Analysis of Financial Statements Beverly Ann P. Nombrado MBA - BA

Financial Statement It is a formal record of the financial activities of a business, person or other entity. Financial Statement Analysis It is the process of reviewing and analyzing a company’s financial statements to make better economic decisions and to understand the overall health of an organization. It is also an evaluative method of determining the past, current and projected performance of the company.

3 Main Financial Statements  Balance Sheet (Statement of Financial Position) Snapshot of a company’s financial condition at a specific moment in time, usually at the close of an accounting period. It comprises assets (cash, inventory), liabilities (debt, accounts payable) and equity (share capital, retained earnings, reserves)  Income Statement (Profit and Loss Statement) Summarizes the various transactions of a business during a specified period, showing the net profit or loss.  Statement of Cash Flows (Cash Flow Statement) Shows how changes in Balance Sheet accounts and Income affect cash and cash equivalents, and breaks the analysis down to operating, investing and financing activities. Flow of cash in and out of the business.

Who analyzes Financial Statements?  Internal Users – Management  For planning, evaluating and controlling company operations  External Users – Investors, Creditors, Regulatory Agencies, Stock Market Analysts, Auditors, etc.  Assessing past performance and current financial position and making predictions about the future profitability and solvency of the company as well as evaluating the effectiveness of management.

Methods of Financial Statement Analysis  Horizontal Analysis  Vertical Analysis  Ratio Analysis

Horizontal Analysis (Trend Analysis)  It is the study of percentage changes in comparative financial statements.  You determine the difference of similar account titles of at least two taxable years measuring the same in terms of peso difference, and in terms of percentage – Current Year & Base Year  Formula:

Vertical Analysis  It is the proportional analysis of a financial statement, where each line item on a financial statement is listed as a percentage of another item.  Every line item on an Income Statement is stated as a percentage of Gross Sales. Every line item on a Balance Sheet is stated as a percentage of Total Assets.  Formula

Vertical Analysis of the Income Statement $ TotalsPercent Sales$1,000,000100% Cost of goods sold400,00040% Gross margin600,00060% Salaries and wages250,00025% Office rent50,0005% Supplies10,0001% Utilities20,0002% Other expenses90,0009% Total expenses420,00042% Net profit180,00018%

Vertical Analysis of Balance Sheet Statement $ TotalsPercent Cash$100,00010% Accounts receivable350,00035% Inventory150,00015% Total current assets600,00060% Fixed assets400,00040% Total assets$1,000,000100% Accounts payable$180,00018% Accrued liabilities70,0007% Total current liabilities250,00025% Notes payable300,00030% Total liabilities550,00055% Capital stock200,00020% Retained earnings250,00025% Total equity450,00045% Total liabilities and equity$1,000,000100%

Ratio Analysis  You will compute percentages or ratios based on prescribed formulas tending to establish 3 Major Areas:  Liquidity  Solvency  Profitability

Liquidity – determines how capable your business in paying obligations that will mature soon.  Current Ratio (Working Capital Ratio) – compares current assets to current liabilities to see if a business has enough cash to pay its immediate liabilities (short-term liquidity). Formula: Current Assets/Current Liabilities For example, a supplier wants to learn about the financial condition of Lowry Locomotion. Year 1Year 2Year 3 Current assets$8,000,000$16,400,000$23,400,000 Current liabilities$4,000,000$9,650,000 $18,000,000 Current ratio2:11.7:11.3:1

 Acid-test Ratio (Quick Ratio) - measures the liquidity of a company by calculating how well current assets can cover current liabilities.  It uses only the most liquid current assets that can be converted to cash within 90 days or less such as Cash and Cash Equivalents, Short- term marketable securities and Accounts receivable (net of the allowance for uncollectible accounts)  Formula

Below is the calculation of quick ratio based on the figures that appear on the respective balance sheets of three leading competitors operating in the personal care industrial sector for the fiscal year ending 2017:balance sheetsfiscal year (in millions) Procter & Gamble Johnson & Johnson Kimberly- Clark Corp. Quick Assets (A) $26,490$43,090$5,210 Current Liabilities (B) $30,210$30,540$14,210 Quick Ratio (A/B)

Solvency – determines how capable your business in paying obligations that will mature in long-term.  Debt-to-asset Ratio – is an indicator of a company’s financial leverage. It tells you the percentage of a company’s total assets that were financed by creditors. Example Ted’s Body Shop is an automotive repair shop in the Atlanta area. He is applying for a loan to build out a new facility that will accommodate more lifts. Currently, Ted has $100,000 of assets and $50,000 of liabilities. His DTA would be 0.5

 Debt-to-equity Ratio – measures the riskiness of a company’s financial structure. The ratio reveals the relative proportions of debt and equity financing that a business employs.

The Debt-to-Equity Ratio for Personal Finances

Profitability – determines how profitable your business operations in several aspects.  Earnings per share (EPS) – the portion of a company’s profit allocated to each share of common stock, serving as an indicator of the company’s financial health. In other words, EPS is the portion of a company’s Net Income that would be earned per share if all the profits were paid out to its Shareholders. EPS shows how much money a company makes for each share of its stock. A higher EPS indicates more value because investors will pay more for a firm with higher profits.

The calculation of EPS for three companies at the end of the 2017 fiscal year follows:

 Return on assets (ROA) – calculates the ability of management to efficiently use assets to generate profits. A low return indicates a bloated investment in assets.  Formula: ROA = Net Profit (after tax) / Total Assets  Example: ABC International earns Php 1,000,000 in its most recent year of operation. As of its year-end balance sheet, the company had Php 10,000,000 of total assets. ROA = 1,000,000/10,000,000 = 10%

 Return on equity (ROE)- a measure of how well a company uses investments to generate earnings growth.  Formula ROE = Net Income/Average Shareholders’ Equity Where: Net Income = Amount of income, net of expenses & taxes Ave Shareholders Equity = calculated by adding equity at the beginning of the period

Example: Consider Apple – for the fiscal year ending Sept. 29, 2018, the company generated $59.5 billion in net income. At the end of the fiscal year, it’s shareholders’ equity was $107.1 billion versus $134 billion at the beginning.  Average Shareholders Equity = $ $ =  ROE = $ 59.5/ $ = 49.4%

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