Financial Statement Analysis

Chapter 2
LEARNING OBJECTIVES:

1 2 3 4
Evaluate the
past
Explain the
performance
Discuss the Explain the 5 Tools and
of the
definition of Components Techniques in
company
financial of Financial Financial
through
statements; Statements; Analysis; and
financial ratios.
FINANCIAL STATEMENTS
❑ The summarized data of a company’s assets, liabilities, and
equities in the balance sheet and its revenue and expenses in the
income statement.
❑ Provide information about the financial position, result of
operations, and cash flows of an enterprise in the past and its
prospects in the future that is useful for decision-making to a wide
range of users.
❑ Tool in ascertaining the company’s capability to produce cash in
making payments.
BALANCE SHEET

➢ A statement showing the financial

position of the company at
a particular time.

➢ Composed of the company’s

assets and liabilities
and stockholders’ equity.
INCOME STATEMENT
➢ A formal statement that shows the
result of the operations for a certain
period of time.

➢ Presents the revenue generated

during the operating period, expenses
incurred, and company’s net earnings.
STATEMENT OF CHANGES IN EQUITY

➢ It summarizes the changes occured in

the owner's equity.

➢ A statement that shows the

movements in the components
of the equity.
 DQT Company
Statement of Changes in Equity
For the year ended December 31, 2023

DQT, beg. capital xx

Add: Additional Investment xx
Profit for the period xx
Total xx
Less: Withdrawals (xx)
DQT, end. capital xx
Presentation

Income Statement ➡ Changes in Equity

⬇
Financial Position
STATEMENT OF CASH FLOWS

- Provides information about the cash

receipts and cash payment of an entity
during the period. It is a formal statement
that classifies cash receipts (inflows),
and cash payments (outflows)
into operating, investing and
financing activities.
CASH FLOW STATEMENT
• A statement that shows the firm's cash receipts and cash payments
during a specified period of time.
Recognizes only transactions in which cash changes.
• If the cash from operating activities is greater that the net income, it is
said to be of "high quality".
• If the cash from operating activities is less than the net income, a red
flag is raised as to why the reported net income is not turning into cash.
• Cash flow identifies the coming in and going out of cash. Generating
more cash than using it will give the company the benefit to increase its
dividend, buy back some of its stock, reduce debt, or acquire another
company.
• Some financial decisions like capital budgeting decisions are based on
this.
CASH FLOW FROM OPERATING ACTIVITIES

CASH INFLOWS:
> Receipts from sales of goods & performance of services.
> Receipts from royalties, fees, commissions & other revenues.

CASH OUTFLOWS:
> Payment to suppliers of goods/ services
> Payment to employees
> Payment to taxers
> Payments of interest expense
> Payments for other operating expenses
Remember:
Under Cash Flow from Operating Activities, the transactions
that are involved follows:
1. REVENUE ACCOUNTS;

2. EXPENSE ACCOUNTS; and

3. Accounts Receivable/ Accounts Payable Accounts

CASH FLOW FROM INVESTING ACTIVITIES

CASH INFLOWS:
> Receipts from sales of PPE
> Receipts from sale of investment in debt or
equity securities
> Receipts from collections on notes receivables

CASH OUTFLOWS:
> Payments to acquire PPE
> Payments to acquire debts/ equity securities
> Payments to make loans to other generally in
the form of notes receivables
Remember:
Under CASH FLOW FROM INVESTING ACTIVITIES, the
transactions that are involved follows:

1. NONCURRENT ASSETS

2. NOTES RECEIVABLE ACCOUNT

3. DEBT SECURITIES
CASH FLOW FROM FINANCING ACTIVITIES

CASH INFLOWS:
> Receipts from investments by owner
> Receipts from issuance of Notes Payable

CASH OUTFLOWS:
> Withdrawals of the owner
> Payments to settle notes payable
Under CASH FLOW FROM FINANCING ACTIVITIES, the
transactions that are involved follows:

1. OWNER'S EQUITY

2. WITHDRAWALS

3. NOTES PAYABLE ACCOUNT

DQT
DQT
Accounting Policies and
Notes to Financial Statements

➢ These are the guidelines used in the

preparation of the financial
statements.

➢ Detailed information is indicated here

for clarification, valuation of
inventory, and issuance of capital stocks
CONCEPT

1.0 Concept

1. Notes contain information in addition to that presented in the statement of financial position,
income statement, statement of comprehensive income, statement of changes in equity and
statement of cash flows.

2. In other words, notes to FS are used to report information that does not fit in the body of the
statements in order to enhance the understandability of the statements.

3. Notes provide additional information and help classify the items presented in the financial
statements PAS 1, paragraph 113 provide that an entity shall as far as practicable present notes
in a systematic manner.
4. Each item on the face of the statement of financial
position, income statement, statement of comprehensive
income, statement of changes in equity and statement of
cash flows shall be cross-referenced to any related
information in the notes.

5. The notes to FS shall be highly detailed precise,

complete and easily understood by a reader who has a
reasonable understanding of business affairs and is willing
to study the FS.
Tools and Techniques in Financial Analysis
1. Horizontal Analysis
This is used to evaluate the trend in the accounts over the years. It
is usually shown in comparative financial statements.

a.Comparative Statements. Compared are financial data of two

years showing the increases or decreases in the account balances
with their corresponding percentages.
b. Trend Ratio. A firm’s present ratio is compared with its past and
expected future ratios to determine whether the company’s financial
condition is improving or deteriorating over time. It is similar to
comparative statements except that several consecutive years were
used showing the behavior of financial data.
Vertical Analysis
2. Vertical Analysis
It uses a significant item on the financial statement as a base value.

a. Common Size Statement. Each account in the financial statements is expressed by dividing
them to a common base account (total assets, liabilities and equity, sales or net sales).

b. Financial ratios are broadly classified into the following:

1. Liquidity Ratios provide a measure of the ability of a business to pay its liabilities.

2. Activity Ratios (Asset Management Ratios) provide a measure of how efficient a business is
utilizing its resources.

3. Leverage Ratios (Debt Management Ratios) provide a measure of the extent a business
uses financing or “leverage."

4. Profitability Ratios provide a measure of the performance of a business in terms of its ability
to generate profit from its resources.
Horizontal Analysis
Comparative Statements
-are used to evaluate the changes or behavior patterns of the different accounts
in the financial statements for two or more yeras. In doing the comparison,the
earlier year serves as the base year so that the percentage increase or
decrease is determined by dividing the difference of the base year figure from
the later year figure y the base year figure.

= Later year - Base year

Base year x 100%
Trend Ratios
Trend analysis consists of using ratios to compare company
performance on an indicator over time, often to forecast or
inform future events.

Formula:
Later Year / Base Year x 100%
Financial ratio analysis involves the computation of
percentages, fractions or proportions using certain
formulas. This analysis is designed to emphasize the
meaningful relationships between financial data.
1. Liquidity Ratios
Liquidity ratios provide a measure of the ability of a
business to pay its liabilities.

Examples include:
a. Current Ratio – the most commonly used ratio in
measuring the ability of a business to
pay its short-term debts.
Formula:
Current Ratio = Current Assets/Current Liabilities
b. Quick Ratio (Acid-test Ratio) – a much stricter ratio used to
measure the ability of a business to pay its short-term debts.
Formula:
Quick Ratio = (Cash + Marketable Securities + Accounts
Receivable, net) / Current Liabilities

c. Working Capital – similar to current ratio but measures the ability

of a business to pay its short-term debts by the excess or deficiency
of current assets over current liabilities.
Formula:
Working Capital = Current Assets − Current Liabilities
2. Activity Ratios (Asset Management Ratios)
Activity ratios provide a measure of how efficient a business is utilizing its resources.

Examples include:
a. Inventory Turnover – is a measure of the number of times inventory is sold and
replenished during a period. Generally, the higher the ratio, the better. However, an
unusually high inventory turnover could also indicate inventory shortages due to shortage in raw
materials, production inefficiency, underinvestment, poor inventory planning, and loss of sales.

Formula:
Inventory Turnover = Cost of Good Sold / Average Inventory

where:

Average Inventory = (Inventory, beg. + Inventory, end.)/2

b. Days of Inventory (Average Sale Period) – is a measure of the number of days inventory is
held before it is sold.

Formula:
Days of Inventory = 365 days / Inventory Turnover

c. Accounts Receivable Turnover – is a measure of the number of times accounts

receivable have been collected during a period. It is an indication of the efficiency in collection.
Formula:
Accounts Receivable Turnover = Credit Sales / Average Accounts Receivable

where:
Average Accounts Receivable = (Accounts Receivables, beg. + Accounts Receivables, end.)/2
d. Days of Receivable (Average Collection Period) – is a
measure of the average to collect a receivable.

Formula:
Days of Receivable = 365 days / Receivable Turnover
3. Leverage Ratios (Debt Management Ratios)
Leverage ratios provide a measure of the extent a business
uses financing or “leverage."

a. Debt Ratio (Debt-to-asset Ratio) – measures the

proportion of assets financed through debt.
Formula:
Debt Ratio = Total Liabilities / Total Assets
b. Equity Ratio – measures the proportion of assets financed through equity.

Formula:
Equity Ratio = Total Equity /Total Assets

c. Debt-to-Equity Ratio – indicates how much debt is used to finance the

assets relative to the amount pertaining to the owner(s).
Formula:
Debt-to-Equity Ratio= Total Liabilities / Total Equity
4. Profitability Ratios
Profitability ratios provide a measure of the performance of a
business in terms of its ability to generate profit from its resources.

a. Gross Profit Ratio – shows the relationship between sales and

cost of goods sold.
Formula:
Gross Profit Ratio = Gross Profit / Net Sales

b. Net Profit Ratio – measures profitability after considering all

income and expenses.
Formula:
c. Return on Assets – measures the profit generated in relation to the total
resources
available to the business.

Formula:
Return on Assets = Net Profit / Total Assets

d. Return on Equity (Return on Net Assets) – measures the profit generated

in relation to
the resources invested by (or attributable to) the owner(s) of the business.

Formula:
Return on Equity = Net Profit / Total Equity
END OF CHAPTER 2