MODULE 5 /CHAPTER 4

ANALYSIS OF FINANCIAL
STATEMENTS

DEPARTMENT OF EDUCATION – BUREAU OF CURRICULUM DEVELOPMENT

 FinancialAnalysis

Financial analysis is a process of selecting,

evaluating, and interpreting financial data, along
with other pertinent information, in order to
formulate an assessment of a company’s present
and future financial condition and performance.

DEPARTMENT OF EDUCATION – BUREAU OF CURRICULUM DEVELOPMENT

 Importance Financial Analysis

1. Holding of Share
2. Decisions and Plans
3. Extension of Credit
4. Investment Decision

DEPARTMENT OF EDUCATION – BUREAU OF CURRICULUM DEVELOPMENT

 TWO PHASES Financial Analysis

1. Computation Phase
2. Interpretation Phase

DEPARTMENT OF EDUCATION – BUREAU OF CURRICULUM DEVELOPMENT

 Financial Analysis

Common analysis

1. Horizontal Analysis
2. Vertical Analysis
3. Financial Ratios

DEPARTMENT OF EDUCATION – BUREAU OF CURRICULUM DEVELOPMENT

HORIZONTAL Analysis or Comparative Analysis

Using comparative financial

statements to calculate Useful when comparing
percentage changes in a growth of different
financial statement item from accounts over time.
one period to the next

DEPARTMENT OF EDUCATION – BUREAU OF CURRICULUM DEVELOPMENT

 CLOVER CORPORATION
Comparative Balance Sheets
December 31, 1999 and 1998
Increase (Decrease)
1999 1998 Amount %
Assets
Current assets:
Cash $ 12,000 $ 23,500
Accounts receivable, net 60,000 40,000
Inventory 80,000 100,000
Prepaid expenses 3,000 1,200
Total current assets 155,000 164,700
Property and equipment:
Land 40,000 40,000
Buildings and equipment, net 120,000 85,000
Total property and equipment 160,000 125,000
Total assets $ 315,000 $ 289,700
 HORIZONTAL ANALYSIS EXAMPLE
Horizontal Analysis Example
Calculating Change in Dollar Amounts

Change = Current Year

Figure – Base Year
Figure
 HORIZONTAL ANALYSIS EXAMPLE
Horizontal Analysis Example
Calculating Change in Dollar Amounts

Change = Current Year

Figure – Base Year
Figure

Since we are measuring the amount of

the change between 1998 and 1999,
the amounts for 1998 become the
“base” year figures.
 HORIZONTAL ANALYSIS EXAMPLE
Horizontal Analysis Example
Calculating Change as a Percentage

Percentage Change
Change = Base Year Figure × 100%
 HORIZONTAL ANALYSIS EXAMPLE
Horizontal Analysis Example
CLOVER CORPORATION
Comparative Balance Sheets
December 31, 1999 and 1998
Increase (Decrease)
1999 1998 Amount %
Assets
Current assets:
Cash $ 12,000 $ 23,500 $ (11,500)
Accounts receivable, net 60,000 40,000
Inventory 80,000 100,000
Prepaid expenses 3,000 1,200
Total current assets 155,000 164,700

12,000 – 23,500 = (11,500)

Property and equipment:
Land 40,000 40,000
Buildings and equipment, net 120,000 85,000
Total property and equipment 160,000 125,000
Total assets $ 315,000 $ 289,700
 HORIZONTAL ANALYSIS EXAMPLE
Horizontal Analysis Example
($11,500 ÷ $23,500) × 100% = 48.9%
CLOVER CORPORATION
CLOVER CORPORATION
Comparative
Comparative
Balance SheetsBalance Sheets
December 31,
December
1999 and 1998
31, 1999 and 1998
Increase (Decrease) Increase (Decrease)
1999 1998
1999 Amount 1998 % Amount %
AssetsAssets
Current
Currentassets:
assets:
Cash
Cash $ 12,000 $$ 23,50012,000
$ (11,500)
$ 23,500
(48.9) $ (11,500) (48.9)
Accounts
Accountsreceivable,
receivable,
net net 60,000 40,000
60,000 20,000 40,000 50.0
Inventory
Inventory 80,000 100,000
80,000 (20,000)100,000
(20.0)
Prepaid
Prepaidexpenses
expenses 3,000 1,200
3,000 1,800 1,200
150.0
Total
Total
current
current
assets assets 155,000 164,700
155,000 (9,700)164,700 (5.9)
Property
Propertyand and
equipment:
equipment: ($11,500 ÷ $23,500) × 100% = 48.9%
Land
Land 40,000 40,000
40,000 - 40,0000.0
Buildings
Buildings
and equipment,
and equipment,
net net 120,000 85,000
120,000 35,000 85,000 41.2
Total
Total
property
property
and equipment
and equipment 160,000 125,000
160,000 35,000 125,000 28.0
Total
Totalassets
assets $ 315,000 $$ 289,700315,000$ 25,300
$ 289,700 8.7
 HORIZONTAL ANALYSIS EXAMPLE
Horizontal Analysis Example
Learn more!

Accounting Horizontal Vertical Analysis.mp4

 Complete the table by referring to the given example
Horizontal Analysis Example
CLOVER CORPORATION
CLOVER CORPORATION
Comparative
Comparative
Balance SheetsBalance Sheets
December 31,
December
1999 and 1998
31, 1999 and 1998
Increase (Decrease) Increase (Decrease)
1999 1998
1999 Amount 1998 % Amount %
AssetsAssets
Current
Currentassets:
assets:
Cash
Cash $ 12,000 $$ 23,500
12,000
$ (11,500)
$ 23,500
(48.9) $ (11,500) (48.9)
Accounts
Accountsreceivable,
receivable,
net net 60,000 40,000
60,000 20,000 40,000 50.0
Inventory
Inventory 80,000 100,000
80,000 (20,000)100,000
(20.0)
Prepaid
Prepaidexpenses
expenses 3,000 1,200
3,000 1,800 1,200
150.0
Total
Total
current
current
assets assets 155,000 164,700
155,000 (9,700)164,700(5.9)
Property
Propertyand and
equipment:
equipment:
Land
Land 40,000 40,000
40,000 - 40,0000.0
Buildings
Buildings
and equipment,
and equipment,
net net 120,000 85,000
120,000 35,000 85,000 41.2
Total
Total
property
property
and equipment
and equipment 160,000 125,000
160,000 35,000 125,00028.0
Total
Totalassets
assets $ 315,000 $$ 289,700
315,000
$ 25,300
$ 289,7008.7
VERTICAL Analysis or Common-Size Analysis

uses the aggregate value in a financial statement

for a given year as the base, and each account’s
amount is restated as a percentage of the
aggregate.
Balance sheet: Aggregate amount is total
assets.
Income statement: Aggregate amount is
revenues or sales.
DEPARTMENT OF EDUCATION – BUREAU OF CURRICULUM DEVELOPMENT
 VERTICAL ANALYSIS FORMULA
Horizontal Analysis Example
Calculating the Percentage for Balance Sheet

Account
Percentage = Total Assets × 100%

Calculating the Percentage for Income Statement

Percentage = Account
Total Income × 100%
 VERTICAL ANALYSIS: BALANCE SHEET
Horizontal Analysis Example
December 31, 1999 and 1998
Percentage
1999 1998 1999 1998
Assets
Current assets:
Cash $ 12,000 $ 23,500 3.81
Accounts receivable, net 60,000 40,000
Inventory 80,000 100,000
Prepaid expenses 3,000 1,200
Total current assets 155,000 164,700
Property and equipment: (12, 000 ÷ 315, 000) × 100% = 3.81%
Land 40,000 40,000
Buildings and equipment, net 120,000 85,000
Total property and equipment 160,000 125,000
Total assets $ 315,000 $ 289,700
 Complete the table
Horizontal Analysis Example
December 31, 1999 and 1998
Percentage
1999 1998 1999 1998
Assets
Current assets:
Cash $ 12,000 $ 23,500 3.81
Accounts receivable, net 60,000 40,000
Inventory 80,000 100,000
Prepaid expenses 3,000 1,200
Total current assets 155,000 164,700
Property and equipment:
Land 40,000 40,000
Buildings and equipment, net 120,000 85,000
Total property and equipment 160,000 125,000
Total assets $ 315,000 $ 289,700
 Statement of Comprehensive Income
Horizontal Analysis Example
December 31, 1999 and 1998
Percentage
1999 1998 1999 1998

Net Sales $ 2,213,000 $ 1,739,000 100% 100%

Less: Cost of Sales 1,032,000 832,000 47% 48%
Gross Profit 1,181,000 907,000 53% 52%
Less: Operating Expenses 889,000 660,000 40% 38%
Operating Income 292,000 247,000 13% 14%
Less: Interest Expense 91,000 31,000 4% 2%
Income before Income Taxes 201,000 216,000 9% 12%
Less : Income Taxes Expense 60,000 65,000 3% 4%
NET INCOME $ 141,000 $ 151,000 6% 9%

(1,032,000 ÷ 2,213,000) × 100% = 47%

 FINANCIAL RATIOS

It is used to compare a company’s current

financial position and performance with those
of past years and identify strengths and
weaknesses.

DEPARTMENT OF EDUCATION – BUREAU OF CURRICULUM DEVELOPMENT

 CLOVER CORPORATION
Comparative Balance Sheets
December 31, 1999 and 1998
Increase (Decrease)
1999 1998 Amount %
Assets
Current assets:
Cash $ 12,000 $ 23,500
Accounts receivable, net 60,000 40,000
Inventory 80,000 100,000
Prepaid expenses 3,000 1,200
Total current assets 155,000 164,700
Property and equipment:
Land 40,000 40,000
Buildings and equipment, net 120,000 85,000
Total property and equipment 160,000 125,000
Total assets $ 315,000 $ 289,700
 Statement of Comprehensive Income
Horizontal Analysis Example
December 31, 1999 and 1998

1999 1998

Net Sales $ 2,213,000 $ 1,739,000

Less: Cost of Sales 1,032,000 832,000
Gross Profit 1,181,000 907,000
Less: Operating Expenses 889,000 660,000
Operating Income 292,000 247,000
Less: Interest Expense 91,000 31,000
Income before Income Taxes 201,000 216,000
Less : Income Taxes Expense 60,000 65,000
NET INCOME $ 141,000 $ 151,000
 Different Financial Ratios

1. Liquidity Ratios and Turnover Ratio

2. Solvency Ratios
3. Profitability Ratios

DEPARTMENT OF EDUCATION – BUREAU OF CURRICULUM DEVELOPMENT

 Liquidity Ratio

It calculates the company’s current or

quick assets against its outstanding
liabilities.

DEPARTMENT OF EDUCATION – BUREAU OF CURRICULUM DEVELOPMENT

 Types of Liquidity Ratios

1. Current Ratio
2. Quick Ratio
3. Receivable Turnover
4. Average Collection Period
5. Inventory Turnover
6. Average Sales Period
DEPARTMENT OF EDUCATION – BUREAU OF CURRICULUM DEVELOPMENT
 1. Current Ratio
It measures the ability of the business to pay its
short-term obligations as they fall due.

Current Ratio = Current Assets

Current Liabilities
596,000/380,000 = 1.57 : 1
The higher CR the better.
DEPARTMENT OF EDUCATION – BUREAU OF CURRICULUM DEVELOPMENT
 2. Quick Ratio
- Also known as the acid test ratio, it measures
immediate liquidity with the ability to pay
current with the most liquid assets.

Quick Ratio = Current Assets - Inventory

Current Liabilities
(596,000-250,000)/380,000 = .91 : 1
The higher QR the better.
DEPARTMENT OF EDUCATION – BUREAU OF CURRICULUM DEVELOPMENT
 3. Trade Receivable Turnover (times)
It measures the efficiency to collect the amount
due from credit customers.

Trade Receivable = Net Sales

Turnover Ave. Account Receivables
2,780,000/225,000 = 12.0x : 1

DEPARTMENT OF EDUCATION – BUREAU OF CURRICULUM DEVELOPMENT

 4. Average Collection Period
It is the approximate number of days it takes a
business to collect its receivable s from credit
or account sales.

Average Collection = 360 days

Period Receivables Turnover
360 days /12.0x = 30 days

DEPARTMENT OF EDUCATION – BUREAU OF CURRICULUM DEVELOPMENT

 4. Average Collection Period

Average = Annual Sales

Daily Sales 360 days

DEPARTMENT OF EDUCATION – BUREAU OF CURRICULUM DEVELOPMENT

 5. Inventory Turnover
It measures the number of times a company’s
inventory is sold and replaced during the year.
Inventory Turnover = Cost of goods sold
Average Inventory
Ave Inventory = Beginning Inv. + Ending Inventory
2
= 1,056,000/250,000 = 4.0x : 1
The higher IT the better.
DEPARTMENT OF EDUCATION – BUREAU OF CURRICULUM DEVELOPMENT
 6. Average Sales Period
It is the average time to convert inventory to
sales.

Average Sales = 360 days

Period Inventory Turnover
= 360/4x = 90 days

DEPARTMENT OF EDUCATION – BUREAU OF CURRICULUM DEVELOPMENT

 7. Working Capital
It measures the short term liquidity of a company.

Working Capital =
Current Assets – Current Liabilities
596,000-380,000= 216,000

DEPARTMENT OF EDUCATION – BUREAU OF CURRICULUM DEVELOPMENT

 Problem Solving
1. Current assets is PHP2,000, current liabilities is PHP3,500. What is current ratio? .57 :1
2. Inventory is PHP150. Accounts payable is PHP450. Cash and accounts receivable total PHP800.
What is the current ratio? Quick ratio?
150+800 = 950/450 = 2.11 / 800/450 = 1.77
3. If current ratio is 1.7, what is the total accounts receivable if cash is PHP20,000, inventory is
PHP7,500, and accounts payable is PHP30,000.
AR + 20,000+ 7,500 (51,000) =1.7 1.7x30,000= 51,000 -20,000-7,500 = 23,000
30,000
4. Cash is 30% of total current assets. If current ratio is 2.3, what is the new current
ratio if total non-cash current assets grow by 50%?
100,000 =43,478 100,000 =2.3 30,000+ 70,000 30000+105,000
2.3 43,478 43,478 43,478
= 3.10
DEPARTMENT OF EDUCATION – BUREAU OF CURRICULUM DEVELOPMENT
 Solvency Ratio

Also called leverage ratios, it measure a

company’s ability to pay its maturing
long-term debts while sustaining
operations indefinitely.

DEPARTMENT OF EDUCATION – BUREAU OF CURRICULUM DEVELOPMENT

 Types of Solvency Ratios

1. Debt Ratio
2. Equity Ratio
3. Debt to Equity Ratio
4. Times Interest Earned

DEPARTMENT OF EDUCATION – BUREAU OF CURRICULUM DEVELOPMENT

 1. Debt Ratio
It measures business liabilities as a percentage
of total assets.

Debt Ratio = Total Liabilities

Total Assets
838,000/1,906,000 = .44 : 1
The lower DR the better
DEPARTMENT OF EDUCATION – BUREAU OF CURRICULUM DEVELOPMENT
 2. Equity Ratio
- It measures the percentage of total assets
financed by the owner’s investment. It
measures the extent of total assets owned by
the owner.
Equity Ratio = Total Equity
Total Assets
1,068,000/1,906,000 = .56 : 1
The higher EO the better.
DEPARTMENT OF EDUCATION – BUREAU OF CURRICULUM DEVELOPMENT
 3. Debt to Equity Ratio
Also called as financial leverage ratio, it
measures the financing provided by the
creditors against those provided by the owner.

= Total Liabilities
Debt to Equity Ratio
Total Equity
838,000/1,068,000 = .78 :1
The higher DtE ratio the better.
DEPARTMENT OF EDUCATION – BUREAU OF CURRICULUM DEVELOPMENT
 4. Times Interest Earned
It measures the company’s ability to pay the
interest charged to the company for its
outstanding liabilities.

Times Interest = Income before Interest and Taxes or Operating Income

Earned Interest Expense

1,036,000 /35,000 = 29.6 : 1
The higher TIE the better.
DEPARTMENT OF EDUCATION – BUREAU OF CURRICULUM DEVELOPMENT
 Profitability Ratio

It measure a company’s overall

efficiency and performance based on
its ability to generate profit from
operations relative to its available
assets and resources.

DEPARTMENT OF EDUCATION – BUREAU OF CURRICULUM DEVELOPMENT

 Types of Profitability Ratios

1. Gross Profit Ratio

2. Operating Profit Margin
3. Net Profit Margin
4. Return on Assets

DEPARTMENT OF EDUCATION – BUREAU OF CURRICULUM DEVELOPMENT

 1. Gross Profit Ratio
It measures the percentage of peso sales
earned after deducting cost of goods sold.

Gross Profit = Gross Profit

Net Sales
1,724,000/2,780,000 = .62 or 62%
* The higher GP the better
DEPARTMENT OF EDUCATION – BUREAU OF CURRICULUM DEVELOPMENT
 2. Operating Profit Margin
- It measures the percentage of income earned
after deducting the cost of sales and the
operating expenses.

Operating Profit Margin = Operating Income

Net Sales
OPM = 1,036,000/2,780,000= .37 or 37%
The higher OPM the better.
DEPARTMENT OF EDUCATION – BUREAU OF CURRICULUM DEVELOPMENT
 3. Net Profit Margin
Also called as Return on Sales, it measures the
percentage of net income earned from net sales
after all other income has been added and all
operating expenses and other expenses
including taxes have been paid
975,000/2,780,000 = .35 or 35%
Net Profit Margin = Net Income
Net Sales
DEPARTMENT OF EDUCATION – BUREAU OF CURRICULUM DEVELOPMENT
 4. Return on Assets
Also called as Return on Investment, it
measures the company’s efficiency in using its
level of investment in assets in order to
generate income.
Return on Assets = Net Income
Average Total Assets 2014 – 1M
975,000/1,906,000=.51 or 51%
975,000 / ((1,906,000+1,000,000)/2) = 1,453,000
DEPARTMENT OF EDUCATION – BUREAU OF CURRICULUM DEVELOPMENT