FS ANALYSIS involves the evaluation of the
firms past performance, present condition, and
business potentials by way of careful analysis of
its financial statements pertaining to matters
like: PROFITABILITY OF THE BUSINESS FIRM,
ABILITY TO MEET COMPANY OBLIGATIONS,
SAFETY OF INVESTMENT IN BUSINESS,
EFFECTIVENESS OF MANAGEMENT IN RUNNING
THE FIRM.
VARIOUS MODES OF FINANCIAL STATEMENT
ANALYSIS:
1. HORIZONTAL ANALYSIS or sometimes
called the trend or index analysis
involves comparison of amounts shown
in the FS of two or more consecutive
periods. The difference and percentage
change of the amounts are calculated
using the earlier period as the base
period.
Comparisons can be made between an actual
amount compared against a budgeted amount,
with the budget serving as the basis or pattern
of performance.
*If a negative or a zero amount appears on the
base year, percentage change cannot be
computed.
2. VERTICAL ANALYSIS is the process of
comparing figures in the FS of a single
period. It involves conversion of
amount in the FS to a common base.
This is accomplished by expressing all
figures in the FS as percentages or an
important item such as total assets or
net sales. These converted statements
are called common size statements or
percentage composition statements.
Percentage composition statements are
used for comparing: Multiple years of
data from the same firm, Companies
that are different in size, company to
industry averages.
3. FINANCIAL RATIOS involve development
of mathematical relationships among
accounts found in the FS. Financial
ratios provide relevant information
about the firms liquidity, solvency,
stability, profitability and other aspects
of an entitys financial situation and
potential.
TESTS OF LIQUIDITY refers to
the companys ability to pay its
current liabilities as they fall
due.
Current Ratio It is a measure of the adequacy
of working capital. It is the primary test of
liquidity to meet current obligations from
current assets.
Quick Ratio It measures the number of times
that the current liabilities could be paid with the
available cash and near cash assets.
**Working Capital Activity Ratios (Efficiency
Ratios)
Turnover
Receivable Turnover It measures the number
of times receivables are recorded and collected
during the period.
Average Age of Receivables It indicates the
average number of days during which the
company must wait before receivables are
collected.
Inventory Turnover It measures the number of
times that the inventory is replaced during the
period.
Average Age of Inventory It indicates the
average number of day, during which the
company must wait before the inventories are
sold.
Raw Materials Turnover
Work in Process Turnover
Finished Goods Turnover
Normal Operating Cycle
Trades Payables Turnover
Average Age of Trade Payables It indicates the
length of time during which payables remain
Unpaid.
Current Assets Turnover It measures the
movement and utilization of current assets to
meet operating requirements.
TESTS OF SOLVENCY refers to
the ability of company to pay its
debts.
*These ratios involve leverage ratios. Leverage
refers to how j=much of companys resources
are financed by debt and/or preferred equity,
both of which require fixed payment of interest
and dividends.
Times Interest Earned It determines the
extent to which operations cover interest
expense.
Debt Equity Ratio Proportion of assets
provided by creditors compared to that
provided by owners.
Debt Ratio Proportion of total assets provided
by creditors
Equity Ratio Proportion of total assets
provided by owners
TEST OF PROFITABILITY
Return on Sales Determines the portion of
sales that went into companys earnings.
Return on Assets Efficiency with which assets
are used to operate the business.
**If the intention is to measure operational
performance, income is expressed as BEFORE
INTEREST AND TAX, alternatively, income
before after-tax interest may be used to
exclude the effect of capital structure.
** If the intention is to evaluate total
managerial effort, income is expressed after
interest and tax
*The practice of expressing income after
interest but before tax is being discouraged.
**Income should include dividends and interest
earned if the said investments are included in
asset base.
**It used in the context of DuPont technique,
income must be after interest, taxes and
preferred stock.
Return on Equity measures the amount
earned on the owners or stockholders
investment.
Earnings per Share measures the amount of
net income earned by each common share.
MARKET TEST
Price Earnings (PE) Ratio it indicates the
number of pesos required to buy P1 of earnings.
Dividend Yield measures the rate of return in
the investors common stock investments.
Dividend Pay-Out It indicates the proportion
of earnings distributed as dividends.
OTHER MEANINGFUL RATIOS
RATIOS USED TO EVALUATE LONG-TERM
FINANCIAL POSITION OR STABILITY
Fixed Assets to Total Equity measures the
proportion of owners equity to fixed assets.
Indicative of over or under investment by
owners and weakness in trading on the equity.
Fixed Assets to Total Assets indicates possible
over expansion of plant and equipment.
Sales to Fixed Assets Tests roughly the
efficiency of management in keeping plant
properties employed.
Book Value per Share Common Stock
measures recoverable amount to common
stockholders in the event of liquidation of
assets is realized at their book values.
RATIOS INDICATIVE OF INCOME
POSITION

Times Preferred Dividend Earned it indicates Rate Return on Average Current Asset
ability to provide dividends to preferred measures the profitability of current assets
stockholders. invested

Capital Intensity Ratio measures efficiency of Operating Profit Margin measures profit
the firm to generate sales through employment generated after consideration of operating
of its resources. costs.

Times Fixed Charges Earned measures ability Cash Flow Margin measures the ability of the
to meet fixed charges. firm to translate sales to cash.

TESTS OF OVER ALL SHORT

TERM SOLVNCY OR SHORT
TERM FINANCIAL POSITION

Working Capital Turnover indicates adequacy

of working capital to support operation (sales)

Defensive Interval Ratio measures coverage of

current liabilities.

Payable Turnover measures efficiency of the

company in meeting the accounts payable.

Fixed Assets to Long Term Liabilities reflects

extent of the utilization of resources from long
term debt. Indicative of sources of additional
funds.