FINANCIAL STATEMENT ANALYSIS

Financial analysis is designed to determine the relative strengths and weaknesses of a

company. Financial analysis concentrates on financial statement analysis, which highlights
the key aspects of a firm’s operations.

Financial statement analysis involves a study of the relationships between income

statement and balance sheet accounts, how these relationships change over time (trend
analysis or horizontal analysis), and how a particular firm compares with other firms in its
industry (bench-marking or vertical analysis).

Three basic tools in financial statements analysis.

1. Horizontal Analysis or Trend Analysis. A technique for evaluating a series of

financial statement data over a period of time. Its purpose is to determine the increase
or decrease that has taken place, expressed either an amount or a percentage.

Percentage Change =

2. Vertical Analysis or Common Size Analysis. It is a technique for evaluating

financial statement data that expresses each item in a financial statement as a percent
of a base amount.

Base amount:
Balance Sheet - Total Assets
Income Statement - Net Sales

3. Ratio Analysis. This technique establishes relationships among financial

statement accounts at given date or period of time. These ratios analyze firm’s
liquidity, the use of leverage, asset management, cost control, profitability, growth,
and valuation.

Basic Rules in Computing Financial Ratios:

- When calculating a ratio using balance sheet amounts only, the numerator and
denominator should be based on amounts as of the same balance sheet date. The
same is true for ratios using only income statement numbers. Exception: calculation of
growth ratios.
- If an income statement amount and a balance sheet amount are sued at the same
time to calculate a ratio, the balance sheet amount should be expressed as an average
for the time period represented by the income statement amount.
 - If the beginning balance of a balance sheet account is not available and cannot be
computed from the given data, the ending balance of the account is sued to represent
the average balance.
- If sales and/or purchases are given without making distinction as to whether made in
cash or on credit, assumptions are made depending on the ratio being calculated:
 Turnover ratios: Sales and purchases are made on credit.
 Cash flow ratios: Sales and purchases are made in cash.
- As a rule, an operating year is assumed to have 360 days, unless specified otherwise.

Financial Ratios:

Tests of Liquidity:

Current Ratio 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠 It is a measure of adequacy of

𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑡𝑖𝑒𝑠 working capital. It is the
primary test of liquidity to
meet current obligations from
current assets
Quick Ratio 𝑄𝑢𝑖𝑐𝑘 𝐴𝑠𝑠𝑒𝑡𝑠 It measures the number of
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 times that the current
liabilities could be paid with
the available cash and near-
cash assets (i.e., cash,
current receivables and
marketable securities)

Working Capital Activity Ratios

Receivables Turnover 𝑁𝑒𝑡 𝐶𝑟𝑒𝑑𝑖𝑡 𝑆𝑎𝑙𝑒𝑠 It measures the number of

𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠 times receivables are
recorded and collected
during the period.
Average Age of Receivables 360 𝑑𝑎𝑦𝑠 It indicates the average
𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 number of days during which
the company must wait
before receivables are
collected.
Inventory Turnover 𝐶𝑜𝑠𝑡 𝑜𝑓 𝑔𝑜𝑜𝑑𝑠 𝑠𝑜𝑙𝑑 It measures the number of
𝐴𝑣𝑒. 𝑀𝑒𝑟𝑐ℎ𝑎𝑛𝑑𝑖𝑠𝑒 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 times that the inventory is
replaced during the period.
 Average Age of inventory 360 𝑑𝑎𝑦𝑠 It indicates the average
𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 number of days during which
the company must wait
before the inventories are
sold.

Raw Materials Turnover Cost of materials used / average RM inventory

Work In Process Turnover Cost of goods manufactured / average WIP
inventory
Finished Goods Turnover CGS / Average FG inventory
Normal Operating Cycle Ave. Age of Inventory + Ave. Age of
Receivables
Trade Payables Turnover Net Credit Purchases / Average Trade
Payables
Average Age of Trade Payables 360 days / Payables Turnover
Current Assets Turnover (CGS + OPEX) / Ave. Current Assets

Test of Solvency

Times Interest Earned EBIT / Interest Expense It determines the extent to

which operations cover
interest expense.
Debt-Equity Ratio Total Liabilities / Total Equity Proportion of assets provided
by creditors compared that
provided by owners
Debt Ratio Total Liabilities / Total Assets Proportion of total assets
provided by creditors
Equity Ratio Total Equity / Total Assets Proportion of total assets
provided by owners.

Test of Profitability

Return on Sales Income / Net Sales Determines the proportion of

sales that went into
company’s earnings.
Return on Assets Income / Average Assets Efficiency with which assets
are used to operate the
business
Return on Equity Income / Average Equity Measures the amount earned
on the owners’ or
stockholders’ investment.
 Earnings Per Share (Net Income – Preferred Measures the amount of net
Dividends) / Wtd. Ave. income earned by each
Common Shares Outstanding common share.

Market Tests

Price-Earnings Ratio Price Per Share / Earnings It indicates the number of

Per Share pesos required to buy P1 of
earnings.
Dividend Yield Dividend Per Share / Price Measures the rate of return in
Per Share the investor’s common stock
investments.
Dividend Pay-Out Dividend Per Share / It indicates the proportion of
Earnings Per Share earnings distributed as
dividends.

Stability Ratios

Fixed Assets to Total Equity Fixed Assets / Total Equity Measures the proportion of
owners’ equity to fixed assets.
Indicative of over or under
investment by owners and
weakness in trading the
equity.
Fixed Assets to Total Assets Fixed Assets (net) / Total Indicates the possible over-
Assets expansion of plant and
equipment
Sales to Fixed Assets (Plant Net Sales / Fixed Assets (Net) Tests roughly the efficiency of
Turnover) management in keeping plant
properties employed.
Book Value per share – CS Common Shareholders’ Measures recoverable
Equity / Common Shares amount by stockholders in the
Outstanding event of liquidation if assets
are realized at their book
values.
Times Preferred Dividend Net Income After Taxes / It indicates ability to provide
Earned Preferred Dividends dividends to preferred
stockholders.
Capital intensity ratio Total Assets / Net Sales Measures efficiency of the
firm to generate sales through
employment of its resources.
 Times fixed charges earned Net income before taxes & Measures ability to meet fixed
fixed charges / (Fixed charges charges
+ sinking fund payment)

Tests of Over-all Short-Term Solvency or Short-Term Financial Position

Working Capital Turnover Net Sales / Average Working Indicates adequacy of

Capital working capital to support
operation (sales)
Defensive Interval Ratio Current Liabilities / Cash & Measures coverage of
Cash Equivalent current liabilities
Payable Turnover Net Purchases / Average Measures efficiency of the
Accounts Payable company in meeting the
accounts payable.
Fixed assets to long-term Fixed Assets / Long-term Reflects extent of the
liabilities liabilities utilization of resources from
long-term debt. Indicative of
sources of additional funds.

Ratios indicative of income position

Rate of return on average Income / Average Current Measures the profitability of

current assets Assets current assets invested
Operating Profit Margin Operating profit / net sales Measures profit generated
after consideration of
operating costs.
Cash flow margin Operating cash flow / net Measures the ability of the
sales firm to translate sales to cash.
 FS Analysis Trainer

Problem 1: White Corporation's financial statements for the last year are shown below.
All figures are in thousands (P000). The firm paid a P1,000 dividend to its stockholders
during the year. Two million shares of stock are outstanding. The stock is currently
trading at a price of P50. There were no sales of new stock. Lease payments totaling
P400 are included in cost and expense.

BALANCE SHEET

ASSETS
Cash P 2,000
Accounts receivable 12,000
Inventory 14,000
Current Assets P28,000
Gross Fixed assets P27,000
Accumulated depreciation (16,000)
Net fixed assets 11,000
Total assets P39,000

LIABILITIES
Accounts payable P 3,000
Accruals 1,000
Current Liabilities P 4,000
Long term Debt 10,000
Equity 25,000
Total liabilities & equity P39,000

INCOME STATEMENT
Sales P100,000
COGS 80,000
Gross Margin P 20,000
Cash Expenses 8,000
Depreciation 1,600
9,600
EBIT P 10,400
Interest 800
EBT P 9,600
Tax 2,600
Net Income P 7,000
Requirements: Compute the following for White Corporation:
1. Current Ratio
2. Quick Ratio
3. Fixed Asset Turnover
4. Total Asset Turnover
5. Debt Ratio
6. Debt to Equity ratio
7. Times Interest Earned (TIE)
8. Return on Sales (ROS)
9. Return on Assets (ROA)
10. Return on Equity (ROE)

Problem 2: We are given the following information for the Pudge Tools Corporation:

Sales (credit) 7,200,000

Cash 300,000
Inventory 2,150,000
Current Liabilities 1,400,000
Asset Turnover 1.20 times
Current ratio 2.50 times
Debt-to-assets ratio 40%
Receivables turnover 8 times

Current assets are composed of cash, marketable securities, accounts receivable, and
inventory. Calculate the following balance sheet items:
a. A/R
b. Marketable Securities
c. Fixed Assets
d. Long-term debt

Problem 3: Assume that net income was P 6,000. No other information is known, except the
following:

Return on equity 10% Return on sales 4%

Gross margin percentage 60% Income tax rate 40%
Current ratio 3:1 Return on assets 5%
Inventory turnover 4 Days sales in receivables 90
Long-term debt to equity 2:3

Required: Using the preceding ratios, construct an income statement and a balance sheet with
as much detail as possible.
Problem 4:
a. The current ratio is 2.5 to 1; the acid-test ratio is 0.9 to 1; cash and receivables are
P270,000. The only current assets are cash, receivables, and inventory. (a) What are
current liabilities? (b) How much is inventory?
b. Accounts receivable turnover is 5 times; inventory turnover is 4 times. The company
recently bought inventory. (a) On the average, how long will it be before the new inventory
is sold? (b) On the average, how long after the inventory is sold will cash be collected?
c. Accounts receivables equal 45 days’ credit sales. The coming year should see sales of
P900,000 spread evenly over the year. What should accounts receivable be at the end of
the year?
d. GGG, Inc. has a debt ratio of 50%, and an equity multiplier of 2. What is GGG's
stockholders' equity if total debt is P100,000?
e. If Basyos has a total asset turnover of 1.8, a fixed asset turnover of 3.2, a debt ratio
of .5 and a total debt of P200,000, how much then the amount of fixed assets?
f. What is Babi's times interest earned, if its total interest charges are P20,000, sales
are P220,000, and its net profit margin is 6 percent? Assume a tax rate of 40 percent.
g. Determine the cost of sales for a firm with the following financial ratios and data:
Current ratio = 3.0 Quick ratio = 2.0
Current liabilities P1,000,000 Inventory turnover = 6 times.
h. Find the sales of the Bengge Company using the
following information:
Current ratio 2.0
Quick ratio 1.6
Current liabilities P200,000
Inventory turnover based
on COGS 8.0
Gross margin % 10%
i. Presented below is information related to Milson, Inc.:
December 31,
2021 2020
Common stock P 75,000 P 60,000
6% Preferred stock 350,000 350,000
Retained earnings (includes net income for current year) 90,000 75,000
Net income for year 60,000 32,000
What is Milson's rate of return on common stock equity for 2021?
j. Given the following information, calculate the market price
per share of WAM Inc.
Net income = P200,000
Earnings per share = P2.00
Stockholders’ equity = P2,000,000
Market/Book ratio = 0.20
Problem 5: Tinker Corporation experienced a fire on December 31, 2021, in which its
financial records were partially destroyed. It has been able to salvage some of the records
and has ascertained the following balances:

December 31, 2021 December 31, 2020

Cash P 300,000 P100,000
Receivables (net) 720,500 1,260,000
Inventory 2,000,000 1,800,000
Accounts payable 500,000 200,000
Notes payable 300,000 600,000
Common stock, P100 par 4,000,000 4,000,000
Retained earnings 1,135,000 1,010,000

Additional information:
1. The inventory turnover is 3.6 times
2. The return on common stockholders’ equity is 22%. The company had no additional
paid in capital.
3. The receivables turnover is 9.4 times
4. The return on assets is 20%
5. Total assets as at December 31, 2020, were P6,050,000.

Requirements: Compute the following:

1. Cost of goods sold for 2021

2. Net income for 2021
3. Total assets as at December 31, 2021

GROSS PROFIT VARIANCE ANALYSIS

Problem 6: Badosa Company prepared the following budgetary information for January of
2022 for its tennis racket:

Sales (12,000 units) P 432,000

Cost of Goods Sold P 288,000
Gross Profit P 144,000

In January, actual operations resulted in the production and sale of 13,000 units which were
sold for a selling price of P 34 per unit. The unit cost of goods sold increased by P 3.
Required:
1. Overall Gross Profit Variance
2. Sales Price Variance
3. Sales Volume Variance
4. Cost Price Variance
5. Cost Volume Variance

Problem 7: Ons Company has requested you to determine the cause of the difference
between its 2021 and 2022 gross profit based on the following data:

2021 2022
Sales P 200,000 P 252,000
Cost of Goods Sold P 120,000 P 180,000
Gross Profit P 80,000 P 72,000

No additional data was made available except that unit sales increased by 20% in 2022.

Required:
1. Overall Gross Profit Variance
2. Price Factor
3. Cost Factor
4. Volume Factor

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