Financial Statements Analysis

Prepared By:
Krissa Joyce O. Sustal
What is Financial Statement Analysis?

 Financial Statements Analysis is the selection, evaluation, and

interpretation of financial data and other pertinent data.

Financial statement analysis helps users

make better decisions.
Purpose of Financial Statement Analysis

 To determine the ability of a business to generate cash,

and the sources and uses of that cash.
 To determine whether a business has the capability to pay
back its debts.
 To track financial results on a trend line to spot any
looming profitability issues.
 To derive financial ratios from the statements that can
indicate the condition of the business.
Methods of Financial Statement
Analysis
 There are two key methods for analyzing financial
statements. The first method is the use of horizontal and
vertical analysis.
 Horizontal analysis is the comparison of financial
information over a series of reporting periods,
while vertical analysis is the proportional analysis of a
financial statement, where each line item on a financial
statement is listed as a percentage of another item.
Methods of Financial Statement
Analysis
 The second method for analyzing financial statements is
the use of many kinds of ratios. Ratios are used to
calculate the relative size of one number in relation to
another. After a ratio is calculated, you can then compare
it to the same ratio calculated for a prior period, or that
is based on an industry average, to see if the company is
performing in accordance with expectations.
Financial ratios

 Example:
 Company A Company B
Good Better

Financial Ratios

1. Liquidity Ratio
2. Profitability Ratio
3. Leverage Ratio
Liquidity Ratio

 Liquidity ratios analyze the ability of a company to pay off

both its current liabilities as they become due as well as
their long-term liabilities as they become current.
Example:
Current Ratio= Current Assets
Current Liabilities
Higher = Lower Risk = better
Profitability Ratio

 Profitability ratios compare income statement accounts

and categories to show a company’s ability to generate
profits from its operations. Profitability ratios focus on a
company’s return on investment in inventory and other
assets. These ratios basically show how well companies
can achieve profits from their operations.

 Example:
Profit Margin = Profit
Sales
Higher = better
Leverage Ratio

 Financial leverage ratios, sometimes called equity

or debt ratios, measure the value of equity in a
company by analyzing its overall debt picture.
This shows how much of the company assets
belong to the shareholders rather than creditors.
 Example:
 Debt Ratio = Assets – Equity
Assets

Lower debt ratio = safer

General Approach to Financial Analysis

 1.Background study and evaluation of firm

industry, economy, and outlook
- Since economic developments and the actions
of competitors affect the ability of any business
enterprise to perform successfully, it is necessary
to start the analysis of a firm’s financial
statements with an evaluation of the
environment in which the firm conduct business.
General Approach to Financial Analysis…
 2. Short-term solvency analysis
- This refers to analysis of the company’s ability
to meet near-term demand for cash and normal
operating requirements. Some of the
indications that a company enjoys a
satisfactory short-term solvency position are:
- A. Favorable credit position
- B. Satisfactory proportion of cash to the requirements of the
current volume
- C. Ability to pay current debts in the regular course of business
- D. Ability to extend more credit customers
- E. Ability to replenish inventory promptly
General Approach to Financial Analysis…

 3.
Capital structure and long-term solvency
analysis
- This pertains to the evaluation of the amount
and proportion of debt in a firm’s capital
structure to assess its ability to service debt. This
will also cover the analysis of the use of financial
leverage to maximize the return to the owners.
General Approach to Financial Analysis…
 4. Operating Efficiency and Profitability analysis
- This involves the evaluation of how well assets have
been employed by management in terms of generating
revenues and maximizing returns on such resources.
Some indicators of managerial efficiency in the use of the
resources are:
A. Ability to earn a satisfactory return on its investment of
borrowed funds and equity
B. Ability to control operating costs within reasonable limits
C. Optimum level of investment
General Approach to Financial Analysis…

 5. Other considerations
- Quality of earnings. The assessment of earnings
quality is critical in the analysis of financial
statements. The income encompasses many areas
that provide management with opportunities to
influence the outcome of reported earnings in
ways that may not best represent economic
reality of the future operating potential of a
firm.
Thank You for listening! :)
Reference:

 https://www.accountingtools.com/articles/2017/5/14/financial-statement-
analysis
 https://www.accountingtools.com/articles/2017/5/17/horizontal-analysis
 https://www.accountingtools.com/articles/2017/5/17/vertical-analysis
 https://www.myaccountingcourse.com/financial-ratios/liquidity-ratios
 https://www.myaccountingcourse.com/financial-ratios/profitability-ratios
 https://www.myaccountingcourse.com/financial-ratios/financial-leverage-
ratios