GenSantos Foundation Collage Inc

Bulaong Ext. Brgy. North,

General Santos City

Financial Statement Analysis

(Techniques of Analysis)

Submitted by:
Gonida, Jane Claire D.
Balbarona, Eula Mae
Baguio, Micah
Butt, Gerald
Monarca, Nerrika Joy

Submitted to:
Mrs. Jhingle Javier Coyme
TECHNIQUES OF FINANCIAL ANALYSIS

Various techniques are used by financial statement analyst in order to

convert financial statements data into formats that facilitate the evaluation of
a firms financial condition and performance, both over time and comparison
with industry competitors.

These Include:

Comparative

statements
Common
statements

financial
size

financial

Trend percentage
Funds flow analysis
Cash flow analysis
Cost volume profit analysis
And Ration analysis

Techniques
Comparative Financial Statement

Purpose
To understand financial results
and changes that have taken

Common

Size

Financial

place.
Common

percentage

are

Statement

computed between years and

Trend Percentage
Fund flow analysis

interpretations are made.

Tread is studied
Inflow and outflow of funds are

Cash flow analysis

studied
Cash inflows and cash outflows

are studied
To determine the probable profit

Cash-volume-profit

analysis

or

break even analysis

at any level of operation. The

relationship

among

production,

cost

volume

of
of

production, the profit and the

Ration Analysis

sale is established.
Analysis
is
made

through

different ratios.

Comparative Financial statements - Are prepared to provide Time

perspective to the consideration of different elements of financial position,
income position or both. This is done to make financial data more meaningful

Comparative statements can be prepared for both income statement and

position statement

Comparative position statement: It is prepared to know the financial

results and changes that have taken place.

Comparative income statement: This is prepared to understand the
operating results and the changes that have taken place

Classification of Comparative statements

1. Inter-Firm Comparison
Comparative statements are prepared for two or more business enterprises.
Financial statements of two or more firms may be compared for drawing
inferences and conclusions. Such a comparison may be done for: (a) position
statement (b) income statement or (c) both
2. Intra-Firm comparison
Financial statements of a firm may be compared over a span of 3-5 years for
drawing inferences and conclusions. Such a comparison may be made for (a)
position statement; (b) Income statement or (c) both.
3. Inter-period comparison
Financial statements of an enterprise over a period of 5-7 years may be
compared for drawing inferences and conclusions. Such an analysis and
comparison may be done for: (a) Position statement; (b) Income statement or
(c) Both
4. Trend analysis
It is the time series analysis of individual component of financial statement
over a pretty long period, say. 10 years or 15 years. A base year is taken,
usually the first year of the series. Trend percentages are calculated for each
item in the statement that bears the same item in the base year. It will tell
the growth or decline of the item in comparison to the year.

Common Size Statement also called Common measurement statement

or Common measurement analysis. This statement indicates the relationship
of various items with some common items. It is generally expressed as
percentage of the common items. This statements can be prepared for both
income statement and balance sheet in general.

Common Size Statement Analysis can be prepared either for profit and
loss account or balance sheet or both the analyst is able to assess the figures
in relation to total values.

Procedure for common size balance sheet

1. The total assets or liabilities are taken as 100

2. The individual assets or liabilities are expressed as a percentage of total

assets or liabilities, that is 100

Ratio Analysis is a powerful tool of financial analysis used by financial

analyst. It is the process of establishing and interpreting different ratios
showing quantitative relationship between figures and groups of figures.
Ratio analysis is useful for assessment of business performance, evaluation of
financial condition of an enterprise and making decisions in the business.

Procedure

1. Selection of data: selection relevant data from financial statements

depending on the aim of the problem
2. Appropriate ratio: Computation of appropriate ratio
3. Comparison: Comparative study of calculated ratios with that of past ratios.
4. Interpretation: Interpretation of ratios to draw inferences and conclusions.

Classification

According to test, it can be classified as follows:

Liquidity ratio: It means the short-term solvency of a firm. These are useful
for understanding short-term paying capacity of a firm. The liquidity ratios
are: current ratio, liquid ratio, absolute liquid ratio, debtors turnover ratio and
creditors turnover ratio.

Leverage ratio: It conveys an enterprises ability to meet interest costs and

repayments of long-term debt. For this purpose, generally, debt-equity ratio
and interest coverage ratio are calculated.

Activity ratio: It is calculated to measure the efficiency with which the

resources have been employed. Some of the activity ratio are debtors
turnover ratio and creditors turnover ratio.

Profitability

ratio:

It

measures

the

results

of

business

activities,

performance and effectiveness of the enterprise. Profitability in relation to

sales and profitability in relation to investment are individual prepared.

TREND ANALYSIS

Trend analysis is an important tool of horizontal financial analysis which is

popularly helpful in making a comparative study of financial statement of
several years or periods.

Precautions

1.
2.
3.
4.

Accounting principles show be followed constantly.

Consistency should be maintained throughout the period of rime.
The base year be a normal year.
Trend is computed only for those components which possess logical
relationship with others

Methods of computation

1.
2.
3.
4.

Trend percentages
Trend ratios
Graphic Representation
Diagrammatic representation

INTER-FIRM COMPARISON

Inter-firm comparison is a technique by which the operating and financial

results of one firm is compared with another firm in the same line of activity.

Objectives

1. To find out weak points and strong points and then be interpreted.
2. To find out the cost centers which are uneconomical and make these centers
productive.
3. To find out profitability and compare.
4. To know product quality.

5. To conserve energy.

Methodology for Inter-Firm Comparison

1. Data collection: All required information is collected from the participating

enterprise depending on the aim of comparison.
2. Application of uniform definitions: Data collected are processed on the
3.
4.
5.
6.

basis of uniform terms, procedures, methods and accounting period.

Tools used: generally, ratios are used
Comparison: Each participating firm is supplied with a questionnaire.
Final comparison: Final comparative statements are prepared.
Result: On comparison, results and shortcomings are understood and

reported.
7. Report preparations: Reports are prepared and submitted

Classification for inter-Firm Comparison

Different types of measures and techniques are available for inter-firm

comparison. Usually there are following three kinds of comparison:

1. Management Ratios
These are meant to provide the management with a comparative picture: (a)
operation perfor-mance; (b) financial performance; (c) liquidity; (d) long-term;
(e) solvency and (f) profitability
2. Cost Ratios
Cost Ratios relate to the cost aspect of the firms. Cost aspect of the firms.
Cost effectiveness of the firms can be compared. Cost ratios include cost,
factory cost, other cost and selling distribution cost.
3. Technical data
In a highly technical and competitive business environment, comparison of
technical data of a firm with that of another is the need of the situation. For
the inter-firm comparison, we can develop, compute and analyze ratios such
as management ratios, cost ratios and technical ratios to get an overall
picture. Such an analysis aids the management for diligent decision making
on an all-round basis

Requisites Inter-Firm Comparison

1. Enterprises are in the same industry

2. Enterprises participating in inter-firm comparison are under uniform costing.
3. Enterprises are ready and willing to provide necessary

Advantage of inter-firm Comparison

1. Inter-firm comparison encourages managerial efficiencies in the organization

by spotting the weakness and correcting them whenever necessary
2. It brings consistency in cost structure for better comparison
3. Cost consciousness, cost efficiency and cost effectiveness can be created
among participating enterprises.
4. Launching of cost reduction programmers and cost control programmers is
5.
6.
7.
8.
9.

possible after comparing the structure of other firms

Productivity can be increased by eliminating unproductive cost
Review of operations and policies on a regular basis.
Ratios of inter-firm can be used for other activities and purposes
Reporting to management is possible which helps in decision making
It serves the government and regulators on various spheres for their use and
decision making.

Limitations of Inter-Firm Comparison

1. Due to difference in maintenance of books, policies, strategies, and

principles, it is difficult to practice inter-firm comparison.
2. To have an inter-firm comparison, individual firm should change its entire
system with that of other firms which Is costly
3. Uniform costing is a big task for many firms due to the very nature of its
business.

INTRA-FIRM COMPARISON

When performance of a specific business is assessed over a period of time it

is called intra-firm comparison

Features

1. A single firm is considered e.g., one company or any industry

2. Financial data over a period of 10-15 years of that single enterprise is

considered.
3. Financial data in real terms is collected and tabulated taking as many number
of periods of time as possible
4. Technique of ratios is adopted for interpretation.
5. Inferences are drawn
6. For data it is better to consult annual reports of the past 15 years of one
individual company.
7. In order to study inter-firm relationship, analyst can prepare a trend
statement over the said period.

WINDOW DRESSING

Window dressing is a term that describes the act of making a company's

performance, particularly its financial statements, look attractive.

Different Forms of Window Dressing

1. Non-operational income being principal source of income.

2. Not providing for decrease in value of long-term investment due to
alternative available to the management.
3. Capitalization of revenue expenses to show more net profits in profit and loss
account.
4. Revaluation of fixed assets to give a better financial status.
5. Extension of the time of billing on the customer towards the year-end to
increase debtors and profits.
6. Extension of the time of billing on the customer towards the year-end to
increase debtors and profits.
7. Less provision for doubtful debts.
8. Increasing the estimated economic life of fixed assets to change lower
depreciation.
9. Showing lesser amounts than actual written offs on intangible assets.
10.
No separate disclosure of prior period adjustments or extraordinary
income.
11.
Increasing

the

estimates

of

useful

life

of

deferred

revenue

expenditures.
12.
Increasing the estimates of useful life of intangible assets.
13.
Appropriating unamortized public issue expenses against
premium

Beating Window Dressing

share

To combat window dressing, the following measures are to be adhered to

analyze financial statement:

1. Thorough study of notes to accounts and accounting policies annexed to

the financial statement and an assessment of the various policies, accounting
estimates, extraordinary items and contingent liabilities.
2. Evaluation of the financial impact of qualifications in auditors report on the
profitability and financial position of an enterprise.
3. Study of Chairmans statement, directors report, corporate governance
report, especially the management discussion and analysis (MD & A)
contained therein and reconciling them with them with the study of financial
statements.
4. Comparison of basic and diluted EPS to forecast the EPS sustainable in future
periods.
5. Evaluation of related party transaction to find out whether any undue benefit
is being given to them at the cost of the company.
6. Study of segment results to analyze whether any line of business is making
an effect on the overall bottom line.

ADDITIONAL CARE IN ANALYSIS

The financial analyst requires to take the following care in analyze

1. Study of trends a longer period say 10-20 years to confirm current year
findings
2. Assessment of results against industry benchmarks.
3. Study of core accounting and financial ratios
4. Inter-firm comparisons to find out the effect of discrepancies in accounting
policies and comparative performance of different lines of business in case of
multinationals and group companies