Lesson 3 Financial Statement Analysis 1 PDF

Lesson 3 Financial Statement Analysis 1 Learning Objectives At the end of the lesson, the students are expected to be able to: 1. Explain objectives of Financial Statement analysis 2. Discuss the steps in doing the Financial statement analysis. 3. Explain and distinguish the limitations of financia...

Lesson 3 Financial Statement Analysis 1 Learning Objectives At the end of the lesson, the students are expected to be able to: 1. Explain objectives of Financial Statement analysis 2. Discuss the steps in doing the Financial statement analysis. 3. Explain and distinguish the limitations of financial statement analysis 4. Perform the steps in doing Financial statement analysis by applying the different techniques, interpretations and conclusions learned in this lesson. FINANCIAL STATEMENT ANALYSIS  FINANCIAL STATEMENT ANALYSIS Financial statement analysis is the process of analyzing a company’s financial statements for decision-making purposes.  OBJEC TIVES OF FINANCIAL STATEMENT ANALYSIS 1. Profitability  OBJEC TIVES OF FINANCIAL STATEMENT ANALYSIS 1. Profitability 2. Liquidity and Stability  OBJEC TIVES OF FINANCIAL STATEMENT ANALYSIS 1. Profitability 2. Liquidity and Stability 3. Asset Utilization or Activity  OBJEC TIVES OF FINANCIAL STATEMENT ANALYSIS 1. Profitability 2. Liquidity and Stability 3. Asset Utilization or Activity 4. Debt Utilization and Leverage  LIMITATIONS OF FINANCIAL STATEMENT ANALYSIS 1. Its failure to consider changes in the purchasing power of currencies  LIMITATIONS OF FINANCIAL STATEMENT ANALYSIS 2. The age of the Financial Statement  LIMITATIONS OF FINANCIAL STATEMENT ANALYSIS 3. Failure to read and understand the information in the notes to the Financial Statement  LIMITATIONS OF FINANCIAL STATEMENT ANALYSIS 4. Financial statements that have not undergone external auditing procedures, or it may not conform to Philippine Financial Reporting Standard (PFRS) previously known as GAAP, usage of this may lead to erroneous analysis and ultimately erroneous decisions.  LIMITATIONS OF FINANCIAL STATEMENT ANALYSIS 5. Financial statements that have not undergone external auditing procedures, may be inaccurate or worse, fraudulent, hence do not fairly present the company’s financial condition.  STEPS IN ANALYZING FINANCIAL STATEMENTS 1. Identify the needs of the company  STEPS IN ANALYZING FINANCIAL STATEMENTS 2. Identify the industry economic characteristic  STEPS IN ANALYZING FINANCIAL STATEMENTS 3. Know the company you are analyzing  STEPS IN ANALYZING FINANCIAL STATEMENTS 4 Assess and analyze the Financial Statements  STEPS IN ANALYZING FINANCIAL STATEMENTS 4 Assess and analyze the Financial Statements Horizontal analysis Vertical analysis Ratio analysis  STEPS IN ANALYZING FINANCIAL STATEMENTS 5. Interpret the result of the computation and ratios  STEPS IN ANALYZING FINANCIAL STATEMENTS 6. Draw conclusions from the interpretation made in step 5.  HORIZONTAL ANALYSIS OF COMPARATIVE STATEMENTS The horizontal analysis Trend analysis Time series analysis,  HORIZONTAL ANALYSIS OF COMPARATIVE STATEMENTS It is the comparison of Financial Statements’ figures from one time period from a base time period to get an overview of changes over time.  HORIZONTAL ANALYSIS OF COMPARATIVE STATEMENTS Advantages of horizontal analysis You can track how company’s financial state has changed. Find patterns in its data Spot potential problems and opportunities. HOW TO PERFORM HORIZONTAL ANALYSIS 1. Gather financial statements 2. Compare the statements 3. Identify patterns and trends in the data.  Increase/ 2022 2023 decrease amount Percent cash 100 170 70 70 Accounts receivable 200 280 80 40 Inventory 300 400 100 33 Other CA 400 450 50 12.5 Total CA 1,000 1,300 300 30 PPE (Net) 4,000 3,800 (200) (5) Total Assets 5,000 5,100 100 2  WHAT IS VERTIC AL ANALYSIS Vertical analysis uses percentages or ratios that presents the relationship of different accounts or items in the financial statement  WHAT IS VERTIC AL ANALYSIS In vertical analysis, one line on the financial statement shows a base figure of 100%, and the other lines represent a percentage of the base figure.  WHAT IS VERTIC AL ANALYSIS For example, when you perform vertical analysis on a balance sheet, the base figure is the total assets or total liabilities and owner’s equity  WHAT IS VERTIC AL ANALYSIS On an income statement, the base figure is the net sales. Another example is using total sales as the base value and restating each sales category as a percentage of the base value.  HOW TO PERFORM VERTIC AL ANALYSIS 1. Choose a financial statement 2. Analyze the amounts located in the same column of the statement 3. Calculate each amount as a percentage of a base figure.  EX AMPLE 2022 percent 2023 Percent cash 100 2 170 3.33 Accounts 200 4 280 5.49 receivable Inventory 300 6 400 7.84 Other CA 400 8 450 8.82 Total CA 1,000 20 1,300 25.43 PPE (Net) 4,000 80 3,800 74.51 Total Assets 5,000 100 5,100 100  SIMILARITIES OF HORIZONTAL AND VERTIC AL ANALYSIS 1. Both can be used by internal and external stakeholders 2. Both forms of analysis can help you pick out trends and patterns in financial data and develop strategies. 3. Both forms can help you analyze various financial statements including balance sheet and income statements.  PRIMARY DIFF ERENCE S Horizontal Analysis Vertical Analysis a. Performed across time periods Performed inside a column b. Represents changes over years or Represents amounts as percentage of a periods. base figure c. It usually examines many reporting Focuses on one reporting period. periods It helps you compare a company’s It helps you compare one company’s current financial status to its past financial status to another.  TREND ANALYSIS It is the determination of changes for several periods. (ex. 5 years)  TREND ANALYSIS In trend analysis, the base period is the oldest year. Divide each amount by the base year figure  EX AMPLE 2019 2020 2021 2022 2023 Cash and cash equivalents 57 119 181 350 168 Trade and other receivables 211 298 256 280 231 Inventory 530 546 517 592 515 Prepaid expenses 384 384 345 310 279 Total current assets 1,182 1,347 1299 1,532 1,193 Non-current assets 1260 1,460 1,734 1,742 2,128 Total assets 2,442 2807 3,033 3,274 3,321  2019 2020 2021 2022 2023 Cash and cash equivalents 100 209 318 614 295 Trade and other receivables 100 141 121 133 109 Inventory 100 103 98 112 97 Prepaid expenses 100 100 90 81 73 Total current assets 100 114 110 130 101 Non-current assets 100 116 138 138 169 Total assets 100 115 124 134 136  INTERPRE TATIO N Net working capital is improving upward trend in current assets downward trend in current liabilities Cash and other current assets also shows upward trend The consistent upward of the accounts receivable is supported by the increase in sales Reference: Fundamentals of Financial Management (revised edition)