Financial statement is part of a

yearly compilation of reports

prepared by companies that is
commonly called as Annual
Report. The report is composed of
quantitative and qualitative
information. The explanation as
the results of the financial analysis and other significant non-
financial additional information form part the qualitative part of
the report while the financial statement mainly comprised the
quantitative part of the Annual Report.

The preparation of financial statement is not the end but merely

the beginning of its purpose. In order for the financial statement
to be useful in decision making, it has to undergo a process
called financial statement analysis.

Definition

Financial statement analysis is the process of evaluating the company’s financial

performance and its overall financial health in order to arrive a better and reliable decision.

Users of Financial Statements

The various users interested in the analysis of financial statements are:

1. Investors

2. Management 6. Tax Authorities

3. Trade unions 7. Employees

4. Lenders 8. Researchers

5. Suppliers 9. Government

Objectives of Financial Statement Analysis Source:www.cleverism.com

Below are the most common objectives that diverse users of financial statement are
interested:

1. Profitability. As an objective of analysis, profitability refers to capacity of the firm to

generate sufficient revenue that will result to a positive and ample profit.

2. Liquidity or Short-term Solvency. This objective refers to the capacity of the firm to pay its
currently maturing obligation.

3. Stability or Long-term Solvency. This refers to the paying capacity of the firm to settle its
long-term obligations.

4. Asset Utilization. It is also called Activity. This refers to how efficient the company in
utilizing their resources.

5. Debt utilization. It is also called Leverage. This refers to the overall debt status of the firm.
Limitations of Financial Statement Analysis

1. It does not consider changes in purchasing power of currencies.

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 2. It does not consider inconsistencies and dissimilarities in accounting principles,
policies, and procedures used by the firms in the industry.

3. Financial data is not adjusted for price changes or inflation/deflation mainly

because the cost principle is used to prepare financial statements.

4. Differences in fiscal year ends making comparison of companies’ difficult if the

industry is cyclical.

5. The diversity of the companies’ operation make it difficult to classify for

comparison purposes.
Differences in accounting methods, such inventory and depreciation methods,
makes comparison difficult for companies.

Financial Statement Analysis Process

Different Standard Used in Financial Statement Analysis

There are 4 most common standard that a company can used in performing
financial statement analysis:

1. Previous Year’s Financial Data. Preparation of Finan-

cial Statement (FS
)
2. Budgeted Data
3. Competitor’s Data
4. Industry Average
Analysis of Financial
Statement

Interpretation of FS
Analysis

Conclusion

Recommendation

Accessibility is an important factor when selecting what standard to choose. The

information which is quickly retrievable at a least cost should be the choice in the
analysis.
Practical Steps in Financial Statement Analysis
1. Know the firm first.
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 Know their vision and mission, strategies, organizational structure and their nature
of operation. Knowledge on the company background is essential prior to the
conduct of the analysis.
2. Know the objective/s of the analysis.
Determine what the company’s wants you to assess. It can the liquidity, profitability,
solvency or other objectives, if not all objectives of the financial analysis.
3. Know the standard of the analysis.
Standard in analysis serves as the benchmark, the basis for conclusion.
4. Know the macroeconomic factors.
Factors such as changes in market preferences, economic conditions, changes in
laws and additional government policies and regulations and etc. can affect the
performance and financial health of the firm
5. Analyze the company’s financial statements.
Analyzing the financial statement means doing computations using the appropriate
tools that will address the objective of the analysis.
6. Interpret the results of the analysis.
When interpreting, it is important to account and justify for the changes or increases
and decreases of the accounts in the financial statement. Cross link the changes
with the other elements of the financial statement
7. Draw conclusion.
The conclusion must address the objectives of the analysis. It should address
whether has increased or decreased in their liquidity, profitability, stability, asset
utilization or debtutilization.
8. Make recommendation.

Different Techniques in Financial Statement Analysis

Cross-sectional analysis. It is also Time series analysis. It is also called
known as inter firm comparison. This as intra-firm comparison. According to
analysis helps in analysing financial this method, the relationship between
characteristics of an enterprise with different items of financial statement is
financial characteristics of another established, comparisons are made and
similar enterprise in that accounting results obtained. For example,
period. For example, comparing Globe comparing Ayala Corp. 2018 and 2019
Telecom and PLDT financial statement or BPI Malaybalay
and BPI Valencia
Cross-sectional time series analysis. This analysis is intended to compare the
financial characteristics of two or more enterprises for a defined accounting period
This approach is most effective in analysing of financial statements. For example is
comparing the financial statements of Coca-Cola and Pepsi Co. for the years 2016 to
2018.

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 Tools in Financial Statement Analysis
The following are the important tools which are commonly used for analyzing and
interpreting financial statements:
Horizontal Analysis
1.1Comparative financial statements
1.2. Trend percentage analysis
2. Vertical Analysis
3. Ratio Analysis
4. Cash Flows Statement Analysis

Learning Activities
Activity 1. Identify the different tools used in financial statement analysis based
from the results presented below.
RESULT TOOL USED
10% of Sales
2.50:1.0
36 times
Increased by Php 25,000
225 days
74% of total assets
Gross profit variance of Php 12,000
(Php 23,000)

LESSON
HORIZONTAL ANALYSIS
II
Provided below are data extracted from the annual
financial report of Berry Bags Inc. for the
comparative year 2019 and 2018. Based from your
learnings in your prerequisite subjects, you are to
compute for the change in amount and the
percentage change. After computing, you are to
answer the questions presented after the table.

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 2019 2018 Change Percentage
in Change
Amount
Sales Php 960,000 Php 1,275,000
Cost of Sales 640,000 850,000
Gross Profit 320,000 425,000
Operating 180,000 220,000
Expens-
Operating Income 140,000 205,000
Interest Expense 10,000 95,000
Taxable Income 130,000 110,000
Income Tax 39,000 33,000
After-tax Profit 91,000 77,000
Which year has a better Sales? __________________

Which year yield more gross profit? __________________

How much is the difference is the company’s operating income from 2018 to
2019? __________________

Which year is more profitable? _________________

Self Assessment
After answering the warm-up activity above:
Did you find it easy to calculate the required figures?
Were you able to correctly assess the information based from
your prior knowledge?
How did you find the level of difficulty of the activity?
What are the challenges that you have met while answering the
questions?

The importance of having a reliable basis for decision making cannot be

undermined in modern business world. Without sufficient data that will help give
meaning to the figures in the financial statement can either me or break a company.
This is why companies resort to different tools and techniques in analyzing their
financial statement for it to be useful in the decision making.

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 Definition of Horizontal Analysis
Horizontal analysis, also called dynamic analysis or trend analysis, is the
comparison of financial information of a company with historical financial
information of the same company over a number of reporting periods.
Purpose of Horizontal Analysis
The main purpose is to see if the numbers are high or low in comparison to past
records, which may be used to investigate any causes for concern. For example,
certain expenditures that are high currently, but were well under budget in
previous years may cause the management to investigate the cause for the rise in
costs; it may be due to switching suppliers or using better quality raw material.

Advantages Disadvantages
Company can review its performance The aggregated information expressed in the
in comparison to the previous periods financial statements may have changed over time

Allows investors and analysts to see Changes can cause variances to creep up when
what has been driving a company's account balances are compared across periods.
financial performance over a number
of years

Enables to spot trends and growth It can be manipulated to show comparisons

patterns such as seasonality. across periods.

Enables management to assess

relative changes in different line items
over time, and project them into the
future.

Comparative financial statements

Comparative study of financial statements is the comparison of the financial statements of

the business with the previous year’s financial statements.

Comparative Balance Sheet

The comparative balance sheet shows the different assets and liabilities of the firm on
different dates to make comparison of balances from one date to another. The
comparative balance sheet has two columns for the data of original balance
(increase/decrease) in figures. The fourth column may be added for giving percentages of
increase or decrease. When looking into the liquidity position of a concern, the analyst
should examine the working capital in both the years. Working capital refers to the excess
of current assets over current liabilities. When looking into the long-term financial
position of the concern, the changes in fixed assets, long-term liabilities and capital one
should be examined. When profitability is the concern of the analyst, the study of increase
or decrease in profit will help the interpreter to observe whether the profitability has
improved or not.

Yushua Corporation
Comparative Statement of Financial Position
As of December 31, 2018 and 2019
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 Assets 2019 2018 Change in Amount PHP Change in %

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 Current Assets

Cash PHP 40,000 PHP 20,000 Php 20,000 100

Marketable 350,000 250,000 100,000 40

Securities

Receivables 330,000 300,000 30,000 10

Prepaid Expenses 2,000 - 2,000 -

Total Current
722,000 570,000 152,000 26.67
Assets

Non-current Assets

Building 170,000 270,000 (100,000) (37.3)

Machinery 600,000 400,000 200,000 50

Furniture 25,000 20,000 5,000 25

Other Fixed Assets 30,000 25,000 5,000 20

Total Fixed Assets 825,000 715,000 110,000 13.49

Total Assets PHP 1,547,000 PHP 1,285,000 262,000 20.39

Liabilities

Current Liabilities

Accounts Payable 45,000 50,000 (5,000) (10)

Short-term Notes 120,000 100,000 20,000 20

Accrued Expenses 10,000 5,000 5,000 100

Total Current 175,000 155,000 20,000 12.9

Liabilities

Non-current
Liabilities

Bond Payable 300,000 200,000 100,000 50

Mortgage Payable 150,000 100,000 50,000 50

Total Non-current 625,000 455,000 170,000 37.36

Liabilities

Equity

Ordinary Shares 700,000 500,000 200,000 40

Retained Earnings 222,000 330,000 (108,000) (32.73)

Total Liabilities and PHP 1,547,000 PHP 1,285,000 262,000 20.39

Equity

Interpretation
The comparative balance sheet of the company reveals that during 2019 there has
been an increase in fixed assets by 110,000 or 13.49%. This increase could be
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 due to additional purchases of fixed assets. Mortgage Payable have relatively
increased by Php 50, 000 and Ordinary shares has increased by Php 200, 000.
The increase in ordinary shares is due to the additional issuances of shares for
the year 2019. The increase in both ordinary shares and mortgage payable
indicates that the company financed its fixed assets acquisition from the long-
term sources.
On the other hand, the current assets have increased by Php 152, 000 or 26.67%.
A significant increase in marketable securities by Php 100,000 or 40% was due to
the increase in short-term investments of the company. Cash has increased by
Php 20,000 due to the collection of customer accounts and additional borrowings
of the company. Moreover, the current liabilities have increased only by Php
20,000 or 12.9%. This further confirms that the
company has used long-term finances even for the current assets resulting into an
improvement in the liquidity position of the company.
Retained earnings have decreased from Php 330,000 to Php 222,000 or 32.73%
which shows that the company has utilized surplus for the payment of dividends
to shareholders either in cash or by way of bonus. The overall financial position of
the company is favora-

2. Comparative Income statement

The comparative income statement gives an idea of the progress of a business over a
period of time. The changes in money value and percentage can be determined to
analyse the profitability of the business. Like comparative balance sheet, income
statement also has four columns.

Yushua Corporation

Comparative Income Statement

Year Ended December 31, 2018 and 2019

2019 2018 Change in Amount PHP Change in %

Net Sales PHP 900,000 PHP 785,000 Php 115,000 14.65 %

Less: Cost of Sales 500,000 450,000 50,000 11.11 %

Gross Profit 400,000 335,000 65,000 19.40 %

Operating Expenses:

Selling Expenses 90,000 80,000 10,000 12.50 %

General and 72,000 70,000 2,000 2.80 %

Administrative
Expenses

Total Expenses 162,000 150,000 12,000 8.0 %

Operating Income 238,000 185,000 53,000 28.65 %

Less: Interest
30,000 25,000 5,000 20 %
Expenses

Taxable Income 208,000 160,000 48,000 30 %

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 Income Tax 80,000 70,000 10,000 14.28 %

Net Income PHP 128,000 PHP90,000 38,000 42.22 %

Interpretation
The comparative income statement given above shows that there has been an
increase in net sales of 14.65%. The cost of goods sold has increased by 11%. This
has resulted in increase of gross profit by 19.4%. Operating expenses have increased
by 8%. The increase in gross profit is sufficient to cover the operating expenses.
There is also an increase in net profit after tax of
Php 38000 or 42.22%.
It is concluded from the above analysis that there is sufficient progress in the
performance of the company and the overall profitability of
the company is favorable.
Trend Analysis
The trend analysis is a technique of studying several financial statements over a
series of years. In this analysis, the trend percentages are calculated for each item
by taking the figure of that item for the base year taken as 100. Generally the first
year is taken as a base year. The analyst is able to see the trend of figures, whether
moving upward or downward
In brief, the procedure for calculating trends is as:
– One year is taken as a base year which is generally is the first year or

last year. – Trend percentages are calculated in relation to base year

Illustration:
The following are data extracted from the Income Statement of Will Barry
Enterprise, Inc.
2015 2016 2017 2018

Net Sales Php 200,000 Php 190,000 Php 249,000 Php 260,000

Less: Cost of Sales 120,000 117,800 139,200 145,600

Gross Profit 80,000 72,000 100,800 114,400

Less: Operating 20,000 19,400 22,000 24,000

Expenses

Net Income PHP 60,000 PHP52,800 PHP78,800 PHP90,400

Will Barry Enterprises, Inc.

Trend Analysis
2015 2016 2017 2018

Net Sales 100% 95.0% 124.5% 130.0%

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 Less: Cost of Sales 100% 98.2% 116.0% 121.3%

Gross Profit 100% 90.3% 126.0% 143.0%

Less: Operating 100% 97% 110.0% 120.0%

Expenses

Net Income 100% 88% 131.3% 150.67%

Interpretation
On the whole, 2016 was not a favorable year but the recovery was made during
2017. In this year, there is increase in sales as well as profit. Figures from 2016
when compared with 2015 reveal that the sales have come down by 5%. However,
the cost of goods sold and the expenses have decreased only by 1.8% and 3%
respectively. This has resulted in decrease in Net profit by 12%. The position was
recovered in 2017 with a positive growth in both 2017 and 2018. Moreover, the
increase in profit by 31.3% (2017) and 50.6% (2018) is much more than the
increased in sales by 20% and 30% respectively.

Learning
Activities Activity
1.

Fill in the blanks with appropriate word/words

1. Comparative statement is a _______________ for financial statement analysis. 2.
_______________ is the comparison of the financial statement of business with the
previous years financial statement.
3. Comparative ______________ shows the different assets and liabilities of the firm
on different dates to make comparison of balance from one date to another.
4.___________________ income statement gives an idea of the progress of a business
over a period of time.
5. When computing for the percentage change in comparative statement, the
change in amount is divided by the ________________.
6. Change in amount for comparative statement is also called
______________________.

Assets 2018 2017 Liabilities 2018 2017

Current Assets Current Liabilities

Cash PHP 40,000 PHP 20,000 Accounts Payable 45,000 50,000

Marketable 350,000 250,000 Short-term Notes 120,000 100,000

Securities

Receivables 330,000 300,000 Accrued Expenses 10,000 5,000

Non-current
Prepaid Expenses 2,000 -
Liabilities

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 Non-current
Bond Payable 300,000 200,000
Assets

Building 170,000 270,000 Mortgage Payable 150,000 100,000

Machinery 600,000 400,000 Equity

Furniture 25,000 20,000 Ordinary Shares 700,000 500,000

Other Fixed Assets 30,000 25,000 Retained Earnings 222,000 330,000

Total Assets PHP 1,547,000 PHP 1,285,000 Total Liabilities and PHP 1,547,000 PHP 1,285,000
Equity

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