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FINANCIAL STATEMENT

ANALYSIS

Involves

careful selection of data from


financial statements in order to assess and
evaluate the firms past performance, its
present condition and future business
potentials

the

process of identifying financial strengths


and weaknesses of the firm by properly
establishing relationship between the items
of the balance sheet and the profit and loss
account

To

evaluate and forecast the companys financial


health. Interested parties can identify the
companys financial strengths and weaknesses
and know about the:
Profitability of the business firm;
Firms ability to meet its obligation;
Safety of the investment in the business; and
Effectiveness of management in running the firm

Objectives

Comparison

of financial data

Differences between companies


Differences in accounting methods and estimates
Valuation problem
Timing of transactions and use of averages in applying the
various techniques in FS analysis affect the results obtained

The

need to look beyond ratios

The FS does not include all the factors needed for the evaluation

Limitations

INFLATION

increase in general price level


DEFLATION decrease in general price level
*** General price level is inversely related to the
purchasing power of money

Change in price levels

Higher

rates of inflation lead to higher interest rates


It increases prices of resources
Higher tax brackets
Distorts profit
Accuracy of predictions needed in business planning is
reduced
Hurts creditors but benefits debtors

Impact of Inflation on Financial


Management

Involves

comparison of figures shown in the FS of two or


more consecutive periods
Difference between the figures of the two periods is
calculated, and the percentage change from one period
to next is computed using the earlier period as the base:
Percentage of Change = (Most recent value- Base Period value)
Base Period value

Horizontal Analysis

Process

of comparing figures in the financial statements


of a single period
It is expressing all the figures in the statements as
percentages of an important item such as total assets
(BS) or total net sales (IS)
The converted statements are called COMMON-SIZE
STATEMENTS or PERCENTAGE COMPOSITION
STATEMENTS

Vertical Analysis

Ratios

are calculated from the financial statements to


provide users of such statements with relevant
information about the firms liquidity, use of leverage,
asset management, cost control, profitability, growth and
valuation

Ratio Analysis

Reports

on the financial performance of the


company in terms of earning revenue and
incurring expenses over a period of time and
explains, in part, how the companys
financial performance changed between the
beginning and ending of a period

The Income Statement

Sales(Revenue)
Cost of Good Sold
(400)
Gross Margin
Expenses
Earnings before interest & taxes
170
Interest expense
Earnings before tax
150
Tax
Net income

Presentation

1 000

400
(230)

(20)

( 45)
105

The Balance Sheet


It is also called the Statement of Financial Position
- It reports a companys financial position at a point in
time

ASSETS-

Resources of the company

LIABILITIES-

outsiders.

EQUITY-

It represents what the company owes to

Represents funds supplied to businesses by


their owners.

It includes:

Cash-

money in bank checking accounts plus currency on

hand.
Accounts Receivable- credit sales not have been collected.
:The Bad-Debt reserve- Allowance for doubtful accounts.
Inventory- product held for sale in the normal course of
business.
Fixed Assets- Longer-lived assets/PPE
:Depreciation- spread the cost of the assets over useful life.

ASSETS

Accounts

Payable- arise when firms buy from vendors on

credit.
Term of sale- length time allowed until payment is due
on a credit sale is specified.

Accruals-

used to recognized expenses and liabilities


associated with transactions that are not entirely
complete.

LIABILITIES

Working

capital- difference between current assets and


current liabilities.

Long-term

Debt- a noncurrent liability; usually consist of


bonds and long-term loans.

Direct

investment by owners- Direct equity investment


that is the money paid for the stocks.
Retained Earnings- Earnings kept in the business
Preferred Stock- Security issued by some firms

Total

Capital- Sum of long term debt and equity

EQUITY

CASH FLOW ANALYSIS

Detailed

study of the net change in cash


as a result of OPERATING, INVESTING,
and FINANCING activities during the
period

Reports

the cash receipts, cash payments, and net


changes in cash resulting from operating, investing and
financing activities of the firm during the period

Statement of Cash Flows

Operating

Activities cash effects of transactions that


create revenues and expenses; relate to changes in
current assets and current liabilities
Investing Activities relate to changes in non-current
assets
Financing Activities relate to changes in long-term
liabilities and stockholders equity accounts

Classification

RESIDUAL

INCOME (1) = Actual Income Target

Income
RESIDUAL INCOME (2) = Actual Income (Assets x
Target ROI)
ECONOMIC

VALUE ADDED (EVA) = Net Operating


Income - (Operating Assets x WACC)

FREE

CASH FLOW = Net operating profit after taxes +


Depreciation expense Change in net working capital
Capital expenditures

Additional concepts:

Cash

generated by operations that is available for


distribution to investors
Allows us to estimate whether a company will provide
cash or require it in the future
POSITIVE business operations are likely to fund their
own growth and money is available to pay interest and/or
dividends
NEGATIVE continuing will require cash contributions
from outside the business

Free Cash Flow (FCF)

Cash Conversion Cycle (CCC)


Race track diagram

Gives

us a relative measures of the


firms money-making success.
Estimates profit per peso of sales
made, assets employed, or equity
invested

Profitability Ratios

Return on Assets
- A measure of the productivity
of assets, regardless of how the
assets are financed.

Method of computation:
OPERATING INCOME
AVERAGE TOTALS ASSETS

Example 1: Total assets of Company X on July 1, 2014


and June 30, 2015 were 2,132,000 and 2,434,000
respectively. During the year ended June 30, 2015 it
earned net income of 213,000. Calculate its return on
assets ratio.
Solution
Average Total Assets = ( 2,132,000 + 2,434,000 ) / 2 =
2,283,000
Return On Assets = 213,000 / 2,283,000 0.09 or 9%

Example 2: Total liabilities and total equity of Company Y on


Dec 31, 2010 were 942,000 and 1,610,000 respectively. During
the year ended Dec 31, 2014 the company earned net income of
$315,000. What were the total assets of the company on Jan 1,
2014 given that its ROA for the year was 0.12
Solution
Step 1: Average Total Assets = Net Income / ROA = 315,000 / 0.12 = 2,625,000
Step 2: Ending Total Assets = 942,000 + 1,610,000 = 2,552,000
Step 3: Beginning Total Assets = ( 2 2,625,000 ) 2,552,000 = 2,698,000

If company A has a higher rate of return on assets


than company B, this could be because company A
has a ______ profit margin on sales, or a ________
asset turn over ratio, or both.
A. Higher, higher
B. higher, lower
C. lower, higher
D. lower, lower

Return on Equity
- The rate of return earned on the
stockholders equity in the
business

NET INCOME
AVERAGE TOTAL EQUITY
Or
Profit margin x Total asset Turnover x financial leverage

Method of Computation:

ROE = ($2,000/$10,000) x ($10,000/$25,000) x ($25,000/$5,000) = 0.20 x


0.40 x 5 = 0.40 or 40%

Example 1: Company A earned net income of


1,722,000 during the year ending march 31, 2015.
The shareholders' equity on April 30, 2014 and March
31, 2015 was 14,587,000 and 16,332,000
respectively. Calculate its return on equity for the
year ending March 31, 2015.
Solution
Average Shareholders' Equity = ( 14,587,000 + 16,332,000 ) / 2 =
15,459,500
Return On Equity = 1,722,000 / 15,459,500 0.11 or 11%

Example 2: Total assets and total liabilities of


Company B on Jan 1, 2013 were 2,342,000 and
1,383,000. During the year ended December 31,
2014 it made a net profit of 242,000 and its
shareholders' equity increased by 302,000. Calculate
ROE of Company B.
Solution
Step 1: Beginning Shareholders' Equity = 2,342,000 1,383,000 =
959,000
Step 2: Ending Shareholders' Equity = 959,000 + 302,000 =
1,261,000
Step 3: Average Shareholders' Equity = ( 959,000 + 1,261,000 ) / 2
= 1,110,000
Step 4: Return On Equity = 242,000 / 1,110,000 0.22 or 22%

Measures the percentage of net income to sales

Return on Sales

Net Income
Net Sales

Method of Computation:

Measures

the ability to meet shortterm financial obligations

Liquidity Ratios

Current ratio = current assets


current liabilities
Quick ratio

= current assets inventory


current liabilities

Method of Computation

Example 1: On December 31, 2004 Company A had


current assets of 100,000 and current liabilities of
50,000. Calculate its current ratio.
Solution
Current ratio = 100,000 50,000 = 2.00

Example 2: On December 31, 2014 Company B had


total asset of 150,000, equity of 75,000,
non-current assets of 50,000 and non-current
liabilities of 50,000. Calculate the current ratio.
Solution
Current Assets = Total Asset Non-Current Assets = 150,000 50,000
= 100,000
Total Liabilities = Total Assets Total Equity = 150,000 75,000 =
75,000
Current Liabilities = 75,000 50,000 = 25,000
Current Ratio = 100,000 25,000 = 4.00

3: A company has following assets and


liabilities at the year ended December 31, 2009:
Calculate quick ratio (acid test ratio)
Example

Cash

$34,390

Marketable Securities

12,000

Accounts Receivable

56,200

Prepaid Insurance
Total Current Assets
Total Current Liabilities

9,000
111,590
73,780

Solution
Quick ratio = ( 34,390 + 12,000 + 56,200 ) / 73,780 = 102,590 / 73,780 = 1.39
OR
Quick ratio = ( 111,590 9,000 ) / 73,780 = 102,590 / 73,780 = 1.39

Example 4: Calculate quick ratio from the following


information:
Cash

21,720

Treasury Bills

18,500

Accounts Receivable

15,930

Prepaid Rent

6,500

Inventory

17,240

Total Current Assets

79,890

Total Current Liabilities

52,960

Solution
In this example, treasury bills are marketable securities thus we will
calculate quick ratio as follows:
Quick ratio = ( 79,890 6,500 17,240 ) / 52,960 = 56,150 / 52,960 =
1.06
OR
Quick ratio = ( 21,720 + 18,500 + 15,930 ) / 52,960 = 56,150 / 52,960 =
1.06

Measures

how the firm uses its assets to


generate revenue and income

Asset Management

PURPOSE
RATIOS
Average Collection Period
(ACP)

FORMULA
ACP = Accounts Receivable
Average Daily Sales
ACP = Accounts receivable
Sales

x360

Inventory Turnover
Invty. TO = Cost of Goods Sold
Inventory

Fixed Asset Turnover

FA TO = Net Sales
Average
Net FA

Measures the average number


of days to collect a receivable

Indicates if a firm holds


excessive stocks of inventories
that are unproductive and that
lessen the companys
profitability
Measures the level of use of
property, plant and equipment

FA TO = Sales
FA
Total Asset Turnover

TA TO = Net Sales
Average
Net TA
TA TO = Sales

Measures the level of capital


investment relative to the
sales volume

As of December 31
2008
2007
CASH
P 80,000
P 640, 000
Notes and AR (net)
400,000
1, 200, 000
Merchandise Invty.
720,000
1, 200, 000
Machinery and Equip.
1, 240,000
1, 080, 000
Land and buildings (net)
2, 720,000
2, 880, 000
Bonds payable LT
2, 160,000
2, 240, 000
Accounts Payable trade
560,000
880, 000
Notes Payable ST
160,000
320, 000
Sales (20% cash, 80% credit sales)
P 18, 400,000 P 19, 200, 000
Cost of Goods Sold
8, 400 000
11, 200, 000

ACP?
INVENTORY

TURNOVER?
TOTAL ASSETS TURNOVER?

ACP=

18.4x
INVENTORY TURNOVER= 8.33x
TOTAL ASSETS TURNOVER= 3.03x

DEBT MANANGEMNT RATIOS


- This ratios would tell us how the firm financed its
assets as well as the firms ability to repay its long-term
debt.

Shows

debt.

proportion of all assets that are financed with

TOTAL LIABILTIES
TOTAL ASSETS

DEBT RATIO:

Indicates

proportion of assets provided by owners.


Reflects financial strength and caution to creditors.
TOTAL EQUITY
TOTAL ASSETS

EQUITY RATIO:

Measures

debt relative to amounts of resources provided


by owners.

TOTAL LIABILITIES
TOTAL EQUITY

DEBT TO EQUITY RATIO:

Reflects

extent of investment in long term assets


financed from long term debt.

FIXED ASSETS (net)


TOTAL LONG-TERM LIABILITIES

FIXED ASSETS TO LONG-TERM LIABILITIES:

Measures

the proportion of owners capital invested in


fixed assets.

FIXED ASSETS (net)


TOTAL EQUITY

FIXED ASSETS TO TOTAL EQUITY:

Measures

investment in long-term capital assets.

FIXED ASSETS (net)


TOTAL ASSETS

FIXED ASSETS TO TOTAL ASSETS:

Measures

how many times interest expense is covered by


operating profit.

NET INCOME BEFORE INTEREST AND TAXES


ANNUAL INTEREST CHARGES

TIMES INTEREST EARNED:

Tiggies

Dog Toys, Inc. reported a debt to equity


ratio of 1.75 times at the end of 2008. If the
firms total assets at year-end were $25 million,
how much of their assets are financed with debt
and how much with equity?

Debt to equity = 1.75 = Total debt/Total equity = Total


debt/(Total assets Total debt)
1.75 = Total debt/($25m. Total debt)
=> 1.75 x ($25m. Total debt) = Total debt

=>

(1.75 x $25m.) (1.75 x Total debt) = Total debt =>


$43.75m. = 2.75 x Total debt

=>

Total debt = $43.75m./2.75 = $15.91m.


=> Total equity = $25m. - $15.91m. = $9.09m.

Measure

of shareholder value as reflected in


the price of the firms stock

Valuation Ratios

Ratios
Market to book ratio

Formula
Market Price per share
Book Value per share

Purpose
Measures how high is the
shares market price in
relation to book value

Book Value per share

Equity
Shares Outstanding

Measures the amt. of net


assets available to the
shareholders of a given type
of stock

Price/Earning ratio

Market Price
Earnings per share

Measures the relationship


between the shares market
price and earnings per share.

Gambit

Golfs market-to-book ratio is currently


2.5 times and PE ratio is 6.75 times. If Gambit
Golfs common stock is currently selling at P12.50
per share, what is the book value per share and
earnings per share?

Market-to-book ratio = 2.50 =


Book value per share

P 12.50

Book value per share = P12.50/2.50 = P5.00

Price-earnings ratio = 6.75 times =


Earnings per share

$12.50

Earnings per share = $12.50/6.75 = $1.85