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FINANCIAL STATEMENT ANALYSIS

F/S ANALYSIS – involves the assessment and evaluation of the firm’s past performance, its present
condition and future business potentials. The analysis serves to provide information about
the following:
 Probability of the business firm
 Ability to meet its obligation
 Safety of investment in the business
 Effectiveness of management in running the firm
F/S ANALYSIS TOOLS AND TECHNIQUES
1. Vertical analysis (common-size statement or percentage composition statements)
2. Horizontal analysis (trend percentages or index analysis)
3. Financial ratios (ratio analysis)
4. Gross profit variation analysis
5. Cash flow statement

HORIZONTAL ANALYSIS
Horizontal or index analysis involves comparison of figures shown in the financial statements of two
or more consecutive periods. The difference between the figures of the two periods is calculated, and the
percentage change from one period to the next is computed using the earlier period as the base.
Formula:

Percentage Change = (Most Recent Value – Base Period Value) / Base

Period Value

Comparison may be:

1. Actual vs. Budget (base)
2. Present period vs. Previous period (base)

VERTICAL ANALYSIS
The process of comparing figures in the financial statements of a single period. It involves
conversion of figures in the statements to a common base. This is accomplished by expressing all figures
in the statements as percentages of an important item such as total assets (in the balance sheet) or total
or net sales (in the income statement). These converted statements are called common-size statements
or percentage composition statements.

Percentage composition statements are used for comparing:

1. Multiple years of data from the same firm
2. Companies that are different in size
3. Company to industry averages

RATIO ANALYSIS
Ratio analysis involves development of mathematical relationships between accounts in the
financial statements. Ratios calculated from these statements provide users and analysis with relevant
information about the business firm’s liquidity, solvency, and profitability.

CALCULATION RULES AND LIMITATIONS

1. When calculating a ratio using balance sheet number only, the numerator and denominator
should be from the SAME balance sheet date, not different time periods. The same is true with
ratios using only income statement numbers. EXCEPTION: calculation of growth ratios.
2. When an income statement number and a balance sheet number are both used, the balance
sheet number should be an average (simple) for the time period represented by the income
statement number. If the beginning balance of a balance sheet account is not available, the
ending balance is normally used to represent the average balance of the account.
3. Generally, the number of days in a month or year are not critical to the analysis; a year may
have 360 days. 52, weeks, and 12 months; alternatively, a year may be comprised of 365
calendar days or 300 working days.
4. Limitation for percentage change calculations: if a negative or a zero amount appears in the
base year, percentage change cannot be computed.
FINANCIAL RATIOS
 TESTS OF LIQUIDITY (Liquidity refers to the company’s ability to pay its current liabilities
as they fall due.)
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Current Ratio It is a measure of adequacy of

(Banker’s Ratio) Current Assets working capital.
(Working Capital Ratio) Current Liabilities It is the primary test of solvency to
meet current obligations from current
assets.
Quick Ratio Quick Assets It measures the number of times that
(Acid Test Ratio) Current Liabilities the current liabilities could be paid
with the available cash and near-cash
assets (i.e., cash, accounts receivable
and marketable securities.
Working Capital Activity Ratios (TURNOVERS)
Receivables Turnover Net Credit Sales It is the time required to complete
Average one collection cycle from the time
Receivables receivables are recorded, then
collected, to the time new receivables
are recorded again.
Average Age of It indicates the average number of
Receivables 360 days days during which the company must
(Average Collection Period) Receivable wait before receivables are collected.
(Days’ Sales in Turnover
Receivables)
Cost of Goods Sold It measures the number of times that
Inventory Turnover Ave. Merchandise the inventory is replaced during the
Inventory period.
Average Age of Inventory 360 days It indicates the average number of
Inventory Turnover days during which the company must
wait before the inventories are sold.
Raw Materials Turnover Cost of Materials Used
Average Raw Materials Inventory
Goods in Process Turnover Cost of Goods Manufactured
Average Work in Process Inventory
Finished goods Turnover Cost of Goods Sold
Average Finished Goods Inventory
(Days in) Operating Cycle Sum of average ages of receivables, raw materials, goods
in process, and finished goods inventories (for
manufacturing firms)
Trade Payable Turnover Net Credit Purchases
Ave. Trade Payables

360 days It indicates the length of

Average Age of Trade time during which payables
Payable Payables Turnover remain unpaid.

Current Asset Turnover

Cost of Sales + Operating It measures the movement
Expenses (excluding and utilization of current
depreciation and assets to meet operating
amortization) Ave. Current requirements.
Assets
 TESTS OF SOVENCY (Solvency refers to the ability to pay its debts, current or non-
current)
Time Interest Earned ____EBIT___ It determines the extent to which
Interest Expense operations cover interest expense.
Debt-Equity Ratio Total Liabilities Proportion of assets provided by
Total SHE creditors compared to that provided
by owners.
Debt Ratio Total Liabilities Proportion of total assets provided by
Total Assets creditors
Equity Ratio Total SHE Proportion of total assets provided by
Total Assets owners.
 TESTS OF PROFITABILITY
Return on Sales Income Determines the amount of income by
(Net Profit Margin) Net Sales owners
Return on Total Assets Income Efficiency with which assets are used
Ave. Total Assets to operate the business

What income figure should be used?

1. Net income from continuing operations, excluding extraordinary items, disposals of segments of
business, and cumulative effects changes in accounting principles.
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2. Include dividends and interest earned on investments in net income, if the said investments are
included in asset base.
3. Use income before interest and tax if the intention is to measure operational performance.
4. Use net income (after interest and tax) if the intention is to evaluate total managerial effort.

Return on Owner’s Equity Net Income Measures the amount earned on the
Ave. Owner’s owners’ or stockholders’ investments.
Equity
Net Income –
preferred
Earnings per Share Dividends _____(if Measures the amount of net income
any)_____ earned by each common share.
Weighted Ave.
Common Shares
Outstanding

 MARKET TESTS
Price-Earnings Ratio (P/E) Price Per Share It indicates the number of pesos
Earning Per Share required to buy P1 of earnings.
Dividends Yield Dividends per Measures the rate of return in the
Share investor’s common stock
Price per Share investments.
Dividends Pay-Out Common It indicates the proportion of earnings
Dividends _____per distributed as dividends.
Share____
Earnings per Share

OTHER MEANINGFUL RATIOS

 RATIOS USED TO EVALUATE LONG-TERM FINANCIAL POSITION OR STABILITY
Measures the proportion of owners’
equity to fixed assets. Indicative of
Fixed Assets to Total Fixed Assets over or under investment by owners
Equity Total Equity and weakness in trading on the
equity.
Fixed Assets to Total Fixed Assets (Net) Indicates possible over-expansion of
Assets Total Assets plant and equipment
Sales to Fixed Assets Net Sales Tests roughly the efficiency of
(Plant Turnover) Fixed Assets (net) management in keeping plant
properties employed
Book Value per Share – Common Measures recoverable amount by
Common Stock Stockholders’ common stockholders in the event of
Equity liquidation if assets are realized at
Common share their book values.
outstanding
Time Preferred Dividends Net Income After
Requirements ____Taxes_____ It indicates ability provide dividends
Preferred to preferred stockholders.
Dividends
Requirements
Capital Intensity Ratio Total Assets Measures efficiency of the firm to
Net Sales generate sales through employment
of its resources
Times Fixed Changes Net Income before
Earned Taxes and Fixed
_____Charges_____ Measures ability to meet fixed
Fixed Charges charges
(Rent + Interest) +
Sinking Fund
payment (before
taxes)
 TESTS OF OVER-ALL SHORT-TERM SOLVENCY OR SHORT-TERM FINANCIAL POSITION
Working Capital Turnover Net Sales It indicates adequacy and activity of
Ave. Working working capital
Capital
Defensive Interval Ratio Current Liabilities Measures coverage of current
Cash & Cash liabilities
Equivalents
Payable Turnover Net Purchases Measures efficiency of the company
Ave. Accounts in meeting the accounts payable
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Payable
Fixed Assets to Long-term Fixed Assets Reflects extent of the utilization of
Liabilities Long-term resources from long-term debt.
Liabilities Indicative of sources of additional
funds.
 RATIOS INDICATIVE OF INCOME POSITION
Rate of Return on Ave. Net Income Measures the profitability of current
Current Assets Ave. Current assets invested
Assets
Operating Profit Margin Operating Profit Measures profit generated after
Net Sales consideration of operating assets
Cash Flow Margin Operating Measures the ability of the firm to
Activities Cash translate sales to cash
Flow
Net Sales

EXERCISES: FINANCIAL STATEMENT ANALYSIS

1. VERTICAL AND HORIZONTAL ANALYSIS

Following are the financial statements of JAGUAR Company:

JAGUAR COMPANY
Condensed Statement of Financial Position
December 31,2022 (In thousands)

ASSETS LIABILITIES AND

STOCKHOLDER’S EQUITY
Cash P 75 Current Liabilities P 50
Non-cash 125 Long-term Debts 150
Current
Fixed Assets 300 Capital Stock 200
______________ Retained Earnings ______100
TOTAL ASSETS P 500 TOTAL LIAB. & SHE P 500

For 2002, net sales totaled P 2,000; CGS, P 1,300; Operating Expenses, P 300; Interest and tax
charges, P 220.
For 2001, net sales totaled P 1,600; CGS, P 1,000; Operating Expenses, P 300; Interest and tax
charges, P 200.

REQUIRED:
1. Prepare common-size 2022 financial statements.
2. Perform index analysis or compute trend percentages for (net) sales, EBIT, and net income.

2. LIQUIDITY ANALYSIS
Indicate the effects of each of the following transactions on the company’s (A) current ratio and (B)
acid-test ratio. There are three possible answers: (+) increase, (-) decrease, and (0) no effect. Before
each transaction takes place, both ratios are greater than 1 to 1.

_______________Effects on__________________
Transactions: (A) Current Ratio (B) Acid-test Ratio
Example: Sell merchandise for cash + +
1. Buy inventory for cash __________________ __________________
2. Pay an accounts payable __________________ __________________
3. Borrow cash on a short-term __________________ __________________
loan
4. Purchase plant assets for cash __________________ __________________
5. Issue long-term bonds payable __________________ __________________
6. Collect an accounts receivable __________________ __________________
7. Record accrued expenses __________________ __________________
payable
8. Sell a plant assets for cash at a __________________ __________________
profit
9. Sell a plant assets for cash at a __________________ __________________
loss
10. Buy marketable securities, for __________________ __________________
cash
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3. FINANCIAL RATIOS
ISOY has 1,000,000 common shares outstanding. The price of the stock is P 8. Isoy declared
dividends per share of P 0.10. The balance sheet at the end of 2022 showed approximately the same
amounts as that at the end 2023. The financial statements for Isoy Merchandising are as follows:

Isoy Company, Income Statement for 2023 (in thousands)

Sales P 4,700
Cost of Goods Sold __2,300
Gross Profit P 2,400
Operating Expenses:
Depreciation P 320
Other 1,230 1,550
Income before interest and taxes P 850
Interest expense 150
Income before taxes P 700
Income taxes 280
Net income P 420

Isoy Company, Balance Sheet at 2023 (in thousands)

Assets Liabilities and SHE

Cash P 220 Accounts payable P 190
Accounts Receivable 440 Accrued expenses 180
Inventory 410 Total current P 370
liabilities
Total current P 1,070 Long-term Debt 1,960
Assets
Plant and Equipment 5,600 Common stock 1,810
Accumulated (2,100) Retained Earnings 430
Depreciation
Total Assets P 4,570 Total Liabilities & P 4,570
SHE

REQUIRED: (round-off answers to one decimal place)

1. Current ratio (2.9:1) 11. EPS (0.42)
2. Acid-test ratio (1:8:1) 12. P/E Ratio (19.0)
3. Accounts Receivable turnover (10.7 13. Dividend Yield (1.3%)
times)
4. Inventory turnover (5.6 times) 14. Payout ratio (23.8%)
5. Gross Profit margin (51.1%) 15. Debt ratio (51.0%)
6. Operating profit margin (18.1%) 16. Debt-Equity ratio (1.04:1)
7. Net profit margin or RoS (8.9%) 17. Times interest earned (5.7 times)
8. RoA – operational performance 18. Defensive interval ratio (1.7:1)
(18.6%)
9. RoA – total management effort 19. Cash flow to total debt (31.8%)
(9.2%)
10. RoE (18.8%) 20. Cash flow Margin (15.7%)

4. CONSTRUCTION OF FINANCIAL STATEMENTS

The following information is available concerning Timang Company’s expected results in 2003 (in
thousands of pesos). Turnovers are based on year-end values.

REQUIRED: Fill in the blanks

Return on sales 6%
Gross profit percentage 40%
Inventory turnover 4 times
Receivable turnover 5 times
Current ratio 3 to 1
Ratio of total debt to total assets 40%

Condensed Income Statement

Sales P 900
Cost of Sales _________
Gross profit _________
Operating expenses _________
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Net income P _________

Condensed Balance Sheet

Cash P 30 Current liabilities _________
Receivables _________ Long-term debt _________
Inventory _________ Stockholders’ equity _________
Plant and 670
Equipment
TOTAL _________ TOTAL _________

End

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