FINFSAF/FINFSAN

September 11, 2023

Financial Statement Analysis
Financial statement analysis is the process of understanding the risk and
profitability of a firm through analysis of reported financial information.

What may be analyzed?

Published annual reports
 Financial Statements
 Notes to Financial Statements
 Letters to Stockholders
 Management’ discussion and analysis

Others:
 Newspapers ( Wall Street Journal, Business World, Philstar, PDI, etc)
 Periodical (Forbes, Fortune)
 Financial information organization such as Moody’s Investors Service, Standard and Poor’s Global
Rating, etc.
 Other business publications
 Purpose of Financial Statement Analysis

How good is our Will I be paid?

investment? How are we performing?
Purpose of Financial Statement Analysis

To evaluate the performance and the financial position

of the firm given the strategy of the firm, the economic
and the industrial environment in which the company is
competitive, the level of accounting flexibility
influenced by the quality of accounting principles
applied and the incentives and opportunities present
towards earning management.
FINANCIAL STATEMENT ANALYSIS
Most Common Methods Used
Methods
calculations and
comparisons of the results
to historical data,
competitors, or industry
averages

to determine the relative

strength and performance
of the company being
analyzed
Financial Statement Analysis
 To identify the trends and relationships between financial statement
items

 Both internal and external users (such as analysts, creditors, and

investors) of the financial statements need to evaluate an entity’s
profitability, liquidity and solvency

 Ratio analysis expresses the relationship among selected items of

financial statement data.
Financial Statements

Statement of Financial Position (Balance Sheet, Statement of

Condition, Statement of Assets and Liabilities)

Statement of Income (Statement of Profit and Loss, Statement of

Comprehensive Income, Statement of Operations, Statement of
Performance, Statement of Income and Retained Earnings)
Financial Statements
Statement of Changes in Equity (Capital Stock, Retained
Earnings, Other Components of Equity)

Notes to FS (footnotes, additional information pertaining to a

company's operations and financial position and are considered to be
an integral part of the financial statements)

Statement of Cash Flows (Operating, Investing and Financing

Activities)
Financial Statements
Statement of Financial Position (Balance Sheet,
Statement of Condition, Statement of Assets and
Liabilities)

Equity

Equity
Equity
Financial Statements

Statement of Income (Statement of Profit and Loss,

Statement of Comprehensive Income, Statement of Operations,
Statement of Performance, Statement of Income and Retained
Earnings)
Financial Statements
Statement of Changes in Equity (Capital Stock,
Retained Earnings, Other Components of Equity)
 Financial Statements
Statement of Cash Flows ( Operating, Investing and
Financing Activities)
FINFSAF/FINFSAN
September 14, 2023
Most Common Methods Used
Types of analysis
Trend analysis or
horizontal analysis
Common size
analysis or
Vertical analysis
Cash flow analysis
Trend analysis or Horizontal analysis

With the use of trend analysis we compare the performance of the firm
with its own history
Determine the base year in the analysis
Benchmarks are necessary to make a sound judgement about the
performance of a company
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.
Cash flow analysis

Cash flow information helps external users to get an idea of whether or

not a company is able to generate net positive cash flows
 Ratio Analysis

 Financial ratio, or accounting ratio

derived from a company’s financial statements
a calculation showing the relative magnitude of selected
numerical values taken from those financial statements

 The numbers contained in financial statements need to be put

into context so that investors can better understand different
aspects of the company’s operations.
Ratio Analysis

 Ratio analysis is one method an investor can use to gain

understanding on financial status, performance and investment
 Ratio Analysis
Areas of interest in which users’ needs and objectives:
Financial Status
Can the business meet its financial commitments?
Can the business pay its debt?
Is it liquid?
Performance
How successful is the business?
Is it making a reasonable profit?
Is it utilizing its assets to the fullest?
Is it profitable and efficient?
 Ratio Analysis

Areas of interest in which users’ needs and objectives:

Investment
Is the business suitable investment for shareholders
or would returns be greater if they invested
elsewhere?
Is it a good investment?
Ratio Analysis
Ratio Analysis
Financial Status
Liquidity Ratios
Current Ratio
Acid Test Ratio
 Financial Status
Solvency Ratio
Debt Equity Ratio
Importance of liquidity
A very basic requirement of
public confidence in the
banking system is that the
depositors should believe that
they can have access to their
funds whenever they need
them.

With this belief, they will be

confident that they are
incurring no risk in depositing
their money in the bank.
Who are the parties interested in liquidity of banks?

Depositors
Regulators
Bank managers
Independent analysts
Two most important measures of profitability are

2. Performance

• Return on Equity –
• measures the return on shareholder’s equity
• it is desirable to use average denominator

• Net income/Average Capital

Two most important measures of profitability are

2. Performance

• Return on Assets –
• relates operating profits to total resources under management
• is considered by many to be the best singe ratio for evaluating
the performance of management
• the denominator would be average daily outstanding
• Net Income /Average Total Assets
3. Investment
Book Value per share
Earnings per share
Price earnings ratio
Summary
Summary
Summary
Summary
Benchmarking
 Identify benchmarks or indicators we
can use
 Consider the indicators limitations

 Possible benchmarks
Past period achievements
Budgeted achievements
Other businesses’ achievements
Averages of businesses’ achievements
in the same area
Assignment for the Next Meeting

 Read Chapter 1 of our Textbook

 On Monday, September 18, you have to submit 1 pager of your

visual understanding of why FIs are important

 Also, please bring pad paper for seatwork

FINFSAF/FINFSAN
K 31

SEPTEMBER 18, 2023

Financial Institution
A financial institution is a company engaged in the business of
dealing with financial and monetary transactions such as
deposits, loans, investments, and currency exchange.
 Financial Institutions
encompass a broad range of
business operations within the
financial services sector including
banks
trust companies
insurance companies
brokerage firms
investment dealers
Financial Institutions

•Everyone living in a developed and

developing economy has an ongoing or at
least periodic need from the services of
financial institutions
Financial Institutions
The financial system matches savers and borrowers through
two channels:
A. financial markets, and
B. banks and other financial intermediaries
Financial Institutions VS Financial Markets
Financial institutions are those Financial Markets are the
engaged in the business of meeting place for people,
dealing with financial and corporations and institutions
monetary transactions such as that either need money or
deposits, loans, investments, and have money to lend or invest.
currency exchange.
Funds flow from lenders to borrowers

• DIRECTLY though financial markets

(New York Stock Exchange and Philippine
Stock Exchange)

• INDIRECTLY though financial intermediaries

such as banks
Financial Institutions
Financial Intermediaries
• A financial intermediary is a financial firm, such as bank,
that borrows funds from savers and lends them to the
borrowers.

• Basic
1. Structures
Depository Institutions of Financial Institutions / Intermediaries
Commercial Banks / Universal Banks

Savings and Loans Associations

Mutual Savings Bank

Credit Union
Financial Intermediaries
• Basic Structures of Financial Institutions / Intermediaries
2. Contractual Savings Institutions
Insurance Companies
Pension Funds

3. Investment Intermediaries
Investment Banks
Mutual Funds
Hedge Funds
Finance Companies
Money Market Mutual Funds
Primary Assets and Liabilities of Financial Intermediaries
Type of Intermediary Primary Liabilities (Sources of Primary Assets
Funds) (Uses of Funds)

DEPOSITORY INSTITUTIONS

Commercial Banks Deposits Business and consumer loans,

mortgages, national
government securities, bonds

Savings and Loan Associations Deposits Mortgages

Mutual Savings Bank Deposits Mortgages

Credit Unions Deposits Consumer loans

Primary Assets and Liabilities of Financial Intermediaries
Type of Intermediary Primary Liabilities (Sources of Primary Assets
Funds) (Uses of Funds)

CONTRACTUAL SAVINGS INSTITUTIONS

Life insurance companies Premiums from policies Corporate bonds and

mortgages

Fire and casualty insurance Premiums from policies Government bonds, corporate
bonds and stock, national
government securities

Pension funds, government Employer and employee Corporate bonds and stock
retirement funds contributions
Primary Assets and Liabilities of Financial Intermediaries
Type of Intermediary Primary Liabilities (Sources of Primary Assets
Funds) (Uses of Funds)

INVESTMENT INTERMEDIARIES

Mutual funds Shares Stocks, bonds

Hedge funds Shares Stocks, bonds, derivatives

Finance companies Commercial paper, stocks, Consumer and business loans

bonds

Money market mutual funds Shares Money market instruments

 SPECIAL FUNCTIONS PROVIDED BY FIS
Services Areas of Financial Intermediaries

Information Costs Aggregation of funds in an FI provides greater incentive to

collect information about customers and to monitor their
actions.

The relatively large size of the FI allows this collection of

information to be accomplished at a lower average cost
(so-called economies of scale) than would be
the case for individuals.

Liquidity and Price Risk FIs provide financial claims to household savers with
superior liquidity attributes and with lower price risk.

Transaction Cost Service Similar to economies of scale in information production

costs, an FI’s size can result in economies of scale in
transaction costs.
 SPECIAL FUNCTIONS PROVIDED BY FIS
Services Areas of Financial Intermediaries

Maturity Intermediation FIs can better bear the risk of mismatching the maturities of
their assets and liabilities

Transmission of Monetary Supply Depository institutions are the conduit through which
monetary policy actions by the country’s central bank
impact the rest of the financial system and the economy.

Credit Allocation FIs are often viewed as the major, and sometimes only,
source of financing for particular sectors of the economy,
such as farming, small business, and residential real estate.

Intergenerational Wealth Transfers FIs, especially life insurance companies and

pension funds, provide savers with the ability to transfer
wealth from one generation to the next.
SPECIAL FUNCTIONS PROVIDED BY FIS
Services Areas of Financial Intermediaries

Payment Services The efficiency with which depository institutions

provide payment
services such as check clearing directly benefits the
economy.

Denomination Intermediation FIs, such as mutual funds, allow small investors to

overcome constraints to buying assets imposed by
large minimum denomination size.
Why are financial institutions special?

Information Payment
Funds Asset Credit Services
Allocation Producer
Flow Transformers

Transition
Delegated of
Brokers Monitor Monetary Brokers
Policy
Why Are Financial Institutions Special?
Financial institutions (e.g., banks, credit unions, insurance companies,
and mutual funds) perform the essential function of channeling funds
from those with surplus funds (suppliers of funds) to those with shortages
of funds (users of funds).
FIs Function as Brokers
• When acting as a pure broker, an FI acts as an agent for the saver
by providing information and transaction services.
FIs Function as Brokers
• Full-service securities firms (e.g., Bank of America Merrill Lynch) carry
out investment research and make investment recommendations for
their retail (or household) clients as well as conduct the purchase or
sale of securities for commission or fees.

• Discount brokers (e.g., Charles Schwab) carry out the purchase or sale
of securities at better prices and with greater efficiency than
household savers could achieve by trading on their own. This
• economies of scale
efficiency results in reduced costs of trading, or economies of scale.
The concept that the cost reduction in trading and other transaction
services results in increased efficiency when FIs perform these services.
FIs Function as Brokers
• FI plays an extremely important role by reducing
transaction and information costs or imperfections between
households and corporations.

• Independent insurance brokers identify the best types of

insurance policies household savers can buy to fit their
savings and retirement plans.
FIs Function as Asset Transformers
• In acting as an asset transformer, the FI issues financial claims that are far
more attractive to household savers than the claims directly issued by
corporations.
• That is, for many households, the financial claims issued by FIs dominate
those issued directly by corporations as a result of lower monitoring costs,
lower liquidity costs, and lower price risk.
• In acting as asset transformers, FIs purchase the financial claims issued by
corporations —equities, bonds, and other debt claims called primary
securities—and finance these purchases by selling financial claims to
household investors and other sectors in the form of deposits, insurance
policies, and so on.
FIs Function as Asset Transformers

• The financial claims of FIs may be considered secondary securities

because these assets are backed by the primary securities issued by
commercial corporations that in turn invest in real assets.
• Specifically, FIs are independent market parties that create financial
products whose value added to their clients is the transformation of
financial risk.
FIs Function as Asset Transformers
Asset transformer
An FI issues financial claims that are more attractive to
household savers than the claims directly issued by
corporations.

Primary securities
Securities issued by corporations and backed by the real assets
of those corporations.

Secondary securities
Securities issued by FIs and backed by primary securities.
FI’s Role as Delegated Monitor

• Delegated monitor - an economic agent appointed to act on behalf of

smaller agents in collecting information and/or investing funds on their
behalf
• Small savers pooling their funds together and invest in the direct or
primary financial claims issued by firms have appointed the FI as a
delegated monitor to act on their behalf
FI’s Role as Information Producer
• FIs reduce the degree of information imperfection and asymmetry between the
ultimate suppliers and users of funds in the economy.
Example:
• Bank loans are generally shorter-term debt contracts than bond contracts. This short-
term nature allows the FI to exercise more monitoring power and control over the
borrower.
• The information the FI generates regarding the firm is frequently updated as its loan
renewal decisions are made.
• The banker becomes almost like an insider to the firm regarding informational
familiarity with its operations and financial conditions.
• This more frequent monitoring often replaces the need for the relatively inflexible and
hard-to-enforce covenants found in bond contracts.
• Thus, by acting as a delegated monitor and producing better and more timely
information.
Transmission of Monetary Policy

• Depository institutions are the conduit through which monetary policy actions
impact the rest of the financial sector and the economy in general.
• Monetary policy actions include
• open market operations (the purchase and sale of securities in the U.S. Treasury
securities market)
• setting the discount rate (the rate charged on “lender of last resort” borrowing
from the Federal Reserve)
• setting reserve requirements (the minimum amount of reserve assets depository
institutions must hold to back deposits held as liabilities on their balance sheets)
Credit Allocation
• FIs are the major and sometimes the only source of financing
for a particular sector of the economy pre-identified as being in
special need of financing

• residential real estate as needing special subsidies –In US,

the savings associations and savings banks have traditionally
served the credit needs of the residential real estate sector
Credit Allocation
• farming is an especially important area of the economy in terms
of the overall social welfare of the population. The U.S.
government has even directly encouraged financial institutions
to specialize in financing this area of activity through the
creation of Federal Farm Credit Banks.

• the provision of credit to make houses more affordable or farms

more viable leads to a more stable and productive society.
 Payment Services
• Depository institutions are special in that the efficiency with which
they provide payment services directly benefits the economy.

• Two important payment services are check-clearing and wire

transfer services.
Payment Services
For example :
• On any given day, trillions of dollars worth of payments are effected
through Fedwire and CHIPS, the two large wholesale payment wire
networks in the United States.

• Any breakdowns in these systems probably would produce gridlock in the

payment system with resulting harmful effects to the economy.
 Assignment for next meeting
• Read Chapter 2 of our
Textbook

• Financial Services:
Depository Institution
FINFSAF/FINFSAN
September 21, 2023
Depository Institutions
A. Private Institutions
 1. Universal Bank (UB) or Expanded Commercial Bank (EKB)
any commercial bank, which performs the investments house
function in addition to its commercial banking authority
may invest in the equities of allied and non allied enterprises
Allied enterprises may either be financial or non-financial.
Depository Institutions
 2. Commercial Bank or Domestic Bank (KB)
any commercial bank that is confined only to commercial bank
functions
accepting drafts
Depository Institutions
commercial bank functions
issuing letters of credit
discounting and negotiating promissory notes, drafts and bills of
exchange, and other evidences of debt
Depository Institutions
commercial bank functions
accepting or creating demand deposits
receiving other types of deposit substitutes (surety bonds/guarantees)
buying and selling foreign exchange
 acquiring marketable bonds and other debts securities
extending credit subject to such rules that the Monetary Board may
promulgate
 3. Thrift Banks (TB)

 include savings and mortgage banks, stock savings and loan associations
and private development banks
 functions
to accumulate the savings of depositors
to invest them (together with their capital, loans secured by bonds,
mortgages in real estate and insured improvements thereon, chattel
mortgages, bonds and other forms of security or loans for personal or
household finance, whether, secured or unsecured, or in financing for
home building and home development)
 4. Rural Bank (RB)
any bank authorized by the Central Bank to accept deposits
make credit available to farmers, businessmen and cottage
industries in the rural areas
Loans may be granted by rural banks on the security of land without
Torrens title where the owner of private property can show five (5)
years or more peaceful continuous and uninterrupted possession of
the land in the concept of ownership

 5. Cooperative Banks
banks established to assist the various cooperatives by lending
those funds at reasonable interest rates
B. Government Banks or Specialized Government Banking Institutions
 1. Development Bank of the Philippines (DBP)
 provides loans for development purposes, give loans to the agricultural
sector, commercial sector and the industrial sector
 2. Land Bank of the Philippines (LBP)
 a government bank, which provides financial support in the
implementation of the Agrarian Reform Program (CARP) of the
government
 3. Al-Amanah Islamic Investment Bank:
 Republic Act No. 6048 provides for the charter of the Al-Amanah
Islamic Investment Bank.
 This Act authorizes the bank to promote and accelerate the socio-
economic development of the Autonomous Region of Muslim
Mindanao by performing banking, financing and investment
operations, and to establish and participate in agriculture, commercial
and industrial ventures based on the Islamic concept of banking.
1. What gave birth to savings institutions?

Savings institutions were first created in the early 1800s in

response to commercial banks’ concentration on serving the
needs of business (commercial) enterprises rather than the
needs of individuals requiring borrowed funds to purchase
homes.

Thus, the first savings institutions pooled individual savings and

invested them mainly in mortgages and other securities.
2. How would you describe the liability structure of
bank balance sheet?

 liability structure of bank balance sheets tends to reflect a

shorter maturity structure deposits & interbank borrowings

 asset portfolio with relatively more liquid instruments used

to fund less liquid assets such as loans
3. What are the non deposit liabilities in banks?
Non deposit liabilities comprise
borrowings and other liabilities that
include a broad array of instruments,
such as purchases of federal funds
(bank reserves) on the interbank market
and repurchase agreements (temporary
swaps of securities for federal funds) at
the short end of the maturity spectrum
to the issuance of notes and bonds at
the longer end.
4. Describe the establishment of credit unions?

Credit unions were first established in the United States in

the early 1900s as self-help organizations intended to
alleviate widespread poverty. The first credit unions were
organized in the Northeast, initially in Massachusetts.
10. Describe the mechanics of how the credit
unions operate?
 Members paid an entrance fee and invested funds to purchase at
least one deposit share in the CU.

 Members were expected to deposit their savings in the CU, and these
funds were lent only to other members.

CUs are prohibited from serving the general public.

In organizing a credit union, members are required to have a common

bond of occupation (e.g., police CUs) or association (e.g., university-
affiliated CUs), or to cover a well-defined neighborhood, community,
or rural district.
11. What is the tax liability of credit unions?

Credit unions are nonprofit organizations, their net income

is not taxed and they are not subject to the local
investment requirements established under the 1977
Community Reinvestment Act.

This tax-exempt status allows CUs to offer higher rates on

deposits, and charge lower rates on some types of loans,
than do banks and savings institutions.
12. What is the primary goals of credit unions in
maintaining their operation?

 Given the mutual-ownership status of CU, growth in profits is not

necessarily its primary goal.
 Rather, as long as capital or equity levels are sufficient to protect a
CU against unexpected losses on its credit portfolio as well as other
financial and operational risks, this not-for-profit industry has primary
goal of serving the deposit and lending needs of its members.
 This contrasts with the emphasis placed in profitability by
stockholder-owned commercial banks and savings institutions.
13. Why evaluate the performance of commercial
banks?

 To evaluate the overall safety and soundness of a bank

14. What are the two basic documents prepared by
commercial banks to report their financial
information?
Financial information on commercial banks is reported in two basic
documents:

Report of condition (or balance sheet) presents financial information on a

bank’s assets, liabilities, and equity capital and reports a bank’s condition
at a single point in time.

Report of income (or income statement) presents the major categories of

revenues and expenses (or costs) and the net profit or loss for a bank over
a period of time.
15. What are the four major subcategories of bank’s
assets?

A bank’s assets are grouped into four major subcategories:

• cash and due from depository institutions

• investment securities
• loans and leases
• other assets
Cash and due from depository institutions consists of
• vault cash
• deposits at the Federal Reserve (the central bank)
• deposits at other financial institutions
• cash items in the process of collection

Bank’s earning assets

• Investment securities
• loans and leases
16. What are the composition of Other Assets of
commercial banks?

Other assets on the bank’s balance sheet consist of items such as

premises and fixed assets
other real estate owned (collateral seized on defaulted loans)
intangible assets (i.e., goodwill and mortgage servicing rights)
and other (i.e., deferred taxes, prepaid expenses, and mortgage
servicing fees receivable)

These accounts are generally a small part of the bank’s overall assets.
17. What are core deposits and how will they affect
funding of banks?
The stable deposits of the bank are referred to as core
deposits.
These deposits are not expected to be withdrawn over short
periods of time and are therefore a more permanent source
of funding for the bank.
Core deposits are also the cheapest funds banks can use to
finance their assets.
Because they are both a stable and low-cost source of
funding, core deposits are the most frequently used source of
funding by commercial banks.
18. What are the sources of income of banks?

The income statement for a commercial bank shows the

sources of interest income:
Interest and fee income on loans and leases is the largest
interest income-producing category
Most banks also list income on leases as a separate item
Interest on investment securities held is also included as
interest income
19. How do we compute the total revenues of the
banks?

The total operating income or total revenue is computed by

adding the interest income and noninterest income of the
bank.

Total operating income for a bank is equivalent to total

sales in a manufacturing firm and represents the bank’s
income received from all sources.
20. What are the major expenses of banks?

Interest expense is the major category expense paid by

the banks. Items listed come directly from the liability
section of the balance sheet:
interest on deposits
and interest on other borrowed funds
For our next meeting to discuss
Article: Review of Banking
Regulations
Rafael A Morales
Morales and Justiniano
May 4, 2021
https://thelawreviews.co.uk/title/t
he-banking-regulation-
review/philippines