The document is a presentation on analyzing financial statements. It covers the objectives of financial statement analysis, which include determining a firm's profitability, solvency, and stability. It discusses the key users of financial statements and external factors to consider. The presentation outlines techniques for financial statement analysis, including ratio analysis, common-size statements, gross profit variance analysis, and cash flow statement analysis. It describes the advantages and limitations of using financial ratios to evaluate a company's liquidity, debt, and profitability. The document provides details on calculating and interpreting various financial ratios.

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FINANCIAL
ANALYSIS
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2. CPA REVIEW ASSISTANCE PROGRAM
MAS2
Understanding, Analysis and
Interpretation of Financial
Statements
June 21, 2013 - Friday
1:00pm – 3:00 pm
Walter Paraiso, CPA, CMA - MAS Reviewer
2

3. MAS 2
Session Coverage
Topic 1 : Objectives of FS Analysis
Topic 2 : FS Users Group & External Factors
Topic 3 : Financial Ratios Advantages
Topic 4 : Financial Ratios Limitations
Topic 5 : Techniques used in FS Analysis
Topic 6 : Gross Profit Variance Analysis
Topic 7 : Cash Flow Statement Analysis
Topic 8 : Session Quiz
Walter Paraiso, CPA, CMA - MAS Reviewer
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4. Topic 1: What is FS Analysis?
FS Analysis  involves careful selection of
data from the financial statements in order
to:
• assess and evaluate the firm’s past
performance, its present condition and
future business potentials.
• Analyzing ratios or numerical calculations
• Comparing a company to its industry
Walter Paraiso, CPA, CMA - MAS Reviewer
4

5. Topic 1: Objectives of FS Analysis
The primary objective is to determine the
extent of a firm’s success in attaining its
financial goals, namely:
a. To earn maximum profit
b. To maintain solvency
c. To maintain stability
Walter Paraiso, CPA, CMA - MAS Reviewer
5

6. Topic 2: 3 Major User Groups of FS
1. Creditors
2. Equity Investors
3. Management
Walter Paraiso, CPA, CMA - MAS Reviewer
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7. Topic 2: 3 Types of External Factors
1. General economic conditions and
expectations
2. Political events and political climate
3. Industry outlook
Walter Paraiso, CPA, CMA - MAS Reviewer
7

8. Topic 3: Financial Ratios Advantages
•
Measurement of economic events and
transactions; communication of information
about them to interested users/partners
including management.
•
Financial ratios are part of the communication
process that includes analysis, interpretation
and evaluation of the financial statements.
Walter Paraiso, CPA, CMA - MAS Reviewer
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9. Topic 3: Financial Ratios Advantages
•
Display relationship between various elements
of financial data and are used to assist
management in interpreting and explaining
financial statements and can be effective tools
in the evaluating a company’s liquidity, debt
position and profitability.
•
Financial ratios are an important part of
evaluating a company past performance and
are useful in projecting its financial future.
Walter Paraiso, CPA, CMA - MAS Reviewer
9

10. Topic 3: Financial Ratios Advantages
•
Provide an insight on how effectively the
business is being managed
•
Evaluate risks and financial position
•
Determine the quality of your assets and results
of operations
•
Ratios are indicators which help to explain the
full story about your business
•
May provide other stories behind the numbers
Walter Paraiso, CPA, CMA - MAS Reviewer
10

11. Topic 3: Financial Ratios Advantages
•
Help in developing and implementing plans to
improve profitability, liquidity, financial structure
and leverage
•
Financial Ratios may also be predictive and
provide indications of potential problems
•
Ratios highlight financial trends which can be
used to correct declines
Walter Paraiso, CPA, CMA - MAS Reviewer
11

12. Topic 4: Financial Ratios Limitations
1. Too much reliance on the ratios.
2. Attempting to predict the future using past
results is problematic at best.
3. The financial statements used as the basis of
the ratios are based on historical cost
(valuation problem).
4. Figures from the balance sheet used in the
calculation of the ratios are year-end numbers.
5. Industry peculiarities
6. There are no hard-and-fast rules what
numbers to use to calculate ratios.
Walter Paraiso, CPA, CMA - MAS Reviewer
12

13. Topic 5: FS Analysis – Basic Guidelines
Accounting is an art, the processes and
methodologies are based on common sense
and simple logic
There are no scientific complexities
There are certain generally accepted rules,
principles, conventions, practices and formats
mainly for purposes of consistency, common
interpretation and to put order on how
transactions will be recorded, summarized,
reported and interpreted.
Walter Paraiso, CPA, CMA - MAS Reviewer
13

14. Topic 5: FS Analysis – Analytical Process
Ratio Analysis
Trends and Comparison
Qualitative Business Review
Interpretation of Findings
1.
Based on industry standards
2.
Based on established benchmark
3.
Based on current economic situation
Walter Paraiso, CPA, CMA - MAS Reviewer
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15. Topic 5: FS Analysis Techniques
1. Horizontal Analysis (trend ratios and
percentages)
2. Vertical Analysis (common-size statements)
3. Ratio Analysis
4. Gross Profit Variation Analysis
5. Cash Flow Analysis
Walter Paraiso, CPA, CMA - MAS Reviewer
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16. Topic 5: Financial Ratios
1. Liquidity Ratios
2. Asset Management Ratios
3. Leverage Ratios
4. Valuation Ratios
5. Profitability Ratios
6. Cost Management Ratios
7. Growth Ratios
Walter Paraiso, CPA, CMA - MAS Reviewer
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17. Topic 5: Financial Ratios Core Concepts
1. Profitability
2. Liquidity
3. Solvency
4. Leverage (relative of fixed cost in the Capital
Structure)
5. Earning Coverage
6. Operating Cycle
7. Liquidity Index
Walter Paraiso, CPA, CMA - MAS Reviewer
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18. Topic 5: Financial Ratios Core Concepts
Profitability
• Measures the ease with which a company
generates income.
Walter Paraiso, CPA, CMA - MAS Reviewer
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19. Topic 5: Financial Ratios Core Concepts
Liquidity
• Firm’s the ability to pay off its current
obligations as they come due and thus remain
in business in the short run.
• Measures the ease with which assets can be
converted to cash
Walter Paraiso, CPA, CMA - MAS Reviewer
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20. Topic 5: Financial Ratios Core Concepts
Solvency
• Firm’s the ability to pay off its noncurrent
obligations as they come due and thus remain
in business in the long run (contrast with
liquidity).
• Key ingredients are the firm’s capital structure
and degree of leverage.
Walter Paraiso, CPA, CMA - MAS Reviewer
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21. Topic 5: Financial Ratios Core Concepts
Capital Structure
• Includes its source of financing both short-term
and long-term. These can be in the form of
debt (external financing) or equity (internal
financing).
Debt
• Credit interest in the firm.
Equity
• Ownership interest in the firm.
Walter Paraiso, CPA, CMA - MAS Reviewer
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22. Topic 5: Financial Ratios Core Concepts
Leverage
• Relative amount of fixed cost in a firm’s capital
structure. It creates risk because fixed cost must be
covered regardless of sales level.
Degree of Operating Leverage (DOL)
• Derived from the use of a high level of plant and
machinery through depreciation, insurance etc.
Degree of Financial Leverage (DFL)
• Derived from the use of a high level of debt in the
firm’s financing structure through interest payments.
Walter Paraiso, CPA, CMA - MAS Reviewer
22

23. Topic 5: Financial Ratios Core Concepts
• Financial leverage is the relative mix of debt (especially
long-term debt) & equity
• Long-term debt increases credit risk & has interest
charges
• The financial leverage index (FLI) is ROE/ROA
• A high FLI indicates the increasing use of leverage to
raise ROE relative to ROA
• The financial structure leverage ratio (FSLR) is average
total assets/average common equity. This is the same
ratio used in the DuPont Model for solvency. A higher
ratio means higher leverage, but also a higher ROE. The
ratio is identical to FLI if there is no preferred stock. When
preferred stock is present, the FSLR is higher than FLI.
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24. Topic 5: Financial Ratios Core Concepts
Earning Coverage
• Creditor’s best measure of a firm’s ongoing
ability to generate earnings to allow satisfy
long-term debts and remain solvent.
Time-Interest Earned Ratio
• Evaluate firm ongoing ability to meet the
interest payments on debts obligations.
Walter Paraiso, CPA, CMA - MAS Reviewer
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25. Topic 5: Financial Ratios Core Concepts
Operating Cycle
• Amount of time that passes by between the
acquisition of inventory and the collection of
cash on the sale of that inventory.
Liquidity Index
• Measure the proportion that the two major
noncash current assets (weighted) make up of
all liquid assets.
Walter Paraiso, CPA, CMA - MAS Reviewer
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26. Profitability Ratios: DuPont analysis
Net Income

Sales

Profit
Margin

Asset
Turnover
Total Assets
Return on
Assets
Return on Assets 
(1 - Debt/Assets)
Total Debt

Total Assets
Financing
Plan
Return on
Equity

27. Topic 6: Gross Profit Variance Analysis
• 4-Way Variance Analysis
• 3-Way Variance Analysis
• 6-Way Variance Analysis
Walter Paraiso, CPA, CMA - MAS Reviewer
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28. Topic 7: Cash Flow Statement
• Operating Activities
• Investing Activities
• Financing Activities
Walter Paraiso, CPA, CMA - MAS Reviewer
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29. Thank You
Walter Paraiso, CPA, CMA - MAS Reviewer
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