Chapter 11:

Concerned with how the performance of the

company may be reviewed through analysis
and interpretation of its FS
Org structure: vision, mission, goals,
objectives, long range and short range plans,
core competencies, and limitation enables
an analyst to come up with correct analysis
and interpretation of the companys
financial performance
Financial statement- informative reports
Should be analyzed and interpreted to
have a complete picture whether the
company has performed efficiently and
effectively
Questions:
Is the profit generated by sales
adequate?
Is the profit sufficient return on what
the owner invested?
Are the assets being used efficiently to
generate profit?
Can the business pay its obligations on
time?
Is it safe to borrow some more?

Financial Statement Analysis- process if

assessing the Financial condition, operating
performance and viability of the enterprise; A
powerful and effective measurement tool
which will assist all statement users to make
informed judgment and decision
When you analyze, you get to know (predicts
companys success)
Profitability
Liquidity
Solvency
Profitability- not just simply earning more
revenues than expenses
- The ability of business to earn a
satisfactory rate of return on
owners or investors capital
- Objective: to make sure that the
profit is maximized, for in so doing
owners wealth is also maximized
Liquidity- enhances the financial position of
the business with reference to its ability to
manage its working capital and payfor short
term obligations
Solvency/Stability- long term liquidity which
also enhances financial position of the

company with reference to how it manages

all its resources and pay for its long term
liabilities
Resources = financed by owner/investor; but
company resort to borrowings when
owner/investor is incapable
In analyzing the figures contained in FS, to
make them meaningful, we standardize the
raw figures by reducing them into:
Ratios
Turnovers
Percentages
Intracomparability- compared against
previous years ratios/percentages
Intercomparability/Benchmarking- compared
against the competitors ratios/percentages
Ratio- measure of the relationship of one
item against another item (net income
against sale)
Efficiency- results when the pricing policy is
good and the activities are properly
monitored and controlled so that less time
and effort are used this minimizing the cost
or expenses of the company
Rules/Procedures:
a. Ratios and percentages were
determined
b. Two or more data were used
c. Figures used to form a ratio didnt
come only from one FS
d. To make analysis and interpretation
more meaningful a comparison was
made between two competitors
Advantages of analyzing FS:
a. Determine whether company is
efficient in its operation
b. Determine whether cpmpnys FP is
strong considering liquidity and
solvency
c. Determine whether or not the
companys efficient in using resources
d. Spot trends, weaknesses, and
potential problems
e. Use the analyses to forecast
expectation on companys future
performance
f. Create new plans or revise old pans in
accordance to ones goal or objective
depending on your position

First step in analyzing the companys

performance- place side by side FS for 2
periods or the FS of two competing
companies
Comparability- one of the qualitative
characteristics of FS which makes info more
relevant
3 tools in analyzing:
Horizontal Analysis
Vertical Analysis
Financial Ratio Analysis
Horizontal analysis- enables one to draw a
picture on what changes ( +/-) are taking
place in the financial activities of an
enterprise
-shows increases and decreases in
absolute amounts an in percentages of
financial data for 2 periods
Trend Analysis- shows the comparison of
more than 2 periods against a base year
The increase and decrease will trigger
an inquisition from management to
determine what caused the change and
whether change is good for company
Procedure: get the difference between the
figures for 2 years and divide by base
amount
Vertical Analysis- another tool used in
evaluating the importance of individual items
to the specific base item which is the gross
sales, total assets, total equity
Base item expressed as 100%
If theres sales returns, a llowances, or sales
discount- base item = net sales
Computed by dividing the amount of
each item to specific base
*when preparing comparative analysis, it
shows changes in the relative size of each
item to the specific base item and whether
its good or not depends on its effect on the
financial position of performance of the
business
Financial ratios- widely used tool in financial
statement analysis as they provide means of

measuring and evaluating company

performance and financial position
-Must know how to use formulas to
draw out ratios and percentages and identify
relevant relationships among financial data
-To be able to arrive at informed
judgment, one must use
intercomparability/intracomparability
Liquidity- ability of business to efficiently
manage working capital and ensure that
theres adequate assets to cover for its
current obligations as they fall due
-comparing the current assets and the
current liabilities & computing working
capital, current ratio, and acid test ratio
Working capital- difference between current
assets and current liab
Current ratio- current assets/current liab;
ideal ratio- 2:1
Acid test ratio- Quick assets (cash, cash
equivalents, receivables, marketable
securities)/current liab
1:1 liquidity of the firm is used by a
creditor evaluating safety of a loan
Turnover rates
-complementing the liquidity ratios
-signifies efficiency in using resources
-Gives u the number of times
resources are used to generate revenue
Receivable turnover- measure of efficiency in
collection which would greatly affect the
liquidity position of company
Inventory turnover- MOE using the
merchandise wc would greatly affect liquidity
and profitability
Asset Turnover- MOE in using all company
resources in generating revenues

More turnovers-more quickly cash is

collected
More times merchandise bought and
sold- more times revenue is generated
More Revenues, if cost and expenses
managed efficiently, the greater profit
is obtained
Higher ROE, business is profitable

Receivable turnover- Credit revenue/average

Receivable

Inventory Turnover- informs us of the number

of times inventory is replaced or sold
-the more it is replaced, the more the
profit cycle is repeated, the more profitable
business is
-expensive items; low turnover,
necessity/perishable items;high turnover
Cost of sales/Average inventory
Asset turnover- revenue/Ave total assets
Profitability- ability of business to earn a
satisfactory ROE (net income/ave equity)
ROE must be atleast equal or greater
than the banks prime interest rate if
investors money is placed in some other
profitable venture such as banks time
deposit
Determined by computing:
Profit margin ratio/Return on sales ratio- net
income/revenues earned;
-measures proportion of revenue going
to profit
Operating margin ratio: operating
income/divided by sales measures
efficiency in operating business; measures
the efficiency of the company to control cost
and expenses
Return on total aassets/ROa- net income
divided by ave total assets measure if
profitability like ROE