MODULE 2

Title : Evaluation of financial performance

I. Objectives :

At the end of the period, the students should be able to:

1. identify the various information provided by the basic financial statements;

2. enumerate the key financial statements part;

3. appreciate the relevance and importance of financial statement analysis;
4. perform vertical and horizontal methods of financial statement analysis; and
5. compute, analyze and interpret financial ratios.

II. Subject Matter

1. Topics
 1.1.Financial statements
1.2.Components of financial statements
1.3.Financial statement analysis
1.4.The role of financial statement analysis in decision-making
1.5.Tools and techniques in financial analysis
1.6.Financial ratio

2 Educational Resource(s)

R1 Anastacio, M., Dacanay, R.C. & Aliling, L.E. (2016). Fundamentals of financial
management (with industry based perspective. Manila, Philippines: Rex
Book Store, Inc.
R2 Brealey, R.A., Myers, S.C., & Marcus, A.J.(2018) Fundamentals of corporate
finance ( 9th ed.). New York: McGraw-Hill Education.
R3 Lasher, W.R. (2017). Practical financial management (8th ed.). Boston:
Cengage Learning.
R4 Moyer, R.C. , Mcguigan, J.R., Rao, R.P. (2018). Contemporary financial
management. (14th ed.). Boston: Cengage Learning.
R5 Ross, S. A. , Westerfield, R.W. , Jaffe, J.F. & Jordan, B. D. (2018). Corporate
finance; core principles & applications.New York: McGraw-Hill Education.
R6 "CFO Special - Interview: 'A Modern CFO is a Driver and Executor of Business
Strategy'." Dalal Street Investment Journal, 21 Aug. 2017. Infotrac
Newsstand, Retrieved from
http://link.galegroup.com/apps/doc/A501285393/GPS?
u=phhcdc&sid=GPS&xid=d2ef2592.
R7 "Investors' Perceptions and Valuation Approaches Towards Financial
Statements/Reports." Journal of Business Strategies [Karachi], 30 June
2016, p. 109. AcademicOneFile, Retrieved from
http://link.galegroup.com/apps/doc/A461211497/GPS?
u=phhcdc&sid=GPS&xid=4c2ee6c4.
 3 Materials

3.1. Bond paper and notebook

3.2. Ballpen and markers
3.3. Course syllabus
3.4. Computer/laptop/cellphones
3.5. Calculator

III.Learning Procedures and Strategies

a. Lesson Proper

1.1. Financial Statements- consider as an important tool used to provide useful

information for finance decision-making.
1.2. Components of Financial Statements

1.2.1. The Balance Sheet or The Statement of Financial Position-contains

information of assets, liabilities and stockholders’ equity. The figures
provide a “snapshot” view of the firm’s financial health as of a given
period.

1.2.2. The Income Statement or The Statement of Financial Performance –

shows the performance of company during the period. The cost of
sales, other operating expenses, interest expenses and taxes are
deducted from the revenues generated or net sales, to arrive at the
firm’s net income or earnings after taxes.

1.2.3. Statement of Cash Flows – indicates how a firm generated cash flows
from its operations, how it used cash in investing activities, and how it
obtained cash from financing activities. It provides relevant information
about a company’s cash receipts and cash payments during a
particular period.

1.2.4. Statement of Retained Earnings – purpose is to reconcile the retained

earnings numbers in the balance sheet with the net income figure from
the income statement.

1.2.5. Statement of Shareholders’ Equity – similar purpose, but in addition,

also shows changes in the various shareholders’ equity account over
the year.
1.3. Financial statement analysis is the process of identifying financial
strengths and weaknesses of the company by properly establishing
relationship between the items of the balance sheet and the income
statement account. There are various methods or techniques that are
used in analyzing financial statements such as comparative statements,
schedule of changes in working capital, common size percentages, funds
analysis, trend analysis, and ratio analysis.

1.4. The Role of financial statement analysis in decision-making

1.4.1. Uses of financial analysis

● Assist in identifying the major strength and weaknesses of a buss

enterprise. It indicates whether a firm has enough cash to meet
obligations; a reasonable Account Receivable collection period; an
efficient inventory management policy; sufficient Property Plant and
Equipment and an adequate capital structure – all of which are
necessary if a firm is to achieve the goal of maximizing shareholder
wealth.
● Can also be used to assess a firm’s viability as an ongoing enterprise
and to determine whether a satisfactory return is being earned for the
risks taken.
● Analyst may discover specific problem areas in time for remedial action.
 ● May indicate facts and trends that can aid the finance manager in
planning and implementing a course of action consistent with the goal of
maximizing shareholders wealth.

1.4.2. Other people who use Financial Analysis other than Financial
Managers

● Credit Managers – may examine basis financial ratios of a prospective

customer when deciding whether to extend credit.
● Security Analyst – helps to assess the investment worth of diff
securities.
● Bankers – use the tools of financial analysis when deciding whether to
grant loans. Financial ratios have been used successfully to forecast
such financial events as impending bankruptcy.
● Labor Unions – refer to financial ratios when evaluating the bargaining
position of certain employers.
● Student/Job Hunters – may perform financial analyses of potential
employers to determine career opportunities.

1.5. Tools and techniques in financial analysis

1.5.1. Horizontal analysis – two or more sets of financial statements are used.
The earliest year is used as the base year.

a. Comparative statement – shows the increases or decreases in

percentage.
b. Trends ratios – behavior of financial data for each periods.

1.5.2. Vertical analysis – only one set of financial statements used.

a. common size statement- each item is expressed in terms of percentage.

It shows the component percentages or the relationship of each item to
the whole.

b. Financial ratios

A carefully executed financial statement analysis can assist financial

managers in assessing the current financial condition of a firm.
1.6. What is a Financial Ratio?

- It is a relationship that indicates something about a company’s activities.

- It is about comparing two items in the financial statements resulting to
ratio interpreted in a way that is not possible when interpreting the items
separately.
- It enables an analyst to make a comparison of a company’s financial
condition over time or in relation to other firms.

Six Group of Ratios

1. Liquidity Ratios – indicates a firm’s ability to meet short-term financial
obligations.
2. Activity Ratios or Asset Management Ratios – indicate how efficiently a
firm is using its assets to generate sales.
3. Leverage Ratios – indicate a firm’s capacity to meet short-term and long-
term debt obligations.
4. Profitability ratios – measure how effectively a firm’s management
generates profits on sales, assets and stockholders’ investments.
5. Market-Based Ratios – measure the financial market’s evaluation of a
company’s performance.
6. Dividend Policy Ratios – indicate the dividend practices of a firm.
 LIQUIDITY

Ratio Formula

Current Current Assets__

Current Liabilities

Quick asset (Acid-test) Cash + Marketable Securities + Receivables

Current Liabilities

ASSET MANAGEMENT OR ACTIVITY

Ratio Formula

Accounts receivable turnover Net credit sales __

Average accounts receivable
 Ratio Formula

Average collection period __ 360__________

Accounts receivable turnover

Inventory turnover Cost of goods sold __

Average inventory

Average age of inventory __ 360________

Inventory turnover

Fixed asset turnover __ Sales __

Fixed assets

Total asset turnover __ Sales __

Total assets

LEVERAGE
 Ratio Formula

Debt Total debt __

Total assets

Debt to equity Total debt __

Total equity

Times interest earned Earnings before interest and taxes (EBIT)__

Interest charges

PROFITABILITY

Ratio Formula

Gross profit margin Sales- Cost of Sales __

Sales
 Ratio Formula

Net profit margin Earnings after tax __

Sales

Return on investment Earnings after tax __

Total assets

Return on stockholders’ Earnings after tax __

equity Stockholders’ equity

MARKET-BASED

Ratio Formula

Price –to-earnings Market price per share __

Current earnings per share
 Ratio Formula

Market-to-book value Market price per share __

Book value per share

DIVIDEND POLICY

Ratio Formula

Payout Dividends per share __

Earnings per share

Dividend yield Expected dividend per share __

Stock price
Financial ratios provide two types of comparisons

1. Industry comparison- the company may be able to compare their performance

against their competitors’ and how they fare with them
2. Trend analysis – an analysis that indicates a company’s performance over
time and may reveal whether the company is improving or not as compared
with other companies in the same industry.