UNIVERSITY OF CEBU LAPU LAPU AND MANDAUE

SENIOR HIGH SCHOOL DEPARTMENT

COMPILATION NOTES FOR ABM 2

Financial Statement Analysis

There are two phases involved in financial statement analysis. First the Computation phase,
second is the Interpretation phase. In the first phase, we compute the differences, percentages, or
ratios. In the second phase, we interpret the results of the figures we get from the first phase. The
second phase, although more difficult than the first phase, makes the analysis of financial statements
more meaningful because it communicates to the users the significance of the results.

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 the
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.
It is also known as comparative analysis that helps management analyse the increase and
decrease in the balance sheet and income statement account. For balance sheet account items, it helps
to management for decision making purposes. For income statement accounts it helps management
analyze significant increase or decrease in sales, cost of sales and expenses.

Illustrative Steps in performing a horizontal analysis:

1. Prepare comparative financial statement of two consecutive years using the first and second
column.
2. Use the 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 base year from the current 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.

% change = Current year amount – Base year amount / Base year amount X 100

Example from below Current assets = 725.8 – 665.4 / 665.4 X 100 = 9.1%

Fidas Merchandising
Statement of Financial Position
As of December 31
(in millions Pesos)

Assets 2017 2016 Increase (Decrease)

Amount Percent
Current Assets
Cash 222.9 330.2 (107.3) (32.5)
Accounts Receivable (net) 282.5 172.1 110.4 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) 1,866.4 556.2 1,310.2 235.6

Total Assets 2,592.2 1,221.6 1,370.6 112.2
===== ===== =====
Liabilities and Owner’s Equity

Current Liabilities
Trade and Other Payables 551.9 620.6 (68.7) (11.1)
Non-Current Liabilities
Loan Payable 1,822.4 376.6 1,445.8 383.9
Total Liabilities 2,374.3 997.2 1,377.1 138.1
Owner’s Equity 217.9 224.4 (6.5) (2.9)
Total Liabilities and Owner’s Equity 2,592.2 1,221.6 1,370.6 112.2
===== ===== =====
 Fidas Merchandising
Income Statement
For the Years Ended December 31
(in millions Pesos)

Increase (Decrease)
2017 2016 Amount Percent
Net Sales 2,213.3 1,738.7 474.6 27.3
Cost of Goods Sold 1,032.1 831.8 200.3 24.1
Gross Profit 1,181.2 906.9 274.3 30.2
Selling and Adm. Expenses 889.2 659.5 229.7 34.8
Operating Income 292.0 247.4 44.6 18.0
Interest Expense 90.9 30.5 60.4 198.0
Income Before Income Tax 201.1 216.9 (15.8) (7.3)
Income Tax Expense 60.3 65.0 (4.7) (7.2)
Net Income 140.8 151.9 (11.1) (7.3)
=========================

Analysis

1. Current assets increased by 9.1%. This increase is a result of a 64.1% increase in accounts receivable
and a 57.7% increase in inventory. This increase in accounts receivable entails management to check
their credit and collection policy for prompt collection of accounts especially that increase in the net
sales was only 27.3% and cash decreased by 32.5%. Likewise, the increase in merchandise inventory
necessitates management to check their inventory stocks for obsolescence or slow moving items
comparing their increase in sales and increase in inventory.

2. Property, Plant, and Equipment showed a 235.6% increase. This may be due to purchases made by
the company to invest in plant assets. It is possible for the owner to invest property and equipment in
the business. However, in the case of Fidas Merchandising, owner’s equity showed a decrease of 2.9%.
This might not be possible unless the owner invested non-current assets then afterward made large
amounts of withdrawals during the year.

3. Current liabilities and owner’s equity decreased despite increase in total liabilities and owner’s equity.
This can be explained by the 383.9% increase in the company’s non-current liabilities which means
that the company made heavy borrowing during the year. Sources of business funds are generated
either from the investment of the owner or loans from banks or financial institutions. In the case of
Fidas Merchandising, the company obtained additional funds from loan. With the significant increase
in non-current assets, it can be inferred that the loan obtained by the company was used to finance
the acquisitions of the property, plant, and equipment.

4. Net sales increased by 27.3% during the year. However, despite the increase in sales, net income
decreased by 7.3%. Looking at the other components of the income statement, cost of goods sold
increased by 24.1%. Even with this increase in cost of goods sold, gross margin registered a 30.2%
increase. Selling and administrative expense showed a 34.8% increase. Despite this, income from
operations recorded an 18% increase. The company’s increase in interest expense of 198% resulted
in a decrease in income before taxes despite the increase in net sales. Analyzing the components of
the income statement, we were able to explain the decreased in net income despite increase in net
sales.

Vertical Analysis
- Otherwise known as common-size analysis that 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 in liabilities? What percent is owner’s
equity?
The answer of the above questions may lead to other questions such as when accounts
receivable occupy a big percentage of current assets, are these receivable collectible? This may reflect
on the company’s credit and collection policy. This indicates the leniency of a company in the extending
credit to its customers and the terms and policies for collection. If a big percentage of the total assets
is allotted to merchandise inventory, this raises a question as to the whether the inventory is saleable
or 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 creditors and what part of the total assets is financed by the owner?
In income statement, vertical analysis helps management analyse the components of the income
statement in relation to its revenue account which is sales. It helps management answer certain
questions as follows:

1. What percentage of net sales 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 statements of two consecutive years.
2. Add one column on the right side of each year.
3. For the comparative statement of financial position, express each account as percentage of the
total assets. The total is automatically 100%. Likewise, total liabilities and owner’s equity is
automatically 100%.

Example: From previous data:

% of current assets = 725.8 / 2,592.2 X 100% = 28%

% of non – current liabilities = 1,822.4 / 2,592.3 X 100% = 70.3%

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

% of cost of goods sold = 1,032.1 / 2,213.3 X 100% = 46.6%

Fidas Merchandising
Statement of Financial Position
As of December 31
(in millions Pesos)

Assets 2017 Percent 2016 Percent

Current Assets
Cash 222.9 8.6 330.2 27.0
Accounts Receivable (net) 282.5 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 Assets 725.8 28.0 665.4 54.5

Property, Plant, and Equipment (net) 1,866.4 72.0 556.2 45.5

Total Assets 2,592.2 100 1,221.6 100
===== ===== ===== ===
Liabilities and Owner’s Equity
Current Liabilities
Trade and Other Payables 551.9 21.3 620.6 50.8
Non-Current Liabilities
Loan Payable 1,822.4 70.3 376.6 30.8
Total Liabilities 2,374.3 91.6 997.2 81.6
Owner’s Equity 217.9 8.4 224.4 18.4
Total Liabilities and Owner’s Equity 2,592.2 100 1,221.6 100
===== ===== ===== ====

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 Years Ended December 31
(in millions Pesos)

2017 Percent 2016 Percent

Net Sales 2,213.3 100 1,738.7 100
Cost of Goods Sold 1,032.1 46.6 831.8 47.8
Gross Profit 1,181.2 53.4 906.9 52.2
Selling and Adm. 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 Tax 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
===== ==== ==== ===

Note: Notice that each component of the income statement is expressed as a percentage of net
sales.

INTERPRETATION OF DATA

Analysis
1. Current assets was 54.5% of total assets in 2016. However, this percentage decreased to 28% in
2017. This was due to the significant increase in property, plant, and equipment. Hence, the dramatic
change in total assets composition.
2. Non-current assets represented by property, plant, and equipment was 45.5% of total assets in 2016
and 72% in 2017. This may be due to purchases made by the company during the year to invest in
plant assets.
3. Current liabilities was 50.8% of total liabilities and owner’s equity in 2016 but significantly decreased
to 21.3% in 2017. This is opposite to non-current liabilities which was 30.8% of total liabilities and
owner’s equity in 2016 but increased to 70.3% in 2017. The company made a loan during the year and
might have paid its current liabilities. Hence, the opposite change in the two liabilities. Percentage of
owner’s equity to total liabilities and owner’s equity was 18.4% in 2016 and 8.4% in 2017. This means
that the equity financed by creditors represented by total liabilities was 81.6% in 2016 and 91.6% in
2017. This is not a good sign as the company’s business funds are heavily provided by creditors.
4. From the income statement, the percentage of net income to sales decreased from 8.7% to 6.4%.
This decrease has been explained by the onerous interest expense in the horizontal analysis discussed
in the previous lesson. The percentage of cost of goods sold in relation to net sales indicated a minimal
decrease from 47.8% to 46.6% while selling and administrative expenses indicated a minimal increase
from 38% to 40.2%. The relation of interest expense to net sales during the year increased more than
double from 1.8% to 4.1%. Finally, net income in relation to net sales decreased from 8.7% to 6.4%
despite the company’s acquisition of property, plant, and equipment.

TREND ANALYSIS

In trend analysis, a base year is established which is labelled 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 / Base Year X 100%

Example:
Current Assets Trend % 2016 = 665.40/597.60 X 100% = 111.3%
 Fidas Merchandising
Statement of Financial Position
As of December 31
(in millions Pesos)

Assets 2017 2016 2015

Current Assets
Cash 222.9 330.2 290.0
Accounts Receivable (net) 282.5 172.1 156.0
Inventory 146.3 92.8 90.9
Prepaid Expenses 74.1 70.3 60.7
Total Current Assets 725.8 665.4 597.6

Property, Plant, and Equipment (net) 1,866.4 556.2 625.5

Total Assets 2,592.2 1,221.6 1,223.1
===== ===== =====
Liabilities and Owner’s Equity

Current Liabilities
Trade and Other Payables 551.9 620.6 580.7
Non-Current Liabilities
Loan Payable 1,822.4 376.6 400.0
Total Liabilities 2,374.3 997.2 980.7
Owner’s Equity 217.9 224.4 242.4
Total Liabilities and Owner’s Equity 2,592.2 1,221.6 1,223.1
===== ===== ====

Fidas Merchandising
Statement of Financial Position
As of December 31
(in millions)

Assets 2017 2016 2015

% % %
Current Assets
Cash 76.9 113.9 100
Accounts Receivable (net) 181.1 110.3 100
Inventory 160.9 102.1 100
Prepaid Expenses 122.1 115.8 100
Total Current Assets 121.5 111.3 100

Property, Plant, and Equipment (net) 298.4 88.9 100

Total Assets 211.9 99.9 100
==== ==== ===
Liabilities and Owner’s Equity

Current Liabilities
Trade and Other Payables 95.0 106.9 100
Non-Current Liabilities
Loan Payable 455.6 94.2 100
Total Liabilities 242.1 101.7 100
Owner’s Equity 89.9 92.6 100
Total Liabilities and Owner’s Equity 211.9 99.9 100
==== === ===
 Fidas Merchandising
Income Statement
For the Years Ended December 31
(in millions Pesos)

2017 2016 2015

Net Sales 2,213.3 1,738.7 1,543.2
Cost of Goods Sold 1,032.1 831.8 700.1
Gross Profit 1,181.2 906.9 843.1
Selling and Adm. Expenses 889.2 659.5 555.5
Operating Income 292.0 247.4 287.6
Interest Expense 90.9 30.5 25.0
Income Before Income Tax 201.1 216.9 262.6
Income Tax Expense 60.3 65.0 77.4
Net Income 140.8 151.9 185.2
===== ===== =====

Fidas Merchandising
Income Statement
For the Years Ended December 31
(in millions Pesos)

2017 2016 2015

% % %
Net Sales 143.4 112.7 100
Cost of Goods Sold 147.4 118.8 100
Gross Profit 140.1 107.6 100
Selling and Adm. Expenses 160.0 118.7 100
Operating Income 101.5 86.0 100
Interest Expense 363.6 122.0 100
Income Before Income Tax 76.6 82.6 100
Income Tax Expense 77.9 84.0 100
Net Income 76.0 82.0 100
==== ==== ===
INTERPRETATION OF DATA
Analysis

1. Cash increased in 2016 but significantly decreased in 2017. Accounts Receivable and Inventory
continued its upward trend for three years. Although net sales has an upward trend, its increase is not
on a par with the increase in accounts receivable and inventory should be checked for obsolete and
slow moving items.
2. Property, Plant, and Equipment decreased in 2016 but drastically increased in 2017 due to
acquisitions made by the company. Likewise, non-current liabilities significantly increase in 2017 which
means that the company used the loan to acquire the property, plant, and equipment.
3. Total liabilities has an upward trend while owner’s equity has a downward trend indicating that the
company heavily relied on outside funds from creditors.
4. Net sales had an upward trend for three years while property, plant, and equipment decreased in
2016 but significantly increased in 2017. This may indicate that the company is benefitting from the
use of the newly acquired non-current assets as evidenced by the increase in sales.
5. Cost of sales has an upward trend but despite this, gross profit managed to follow with an upward
trend. Selling and administrative expense has an upward trend, income from operations decreased in
2016 but increased in 2017.
6. Interest expense has the most significant increasing trend in three years culminating to more than
300 percent increase in 2017. With cost of sales and all expenses going up, income understandably
went on a downward trend despite an upward trend in net sales.
Exercise 1.
Multiple Choice: Write the letter in space as provided.
__ 1. In horizontal analysis, each account is expressed as a percentage of
a. total assets c. base year
b. total liabilities and owner’s equity d. none of the above
__ 2. In vertical analysis, the base amount for bad debts expense is
a. accounts receivable c. bad debts expense of past year
b. non-current assets d. none of the above
__ 3. Identify the type of analysis shown on the items below
Amount in Pesos Percent

Total Liabilities 300,000 60%

Owner’s Equity 200,000 40%
Total Liabilities and Owner’s Equity 500,000
a. horizontal analysis c. trend analysis
b. ratio analysis d. vertical analysis
__ 4. Talula Co. reported net sales of P150,000, P200,000 and P300,000 for 2015, 2016, and 2017,
respectively. Assuming the base year to be 2015, what is the trend percentage for 2017?
a. 100% c. 133%
b. 150% d. 200%

Exercise 2
Identify the type of financial statement analysis performed under each of the following.
_____________________ 1. Shows the relationship of each part to the whole in a single financial
statement.
_____________________ 2. Describes the significant relationship between the numbers presented in
the financial statements.

_____________________ 3. Compares the same account in the financial statements to two periods
(current and past) determining the amount of changes and computing its percentage change using a
base year as comparison.
_____________________ 4. Analyzes not only two years in comparison but covers three, four or
five years’ financial statements to determine the trends in the industry.
_____________________ 5. In the income statement, each item is presented as a percentage of net
sales.
_____________________ 6. This can be expressed either as a rate, percentage, or a proportion
_____________________ 7. This is to determine the trends in the industry
_____________________ 8. In the statement of financial position, each item is expressed as a
percentage of total assets.
_____________________ 9. 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
_____________________ 10. Helps management analyse increases and decreases in balance sheet
and income statement accounts.

Exercise 3
Perform a horizontal analysis for Sunlight Sonata Trading
2017 2016

Net Sales P450,000 P375,000

Cost of Goods Sold 315,000 300,000
Gross Profit P135,000 75,000
Operating Expenses 101,250 60,000
Net Income P 33,750 P 15,000
====== ======
Exercise 4
The following are accounts taken from the books of Sunlight Sonata Trading for the month of April.
Perform a vertical analysis for the company.

2017 2016

Net Sales P450,000 P375,000

Cost of Goods Sold 315,000 300,000
Gross Profit P135,000 75,000
Operating Expenses 101,250 60,000
Net Income P 33,750 P 15,000
====== ======
Exercise 5
The following are accounts taken from the books of Sunlight Sonata Trading for the month of April.
Perform a trend analysis for the company.
2017 2016 2015

Net Sales P450,000 P375,000 P320,000

Cost of Goods Sold 315,000 300,000 280,000
Gross Profit P135,000 75,000 P 40,000
Operating Expenses 101,250 60,000 25,000
Net Income P 33,750 P 15,000 15,000
====== ====== ======