FINANCIAL STATEMENTS ANALYSIS

It involves careful selection of data from financial statements in order to assess and evaluate the firm’s past performance, its present condition, and future business potentials.

Financial Statements Analysis

What is the primary purpose of FS analysis?

To evaluate and forecast the company’s financial health.

Through FS analysis, interested parties, such as the managers, investors, and creditors, can identify the company’s financial strengths and weaknesses and know about the following:

1. Profitability of the business firm

2. Firms’ ability to meet its obligations (Liquidity and Solvency)

3. Safety of the investment in the business (Stability)

4. Effectiveness of management in running the firm (Turnover)

5. Overall company marketability

It involves comparison of figures shown in the financial statements of two or more consecutive periods. The difference between the figures of the two periods is calculated, and the percentage change from one period to the next is computed using the earlier period as the base. It is also known as trend percentages and index analysis.

Horizontal Analysis

It involves comparison of figures shown in the financial statements of a single period. It involves converting of figures in the FS to a common base. This is accomplished by expressing all the figures in the statements as percentage of an important item such as total assets (in the Balance sheet) or total or net sales (in the income statement).

Vertical Analysis

The converted statements are also called

Common-size statements or percentage composition statements

This is the main income generating activities of the entity. It should always be net cash inflow

Operating Activities

It is the cash left over after a company pays for its operating expenses (OpEx) and capital expenditures. It is the cash flow available for the company to repay creditors or pay dividends and interest to investors.

Free Cash Flow

Interpretation of Free Cash Flow if it is growing

Increase in Earnings

A shrinking Free Cash Flow is always necessarily a bad thing (T/F)

False (if the cause is increasing capital expenditures/investment)

Interpretation of Free Cash Flow if it is shrinking

Unable to sustain earnings growth

It is used to determine the reasons why the gross profit margin changes from period to period, so that management can take steps to bring the gross margin in line with expectations

Gross Profit Analysis

Two Primary Factors That Result to Revenue Variances

1. Price Factors (Selling price and/or unit cost)

2. Physical/Quantity Factors

The higher the ration the better (T/F)

True

The lower the period the better (T/F)

True

Ideal Liquidity Ratio

Greater than 1

Current Ratio

Current Asset ÷ Current Liabilities

Working Capital

Current Assets - Current Liabilities

Quick Ratio or Acid Test Ratio

Quick Assets ÷ Current Liabilities

Quick Assets

Cash + Cash Equivalents + Marketable Securities + Receivables; or

Current Assets - Inventory

Cash Ratio

Cash and Marketable Securities ÷ Current Liabilities

Absolute Test of Liquidity

Cash Ratio

Effect of Purchase of Marketable Equity Security for Cash to Current Ratio, Working Capital, and Quick Ratio

No Effect (reclassification, Quick Asset to Quick Asset)

Effect of Disposal of Marketable Equity Security for Cash to Current Ratio, Working Capital, and Quick Ratio, that resulted to:

• No gain

• Loss

• Gain

• No gain - No effect

• Loss - Decrease

• Gain - Increase

Effect of Collection of previously written-off receivables to Current Ratio, Working Capital, and Quick Ratio, under:

• Allowance Method

• Direct Write-off Method

• Allowance Method - no effect (Increase of cash, increase of allowance - JE)

• Direct Write-off Method - Increase

Effect of Receivables Write-off to Current Ratio, Working Capital, and Quick Ratio, under:

• Allowance Method

• Direct Write-off Method

• Allowance Method - No effect

• Direct Write-off Method - Decrease

During the year, the entity recognized a Bad Debt Expense of 10,000, during the same year, the entity write-off 4,000. How much is the net decrease in working capital?

10,000; write-off has no effect. Iyong binawas sa ADA ay dinagdag ng write-off sa A/R

JE:

DA Exp 10K

ADA 10K

ADA 4K

A/R 4K

Receivable Turnover

Credit Sales ÷ Ave Receivables

Average Age of Receivables

365 days ÷ Receivables Turnover or

Average Receivables ÷ Average daily credit sales

Inventory Turnover

COGS ÷ Ave Inventory

Average Age of Inventory

365 days / Inventory Turnover

Average Inventory ÷ Ave Daily COGS

Operating Cycle

Average Age of Receivables + Average Age of Inventories

Trade Payables Turnover

Net Credit Purchases ÷ Ave Trade Payables

Average Age of Trade Payables

365 days ÷ Trade Payables Turnover

Average Accounts Payables ÷ Average Daily Credit Purchase

Cash Conversion Cyle

Average Age of Receivables + Average Age of Inventories - Average Age of Trade Payables

Current Asset Turnover

(COGS + OPEx (excluding depreciation and amortization)) ÷ Average Current Assets

Times Interest Earned

EBIT or Operating Income ÷ Interest Expense

Debt-Equity

Total Liabilities ÷ Total SHE

Debt Ratio

Total Liabilities ÷ Total Assets

Equity Ratio

Total SHE ÷ Total Assets

Equity Multiplier

Average Total Assets ÷ Average Total SHE

Times Preferred Dividend Requirements

EAT / Preferred Dividends

*Earnings After Tax

Times Fixed Charged

EBIT ÷ Total Fixed Charges

Return on Sales

Earnings After Tax (EAT) ÷ Sales

Gross Profit / Margin Ratio

Gross Profit ÷ Sales

Return on Total Assets (ROA)

Earnings Before Interest but After taxes (EBIAT)÷ Average Total Assets

Return on Owner’s Equity (ROE)

Earnings After Tax (EAT)÷ Average Owner’s Equity

Earnings Per Share (EPS)

EAT - Preferred Dividends (if any) ÷ Weighted Average Number of Common Shares Outstanding

Price/Earnings Ratio (P/E) (how much the investors are willing to invest to earn 1 peso. If the investors are willing to pay high amount today, they are expecting that the company will grow in the future)

Price Per Share ÷ Earnings Per Share

Dividend Yield (For every 1 peso invested, how much will return as form of dividends)

Ordinary Dividend Per Share ÷ Price Per Share

Earnings Yield (For every 1 peso invested, how much is its related earnings)

Earnings Per Share ÷ Price Per Share

Dividend Pay-out (how generous the company is in declaring dividend)

Ordinary Dividend Per Share ÷ Earnings Per Share

Plow-back Ratio (kung magkano iyong tinitira ng company when declaring dividend for use to internal financing)

1 - Payout Ratio

It is a useful technique used to decompose the different drivers of Return on Equity (ROE)

Du Pont Equation

Du Pont Equation

Net Profit Margin x Asset Turnover x Equity Multiplier; or

(EAT ÷ Total Sales) x (Total Sales ÷ Ave. Total Assets) x (Ave. Total Assets ÷ Ave. Shareholder’s Equity) or

EAT ÷ Ave. Shareholder’s Equity

It is a way of calculating how much new funding will be required, so that the firm can realistically look at whether or not they will be able to generate the additional funding and therefore be able to achieve the higher sales level.