash+MS+AR) /Current Liabilities
3. Activity Ratios (Asset management ratio)
Accounts Receivable Turnover = Net Credit Sales/Ave. Receivables (Beg+End/2)
Age of Receivables= 360 or 365/AR Turnover
Days sales outstanding/average collection period/days in receivables

Inventory Turnover = Cost of Goods Sold/Ave. Merchandise Inventory (Beg+end/2)

Age of Inventory = 360 or 365/Inventory Turnover
Days in inventory/average holding period

Trade Payables Turnover = Net Credit Purchases/Ave. Trade Payables

Age of Trade Payables = 360 or 365/Payables Turnover
Days in payables/deferral period

Operating Cycle = Age of Inventory + Age of Receivables

Cash Flow Cycle (Cash Conversion Cycle) = Operating cycle – Age of Payables

Test of Solvency (the company’s ability to pay all its debt as they fall due whether such
liabilities are current or noncurrent) A = L + E
1. Debt Ratio = Total Liabilities/Total Assets
2. Equity Ratio = Total Stockholders’ Equity/Total Assets
3. Debt-To-Equity Ratio = Total Liabilities/Total Stockholders’ Equity
4. Times Interest Earned = Earnings before interest and taxes/Interest Expense
5. Fixed Assets to Long-term Liabilities = Fixed Assets/Long-term Liabilities
6. Fixed Assets to Total Equity = Fixed Assets/Total Equity
7. Fixed Assets to Total Assets = Fixed Assets/Total Assets
8. Sales to Fixed Assets = Net Sales/Net Fixed Assets

Test of Profitability
1. Return on Sales/Profit margin = Net income/Net Sales
2. Return on Total Assets = Net income/Ave Total Assets
3. Return on Equity = Net income/Ave owner’s equity
4. Earnings per share = Net income – preferred dividends (if any)/Weighted Ave. Number
of Common Shares (outstanding shares)
5. Return on Current Assets = Net Income/Ave Current Assets
6. Asset Turnover = Total Sales/Average total assets

Market Tests
1. Price/Earnings Ratio = Price per share (Market)/Earnings per share
2. Dividend yield = Ordinary Dividend Per Share/Price Per Share (Market)
3. Dividend Payout = Ordinary Dividend Per Share/ Earnings per share
Exercises

Company A Company B Company C

Current assets 200,000 60,000 120,000
Current liabilities 80,000 50,000 (120,000/1.5)
80,000
Inventory 40,000 20,000 24,000
Current ratio (200/80) 2.5:1 (60/50) 1.2 1.5:1
Acid test ratio (160/80) 2:1 (40/50) 0.8 1.2:1 (96/80)
Working capital (net) 120,000 10,000 40,000

Company A Company B Company C

Sales 800,000 960,000 400,000
Cost of sales 500,000 500,000 250,000
Purchases 400,000 600,000 180,000
Accounts receivable 40,000 80,000
Inventory 50,000 100,000
Accounts payable 80,000 50,000
Inventory turnover COGS/MI = 10 times (COGS/MI) 5
times
Age of inventory 360/ITO = 36 days 360/5 = 72 days 144 days
Receivables turnover Sales/AR = 20 times (Sales/AR) 12
Age of receivables 360/ARTO = 18 days 360/12 = 30 days 180 days
Payables turnover P/AP = 5 times (P/AP) 12
Age of payables 360/APTO = 72 days 360/12 = 30 days 60 days
Operating cycle (36+18) 54 days (72+30) 102 days
Cash conversion cycle (54-72) (18 days) (102-30) 72 days

Company A Company B Company C

Total Assets P100,000 150,000 P200,000 = 180%
Total Liabilities P60,000 60,000 88,889
Total Equity P40,000 P90,000 (200/1.80) 111,111
Debt ratio TL/TA (60/100) 0.60:1 0.40 = TL/TA (88,889/200,000)
0.40 = TL/150 0.44
Tl = 150*0.40
Equity ratio TE/TA (40/100) 0.40 0.60 = TE/TA (111,111/200,000)
0.60 = 90/TA 0.56
TA = 90/0.60
Debt-to-equity ratio (60/40) 1.50:1 60/90 = 0.80 = TL/TE
TL/TE 0.67:1 0.80:1
A=L+E
1 = 0.60 + 0.40 180%=80%+100%
2.50 = 1.50 + 1 1.80 = 0.80+1
 Company A Company B Company C
Operating income 80,000 P50,000 25,000
Interest expense (20,000) (P10,000) (5,000)
Income before tax P60,000 40,000 100% 20,000
Tax (40%) (P24,000) (16,000) 40% (8,000)
Net income 36,000 24,000 60% 12,000
Times interest earned (80/20) 5 = OI/10,000 5 = 25,000/5,000
OI/IE 4 times
TIE = EBIT/IE TIE = IBT+IE/IE TIE = IBT+IE/IE
TIE = IBT+IE/IE 4 = 60+IE/IE 5 = 20,000+IE
TIE = NI+ITE+IE/IE 1 IE
SALES 5 = 4+1
COGS 1 1
GP
OE (GA+SM)
OI/EBIT
IE
IBT
ITE
NI

Company A Company B
Net income P50,000 12,000
Total assets P400,000 40,000
Total liabilities P250,000 10,000
Total equity P150,000 30,000
Total sales P800,000 160,000
Return on assets 50/400 12,000/40,000
NI/TA 12.5% 30%
ROA = ATO*ROS
(DuPont Formula)
Return on equity 50/150 12,000/TE
NI/TE 33% 40%
Profit margin/ROS 50/800 12,000/Sales
6.25% 7.5%
Asset turnover S/TA 800/400 160,000/TA
2 times 4 times

Company A Company B
EPS P10 P25
Market value per share P20 P75
Dividends per share P5 P5
Dividend payout Div/EPS (5/10) 50% (5/25) 20%
Dividend yield Div/Price (5/20) 25% (5/75) 6.7%
Price-earnings ratio 20/10 Price/25
Price/EPS 2 3
A skeleton of Drogon Company’s balance sheet appears as follows (in thousands):

Cash P75 Total Current Liabilities P1,900

Receivables 685 Long-term note payable
Inventory 725 Other long-term liabilities 980
Prepaid expenses 35
Total current assets 1,520 Stockholders’ Equity 2,325
Plant assets
Other assets 2,000
Total Assets P6,800 Total Liabilities and Equity

Current ratio = CA/CL 1,520/1900 = 0.80:1

Quick ratio = QA/CL 760/1900 = 0.40:1

We are given the following information for Ally Corporation:

Sales (credit) P7,200,000

Cash 300,000
Inventory 2,150,000
Current liabilities 1,400,000
Asset turnover (sales/TA) 7,200,000/TA=1.20
Current ratio 2.50
Debt-to-assets ratio 40%
Receivables turnover 8

Current assets are composed of cash, marketable securities, accounts receivable and inventory.
Compute for the following balance sheet items: Accounts receivable, Marketable securities, Fixed
Assets and Long-term debt (300,000+150,000+900,000+2,150,000 = 3,500,000)

CR = CA/CL 2.5 = CA/1,400,000 = 3,500,000 2.5 = 3500/1400

ARTO = Sales/AR 8 = 7,200,000/AR = 900,000 8 = 7200/900
ATO = Sales/TA 1.20 = 7,200/TA = 6,000,000 less CA 3,500,000 = 2,500,000
DR = TL/TA 0.40 = TL/7,200 TL = 7200*.40 = 2,400,000 TL less CL 1400

NCL = 1,000,000

Hargreeves Corporation reported the following figures (in thousands):

ARTO = Sales/Ave AR ARTO = 20,941/(1813+1611/2) = 20,941/1712 = 12 times

Age of AR = 360/12 = 30 days
ITO = COGS/Ave MI ITO = 7,055/(1324+1060/2) = 7055/1192 = 6 times
Age of MI = 360/6 = 60 days
Operating cycle = 90 days
CR = CA/CL = 7296/7230 = 1.01
QR = QA/CL = 4263/7230 = 0.59
 2021 2020

Cash and cash equivalents P2,450 P2,094

Receivables 1,813 1,611
Inventory 1,324 1,060
Prepaid expenses 1,709 2,120
Total Current Assets 7,296 6,885
Other Assets 18,500 15,737
Total Assets P25,796 P22,622
Total Current Liabilities 7,230 8,467
Long-term Liabilities 4,798 3,792
Common Stock 6,568 4,363
Retained Earnings 7,200 6,000
Total Liabilities and Equity P25,796 P22,622

Sales P20,941 100%

Cost of Sales (7,055) (34%)
Gross profit 13,886 66%
Operating Expenses (7,065) (34%)
Operating Income 6,821
Interest Expense 210
Income tax 2,563
Net Income P4,048 19%

1. Horizontal analysis of Hargreeve’s balance sheet for 2021 would report

a. Cash as 9.5% of total assets c. current ratio of 1.01
b. 17% increase in cash d. inventory turnover of 6 times

2. Vertical analysis of Hargreeve’s balance sheet for 2021 would report

a. Cash as 9.5% of total assets c. current ratio of 1.01
b. 17% increase in cash d. inventory turnover of 6 times

3. A common-size income statement would report

a. Net income of 19% c. cost of sales at 34%
b. Sales of 100% d. all of the choices

4. Which statement best describes Hargreeve’s acid test ratio?

a. Greater than 1 c. less than 1
b. Equal to 1 d. none of the above

5. Hargreeve’s inventory turnover during 2021 was

a. 6 times c. 8 times
b. 7 times d. not determinable with the given data

6. During 2021, the firm’s days’ sales in receivable

a. 34 days c. 32 days
b. 30 days d. 28 days
 7. Which measure expresses the firm’s times-interest-earned ratio?
a. 54.7% c. 34 times
b. 19 times d. 32 times

8. The company has 2,500 shares of common stock outstanding. What was the firm’s
earnings per share? EPS = NI/OS 4,048/2500=1.62 per share
a. P1.62 c. P2.73
b. P1.75 d. 2.63 times
9. Hargreeve’s stock has traded recently around P48 per share. Use your answer in question 8
to measure the company’s price earnings ratio. PER = Price/EPS = 48/1.62 = 29.62
a. 1.01 c. 48
b. 30 d. 78

Rhaenyra Company has P1,000,000 in assets and P600,000 of debt. It reports net income of
P100,000.

a. What is the return on assets? ROA = NI/TA = 100,000/1,000,000 = 10%

b. What is the return on equity? ROE = NI/TE = 100,000/400,000 = 25%
c. If the company has an asset turnover of 2, what is the profit margin ROS?

ROS = NI/TS

ROA = ATO*ROS 10% = 2 * 5%

Anya Company has 40,000 shares of common stock outstanding that it originally issued at P30 per
share. The following data pertains to these shares for the recent year:

Book value, Dec 31 P60 per share

Market value, Jan 1 P75 per share
Market value, Dec 31 P80 per share

The total dividend on common stock was P360,000. What is the dividend yield for the year?
DY = Dividends/Price
DY = (360,000/40,000)/80
DY = 9/80
DY = 11.25%

Brother Company has provided the following data:

Common stock outstanding 30,000
Market value, Dec 31 P165,000 / 30,000 = 5.50 per share
Book value, Dec 31 P90,000
Dividends paid P40,000
Preferred stock, 10%, P100 par P100,000 (dividends = 10,000)
Net income P150,000 – 10,000 = 140,000/30,000 shares = 4.67
Interest on long term debt P15,000
What is the price earnings ratio?
PER = Price/EPS
= 5.50/4.67
= 1.18
The following figures (in thousands) were provided regarding Klaus Company’s balance sheet:
Cash ? Gross margin 25%
Accounts receivable ? Debt to equity ratio 0.25
Inventory 80 Current ratio 3
Fixed Assets (net) ? Inventory turnover 15
Current liabilities 100 Ave. Collection period
(360 days) 15 days
Common stock 100
Retained earnings ?

Add as much to Klaus’ balance sheet as possible from the data provided.

Assume that net income was P6,000. No other information is known, except the following:
Return on equity 10% Long-term debt-to-equity ratio 2:3
Gross profit ratio 60% income tax rate 40%
Current ratio 3 Return on assets 5%
Inventory turnover 4 Days sales in receivables 90
Return on sales 4%

Using the preceding ratios, construct an income statement and balance sheet

Sales _________
Cost of sales _________
Gross profit _________
Operating expenses _________
Operating income _________
Income tax _________
Net income P6,000

Cash _________ Current liabilities ________

Accounts receivable _________ Long-term debt ________
Inventory _________ Total liabilities ________
Total current assets _________
Fixed assets _________ Shareholders’ equity ________
Total assets _________ Total liabilities and equity ________