Lesson 1.
Financial Statements (Cabrera & Cabrera, 2017)
The financial statement preparation is vital for decision making process. These
statements will give the decision makers an overall insight on the financial condition of the
business.
1. Four basic financial statements
a. Statement of Comprehensive Income (SCI)
This statement shows the result of the business’ operation -- whether it
gains profits or incurred a loss. In this statement, the revenues and expenses
are also reported.
b. Statement of Financial Position (SFP)
This statement shows the assets, liabilities and equity of the business as
of a specific period. In this statement, the total assets must be equal to the total
of total liabilities and total equity – known as accounting equation (Lee, 2013).
This statement shows information about the capitalization and liquidity of the
business.
c. Statement of Cash Flow
This statement shows the inflows and outflows of cash for a specific
period. In this statement, transactions that involve cash are being exposed. It is
important to know whether the business has sufficient cash to support its
operation thus, the statement of cash flow is created for this purpose.
d. Statement of Changes in Equity
This statement explains the movement of reserves that make up the
shareholder’s equity for a specific period. To be profitable a business must have
enough cash. It requires cash to pay for its bills, to pay bank loans, to pay taxes
and to purchase new properties. An analysis of the cash flow decides if there's
enough capital in a business to do just that.
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Lesson 2. General Approach to FS analysis (Cabrera et. al., 2017)
What is FS analysis?
The FS analysis is the method of examining the FS of a business for the
purpose of making decision. Outside parties use this to understand the overall
health of an organization, as well as to assess its business worth and financial
performance. Internal management use it as a financial management reporting tool.
a. Background study and evaluation of firm industry
Before starting to analyze the financial statements of a firm, you need
to do a background check and evaluate the industry that the business is in. This
will give you a better insight on how the business operates, its competition, etc.
b. Short-term solvency analysis
Solvency ratios calculate the ability of an enterprise to pay its long term
debt, as well as the interest added to it. Solvency ratios, as part of the financial
ratio study, help the company owner assess the long-term survival chances for
the organization. Solvency ratios are confused with liquidity ratios, at times. Both
evaluate the financial health of a company.
c. Capital structure and long-term solvency analysis
Analysis of capital structure is a constant evaluation of all the debt and
equity financing aspects of the organization. The objective of the analysis is to
evaluate which mix of equity and debt the enterprise should choose. This
combination varies significantly, based on the cost of debt and equity and the
risks a company is exposed to.
d. Operating efficiency and profitability analysis
Methods used in fundamental research are the performance ratios and
productivity ratios. Those ratios help investors make their investment decisions
and each reveals something else about a company. Profitability ratios show how
much income a business produces, while efficiency ratios measure how
effectively a company uses its capital to produce profit
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e. Other Considerations
1. Quality of earnings
The quality of earnings of an organization is exposed by discarding any
irregularities, accounting tricks or one-time incidents that could distort the
actual results bottom-line figures. Once these are removed, the proceeds
derived from higher sales or lower costs can be clearly seen.
2. Asset quality and relative indebtedness
Assets must be evaluated in order to determine its market value as well as
the amount of debt that the company owed.
3. Transparent financial reporting
In order for the analysis to be useful, a transparent financial reporting
is needed. It means that the financial statements being presented must be
concise, clear and free from bias.
Lesson 3. FS Analysis (Cabrera et.al. 2017)
Limitations of financial statement analysis
a. Information derived are only “indicators” of profitability and financial strength but
not absolute measures
b. Limitation inherent in accounting data due to some factors, like, failure to reflect
changes in purchasing power, etc.
c. Limitation of performance measures used
d. Management may influence the outcome of financial statements.
Mode of financial statement analysis
a. Horizontal analysis- it involves the conversion of amounts showed in the financial
statements for two or more successive periods
b. Vertical analysis – involves conversion of amounts in the financial statements to
a common base
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c. Gross profit variation analysis – involves analysis the adequacy or inadequacy
of gross profit which determine the final results of operations
d. Cash flow analysis- involves the analysis of the company’s cash disbursements
and receipts in terms of investing, operating, and financing activities.
e. Financial ratios- implies the existence of mathematical relationships between
accounts listed in the financial statements
Assessment Task 1
I. QUESTIONS
1. What is the objective of financial statement analysis?
2. What are some of the indications of satisfactory short-term solvency or working capital
position of a business firm?
3. What are some of the tests of a sound or healthy long-term financial position?
4. Give some indications of managerial efficiency in the use of company resources.
5. What are the most commonly used techniques in the analysis and interpretation of
financial statements?
6. What are the steps involved in using trend percentages in financial analysis?
7. Distinguish between horizontal and vertical analysis of financial statement data
8. What is the basic objective in looking at trends in financial ratios and other data?
9. Define trend percentages
10. Discuss the steps in analyzing financial statements using trend percentages.
11. In financial statement analysis, what is the basic objective of observing trends in data
and ratios? Suggest some other standards of comparison.
12. Distinguish between trend percentages and component percentages. Which
would be better suited for analyzing the change in sales over a term of several
years?
13. Nets sales of the Premiere General Store have been increasing at a reasonable
rate, but net income has been declining steadily as a percentage of these sales.
What appears to be the problem?
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14. Under what circumstances would you consider a corporate net income of P1 million for
the year as being unreasonably low? Under what circumstances would you consider a
corporate profit of P1 million as being unreasonably high?
II. TRUE OR FALSE
1. Financial analysis is primarily a matter of making relevant mechanical computations.
2. Percentage changes usually are computed by use of the amounts for the latest
accounting period as a base.
3. The peso amount of change during an accounting period for an item appearing in
financial statements is less significant than the change measured as a percentage.
4. A business enterprise's earnings performance and its financial condition are the two
primary concerns of the financial analyst.
5. An increase in sales volume generally is accompanied by a proportionate increase in
net income.
6. On a common-size income statement, net income is given an equivalent of 100%.
7. The peso amount of a change during a period in a certain item appearing in financial
statements is probably less significant than the change measured as a percentage.
8. Percentage changes are usually computed by using the latest figure as a base.
9. It is possible that a decrease in gross profit rate may be offset by a decrease in
expenses, thus resulting in an increase in net income.
10. Industry standards tend to place the performance of a company in a more
meaningful perspective.
III. PROBLEMS
Problem 1 (Percentage Changes)
Selected information taken from financial statements of Little Company for two
successive years follows. You are to compute the percentage change from 2020 to 2019
whenever possible.
2020 2019
a. Accounts receivable............................... P126, 00 P150,000
b. Marketable securities............................. -0- 250,000
c. Retained earnings................................... 80,000 (80,000)
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d. Notes receivable..................................... 120,000 -0-
e. Notes payables........................................ 860,000 800,000
f. Cash......................................................... 82,400 80,000
g. Sales.................................................. 990,000 900,000
Problem 2 ( computing and Interpreting Rates of Change)
Selected information from the financial statements of Yellow Harvest includes the following:
2020 2019
Net sales…………………………………… P2, 200,000 P2, 000,000
Total expenses…………………………….. 1, 998,000 1,800,000
Required:
a. Compute the percentage change in 2020 for the amounts of (1) net sales and (2) total
expenses
b. Using the information developed in a part a, express your opinion as to whether the
company’s net income for 2020:
1. Increased at a greater or lower percentage rate than did net sales.
2. Represented a larger or smaller percentage of net sales revenue than in 2019. For
each answer, explain your reasoning without making any computations or references
to peso amounts.
Problem 3 (Financial Statement Analysis using Comparative Statements or Increase-
Decrease Method)
The following data are available for XYZ Corporation for years 2020 and 2019.
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XYZ Corporation
Statement of Financial Position
As of December 31
Change
2019 2020 Peso %
Assets
Cash and equivalents 14,000 16,000 2,000 ?
Receivables 28,800 55,000 26,800 93.06%
Inventories 54,000 85,600 ? ?
Prepayments and others 4,800 7,400 2,600 54.17%
Total Current Assets 101,600 164,000 ? 62.01%
Property, Plant &
Equipment-net of 30,200 73,400 43,200 143.05%
depreciation
Total Assets 131,800 238,000 ? ?
Liabilities and Equity
Notes payable to banks 10,000 54,000 44,000 440.00%
Accounts payable 31,600 55,400 23,800 ?
Accrued liabilities 4,200 6,800 2,600 61.90%
Income taxes payable 5,800 7,000 ? ?
Total Current 51,600 123,200 ? ?
liabilities
Share capital 44,600 44,600 0 0.00%
Retained earnings 35,600 70,200 34,600 ?
Total equity 80,200 114,800 34,600 43.14%
Total liabilities and 131,800 238,000 ? ?
equity
XYZ Corporation
Income Statement
Years ended December 31
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(P thousands)
Change
2019 2020 Peso %
Net sales 266,400 424,000 157,600 ?
Cost of goods sold 191,400 314,600 123,200 64.37%
Gross profit 75,000 109,400 ? ?
Selling, general and
administrative 35,500 58,400 ? 64.51%
expenses
Income before income 39,500 51,000 11,500 29.11%
Taxes
Income taxes 12,300 16,400 4,100 33.33%
Net income 27,200 34,600 ? ?
Required
1. Compute the missing changes in peso amounts and percentages in the above
statements
2. Evaluate the company’s short-term financial position, leverages, managerial efficiency
and Profitability using the increase-decrease method of analysis.
IV. MULTIPLE CHOICE
1. The data from comparative financial statements are useful
a. To analyze changes in gross and net earnings over a number accounting
periods
b. To analyze the sources of increase in assets
c. To indicate earnings trends and costs trends for the firm,
d. In accomplishing all of th above
e. In accomplishing (a) and (b) above
2. Index numbers are used in
a. trend analysis
b. ratio analysis
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c. vertical analysis
d. common-size statements
3. "Trading on the equity" (financial leverage) is likely to be a good financial strategy for
shareholders of corporations with:
a. Rapidly growing amounts of net income
b. Steady but low amounts of net income,
c. Widely fluctuating net income over a short period of time
d. Steadily declining amounts of net income,
4. Select one with the CORRECT statement
a. An industry with a low turnover if operating assets would be expected to have
a lower rate operating percentage of sales than in industry with high operating
assets turnover
b. An increase in the rate of operating earnings as a percentage of sale may
accompany a decrease in operating earnings measured in absolute pesos
c. The ratio of net earnings to sales is one of best measures for comparing the
profitability of different companies without regard to the sources of assets
d. Net earnings as a percentage of sales measures the number of centavos of
net earnings on each unit of product sold
5. Comparing performance with industry norms is complicated by
a. The existence of diversified companies
b. the use of different accounting procedures by different companies
c. the fact that companies in the same industry will usually differ in some respect
d. all of the above
6. Which of the following would probably not be found in a company’s annual report?
a. The auditor's report
b. A five-or ten-year summary of operations
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c. Interim financial statements
d. Analysis of the past year's operations
7.What is the first step in an analysis of financial statements?
a. Check the auditor's report
b. Check references containing financial information
c. Specify the objectives of the analysis
d. Do a common size analysis
8. What is a creditor's objective in performing an analysis of financial statements?
a. To decide whether the borrower has the ability to repay interest and principal
on borrowed funds
b. To determine the firm's capital structure
c. To determine the company's future earnings system
d. To decide whether the firm has operated profitably in the past
9. What is an investor's objective in financial statement analysis?
a. To determine if the firm is risky
b. To determine the stability of earnings
c. To determine changes necessary to improve future performance,
d. To determine whether an investment is warranted by estimating a company's
future earnings
10. Which of the following is not a tool or technique used by a financial statement
analyst?
a. Common size financial statements
b. Trend analysis
c. Random sampling analysis
d. Industry comparisons
11. In each of the past five years, the net sales of Beta Co. have increased at about half
the rate of inflation, but net income has increased at approximately twice the rate of
inflation. During this period, the company's total assets, liabilities and equity have
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