Financial Management PDF

w Bicol University College of Business, Economics and Management Daraga, Albay Prof 10 Financial Management A Modularized Instruction by Eric Anthony Lorino  MODULE II Financial Statement Analysis ...

w Bicol University College of Business, Economics and Management Daraga, Albay Prof 10 Financial Management A Modularized Instruction by Eric Anthony Lorino  MODULE II Financial Statement Analysis  Introduction Welcome to the second module of our course for financial management subject. Let us understand more about the financial statements here in the second module. This module covers the following topics: Analytical Process; Basic Decision Areas; Steps in Analyzing the Financial Statements; Types of Financial Statement Analysis MODULE II Specific Learning Outcomes At the end of the module you are expected to: Know and understand the analytical process Determine the basic decision areas in financial statement analysis Enumerate the steps in financial statement analysis Enumerate and describe the types of financial statement analysis MODULE II Discussion Financial Analysis deals with the understanding of the relationship between financial concepts and daily decision- making both analytical and judgmental process used in the managerial context end purpose is to help people make sound decisions and judgments Financial Statements product of financial accounting, show the results of operation, financial position, changes in owner’s equity, sources and uses of funds Basic Financial Statements Income Statement/ Statement of Comprehensive income Balance sheet/ statement of financial position/ statement of financial condition Statement of changes in owner’s/partners’/stockholders’ equity Cash flow statement/ Statement of Cash Flows MODULE II Income Statement Shows the results of the operations of the business. It details the operating revenues/ sales and operating expenses, other income and other expenses. It shows the profitability of the firm Balance Sheet Shows the assets of the firms, along with its liabilities and equity. It presents the liquidity and solvency of the firm. Statement of Changes in Owner’s Equity shows the investments made by the owners of the business decreased by the withdrawals made and increased by the net profit made Cash Flow Statement Details all sources or inflow of cash and expenditures or outflows of cash to show net income or decrease in cash MODULE II Comparison Matrix of Financial Statements MODULE II MODULE II Three Basic Decision Areas When analyzing financial statements the following decision areas are being considered in the process: Operating Decisions deal with the day to day operations of the firm include decisions such as pricing, selecting markets, choosing the appropriate process or technology, outsourcing payroll, among others Investment Decisions deciding on what assets to acquire or projects to pursue Financing Decisions refers to decisions that involve funding investments and operations over the long run MODULE II Steps in Analyzing Financial Statements Understanding the information provided in the financial statements any reader of the financial statements, especially the financial manager who makes decisions for the firm needs to have a basic knowledge of finance in its contextual meaning to avoid confusion and misleading or wrong decisions, which are sometimes fatal to the business Drawing logical conclusion based on the data presented managers must be able to make inferences based on the data on the financial statements of which may be presented in two comparative years Making the appropriate decision on the course of action to take after conclusions are drawn managers will able to determine the course of action to take to correct what needs correction and the steps necessary to redirect company efforts toward the goals that the firm has set to achieve MODULE II Account Concepts Current Asset is one that can be converted into cash in the normal operation of the firm within one year. Fixed Asset are permanent assets that will not normally be converted into cash. On the balance sheet, fixed assets are shown at historical cost, which is the amount actually paid for the asset. Market Value is the price the asset could command in the market. Replacement Cost is the price that would be required to replace the asset if it had to be acquired today. Current liabilities are those that the firm reasonably expects to pay within the next year Accounts Payable are obligations that the firm has for goods it has received from others Notes Payable are short-term debt that the firm must pay-off within the next year MODULE II Accruals are debts the firm owes because payment has not yet been made, such as salaries owed to employees Taxes Payable are taxes that are owned, but that have not yet been paid Long-term liabilities are continuing obligations that will not be completely repaid next year Common Stock are account that reflects capital that were contributed by the equity holders of the firm. Retained Earnings account shows the amount of net income that the firm has not paid out dividends to its shareholders. MODULE II Types of Analysis Vertical Analysis Evaluates financial statement by expressing each item in a financial statement as a percent of the base amount (key figure) Key-figure (such as sales in IS and total assets on BS) are set to 100% Other items are then expressed as percentage of 100 Horizontal Analysis Comparing key figures in financial statement Evaluates a series of financial statement over a period of time. Ratio Analysis It expresses the relationship among selected items of financial statement data. MODULE II Sample Exercise LDM COMPUTERS Income Statement December 31, 2019 Sales P 800,000 100% Operating Expense 480,000 60% Gross Profit 320,000 40% Other Expense 200,000 25% Net Income 120,000 15% In the basic Income Statement shown above, the Sales Account is the base account. The other account in the statement is being evaluated based from its percentages to the sales. For Balance Sheet, the Total Asset account will be the base account and the other accounts in the statement will be analyzed based on the percentage of its relationship to the Total Asset account MODULE II In Horizontal analysis the two year period is shown. This analysis primarily looks into the increase or decrease of the account figures in the financial statements for consecutive periods. An positive value of the percentage indicates that the account in the financial statement increases while the negative value of the percentage indicates otherwise. The increase and decrease in the account, signifies a good or bad signals for the organization. MODULE II LDM COMPUTERS Balance Sheet December 31, 2018 & 2019 Assets 2018 2019 Percentage Current Assets P 500,000 400, 000 -20% Property & 200,000 150,000 Equipment -25% Other Assets Non Current 50,000 50,000 Assets 0% Total Assets P 750,000 600,000 -20% Total Liabilities (all are current 250,000 350,000 liabilities) 40% Total OE 500,000 300,000 -40% Total Liabilities P 750,000 650,000 & OE -15% In the sample, the percentages are directly shown. The analysis will now be based on the nature of the accounts as to whether the increase or decrease is considered to be beneficial for the firm or not. MODULE II Ratio Analysis Importance of Ratio Analysis Quick and easy snapshot of an organization’s achievements Aid for comparisons Ratio provide benchmark to compare on company with another (inter-firm comparison) or to compare the same company over period of time (intra-firm comparison). Types of Ratio Analysis Profitability Ratio It measures the income or operating effectiveness of an organization for a given period of time. A low value of this ratio will affect the company ‘s ability to obtain debt, equity financing and the ability to grow or expand. Liquidity Ratio It measure the short term ability of the organization to pay debt and to meet unexpected need for cash. Quick Ratio This ratio indicates whether current liabilities could be paid without having to sell the inventory This ratio is useful for companies which cannot convert inventory into cash quickly if necessary. MODULE II Solvency Ratio This is to measure the ability of the company to survive over a long period of time The ability to pay interest as it come due/mature Limitations of the Accounting Information Estimates The financial statement contains numerous estimates. Eg. Provision for doubtful debt, depreciation and contingent loss. Cost The traditional financial statements are based on historical cost, it is not adjusted for price-level change. Eg. Inflation affects the sales growth. Alternative Accounting Method A comparison may be misleading as different companies use different accounting method. Eg. FIFO and LIFO. Diversification of firms This diversification of activities of companies limit the usefulness of financial analysis. (no specific industry).  MODULE II Reminders when using Ratio Analysis Ratio analysis is a good way to overview an organization’s activities Ratio analysis must be compared with past result or industry norms, not in isolation Things to be taken into account in using ratio analysis: size of the organization Method used in accounting treatment Same industry Same country Application Copy the sample statement in a separate paper and provide the answer being required for both analysis Perform the Horizontal Analysis LDM COMPUTERS Income Statement December 31, 2018 & 2019 Accounts 2018 2019 Percentage Sales 3270000 2915000 Cost of Sales 2100000 1900000 Gross Profit 1170000 1015000 Operating Expenses Selling Expenses 370000 340000 Administrative Expenses 200000 215000 Total 570000 555000 Operating Income 600000 460000 Interest Expense 100000 100000 Income before tax 500000 360000 Income Tax 150000 108000 Income after Tax 350000 252000 MODULE II Perform Vertical Analysis LDM COMPUTERS Balance Sheet December 31, 2019 Assets 2019 Percentage Current Assets P 500,000 Property & Equipment 200,000 Other Assets Non Current 50,000 Assets Total Assets P 750,000 Total Liabilities (all are current 250,000 liabilities) Total OE 500,000 Total Liabilities & OE P 750,000 MODULE II Answer: _____________________________________________________ _____________________________________________________ _____________________________________________________ _____________________________________________________ _____________________________________________________ _____________________________________________________ _____________________________________________________ _____________________________________________________ _____________________________________________________ _____________________________________________________ _____________________________________________________ _____________________________________________________ _____________________________________________________ _____________________________________________________ _____________________________________________________ _____________________________________________________ _____________________________________________________ _____________________________________________________ _____________________________________________________ _____________________________________________________ _____________________________________________________ _____________________________________________________ _____________________________________________________ _____________________________________________________ _____________________________________________________ _____________________________________________________ _____________________________________________________ _____________________________________________________ _____________________________________________________ _____________________________________________________ _____________________________________________________ _____________________________________________________ _____________________________________________________ _____________________________________________________ _____________________________________________________ _____________________________________________________ _____________________________________________________ ______________________________________ MODULE II Synthesis Financial statement analysis takes into consideration basic decision areas as it performs the three basic financial statement analysis– vertical, horizontal and ratio analysis.  Lopez-Mariano, Norma D. (2014). Elements of Finance. Manila, Philippines: Rex Bookstore Weygandt, Jerry J. et. al (2012). Managerial Accounting. Sixth Edition. Singapore: John Wiley & Sons Smart, Scott B. and Megginson, William L. (2011). Financial Management: An Introduction. Pasig City, Philippines: Cengage Learning Asia Pte Ltd (Philippines Branch) Alminar-Mutya, Ruby F. (2010). Basic REFERENCES Business Finance: Management Approach. Mandaluyong, Philippines:National Bookstore Medina, Roberto G. (2007). Business Finance. Second Edition. Manila Philippines:Rex Bookstore Keown, Arthur J. (2005). Fundamentals of Financial Management: Investment, Financing and Asset Management. Philippine Edition. New Jersey: USA. Pearson Education Inc. Melicher, Ronald W. (2005). Finance Introduction to Institutions, Investments and Management. New Jersey, USA. John Wiley & Sons, Inc. https://www.investopedia.com/terms/e/ exchangerate.asp