The document discusses various techniques for analyzing financial statements, including horizontal analysis, vertical analysis, ratio analysis, and calculations. It defines each technique and provides examples of key financial ratios used to evaluate a company's profitability, liquidity, solvency, operational efficiency, and financial health. These ratios include gross profit margin, return on assets, current ratio, debt-to-equity ratio, inventory turnover, and accounts receivable turnover. The document aims to teach learners how to interpret financial statement data using these analytical methods.

1. Analysis and Interpretation
of
Financial Statements 1

2. MOTIVATION (15 MINS)
• Instruct the learners to imagine themselves as business
owners. Ask some of the learners to share with the class
the businesses that they have in mind. After that, direct the
class back to the questions posted on the board.
• Ask the learners if the answers to these questions are
significant to them as owners of their imaginary businesses.
• Aside from the posted questions, ask the learners to identify
more information that they want to know as business
owners that are not readily available on the face of the FS.

3. Questions
-What is the asset growth in 2014?
- Is the asset composition in 2013 the same as that in
2014?
- Compare the financing mix (portion of assets financed by
debt and equity, respectively) of JFC in 2014 and 2013 and
determine if there is a significant change.
- Is the revenue growth in 2014 better than that in 2013?
- Is the net income growth in 2014 better than that in 2013?

4. Financial statement (FS) analysis
• is the process of evaluating risks, performance, financial
health, and future prospects of a business by subjecting
financial statement data to computational and analytical
techniques with the objective of making economic
decisions.

6. Horizontal analysis
 (also known as trend analysis) is a
financial statement analysis technique
that shows changes in the amounts of
corresponding financial statement items
over a period of time. It is a useful tool to
evaluate the trend situations. The
statements for two or more periods are
used in horizontal analysis.
A horizontal analysis typically looks at a
number of years.

7. - Horizontal analysis uses financial statements of two or more
periods.
- All line items on the FS may be subjected to horizontal analysis.
- Only the simple year-on-year (Y-o-Y)grow this covered in this
lesson.
- Changes can be expressed in monetary value (peso) and
percentages computed by using the following formulas:
• Peso change=Balance of Current Year-Balance of Prior Year
• Percentage change= (Balance of Current Year-Balance of Prior
Year)/(Balance of Prior Year).

8. Example:
2015 2014
SALES P250,000 P175,000
✓Peso change = P250,000 - P175,000 = P75,000
✓Percentage change = (P250,000 - P175,000) / P175,000 = 42.86%

14. Vertical analysis
 is also known as common size
financial statement analysis.
 a vertical analysis looks only at
one year.
 financial statement analysis
wherein each item in the financial
statement is shown in percentage
of the base figure.

22. PRACTICE
C&F Store
Statement of Financial Position
As of December 31
2015 2014
Cash
Accounts Receivable
Inventory
Prepaid Rent
Delivery Van
P110,000
90,000
129,000
12,000
550,000
P 87,400
69,920
218,500
4,370
493,810
TOTAL ASSETS P 891,000 P874,000
Accounts Payable
Loan Payable
Anistle Cruz, Capital
75,000
400,000
416,000
67,298
393,300
413,402
TOTAL LIABILITIES AND P891,000 874,000

23. PRACTICE
C&F Store
Statement of Financial Position
As of December 31
2014 2015
Cash
Accounts Receivable
Inventory
Prepaid Rent
Delivery Van
P110,000
90,000
129,000
12,000
550,000
P 87,400
69,920
218,500
4,370
493,810
TOTAL ASSETS P 891,000 P874,000
Accounts Payable
Loan Payable
Anistle Cruz, Capital
75,000
400,000
416,000
67,298
393,300
413,402
TOTAL LIABILITIES AND P891,000 874,000

29. Ratio analysis
is the comparison of line
items in the financial
statements of a business.
Ratio analysis is used to
evaluate a number of issues
with an entity, such as its
liquidity, efficiency of
operations, and profitability.

30. Ratio analysis
• expresses the relationship among selected items of
financial statement data. The relationship is expressed
in terms of a percentage, a rate, or a simple proportion
• A financial ratio is composed of a numerator and a
denominator. For example, a ratio that divides sales by
assets will find the peso amount of sales generated by
every peso of asset invested. This is an important ratio
because it tells us the efficiency of invested asset to
create revenue. This ratio is called asset turnover.

33. These ratios are generally grouped into
three categories:
• (a) profitability,
• (b) Liquidity and
• (c) solvency ratio/financial health.

34. 1. Profitability ratios
• measure the ability of the company to generate income
from the use of its assets and invested capital as well as
control its cost. The following are the commonly used
profitability ratios:
• 1. Gross profit ratio
• 2. Operating ratio
• 3. Net Profit ratio
• 4. Return on asset(ROA)
• 5. Return on equity(ROE)

35. NAME OF RATIO FORMULA
Gross profit margin Gross Profit / Net Sales
Operating margin Cost of Goods sold+Operatinng
Expense / Net Sales
Net profit margin Net Income /
Net Sales
Return on assets Net Income /
Total Assets
Return on equity Net Income
Average Equity

36. 1. Gross profit ratio
• is the relationship between gross profit and net sales.
• reports the peso value of the gross profit earned for every
peso of sales. We can infer the average pricing policy
from the gross profit margin.

37. 2. Operating Income ratio
• expresses operating income as a percentage of sales. It
measures the percentage of profit earned from each peso
of sales in the company’s core business operations .A
company with a high operating income ratio may imply a
lean operation and have low operating expenses.
Maximizing operating income depends on keeping
operating costs as low as possible.

38. 3. Net Profit ratio
• relates the peso value of the net income earned to every
peso of sales. This shows how much profit will go to the
owner for every peso of sales made.

39. 4. Return on asset(ROA)
• measures the peso value of income generated by
employing the company’s assets. It is viewed as an
interest rate or a form of yield on asset investment. The
numerator of ROA is net income. However, net income is
profit for the shareholders. On the other hand, asset is
allocated to both creditors and shareholders.
• There are also two acceptable denominators for ROA –
ending balance of total assets or average of total assets.
Average assets is computed as beginning balance +
ending balance divided by 2.

40. 5. Return on equity(ROE)
• measures the return (net income) generated by the
owner’s capital invested in the business. Similar to ROA,
the denominator of ROE may also be total equity or
average equity.

43. PRACTICE

45. Liquidity ratios
• measure the ability of an entity to pay currently
maturing obligations and meet unexpected cash
needs.
• intends to measure the company’s ability to pay
debts that are coming due (short term debt).
1. Current ratio
2. Acid-Test Ratio or Quick Ratio

46. Liquidity ratios
Name of Ratio Formula
Current ratio Current Assets /
Current Liabilities
Acid-Test Ratio
or Quick Ratio
Quick Assets/
Current Liabilities

47. Solvency Ratio
• measure the ability of an entity to survive over a long
period of time.
• refers to the company’s capacity to pay their long
term liabilities.
1. Debt to Equity Ratio
2. Debt Ratio
3. Equity Ratio
4. Interest Coverage Ratio

48. Debt to equity ratio
• indicates the company’s reliance to debt or liability as a
source of financing relative to equity. A high ratio suggests
a high level of debt that may result in high interest
expense.

49. Debt ratio
• Debt ratio indicates the percentage of the
company’s assets that are financed by debt. A
high debt to asset ratio implies a high level of
debt.

50. Equity ratio
• indicates the percentage of the company’s assets
that are financed by capital. A high equity to asset
ratio implies a high level of capital.

51. Interest coverage ratio
• measures the company’s ability to cover the
interest expense on its liability with its operating
income. Creditors prefer a high coverage ratio to
give them protection that interest due to them can
be paid.

52. Earnings before interest and taxes (EBIT)
• is a company's net income before income tax
expense and interest expense have been deducted.
EBIT is used to analyze the performance of a
company's core operations without tax expenses
and the costs of the capital structure influencing
profit.
• also called Operating Income.

53. Solvency Ratios
NAME OF RATIO FORMULA
Debt to Equity Ratio Total Debt /
Equity
Debt Ratio Total Debt /Total Assets
Equity Ratio Total Equity /
Total Assets
Interest Coverage Ratio Operating Income /
Interest Expense

55. Operational efficiency ratio
• measures the ability of the company to utilize its assets.
Operational efficiency is measured based on the
company’s ability to generate sales from the utilization of
its assets, as a whole or individually. The turnover ratios
are primarily used to measure operational efficiency.
1. Asset turnover
2. Fixed asset turnover
3. Inventory turnover
4. Accounts receivables turnover

56. 1. Asset turnover
• measures the peso value of sales generated for every
peso of the company’s assets. The higher the turnover
rate, the more efficient the company is in using its assets.

57. 2. Fixed asset turnover
• is indicator of the efficiency of fixed assets in generating
sales.

58. 3. Inventory turnover
• is measured based on cost of goods sold and not sales.
As such both the numerator and denominator of this ratio
are measured at cost. It is an indicator of how fast the
company can sell inventory.An alternative to inventory
turnover is “days in inventory”.
• “days in inventory” -This measures the number of days
from acquisition to sale.

59. 4. Accounts receivables turnover
• Accounts receivables turnover the measures the number
of times the company was able to collect on its average
accounts receivable during the year. An alternative to
accounts receivable turnover is “days in accounts
receivable”.
• This measures the company’s collection period which is
the number of days from sale to collection

60. NAME OF RATIO FORMULA
Asset Turnover Net Sales / Average Asset
Fixed Asset Turnover Net Sales / Average fixed Asset
Inventory Turnover Cost of Goods Sold / Average Inventory
Days in Inventory 365 / Inventory Turnover
Accounts Receivable
Turnover
Net Sales / Average Accounts Receivable
Days in Accounts
Receivable
365 / Accounts Receivable Turnover