Financial Statements Analysis • To compute for the ratio presentation,
current year divided by the prior year.
Overview of Financial Statements
The primary financial statements are: Trend Analysis
1. Statement of Financial Position – presents An extended horizontal analysis could be
financial condition of the company at a given developed as the so-called “Trend Analysis”.
period.
Vertical Analysis
2. Comprehensive Statement of Income – reports
the income and expenses in a given period. Vertical analysis is a technique that expresses each
3. Cash Flow Statement – shows how cash was item within a financial statement as a percentage of
obtained during the period and how it was used a relevant total or a base amount.
also during the period.
Ratio Analysis
Analytical Techniques Used
The real value of financial statements is in the fact
The most widely used techniques in financial statement
analysis are: that they can be used to help predict the firm’s
future earnings and dividends, thus, an analysis of
1. Comparative analysis the firm’s ratios is generally the first step in a
a. Horizontal analysis - comparing two periods
financial analysis.
and becomes trend analysis if extended to
three or more periods having the earliest
year as the base period.
b. Trend analysis The three major areas that concern the users of
c. Vertical analysis - also known as common- financial statements are:
size statements is analysis of the
• Stability
component parts of a single statement in a
• Solvency or liquidity, and
given period.
2. Ratio of Component analysis including • Profitability
turnovers.
Analyzing the Balance Sheet
Horizontal Analysis
Liquidity Ratios – These are ratios that show the
Horizontal analysis is a technique for evaluating a relationship of the company’s cash and other
series of data over a period of time to determine current assets to its current liabilities. Liquidity is
the increase or decrease that has taken place, the number one concern of most financial analysts.
expressed as either an amount or a percentage.
The most common liquidity ratios and their
The following simple rules should be observed: procedural computations are:
• To compute for the peso changes, current 1. Working Capital = Current assets - current
year less prior year. liabilities
• To compute for the percentage changes, 2. Current Asset Ratio = Current assets /
peso change divided by the prior year (serve current liabilities
as the base figure). 3. Quick (Acid) Test Ratio = Quick assets /
current liabilities
Asset Management Ratios – These are set of ratios, Profitability Ratios – These ratios would show the
which measures how effectively a firm is managing net result of the policies and decisions the
its assets. management did in the current period.
The most common asset management ratios are:
Market Value Ratios – This is a set of ratios that
relate the firm’s stock price to its earnings and
book value per share.
Debt Management Ratios or Financial Leverage –
These ratios will measure the extent to which firm
uses its dept financing or the so-called financial
leverage.
Limitations of Financial Statement Analysis
Like any management accounting information,
financial ratios serve only as an attention-directing
device. The ratios raise questions more often than
they answer them.
Further, as financial statements are historical
costs, inflation could badly distort balance sheets
particularly depreciation charges and inventory
costs which affect profit.
Several factors make financial analysis difficult.
• One of them is variations in accounting
methods among firms.
• Another is timing.