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Students!
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“I think once you start putting
phony figures into financial
statements, you get in a lot of
trouble. And we've seen so much of
that in the last 20 years..”
一Warren Buffett

2
Warren Buffett
Warren Edward Buffett is an American investor,
business tycoon, philanthropist, and the chairman
and CEO of Berkshire Hathaway. He is considered
one of the most successful investors in the world
and has a net worth of US$78.9 billion as of
August 2020, making him the world's seventh-
wealthiest person.
Analysis of
Financial Statements
Lesson 4-1
TOOLS AND TECHNIQUES
 The LESSON OBJECTIVES
At the end of this lesson, you should be able to:

● Analyze financial statements horizontally.

● Analyze financial statements vertically.
● Prepare analysis calculations using Microsoft Excel.
THE
HORIZONTAL ANALYSIS
Using horizontal
analysis to evaluate
financial statements.
1
2
CONTENT VERTICAL ANALYSIS
Using vertical
analysis to evaluate
financial statements.

FINANCIAL RATIOS ANALYSIS

The use of ratios as a
financial tool.
 Tools and Techniques
Be familiar with the different tools in analyzing financial statements.
Lesson 4-1 on page 64
Fundamentals of Accountancy, Business, and Management 2
TOOLS AND TECHNIQUES

A company’s financial statements provide important information about a

business enterprise. The analysis helps the user make an informed decision
or judgment rather than rely on guesses and intuition in the process of
decision making by effectively and systematically using the financial data. It
lessens the uncertainty of outcomes with every decision made because of
the use of analytical tools to financial statements and the related data.
TOOLS AND TECHNIQUES

In order to evaluate a company, one-year data or a one year’s financial

statement is not sufficient. One needs at least two periods to make an
evaluation or even three to five years if one is to make a trend analysis.
TOOLS AND TECHNIQUES

Financial statements are analyzed to evaluate company’s present financial

position and operating performance in relation to its past. Using these
figures, the company can predict of forecast future operations.
TOOLS AND TECHNIQUES

Different methods and techniques are used in analyzing financial statements.

There are 2 phases involved namely:
1. Computation Phase
2. Interpretation Phase
 1. COMPUTATION PHASE

The phase where we compute for differences,

percentages, or ratios.

2. INTERPRETATION PHASE

The phase where we interpret the results of the

figures we get from the first phase. This 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.
 FS ANALYSIS

Using the statement of financial position, and the income statement, financial
statement analysis can be analyzed using the following techniques. These are
considered the tools in analyzing the financial data provided by the financial
statements.
TOOLS AND TECHNIQUES

1. Horizontal Analysis
2. Vertical Analysis
3. Trend Analysis
4. Financial Ratio Analysis
 Horizontal Analysis
The use of horizontal analysis to evaluate financial statements.
Lesson 4-2 on page 67
Fundamentals of Accountancy, Business, and Management 2
HORIZONTAL ANALYSIS

is the method of comparing and analyzing financial results of different

accounting periods in each financial statement account and element. It is also
known as “comparative analysis”, that helps management analyze the
increases and decreases in balance sheet and income statement accounts.
HORIZONTAL ANALYSIS
HORIZONTAL ANALYSIS

STEPS IN PERFORMING HORIZONTAL ANALYSIS

1. Prepare comparative financial statements of two consecutive years.
2. Add a 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.
HORIZONTAL ANALYSIS

HOW TO GET THE PERCENTAGE?

✓ Choose the base year which is usually the initial year of analysis.
✓ Deduct the amount of the current year from the base year.
✓ Divide the difference by the amount of base year.
✓ Multiply the quotient by 100 to get the percentage of change.
HORIZONTAL ANALYSIS

This is represented by the

following formula:

Note: For accounts with zero balance in the earlier or initial year, the formula for
the percentage of change will not apply.
Horizontal
Analysis
Using the
statement of
financial position
 Increase/ (Decrease)
2017 2016
Amount Percent
Assets
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
 ANALYSIS
Horizontal 1) Current assets increased by 9.1%. This increase is a
Analysis result of a 64.1% increase in accounts receivable and a
57.7% increase in inventory.
Using the
2) PPE showed a 235.6% increase. This may be due to
statement of
financial position
purchases made by the company to invest in plant
assets.
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 borrowings during the year.
Horizontal
Analysis
Using the income
statement
 2017 2016 Increase/ (Decrease)
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 Administrative 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 Taxes ₱ 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
Net sales increased by 27.3% during the year. However,
despite the increase in sales, net income decreased by 7.3%.
Horizontal Looking at the other components of the income statement,

Analysis cost of goods sold increased by 24.1%.

Even with this increase, in cost of goods sold, gross margin
Using the income registered a 30.2% increase. Selling and administrative
statement expenses 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 decrease in net income despite increase in
net sales.
Hence, the management can now understand that the
magnanimous increase in interest expense caused the
decrease in overall net income.
Answer Drill 1 on
page 72
On The Dot
Trading
 Vertical Analysis
The use of vertical analysis to evaluate financial statements.
Lesson 4-3 on page 74
Fundamentals of Accountancy, Business, and Management 2
VERTICAL ANALYSIS

In the STATEMENT OF FINANCIAL POSITION, vertical analysis, otherwise

known as “common-size analysis”, helps management analyze the
components of the total assets as well as the components of the total
liabilities and owner’s equity.
VERTICAL ANALYSIS

IT HELPS THE MANAGEMENT ANSWER QUESTIONS LIKE:

1. Of the total assets, what percent is classified as current? Non-current?
2. Of the total assets, what percent is accounts receivable? Mdse. 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 is liabilities? What
percent is owner’s equity?
VERTICAL ANALYSIS

In the INCOME STATEMENT, vertical analysis helps management analyze

the components of the income statement in relation to its revenue
account which is sales.
VERTICAL ANALYSIS

IT HELPS THE MANAGEMENT ANSWER QUESTIONS LIKE:

1. What percentage of net sales is cost of sales? Gross profit? Operating
expenses?
2. If operating expenses were divided between selling and administrative
expenses, what percent of the net sales is absorbed by Selling expenses?
Administrative expenses?
3. What is the percentage of net income to sales?
HORIZONTAL ANALYSIS

STEPS IN PERFORMING VERTICAL ANALYSIS

1. Prepare the comparative financial statements of two consecutive years.

2. Add one additional column on the right side of each year.
 VERTICAL ANALYSIS

3. For a comparative statement of financial position, express each account as a

percentage of the total assets. The total assets is automatically 100%. Likewise,
the total liabilities and owner’s equity is automatically 100%
Example:
HORIZONTAL ANALYSIS

4. For the comparative income statement, express each account as a

percentage of net sales. Net sales is automatically 100%
Example:
Vertical
Analysis
Using the
statement of
financial position
 2017 Percent 2016 Percent
Assets
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 ₱ 2,592.2 100.0 ₱ 1,221.6 100.0
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 ₱ 2,592.2 100.0 ₱ 1,221.6 100.0
 ANALYSIS
1. Current assets was 54.5% of total assets in 2016. However,
this percentage decreased to 28% in 2017. This was due to
Vertical the significant increase in property, plant, and equipment.

Analysis Hence, the dramatic change in total assets composition.

2. Non-current assets represented by property, plant, and
Using the equipment was 45.5% of total assets in 2016 and 72% in
statement of 2017. This may be due to purchases made by the
financial position 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 loan
during the year and might have paid its current liabilities.
Hence, the opposite change in the two liabilities.
Vertical
Analysis ANALYSIS
Using the
statement of Percentage of the owner’s equity to total liabilities and owner’s
financial position equity was 18.4% in 2016 and 8.4 in 2017. This means that the
equity financed by the 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 the
creditors.
Vertical
Analysis
Using the income
statement
 2017 Percent 2018 Percent
Net Sales ₱ 2,213.3 100.0 ₱ 1,738.7 100.0
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 Administrative Expenses 889.2 40.2 659.5 37.9
Operating Income ₱ 292.0 13.2 ₱ 247.4 14.2
Interest Expense 90.9 4.1 30.5 1.8
Income Before Income Taxes ₱ 201.1 9.1 ₱ 216.9 12.5
Income Tax Expense 60.3 2.7 65.0 3.7
Net Income ₱ 140.8 6.4 ₱ 151.9 8.7
 ANALYSIS
Vertical
From the income statement, the percentage of net income to
Analysis sales decreased from 8.7% to 6.4%. This decreased has been
Using the income explained by the onerous interest expense in the horizontal
statement 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% to4.1%.
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.
Answer Drill 2 on
page 78
On The Dot
Trading
Let’s Have Exercises
Exercise 1-3 on page 85-86
Let’s Have Exercises
Exercise 4 & 5 on page 87
Let’s Have Exercises
Exercise 6 & 7on page 88
Let’s Have Exercises
Chapter Test I & II on page 89
End of Lessons
49