N-ABM 2 - Financial Statement Analysis

Cebu Technological University – Main Campus

  • Course Code and Title: N-ABM 2 – BUSINESS FINANCE

  • Course Instructor: Dr. Alvin C. Estreba, CPA, RCA

Lesson 1: FINANCIAL STATEMENT ANALYSIS

Objectives of Financial Statement Analysis

  • Evaluate a business entity for financial and management decisions.

  • Assess firm’s profitability and risk (short & long-term liquidity).

  • Measure operational efficiency and investments by owners and creditors.

How to Analyze Financial Statements

  1. Comparative Statements

    • Presentation of financial info for current and prior periods for comparisons.

    • Horizontal Analysis: Percentage change over time with a base year index of 100.

    • Vertical Analysis: Each item presented as a percentage of an appropriate base amount (e.g., Total Net Sales = 100%).

  2. Ratio Analysis/ Financial Ratios

    • Indicates firm’s financial strengths/ weaknesses.

    • Summarizes data for ease of understanding and comparison.

Types of Ratios

  1. Liquidity Ratios

    • Measure ability to meet current obligations.

    • Examples:

      • Current Ratio: Current Assets / Current Liabilities

      • Acid-Test Ratio: (Cash + Marketable Securities + Net Receivables) / Current Liabilities

      • Working Capital to Total Assets: Working Capital / Total Assets

      • Cash Flow from Operations to Current Liabilities

  2. Solvency Ratios

    • Measure financing with debt and ability to cover fixed charges.

    • Examples:

      • Debt Ratio: Total Liabilities / Total Assets

      • Equity Ratio: Total Owner's Equity / Total Assets

      • Debt to Equity Ratio: Total Liabilities / Equity

      • Times Interest Earned: Operating Profit / Interest Expense

  3. Activity Ratios

    • Measure efficiency of asset management.

    • Examples:

      • Receivable Turnover: Net Credit Sales / Average Accounts Receivable

      • Inventory Turnover: Cost of Goods Sold / Average Inventory

      • Working Capital Turnover

      • Asset Turnover Ratio

  4. Profitability Ratios

    • Measure overall performance and efficiency.

    • Examples:

      • Gross Margin Ratio: Gross Margin / Net Sales

      • Profit Margin Ratio: Net Income / Net Sales

      • Return on Total Assets: Net Income / Total Assets

      • Return on Owner’s Equity: Net Income / Owner’s Equity

      • Earnings Per Share (EPS): Net Income - Preferred Dividends / Average Common Shares Outstanding

      • Price-Earnings Ratio: Market Price Per Share / Earnings Per Share

      • Dividends Yield: Dividends Per Share / Market Price Per Common Share

References

  1. Harina, R.M.: Management Advisory Services. Rex Bookstore

  2. Accountancy, Business, and Management. Abiva Publishing House, Inc.

  3. Management Advisory Services. Excel Professional Services, Inc.

Quote

"Be a student as long as you still have something to learn, and this will mean all your life." - Henry L. Doherty