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Report in Business Finance

Group 2 Review of Financial Statement Preparation,


Analysis, and Interpretation

Learning Competencies
1. Prepare financial statements
2. Define the measurement levels, namely, liquidity, solvency, stability, and
profitability
3. Perform vertical and horizontal analysis of financial statements of a single
proprietorship
4. Compute, analyze, and interpret financial ratios such as current ratio,
working capital, gross profit ratio, net profit ratio, receivable turnover,
inventory turnover, debt to-equity ratio, and the like
Basic Financial Statements
1. Statement of Financial Position or Balance Sheet
- The statement of financial position is the new name that the
International Accounting Standards Board suggested for balance
sheet since 2009 to better reflect the kind of information regarding
the liquidity position and capital structure of a company as of a given
date. It must be noted that the information found in this report are only
true as of a given date.
- Liquidity refers to the ability of a company to pay maturing
obligations. The current assets of a company are compared with its
current liabilities to determine its paying capacity.
- Capital structure provides information regarding the amount of assets
financed by debt or liabilities and equity.
2. Statement of Profit or Loss or Income Statement
- The statement of profit or loss or otherwise known as income
statement provides information regarding the revenues or sales,
expenses, and net income of a company over a given accounting
period. This accounting period may be for a month, a quarter, or a
year.
- In analyzing statement of profit or loss, it is important to identify how
much of the income comes from core business and how much comes
from the non-core business. Core business refers to the main business
of a company.
- If an actual statement of profit or loss of a company is examined, one
will realize that this financial statement is not easily found. This is
because the International Accounting Standards Board (IASB) which
serves as the source of our generally accepted accounting principles
gives the preparers of financial statements two options on how to
present their statement of profit or loss. The first option is to present it
as a separate financial statement. The second option is to present it
together with other comprehensive income (OCI). OCI represents
transactions that are not reported in the profit or loss statement but
affects the stockholders equity.
3. Statement of Cash Flows
- The statement of cash flows provides an explanation regarding the
change in cash balance from one accounting period to another.
- The cash flows are also classified into three main categories:
operating, investing, and financing.
- Operating activities is an accounting item indicating the money a
company brings in from ongoing, regular business activities, such as
manufacturing and selling goods or providing a service.
- Investing activities provide information regarding the future direction
of the company.
- Financing activities provide information whether there is a proper
matching investing and financing activities.
4. Statement of Changes in Stockholders Equity
- A statement of changes in equity generally shows the movements of
equity in addition to accumulated earnings and losses so as to enable
the readers to depict on the sources (where it came from) and outlets
of equity (where did it go).
- The changes in the stockholders equity account from one accounting
period to another may be due to the following Profit or loss for the
accounting period, Cash dividend declaration, Issuance of new shares
of stocks, other comprehensive income, treasury stocks, and
revaluation of assets.
5. Notes to Financial Statements
- The notes to financial statements are integral part of the financial
statements. Among the additional information that the notes to
financial statements provide are the following: Brief description of the
company, Summary of significant accounting policies, and
Breakdown of amounts found in the financial statements.
Review of the Financial Statement Preparation
1. Analyzing business transactions
- In this step, a transaction is analyzed to find out if it affects the
company and if it needs to be recorded. Personal transactions of the
owners and managers that do not affect the company should not be
recorded. In this step, a decision may have to be made to identify if a
transaction needs to be recorded in special journals such as sales
journal or purchases journal.
2. Recording in the journals
- Once a transaction is identified and analyzed, the next step is the
preparation of the journal entry. For repetitive transactions, special
journals are made. These special journals include sales journal,
purchases journal, cash receipts journal, and cash disbursements
journal. Transactions which do not fall under any of these four may be
recorded in general journal.
3. Posting to ledger accounts
- After transactions have been recorded in the journals, the next step is
posting the transactions to the ledgers. Ledgers provide chronological
details as to how transactions affect individual accounts. There are
two types of ledgers: the general ledger and subsidiary ledger. The
general ledger is a summary of the different subsidiary ledgers and
can serve as a control account.
4. Preparing the unadjusted trial balance
- At the end of each accounting period, unadjusted trial balance is
prepared from the financial statement account balances found in the
general ledgers. Accounts with debit balances and credit balances are
then added. The sum for the debit balances must exactly equal that of
the credit balances.
5. Making the adjusting entries
- Once the unadjusted trial balance is prepared, adjusting entries are
then prepared to account for the following, among others: Accruals,
Prepayments, Depreciation and amortization expenses, and Allowance
for uncollectible accounts.
6. Preparing the adjusted trial balance
- An adjusted trial balance is prepared after taking into consideration
the effects of the adjusting entries. Again, this is to ensure that the
total debit balances equal the credit balances.
7. Making the closing entries
- Income statement accounts such as revenues and expenses are closed
to prepare the system for the next accounting period. These income
statement accounts are closed to the retained earnings. If the revenues
exceed expenses during an accounting period, retained earnings will
increase. The reverse is true which means that if the expenses exceed
revenues, the retained earnings will decrease.
8. Post-closing trial balance
- The post-closing trial balance is prepared to test if the debit balances
equal the credit balances after closing entries are considered. This is to
ensure that the accounting system is working.
9. Preparing the financial statements
- After the post-closing trial balance, the financial statements can then
be prepared. These are the statement of financial position, statement
of profit or loss, and the statement of cash flows.
Liquidity
- This ratio indicates a companys ability to pay its short-term bills.
Solvency
- Indicate financial stability because they measure a companys debt
relative to its assets and equity.
Stability
- Ability to withstand a temporary problem, such as a decrease in sales,
lack of capital or loss of a key employee or customer analyzing your
cash flow and a variety of negative scenarios will help you determine
whether or not your business is financially stable.
Profitability
- Indicate managements ability to convert sales dollars into profit and
cash flow.
Vertical Analysis
- Vertical analysis or sometimes called common-size analysis is an
important financial statement analysis tool. With vertical analysis, all
accounts in the statement of financial position are presented as a
percentage of total assets while all accounts in the statement of profit
or loss are presented as a percentage of sales or revenues.

Found in Table 2.1 and Table 2.2 are the common-size statements of profit
or loss and statements of financial position of JSC Foods Corporation from 2010 to
2014.

Table 2.1: JSC Foods Corporation


Common-Size Statements of Profit or Loss

For the Years Ending December 31, 2014-2010

2014 2013 2012 2011 2010


Net Sales 100% 100% 100% 100% 100%
Cost of Sales 80% 80% 81% 82% 83%
Gross Profit 20% 20% 19% 18% 17%
Operating Expenses 12% 13% 13% 13% 13%
Operating Income 8% 7% 7% 5% 4%
Interest Expense 0% 1% 1% 1% 1%
Income before Taxes 7% 6% 6% 4% 3%
Taxes 2% 2% 2% 1% 1%
Net Income 5% 4% 4% 3% 2%

Table 2.2: JSC Foods Corporation

Common-Size Statements of Financial Position

December 31, 2014-2010

2014 2013 2012 2011 2010


Assets
Current Assets
Cash 5% 5% 5% 5% 5%
Receivables 10% 9% 10% 9% 8%
Inventories 22% 22% 22% 20% 20%
Other Current Assets 5% 5% 6% 4% 6%
Total Current Assets 42% 41% 42% 38% 39%
Noncurrent Assets
Property, Plant, and Equipment, Net 55% 55% 53% 57% 56%
Other Noncurrent Assets 4% 4% 5% 5% 5%
Total Noncurrent Assets 58% 59% 58% 62% 61%
Total Assets 100% 100% 100% 100% 100%

Liabilities and Equity


Current Liabilities
Trade Payables 23% 23% 24% 20% 17%
Income Taxes Payable 2% 1% 2% 1% 1%
Current Portion of Long-term Debt 10% 12% 6% 12% 12%
Other Current Liabilities
Total Current Liabilities 35% 37% 32% 33% 30%
Noncurrent Liabilities
Long-term Debt, Net of Current Portion 9% 6% 0% 6% 18%
Total Liabilities 44% 43% 32% 39% 47%
Stockholders Equity
Capital Stock 36% 39% 46% 49% 47%
Retained Earnings 20% 19% 22% 12% 5%
Total Stockholders Equity 56% 57% 68% 61% 53%
Total Liabilities and Stockholders Equity 100% 100% 100% 100% 100%

Horizontal Analysis
- Horizontal or trend analysis is a financial statement analysis technique
that shows changes in financial statement accounts over time.
Changes can be shown both in absolute peso amounts and in
percentage.

To compute for the change, simply get the difference from one period to
another. The earlier period is used as the base period. To illustrate, let us
compute the change in the sales of JSC Foods Corporation from 2013-2014.

Peso Change = (Sales2014 Sales2013)


Peso Change = 52 501 085 47 345 223

Peso Change = 5 155 862

% Change = ((Sales2014 Sales2013) / Sales2013) x 100%

% Change = (5 155 862/47 345 223) x 100%

These changes for the different accounts are important to identify


trends. This horizontal analysis can be done for the different accounts from
the statement of financial position, statement of profit or loss, and statement
of cash flows.

Presented in Table 2.3 are the changes in the statement of profit or


loss accounts of JSC Foods Corporation from 2011 to 2014 in peso amounts
while table 2.4 shows the changes in the statements of profit or loss accounts
in percent.

Table 2.3: JSC Foods Corporation

Annual Changes in the Statement of Profit or Loss Accounts in Peso

From 2011 to 2014

2014 2013 2012 2011


Net Sales 5 155 862 5 170 940 3 834 026 3 003 615
Cost of Sales 3 966 102 4 008 454 2 541 163 2 109 598
Gross Profit 1 189 760 1 162 486 1 292 863 894 017
Operating Expenses 300 855 803 183 466 898 421 301
Operating Income 888 905 359 303 825 965 472 716
Interest Expense - - (200 000) 150 000
Income before Taxes 888 905 359 303 1 025 965 322 716
Taxes 266 672 107 791 307 789 96 815
Net Income 622 234 251 512 718 175 225 901

Table 2.4: JSC Foods Corporation

Annual Changes in the Statement of Profit or Loss Accounts in %

From 2011 to 2014

2014 2013 2012 2011


Net Sales 11% 12% 10% 8%
Cost of Sales 10% 12% 8% 7%
Gross Profit 13% 14% 19% 15%
Operating Expenses 5% 15% 9% 9%
Operating Income 28% 13% 42% 31%
Interest Expense 0% 0% -44% 50%
Income before Taxes 31% 14% 67% 27%
Taxes 31% 14% 67% 27%
Net Income 31% 14% 67% 27%

Exhibit 2.1: JSC Foods Corporation


Statements of Profit or Loss
For the Years Ending December 31, 2010-2014
2014 2013 2012 2011 2010
Net Sales 52 501 085 47 345 223 42 174 283 38 340 257 35 336 643
Cost of Sales 41 954 730 37 988 628 33 980 174 31 439 011 29 329 413
Gross Profit 10 546 355 9 356 595 8 194 109 6 901 246 6 007 229
Operating Expenses 6 497 659 6 196 804 5 393 621 4 926 723 4 505 422
Operating Income 4 048 696 3 159 791 2 800 488 1 974 523 1 501 807
Interest Expense 250 000 250 000 250 000 450 000 300 000
Income before Taxes 3 798 696 2 909 791 2 550 488 1 524 523 1 201 807
Taxes 1 139 609 872 937 765 146 457 357 360 542
Net Income 2 659 087 2 036 854 1 785 342 1 067 166 841 265

Exhibit 2.1: JSC Foods Corporation


Statements of Financial Position
December 31, 2010-2014

2014 2013 2012 2011 2010


Assets
Current Assets
Cash 1 062 527 996 904 777 415 766 805 883 416
Trade Receivables 2 300 500 1 921 799 1 722 513 1 454 426 1 396 639
Inventories 4 849 304 4 499 998 3 797 668 3 293 030 3 351 933
Other Current Assets 1 050 00 983 746 984 786 735 608 998 763
9 262 331 8 402 447 7 282 382 6 249 869 6 630 751
Noncurrent Assets
Property, Plant, and Equipment, Net 12 200 000 11 300 000 9 050 000 9 350 000 9 500 000
Other Noncurrent Assets 835 689 925 681 896 842 876 235 827 490
13 035 689 12 225 681 9 946 842 10 226 235 10 327 490
Total Assets 22 298 020 20 628 128 17 229 224 16 476 104 16 958 241

Liabilities and Equity


Current Liabilities
Trade Payables 5 050 810 4 746 252 4 137 815 3 298 699 2 874 911
Income Taxes Payable 433 051 283 705 267 801 149 441 115 330
Current Portion of Long-term Debt 2 250 000 2 500 000 1 000 000 2 000 000 2 000 000
Other Current Liabilities 85 600 28 700 40 990 30 688 37 890
7 819 461 7 558 657 5 446 606 5 478 828 5 028 131
Noncurrent Liabilities
Long-term Debt, Net of Current Portion 2 000 000 1 250 000 1 000 000 3 000 000
Total Liabilities 9 819 461 8 808 657 5 446 606 6 478 828 8 028 131
Stockholders Equity
Capital Stock 8 000 000 8 000 000 8 000 000 8 000 000 8 000 000
Retained Earnings 4 478 559 3 819 472 3 782 618 1 997 276 930 110
Total Stockholders Equity 12 478 559 11 819 472 11 782 618 9 997 276 8 930 110
Total Liabilities and Stockholders 22 298 020 20 628 128 17 229 224 16 476 104 16 958 241
Equity

Liquidity ratio
A. Current Ratio
Current Ratio = Current Assets / Current Liabilities
Current Ratio = 9 262 331 / 7 819 461
Current Ratio = 1.18
B. Acid-Test Ratio or Quick Asset Ratio
Quick Asset Ratio = (Current Assets Inventories) /Current Liabilities
Quick Asset Ratio = (1 062 527 + 2 300 500) / 7 819 461
Quick Asset Ratio = 0.43
C. Cash Ratio
Cash Ratio = Cash + Cash Equivalents / Current Liabilities
Cash Ratio = 9 262 331 / 7 819 461
Cash Ratio = 1.18
D. Networking Capital
Networking Capital = Current Assets Current Liabilities
Networking Capital = 9 262 331 7 819 461
Networking Capital = 1 442 870
Capital Structure Ratio
A. Debt Ratio
Debt Ratio = Total Liabilities / Total Assets
Debt Ratio = 9 819 461 / 22 298 020
Debt Ratio = 0.44
B. Debt Equity Ratio
Debt to Equity Ratio = Total Liabilities / Total Stockholders Equity
Debt to Equity Ratio = 9 819 461 / 12 478 559
Debt to Equity Ratio = 0.79
C. Interest Coverage Ratio
Interest Coverage Ratio = EBIT / Interest Expense
Interest Coverage Ratio = 4 048 696 / 250 000
Interest Coverage Ratio = 16.19
Efficiency Ratio
A. Total Asset Turnover Ratio
Asset Turnover Ratio = Sales / Total Assets
Asset Turnover Ratio = 52 501 085 / 22 298 020
Asset Turnover Ratio = 2.35
B. Fixed Asset Turnover Ratio
Fixed Asset Turnover Ratio = Sales / PPE
Fixed Asset Turnover Ratio = 52 501 085 / 12 200 000
Fixed Asset Turnover Ratio = 4.30
C. Accounts Receivable Turnover Ratio
Accounts Receivable Turnover Ratio = Sales / Accounts Receivable
Accounts Receivable Turnover Ratio = 52 501 085 / 2 300 500
Accounts Receivable Turnover Ratio = 22.82
D. Average Collection Period
Average Collection Period = 360 / 22.82
Average Collection Period = 15.78 or 16 days
E. Inventory Turnover Ratio
Inventory Turnover Ratio = Cost of Sales / Inventories
Inventory Turnover Ratio = 41 954 730 / 4 849 304
Inventory Turnover Ratio = 8.65
F. Days in Inventories
Days in Inventories = 360 / Inventory Turnover Ratio
Days in Inventories = 360 / 8.65
Days in Inventories = 41.62 or 42 days
G. Accounts Payable Turnover Ratio
Accounts Payable Turnover Ratio = Cost of Sales / Trade Accounts
Payable
Accounts Payable Turnover Ratio = 41 954 730 / 5 050 810
Accounts Payable Turnover Ratio = 8.31
H. Days Payable
Days Payable = 360 / Accounts Payable Turnover Ratio
Days Payable = 43.32 or 43 days
I. Operating Cycle
Operating Cycle = Days Inventories + Days Receivable
Operating Cycle = 42 + 16
Operating Cycle = 58 days
J. Cash Conversion Cycle
Cash Conversion Cycle = Operating Cycle Days Payable
Cash Conversion Cycle = 58 days 43 days
Cash Conversion Cycle = 15 days
Profitability
A. Gross Profit Margin
Gross Profit Margin = (Gross Profit / Sales) x 100%
Gross Profit Margin = (10 546 355 / 52 501 085) x 100%
Gross Profit Margin = 20.09%
B. Operating Profit Margin
Operating Profit Margin = (Operating Income / Sales) x 100%
Operating Profit Margin = (4 048 696 / 52 501 085) x 100%
Operating Profit Margin = 7.71%
C. Net Profit Margin
Net Profit Margin = (Net Income / Sales) x 100%
Net Profit Margin = (2 659 087 / 52 501 085) x 100%
Net Profit Margin = 5.06%
D. Return on Assets
ROA = (Operating Income / Total Assets) x 100%
ROA = (4 048 696 / 22 298 020) x 100%
ROA = 18.16%
E. Return on Equity
ROE = (Net Income / Stockholders Equity) x 100%
ROE = (2 659 087 / 12 478 559) x 100%
ROE = 21.31%