ACC C204 – FINANCIAL

MANAGEMENT
Financial Analysis:
Sizing up Firm
Performance

Weeks 2-3

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 FINANCIAL STATEMENT ANALYSIS

➢ It yields important information about the

strengths and weaknesses of a firm’s
financial condition.

➢ It involves analyzing past performance to

predict future cash flows.

➢ Use to evaluate firm’s financial

performance in light of its competitors
and determine how the firm will improve
its operation.
 The Four Key Financial Statements:
The Income Statement

• The income statement provides a financial

summary of a company’s operating results during
a specified period.
• Although they are prepared annually for reporting
purposes, they are generally computed monthly by
management and quarterly for tax purposes.

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 The Four Key Financial Statements:
The Balance Sheet

• The balance sheet presents a summary of a

firm’s financial position at a given point in time.

• The statement balances the firm’s assets (what it

owns) against its financing, which can be either
debt (what it owes) or equity (what was provided
by owners).

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 The Four Key Financial Statements:
Statement of Retained Earnings

The Statement of Retained Earnings

reconciles the net income earned during a
given year, and any cash dividends paid, with
the change in retained earnings between the
start and the end of that year.

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 The Four Key Financial Statements:
Statement of Cash Flows

• The statement of cash flows provides a summary of

the firm’s operating, investment, and financing cash
flows and reconciles them with changes in its cash and
marketable securities during the period.
• The statement also provides insight into a company’s
investment, financing and operating activities, but also
ties together the income statement and previous and
current balance sheets.

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 Basics of Financial Statement Analysis

Analyzing financial statements involves:

Characteristics Comparison Tools of

Bases Analysis

◆ Liquidity ◆ Intracompany ◆ Horizontal

◆ Profitability ◆ Industry ◆ Vertical

averages
◆ Solvency/leverag ◆ Ratio
e ◆ Intercompany

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 Basics of Financial Statement Analysis
Ratio analysis
Liquidity Profitability Solvency

Measures short- Measures the Measures the ability

term ability of the income or of the company to
company to pay its operating success pay its long and
maturing obligations of a company for a short-term
and to meet given period of obligations
unexpected needs time.
for cash.

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 Basics of Financial Statement Analysis
Ratio Comparison
Cross Sectional Time Series
Analysis Benchmarking
Analysis

Involves Type of cross Evaluation of the

comparison of the sectional analysis in firms’ current to past
firms’ financial which the firms’ ratio performance to
ratios to those of are compared to assess the firm’s
other firms in its those of key progress. Develop
industry at the competitor or group of trends by using
same point in time. competitors that it multiyear
wishes to emulate. comparisons.

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 Basics of Financial Statement Analysis
Tools of Analysis
Horizontal Analysis or Trend
✓Analysis
It is an analysis of the
percentage increase and
decrease of related
items in comparative
financial statements.
✓ Technique of evaluating
a series of financial
statement data over a
period
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 Basics of Financial Statement Analysis
Tools of Analysis
Vertical Analysis or Common-size Analysis
✓ A percentage analysis
to show the relationship
of each component to a
total within a single
statement.
✓ Technique that
expresses each
financial statement item
as a percent of a base
amount.

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 Basics of Financial Statement Analysis
Tools of Analysis
Ratios generally are classified into three categories: liquidity,
borrowing capacity or leverage, and profitability.
►Liquidity ratios measure the ability of a company to meet its
current obligations.
►Leverage ratios measure the ability of a company to meet its
long- and short-term obligations. These ratios provide a
measure of the degree of protection provided to a company’s
creditors.
►Profitability ratios measure the earning ability of a company.
These ratios allow investors, creditors, and managers to
evaluate the extent to which invested funds are being used
efficiently.
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 Ratio Analysis Liquidity Ratios

Liquidity Ratios are used to assess the short-

term debt-paying ability of a company.

The most common ones include:

✓ Current ratio
✓ Quick or acid test ratio
✓ Accounts receivable turnover ratio
✓ Inventory turnover ratio

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 Ratio Analysis Liquidity Ratios

The current ratio measures the ability of the firm to meet its short-
term obligations.

Current ratio = Current assets ÷ Current liabilities

The quick (acid-test) ratio excludes inventory, which is generally

the least liquid current asset.

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 Calculating the Current Ratio and
Quick or Acid Test Ratio
Problem
Concorde Industrial Inc. has current assets equal to Php120,000. Of these, Php15,000 is
cash, Php30,000 is accounts receivable, and the remainder is inventories. Current
liabilities total Php50,000.
Required:
1. Calculate the current ratio.
2. Calculate the quick ratio (acid-test ratio).
Solution:
1. Current ratio = Current assets/Current liabilities
= Php120,000/Php50,000
= 2.4
2. Quick ratio = (Cash + Marketable securities + Accounts Receivable) /
Current liabilities
= (Php15,000 + 0 + Php30,000)/ Php50,000
= 0.90

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 Account Receivable Turnover Liquidity Ratios

The liquidity of receivables is measured by the accounts

receivable turnover ratio, computed as follows:

Average accounts receivable is computed as

follows:

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 Account Receivable Turnover in Days
A variant of the receivable turnover ratio is to convert it to
an Average collection period in terms of days. The
objective is to assess the efficiency in collecting receivable
and in the management of credit.

A low turnover ratio may suggest a need to modify credit

and collection policies to speed up the conversion of
receivables to cash.

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 Calculating the Accounts receivable turnover and
Accounts receivable in days

Problem
Concorde Industrial Inc. had net sales of Php 750,000 and cost of goods
sold of
Php 400,000. Concorde had the following balances:
January 1 December 31
Accounts receivable Php 98,500 Php
101,500
Inventories 83,000
87,000

Required:
1. Calculate the accounts receivable turnover
2. Calculate the accounts receivable in days

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 Account Receivable Turnover and Turnover in Days

Solution:
1. Average accounts receivables
= (Php98,500 + Php101,500)/2
= Php 100,000

Accounts receivable turnover = Net sales/Ave. accounts

receivables = P 750,000 /
P100,000
= 7.5 times
2. Accounts receivables In days = 365 / Accounts receivable
turnover
= 365 / 7.5
= 48.7 days

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 Inventory Turnover Liquidity Ratios

Inventory turn over is a measure of the number of times the

average level of inventory is sold during a year. A low turnover
ratio may signal the presence of too much inventory or sluggish
sales
Inventory turnover = Cost of goods sold ÷ Average inventory

Average accounts receivable is computed as

follows:
Average inventory = (Beginning inventory + Ending inventory) /
2
The number of days inventory is held before being sold is
computed as follows:
Average Age of Inventory = 365 / Inventory turnover ratio

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 Calculating the Inventory turnover and
Inventory turnover In days

Problem
Last year, Concorde Industrial Inc. had net sales of Php 750,000 and cost of
goods sold of Php 400,000. Concorde had the following balances:
January 1 December 31
Accounts receivable Php 98,500 Php
101,500
Inventories 83,000
87,000

Required:
1. Calculate the inventory turnover ratio
2. Calculate the inventory turnover in days/Average Age of Inventory

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 Calculating the Inventory turnover ratio and
Inventory turnover In days
Solution:
1. Average inventory = (Beginning Inventory + Ending inventory) / 2
= (Php83,000 + Php87,000)/2
= Php 85,000

Inventory turnover = Cost of goods sold / Ave. inventory

= P 400,000 / P 85,000
= 4.7 times
2. Average Ave of Inventory = 365 / Inventory turnover
= 365 / 4.7
= 77.7 days

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 Solvency Ratios

Solvency ratios measure the ability of a company to survive

over a long period of time.
◆Debt ratio – indicates the proportion of assets financed
with debt.
=Total liabilities ÷ Total assets
◆Times-interest-earned ratio - measures the number of
times operating income can cover interest expense.

= Income from operations ÷ Interest

expense
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 Profitability Ratios

Measure the income or operating success of a company for a given period of

time.

◆Income, or the lack of it, affects the company’s ability to obtain debt
and equity financing, liquidity position, and the ability to grow.

◆Ratios include the profit margin, asset turnover, return on assets,

return on common stockholders’ equity, earnings per share, price-
earnings, and payout ratio.

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 Profitability Ratios

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 Economic Value Added (EVA)

Economic value added (EVA®) combines

accounting income and corporate finance to
measure whether the company’s operations have
increased stockholder wealth.

EVA® = Net income + Interest expense – Capital

charge

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