ANALYSIS AND
INTERPRETATION
OF FINANCIAL
STATEMENTS
By: Pearl Mercado ABM XII - Turqouis
CONTENT
Lesson 1: Introduction to
Financial Statement
Analysis
Lesson 2: Horizontal
Analysis Lesson 3: Vertical
Analysis
Lesson 4: Financial Ratios
LESSON 1:
INTRODUCTION
TO FINANCIAL
STATEMENT
ANALYSIS
Financing decision
refers to decision that
FINANCIAL STATEMENT ANALYSIS involves funding
investments and
• Refers to examination of financial data of an entity to operations over the
determine its profitability, growth, solvency, stability and long run.
eff ectiveness of its management.
• Basically, it's role is to help make business decisions or
financing decisions.
• Users of accounting information are able to determine an entity’s
profitability, liquidity (firm's ability to meet its maturing
obligations in the short run) , and solvency (firm's ability to meet
maturing obligation ion the long run).
• One is able to assess management’s eff ectiveness in running a
business
• Assess the safety of investments in the firm.
FIRST, WHAT IS A FINANCIAL STATEMENT?
• Product of financial accounting.
• Tools that managers use to help them in their decision making considering
financial implications.
THE BASIC FINANCIAL STATEMENTS ARE:
1. Income statement or statement of comprehensive income
- details the revenues earned and the expenses incurred by a company. It shows the results of operation of a company.
- shows the profitability of the firm. It covers a certain accounting period, a month, a quarter, a six-month period, or a
year.
2. Balance Sheet or Statement of Financial Position
- shows the assets, liabilities, and owner's equity of a business. It shows the financial condition or financial position of the
business. It details the company's resources (assets) and obligations (liabilities) and the composition of the owner's
equity. The difference between assets and liabilities is equal to the owner's equity.
3. Statement of Changes in Owner’s Equity
- It shows the beginning owners) equity with additional investments for a sole proprietorship or partnership or, for a
corporation, additional issuances of corporate stock.
- shows the withdrawals made by a sole proprietor or partners) or declaration of dividends of a corporation. It shows profit
for the sole proprietorship or partnership or changes in the retained earnings account if a separate statement of retained
earnings is not made.
4. Statement of Cash Flows
- statement of the sources and assets or the statement of sources and users of funds.
LESSON 2:
HORIZONTAL
ANALYSIS
HORIZONTAL ANALYSIS
- Otherwise known as trend analysis, this helps management analyze increases
and decreases in balance sheet and income statement accounts.
- Comparing consecutive years and noting magnanimous increases or decreases
in other balance sheet items reveals a trend (that's why this is called a trend
analysis). This comparison may also be used by management for decision-
making purposes.
- For income statement accounts, horizontal analysis also helps management
analyze significant increases or decreases in sales, cost of sales and expenses.
> Since a comparison between current and previous data, the formula for a
horizontal analysis is:
Value in new time period – value in old time X
period
100 = % change
Value in old time period
Comparative statements
- show the increases or decreases in account balances and
their corresponding percentages. The following is an
illustration thereof:
The percentage of change in sales of 50% is arrived at by dividing the amount of Php
160,000 increase to the 2016 sales of Php 320,000 and multiplying it to 100 to get the
percentage. Therefore, the sales in the company increased 50% during the year.
Trend Ratios
- percentages showing the behavior of financial data for successive periods. The
following income statements are used in preparing the schedule of trend:
The earliest year is used as the base year so that for
sales, the trend ratios are computed as follows: for
2017 - (100,000/100,000)*100; for 2016 -
(110,000/100,000)*100
From the foregoing schedule of trend ratios, it may
noted that net income went up to 103 %. In 2016, all
the figures went up with interest expense posting the
greatest income, that is, by 78%.
Considering the foregoing changes, it can be
concluded that as the sales are increasing, expenses
are increasing too. While increase in sales could be a
indicate growth in business, increase in expenses could
be a potential ineffi ciency that could affect the
business in the long run. The analyst should look into
the possible causes of increases in expenses to
manage and balance it alongside the growth in the
revenue.
LESSON 3:
VERTICAL
ANALYSIS
Vertical Analysis
• is the process of analyzing the entries on a
financial statement, in relation to the industry
standard.
• involves comparing figures in the financial
statements of a single period
• Each figure in the statement of financial
position is expressed as a percentage of total
assets while in the income statement, every
amount is expressed as a percentage of net
sales.
> In a vertical analysis of a balance sheet would describe each asset as a percent of total assets.
So to compute percentage in balance sheet, the formula is
Accounts X 100 = %
Total Assets
> In a vertical analysis of the income statement, every amount is expressed as a percentage of net
sales. So to compute percentage in balance sheet, the formula is
X 100 = %
Income Statement Accounts
Net Sales
> In a vertical analysis of a
balance sheet would
describe each asset as a
percent of total assets. So
to compute percentage in
balance sheet, the formula
is:
X 100 = %
Accounts
Total Assets
> In a vertical analysis of In a
vertical analysis of the income
statement, every amount is
expressed as a percentage of net
sales. So to compute percentage
in balance sheet, the formula is
Income Statement Accounts
X 100 = %
Total Assets
LESSON 4:
FINANCIAL
RATIOS
Financial Ratios
- These are indices used in expressing financial data in such a way that it can be
compared and trends identified and thus questions can be raised. (Jones, Ernest;
243). Ratios should be used to build up and summarize the evidence available and
to create a picture from which, not conclusions, but better questions can be drawn.
They have a role to play in summarizing financial data so as to produce the right
questions, but it must always be remembered that they do not in themselves in any
way provide answers.
• Liquidity Ratio
• Solvency Ratio
• Profitability Ratio
• Market Value
LIQUIDITY RATIO
- Liquidity ratios attempt to measure a company's ability to meet its short- term obligations.
> Current Ratio : It measures the ability of the company to pay its current obligations using its
current assets.
- The higher the current ratio, the better for it indicates a greater degree of liquidity.
FORMULA
> Quick Ratio : provides a better measure of the firm's overall liquidity than current ratio.
- The higher the quick ratio, the better.
FORMULA
SOLVENCY RATIO
- The debt position of a firm indicates the amount of other people's money being used to generate
profits.
> Debt to equity ratio - shows the relationship between debt and equity.
FORMULA
> Debt Ratio : This value indicates that the company has financed close to half assets with debt.
- The higher this ratio, the greater the amount of other people's money being used to generate profits.
FORMULA
> Time Interest Earned Ratio : Measures the firms ability to make contractual interest payment.
FORMULA
PROFITABILITY RATIO
- Profitability ratios can be used to assess a company's ability to control expenses and to convert sales
into profits. In addition, profitability ratios help determine how effectively the company produces profits
from its resources.
> Gross profi t margin - profitability is the broadest measure of the firm's profit level.
FORMULA
> Operating profi t margin - examines the income of the company before taking into account the
interest and taxes.
FORMULA
> Net profit margin - demonstrates a better assessment of a firm's profitability, particularly for a
company who does owe interest and taxes
FORMULA
PROFITABILITY RATIO
- Profitability ratios can be used to assess a company's ability to control expenses and to convert sales
into profits. In addition, profitability ratios help determine how effectively the company produces profits
from its resources.
> Return of assets - determines profitability in relation to assets management.
FORMULA
> Return on Equity - ROE measures the return earned on the common stockholders' investment in the
firm.
FORMULA
MARKET VALUE
- A firm's value is related to what an investor will pay for its stock. If demand for the stock increases,
then its price will also increase, wherein its increase in share price can be tied to expectation of
increased in future earnings. Some of the tools that determine share prices are book value and earnings
per share.
> Book value - is the basis for fairly determining the worth of the assets in relation to a holders' share,
upon liquidation of the firm.
FORMULA
> Earnings per share - aims to identify the valid earnings per share value, by looking at trends
overtime or the earnings of other companies in the same industry.
FORMULA
THANK YOU!!
