Financial Analysis and

Ratio
Financial Analysis
✔ It is the process of evaluating businesses, projects, budgets, and
other finance-related transactions to determine their performance
and suitability.

✔ It is used to analyze whether an entity is stable, solvent, liquid, or

profitable enough to warrant a monetary investment.
-Investopedia
Tools and Techniques in Financial
Analysis

These are different ways or methods of evaluating and

interpreting a company’s financial statements for various
purposes like planning, investment, and performance.
 ❑ Horizontal Analysis

✔ Evaluation of the trend of account over multiple

periods.
✔ Horizontal Analysis is shown in comparative financial statements.
✔ Comparative Statements are used to evaluate the changes or the
behavior patterns of the different accounts in financial statements for
two or more years.
 ❑ Trend Ratio

✔ Trend analysis evaluates an organization’s financial

information over a period of time.
✔ The goal is to calculate and analyze the amount change and percent
change from one period to the next.
 Trend Ratio
FMA Company 2013 2012 2011 2013/2011 2012- 2011
Trend Analysis of 2011
Balance Sheet ASSETS
For the Years Ended Current Assets
December 31, Cash 65,000 70,000 75,000 86.67% 93.33% 100%
2013,2012 and 2011 Accounts receivable 40,000 35,000 20,000 200.00% 175.00% 100%
Marketable securities 40,000 35,000 10,000 400.00% 350.00% 100%
Inventory 100,000 80,000 100,000 100.00% 80.00% 100%
Total current assets 245,000 220,000 205,000 119.51% 107.32% 100%
Plant assets 200,000 160,000 170,000 117.65% 94.12% 100%

Cash ratio for 2012 TOTAL ASSETS 445,000 380,000 375,000 118.67% 101.33% 100%

is LIABILITIES 100%
Current liabilities 110,800 105,000 104,000 106.54% 100.96% 100%
70, 000 Long-term liabilities 160,000 145,000 140,000 114.29% 103.57% 100%
= -------------- X 100 Total liabilities 270,800 250,000 244,000 110.98% 102.46% 100%
75,000 STOCKHOLDER’S EQUITY
Common stock (P 5.00 par value, 100,000 100,000 100,000 100.00% 100.00% 100%
20,000 shares)
= 93.33%
Retained Earnings 74,200 30,000 31,000 239.35% 96.77% 100%
Total stockholder’s equity 174,200 130,000 131,000 132.98% 99.24% 100%

Total Liabilities and 445,000 380,000 375,000 118.67% 101.33% 100%

stockholder’s equity
 Trend Ratio
FMA Company
Trend Analysis of Income Statement 2013 2012 2011 2013/2011 2012/2011 2011
For the Years Ended December 31, Sales 200,000 210,000 100,000 200.00% 210.00% 100%
2013,2012 and 2011
Sales returns and allowances 40,000 25,000 6,000 666.67% 416.67% 100%

Net sales 160,000 185,000 94,000 170.21% 196.81% 100%

Cost of Goods Sold 100,000 115,625 50,000 200.00% 231.25% 100%

Gross Profit 60,000 69,375 44,000 136.36% 157.67% 100%

Operating Expenses

Selling Expense 22,000 25,000 16,000 137.50% 156.25% 100%

General Expense 8,000 12,000 8,000 100.00% 150.00% 100%

Total Operating Expenses 30,000 37,000 24,000 125.00% 154.17% 100%

Income from operations 30,000 32,375 20,000 150.00% 161.88% 100%

Non-operating income 6,000 2,500 3,500 171.43% 71.43% 100%

Income before interest 36,000 34,875 23,500 153.19% 148.40%

expense and taxes

Interest expense 4,000 3,500 3,000 133.33% 116.67% 100%

Income before taxes 32,000 31,375 20,500 156.10% 153.05% 100%

Income taxes (30% rate) 11,200 10,981 7,175 156.10% 153.05% 100%

Net Income 20,800 20,394 13,325 156.10% 153.05% 100%

 ❑ Vertical Analysis

✔ It is a proportional analysis of a financial statement, where each line item

on a financial statement is listed as a percentage of another item.
✔ Restates each amount in the income statement as a percentage of sales.
✔ Every line item on an income statement is stated as a percentage of gross
sales, while every line item on a balance sheet is stated as a percentage of
total assets.
 Common Size Financial Statement

✔ Common size financial statements help to compare a

company's performance over several periods as well as
against a competitor's.
✔ It is an income statement whereby each line item is
expressed as a percentage of revenue or sales.
✔ The common size percentages help to show how
each line item or component affects the financial
position of the company.
 Common Size Financial Statement

✔ In doing a common size analysis for the balance sheet

1. Total assets are assigned as the base account with a
percentage of 100. An individual asset account is expressed
as a percentage of total assets
2. Total liabilities and stockholders’ equity are assigned as
the base account with a percentage of 100. Individual
accounts in the liability and equity are also expressed as a
percentage of total liabilities and stockholder’ equity.
 Common Size Financial Statement

✔ In doing a common size analysis for the income statement

1. Net sales are given the value of 100 percent and all accounts
are evaluated in the comparison to net sales.

2. The resulting figures are then given in a common size

statement.
 FMA Company
Balance Sheet
December 31, 2013,2012
and 2011
 Financial Analysis

❑ Horizontal
Analysis
Is shown in the Comparative Statements which are used to evaluate the changes or the
behavior patterns of the different accounts in financial statements for two or more years.

❑ Trend
Ratio
The goal is to calculate and analyze the amount change and percent change
from one period to the next.
The firm has to choose the firm’s activity as its base and assigned an index
100.
The index of each account in succeeding years is found by dividing the
account’s amount by the base year amount and multiplying by 100.

❑ Vertical Analysis
Is shown in the Common Size Income Statement restates each amount in
the income statement as a percentage of sales and restate each amount
in the balance sheet as a percentage of total assets (liabilities).
 Financial Ratios

✔ It is one quantitative tool that business managers use to gather valuable

insights into a business firm's profitability, solvency, efficiency, liquidity,
coverage, and market value.
✔ Ratio analysis provides this information to business managers by analyzing
the data contained in the firm's balance sheet, income statement, and
statement of cash flows
 Financial Ratios
Financial Ratios provide two types of comparisons,

✔ Industry Comparison – Financial ratios are computed and compared with

the industry average.
✔ Through industry comparison, the company may be able to compare their
performance as against their competitors and how they are faring with them.

✔ Trend Analysis– The firm’s financial ratios are computed and compared with
their past performance. Through the trends, the company can determine if
their financial performance has improved or not over the years.
 Liquidity Ratios

✔ It provides insight of the firm’s capability to pay its current

obligations.
✔ It is the first item in the financial analysis that creditors/
suppliers look into to ascertain whether they will grant
credits or not to the debtors.
1. Working Capital
2. Current Ratio
3. Quick Ratio
 Liquidity Ratios

1. Working Capital
It is the difference between the firm’s current assets
and current liabilities.

A positive working capital means the firm is able

to meet its current maturing obligation with
safety cushion to meet other unexpected or
unrecorded current liabilities.
 2013 2012 2011

ASSETS

Current Assets

Cash 65,000 70,000 75,000

Accounts receivable 40,000 35,000 20,000

Marketable securities 40,000 35,000 10,000

Inventory 100,000 80,000 100,000

Total current assets 245,000 220,000 205,000

Plant assets 200,000 160,000 170,000

2013 2012 2011
TOTAL ASSETS 445,000 380,000 375,000

LIABILITIES

Current liabilities 110,800 105,000 104,000

= 245,000 – 110,800 = 220,000 – 205,000 = 205,000 – 104,00 Long-term liabilities 160,000 145,000 140,000
= 134,200 = 115,000 = 101,000 Total liabilities 270,800 250,000 244,000

STOCKHOLDER’S EQUITY

Common stock (P 5.00 par value, 100,000 100,000 100,000

20,000 shares)

Retained Earnings 74,200 30,000 31,000

Total stockholder’s equity 174,200 130,000 131,000

 Liquidity Ratios

2. Current Ratio
The most commonly used to measure liquidity; the ability of
the firm to meet its current liabilities as paid by its current
assets.

> 1 ∶ 𝑓𝑖𝑟𝑚 𝑖𝑠 𝑙𝑖𝑞𝑢𝑖𝑑 𝑎𝑛𝑑 𝑖𝑡 𝑖𝑠 𝑖𝑛 𝑎 𝑔𝑜𝑜𝑑 𝑝𝑜𝑠𝑖𝑡𝑖𝑜𝑛 𝑡𝑜 𝑚𝑒𝑒𝑡 𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑚𝑎𝑡𝑢𝑟𝑖𝑛𝑔 𝑜𝑏𝑙𝑖𝑔𝑎𝑡𝑖𝑜𝑛
= 1 ∶ 𝑓𝑖𝑟𝑚 𝑖𝑠 𝑙𝑖𝑞𝑢𝑖𝑑, 𝑡ℎ𝑒 𝑝𝑎𝑦𝑚𝑒𝑛𝑡 𝑜𝑓 𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 𝑖𝑠 𝑡ℎ𝑒 𝑡𝑜𝑡𝑎𝑙 𝑜𝑓 𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑒𝑡𝑠
< 1 ∶ 𝑓𝑖𝑟𝑚 𝑖𝑠 𝑖𝑙𝑙𝑖𝑞𝑢𝑖𝑑 𝑡𝑜𝑡𝑎𝑙 𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑒𝑡 𝑐𝑜𝑢𝑙𝑑 𝑛𝑜𝑡 𝑝𝑎𝑦 𝑓𝑜𝑟 𝑡ℎ𝑒 𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑚𝑎𝑡𝑢𝑟𝑖𝑛𝑔 𝑙𝑜𝑎𝑛
 2013 2012 2011

ASSETS

Current Assets

Cash 65,000 70,000 75,000

Accounts receivable 40,000 35,000 20,000

Marketable securities 40,000 35,000 10,000

Inventory 100,000 80,000 100,000

Total current assets 245,000 220,000 205,000

2013 2012 2011
Plant assets 200,000 160,000 170,000

TOTAL ASSETS 445,000 380,000 375,000

LIABILITIES
245,000 220,000 205,000
-------------- -------------- -------------- Current liabilities 110,800 105,000 104,000
110,800 105,000 104,000 Long-term liabilities 160,000 145,000 140,000

= 2.21 = 2.10 = 1.97 Total liabilities 270,800 250,000 244,000

STOCKHOLDER’S EQUITY

Common stock (P 5.00 par value, 100,000 100,000 100,000

20,000 shares)

Retained Earnings 74,200 30,000 31,000

Total stockholder’s equity 174,200 130,000 131,000

 Liquidity Ratios

3. Quick Ratio (Acid Test)

It has a more stringent test of liquidity than current ratio. It
excludes current assets other than cash, marketable securities
and accounts receivable.

It also measures the firm’s ability to pay its short-term obligations

except that it uses the most liquid current as numerator.

The more higher the quick ratio, the more liquid the firm is.
 2013 2012 2011

ASSETS

Current Assets
2013 2012 2011 Cash 65,000 70,000 75,000

Accounts receivable 40,000 35,000 20,000

Marketable securities 40,000 35,000 10,000

145,000 140,000 105,000
Inventory 100,000 80,000 100,000
-------------- -------------- --------------
110,800 105,000 104,000 Total current assets 245,000 220,000 205,000

Plant assets 200,000 160,000 170,000

= 1.31 = 1.33 = 1.01
TOTAL ASSETS 445,000 380,000 375,000

LIABILITIES

Current liabilities 110,800 105,000 104,000

Long-term liabilities 160,000 145,000 140,000

Total liabilities 270,800 250,000 244,000

The quick ratio improved from 1.01 in STOCKHOLDER’S EQUITY
2011 to 1.31 in 2013 due to increase in Common stock (P 5.00 par value, 100,000 100,000 100,000
accounts receivable and marketable 20,000 shares)

securities. Retained Earnings 74,200 30,000 31,000

Total stockholder’s equity 174,200 130,000 131,000

 Liquidity Ratio
1. Working Capital
Working Capital = Current Assets – Current Liabilities
2. Current Ratio
Current Assets
Current ratio = -------------------------
Current Liabilities
3. Quick Ratio
Quick Ratio = Cash + Marketable Securities + Accounts Receivable
—------------------------------------------------------------------
Current liabilities
 Activity Ratios
(Asset Management Ratios)

✔ It attempts to measure the efficiency of the firm in

managing its assets.
✔ These are used to determine how rapid accounts
receivable goes back to cash and inventory are
converted into sales and back to cash.
A high turnover ratio is associated with good asset
management
A low turnover ratio is associated with poor asset
management
 Activity Ratios
(Asset Management Ratios)

1. Accounts Receivable Turnover

2. Average Collection Period (Days of Receivable Period)
3. Inventory turnover (Days of Inventory)
4. Operating cycle
5. Total asset turnover
 Activity Ratios
(Asset Management Ratios)

1. Accounts receivable turnover

It is used to estimate how fast the accounts receivable is to be
converted into cash during the year.
It is computed by dividing net credit sales by the average of the
beginning and ending balance of the accounts receivable.

↑ 𝐴𝑅𝑇 = 𝑡ℎ𝑒 𝑐𝑜𝑚𝑝𝑎𝑛𝑦 𝑖𝑠 𝑐𝑜𝑙𝑙𝑒𝑐𝑡𝑖𝑛𝑔 𝑡ℎ𝑒𝑖𝑟 𝑐𝑟𝑒𝑑𝑖𝑡 𝑎𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑜𝑛 𝑎 𝑡𝑖𝑚𝑒𝑙𝑦 𝑏𝑎𝑠𝑖𝑠

↓ 𝐴𝑅𝑇= 𝑙𝑜𝑜𝑘 𝑎𝑡 𝑡ℎ𝑒𝑖𝑟 𝑐𝑟𝑒𝑑𝑖𝑡 𝑎𝑛𝑑 𝑐𝑜𝑙𝑙𝑒𝑐𝑡𝑖𝑜𝑛𝑠 𝑝𝑜𝑙𝑖𝑐𝑦 𝑎𝑛𝑑 𝑏𝑒 𝑠𝑢𝑟𝑒 𝑡ℎ𝑒𝑦 𝑎𝑟𝑒 𝑜𝑛 𝑡𝑎𝑟𝑔𝑒𝑡
 2013 2012 2011

ASSETS

Current Assets
2013 2012 Cash 65,000 70,000 75,000
40,000 + 35, 000 35, 000 + 20,000 Accounts receivable 40,000 35,000 20,000
------------------------ ------------------------ Marketable securities 40,000 35,000 10,000
2 2 Inventory 100,000 80,000 100,000
= 37,500 = 27,500
Total current assets 245,000 220,000 205,000
The accounts receivable turnover ratios for 2013 and 2012 are: Plant assets 200,000 160,000 170,000

TOTAL ASSETS 445,000 380,000 375,000

2013 2012 LIABILITIES

Current liabilities 110,800 105,000 104,000

160,000 185,00
= ------------------------ = --------------------- Long-term liabilities 160,000 145,000 140,000

37, 500 27,500 Total liabilities 270,800 250,000 244,000

=4.27 = 6.73 STOCKHOLDER’S EQUITY

Common stock (P 5.00 par value, 100,000 100,000 100,000

In 2012, the accounts receivable turnover ratio was 6.73. The
20,000 shares)
decline in ratio to 4.27 2013 is significant and indicates problem
in the accounts receivable. Retained Earnings 74,200 30,000 31,000

Total stockholder’s equity 174,200 130,000 131,000

If the information with regard
to net credit sales is not
available, the net sales can be
used.
 Activity Ratios
(Asset Management Ratios)

2. Average collection period

It measures the efficiency of the firm’s collection policy by
computing the number of days to collect the receivables.
 Activity Ratios
(Asset Management Ratios)
2. Average collection period
2013 2012
360 360
= ------------------------ = ---------------------
4.27 6.73
2013 2012 =84.31 days = 53.49 days
160,000 185,00
This means that it takes 84.31 days for a sale to be
= ------------------------ = ---------------------
converted into cash in 2013, In 2012, the average
37, 500 27,500
collection period was 53.49 days
=4.27 = 6.73
 Activity Ratios
(Asset Management Ratios)

3. Inventory turnover
It shows the efficiency of the firm in handling its inventory. It
measures how fast the inventory is turned into sales.

A low inventory turnover rate may point to overstocking,

obsolescence or deficiencies in the product line or marketing
effort.
↑ 𝐼𝑇 = 𝑦𝑜𝑢 𝑚𝑎𝑦 𝑏𝑒 𝑖𝑛 𝑑𝑎𝑛𝑔𝑒𝑟 𝑜𝑓 𝑠𝑡𝑜𝑐𝑘 𝑜𝑢𝑡𝑠
↓ 𝐼𝑇 = 𝑤𝑎𝑡𝑐ℎ 𝑜𝑢𝑡 𝑓𝑜𝑟 𝑜𝑏𝑠𝑜𝑙𝑒𝑡𝑒 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦
 Activity Ratios
(Asset Management Ratios)
3. Inventory turnover
Average inventory is determined by adding the
beginning and ending inventories and dividing
the sum by two.

2013 2012 2013 2012

100,000 + 80,000 80,000 + 100,000 100,000 115,625
= ------------------------ = --------------------- = ------------------------ = ---------------------
2 2 90,000 90,000
= 90,000 = 90,000 = 1.11 days = 1.28 days

The inventory turnover declined from 1.28 in 2012 to 1.11 in 2013.

This indicates a problem with regard to stocking of goods.
 Activity Ratios
(Asset Management Ratios)

Inventory Turnover
It is the average number of days it takes for a firm to sell off
inventory.

The average age of inventory in 2013 is

2013 2012
360 360
= ------------------------ = ---------------------
1.11 1.28
In 2012, the average age was 281. 25 = 324.32 days = 281.25 days
days. The lengthening of the holding
period shows a potentially greater risk of
obsolescence.
 Activity Ratios
(Asset Management Ratios)
4. Operating cycle
It measures the time it takes to convert the
inventories and receivables to cash. A short cycle is
desirable. Average Collection Average Age of
Period Inventory
2013 2012 2013 2012
360 360
360 360
= ------------------------ = ---------------------
= ------------------------ = ---------------------
1.11 1.28
4.27 6.73
= 324.32 days = 281.25 days
=84.31 days = 53.49 days

2013 2012
84.31 days + 324.32 days 53.49 days + 281.25 days
= 408.63 days = 334.74days
The operating cycle increased from 334.74 days to 408.63 days.
This is an unfavorable trend since an increased operating cycle means that a
considerable amount of money is tied up in non-cash assets.
 Activity Ratios
(Asset Management Ratios)
5. Total assets turnover
It measures the firm’s ability on how efficient they
are to generate sales.
A low asset turnover ratio may be due to many
factors and it is important to identify the
underlying reasons. Total asset turnover ratio
Average total assets 2013 2012 2013 2012
445,000 + 380,000 380,000 + 375,000 160,000 185,000
= ------------------------ = --------------------- = ------------------------ = ---------------------
2 2 412,500 377,500
= 412,500 = 377,500 = 38.79% = 49%

High total asset turnover indicates an efficient asset

management, while low total asset turnover indicates
an inefficient asset management.
 2013 2012 2011

ASSETS

Current Assets

Cash 65,000 70,000 75,000

Accounts receivable 40,000 35,000 20,000

Marketable securities 40,000 35,000 10,000

Inventory 100,000 80,000 100,000

Total current assets 245,000 220,000 205,000

Plant assets 200,000 160,000 170,000

TOTAL ASSETS 445,000 380,000 375,000

LIABILITIES

Current liabilities 110,800 105,000 104,000

Long-term liabilities 160,000 145,000 140,000

Total liabilities 270,800 250,000 244,000

STOCKHOLDER’S EQUITY

Common stock (P 5.00 par value, 100,000 100,000 100,000

20,000 shares)

Retained Earnings 74,200 30,000 31,000

Total stockholder’s equity 174,200 130,000 131,000

 Liquidity Ratio
IS THE FIRM ABLE TO MEET ITS CURRENT
OBLIGATIONS?
1. Working Capital
Working Capital = Current Assets – Current Liabilities
2. Current Ratio
Current Assets
Current ratio = -------------------
Current Liabilities

3. Quick Ratio
Quick Ratio = cash + Marketable securities + Accounts receivable
----------------------------------------------------------------
Current liabilities
 Activity Ratios
(Asset Management Ratios)
IS THE FIRM EFFECTIVELY MANAGING ITS ASSETS?
1. Accounts receivable turnover
It is used to estimate how fast the accounts
receivable is to be converted into cash during
the year.

2. Average collection period

It is used to estimate how fast the accounts
receivable is to be converted into cash during
the year.
3. Inventory turnover
Cost of goods sold
It shows the efficiency of the firm in handling
Inventory turnover = -----------------------------
its inventory. It measures how fast the
Average inventory
inventory is turned into sales.
 Activity Ratios
(Asset Management Ratios)
360
Average age of inventory Average age of inventory = ----------------------
Inventory turnover
It is the average number of days it takes for a
firm to sell off inventory.
4. Operating cycle Operating cycle = Average collection period + Average age of inventory
It measures the time it takes to convert the
inventories and receivables to cash.

5. Total assets turnover

Net Sales
It measures the firm’s ability on how efficient Total assets turnover= -----------------------------
they are to generate sales. Average total assets
❑ Financial Analysis
✔ the process of evaluating businesses, projects, budgets, and other finance-related transactions
to determine their performance and suitability.

❑✔ Horizontal Analysis
Evaluation of the trend of account over multiple
periods.
❑ Vertical Analysis
✔ It is a proportional analysis of a financial statement, where each line item on a
financial statement is listed as a percentage of another item.

❑ Trend Ratio
✔ Trend analysis evaluates an organization’s financial information over a period of time.

❑ Financial Ratios
✔ It is one quantitative tool that business managers use to gather valuable insights into
a business firm's profitability, solvency, efficiency, liquidity, coverage, and market
value.