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ANALYSIS AND
INTERPRETATION OF
FINANCIAL STATEMENTS
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Financial Statement Analysis


625
Who analyzes financial statements?
 Internal users (i.e., management)
 External users (emphasis of chapter)
Examples?
Investors, creditors, regulatory agencies & …
stock market analysts and
auditors
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Financial Statement Analysis


 What do internal users use it for?
Planning, evaluating and controlling
company operations
 What do external users use it for?
Assessing past performance and current
financial position and making predictions
about the future profitability and solvency
of the company as well as evaluating the
effectiveness of management
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Financial Statement Analysis


Information is available from 627 628

 Published annual reports


(1) Financial statements
(2) Notes to financial statements
(3) Letters to stockholders
(4) Auditor’s report (Independent accountants)
(5) Management’s discussion and analysis
 Reports filed with the government
e.g., Form 1, Form 2 etc..
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Financial Statement Analysis


Information is available from 627 628

 Other sources
(1) Newspapers (e.g., PDI, TMB, TPS )
(2) Periodicals (e.g. Forbes, Fortune)
(3) Financial information organizations such
(4) Other business publications
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Methods of
Financial Statement Analysis
 Horizontal Analysis
 Vertical Analysis
 Common-Size Statements
 Trend Percentages
 Ratio Analysis
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Horizontal Analysis

Using comparative financial


statements to calculate currency
or percentage changes in a
financial statement item from
one period to the next
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Vertical Analysis
For a single financial
statement, each item
is expressed as a
percentage of a
significant total,
e.g., all income
statement items are
expressed as a
percentage of sales
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Common-Size Statements
Financial statements that show
only percentages and no
absolute peso amounts
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Trend Percentages
Show changes over time in
given financial statement items
(can help evaluate financial
information of several years)
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Ratio Analysis
Expression of logical relationships
between items in a financial
statement of a single period
(e.g., percentage relationship
between revenue and net income)
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Ratios
Ratios can be expressed in three
different ways:
1. Ratio (e.g., current ratio of 2:1)
2. % (e.g., profit margin of 2%)
3. Pesos (e.g., EPS of Ph125.25)

CAUTION!
“Using ratios and percentages without
considering the underlying causes may
lead to incorrect conclusions.”
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Categories of Ratios
 Liquidity Ratios
Indicate a company’s short-term
debt-paying ability
 Equity (Long-Term Solvency) Ratios
Show relationship between debt and
equity financing in a company
 Profitability Tests
Relate income to other variables
 Market Tests
Help assess relative merits of stocks in
the marketplace
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10 Ratios You Must Know


Liquidity Ratios
Current (working capital) ratio
Acid-test (quick) ratio
 Cash flow liquidity ratio

Accounts receivable turnover


Number of days’ sales in accounts
receivable
Inventory turnover 651

 Total assets turnover


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10 Ratios You Must Know


Equity (Long-Term Solvency) Ratios
Equity (stockholders’ equity) ratio
 Equity to debt
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10 Ratios You Must Know


Profitability Tests
 Return on operating assets
Net income to net sales (return on
sales or “profit margin”) $
Return on average common
stockholders’ equity (ROE)
 Cash flow margin

Earnings per share


 Times interest earned

 Times preferred dividends earned


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10 Ratios You Must Know


Market Tests
 Earnings yield on common stock
Price-earnings ratio
 Payout ratio on common stock

 Dividend yield on common stock

 Dividend yield on preferred stock

 Cash flow per share of common


stock
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FINANCIAL RESOURCES
MANAGEMENT

• Explain how budgeting relates to


financial planning
• Describe two kinds of financial
reports prepared by businesses
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Financial Management
 One reason small businesses fail is
they do not manage their finances
properly.
 A financial plan is an important part of
a business plan.
 Businesses must manage the money
they take in and pay out to become
profitable and stay in business.
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Financial Planning
 Profit – what is left over after
expenses are paid
 Business Budget – a detailed plan for
meeting the financial needs of the
business
 Anticipating sources and amounts of
income
 Predicting the types and amounts of
expenses
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 Income(Revenue) – the money a


business takes in or receives
 Most revenue or income comes from
sales of products or services
 Credit – many sales not paid for 30 days
or longer
 Statement of Cash Flow – shows actual
cash a business receives and has
available on a daily basis
 Expenses – operating costs of the
business
 Employee wages, benefits, advertising,
rent, utilities, supplies, etc.
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Budgeting
 Budget – a detailed plan for the
financial needs of an individual, family,
or business
 Business budget – projects the
amounts of income and expenses; a
financial forecast
 Well-prepared budget helps avoid
costly financial mistakes
 Lets managers know how the business
is doing in terms of meeting its
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Types of Business Budgets


 Start-Up Budget – used to plan income
and expenses from the beginning of a
new business or major business
expansion until it becomes profitable
 Purchase of buildings and equipment
 Material, supplies, licenses

 Advertising, hiring, payroll


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 Operating Budget – financial plan


for the day-to-day operations of the
business
 Covers a specific period of time (ex. 3
months, 6 months, or 1 year)
 Follows this equation:
• Revenue – Expenses = Profit (or Loss)

 All anticipated revenues and expenses


are listed
 Planned net profit or loss is shown
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 Cash Budget – an estimate of the


money expected to be received and
paid out over a specific period of time
 Lets the manager know when to borrow
 Money must always be on hand to pay
expenses

 Calculate the net profit or loss for the


month for AgriBusiness, Inc. : (use
equation)
• Cash sales – 200,000
• Charge sales – 124,000
• Other revenue -165,000
• Salaries – 124,500
• Advertising – 50,000
• Rent - 30,000
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Financial Records
 Show the financial performance of the
business
 Used to prepare 2 important financial
statements – Income Statement, Balance
Sheet
 Asset records name the buildings and equipment
owned by the business, their original and current
value and amount owed
 Depreciation records identify the amount that assets
have decreased in value due to age and use
 Inventory records identify the type and number of
products on hand for sale
 Payroll records contain information on all employees’
compensation and benefits
 Cash records list all cash received and spent
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Income Statement
 A financial statement that shows
revenues, expenses, and net income
(profit) or loss for a period of time.
 Usually covers a period of 6 months or
a year but may be shorter
 End-of-year statement shows how the
business did for the entire year
 Basis for payment of taxes and
decision-making
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Balance Sheet
 A financial statement that lists a
business’ assets (what a company
owns) and liabilities (what a
company owes)
 Shows what the business is worth
on a particular date, usually the end
of a year
 Shows owners equity (value of the
owner’s investment in the business
(also called net worth)
 Owner’s equity equation:
 Assets – Liabilities = Owner’s Equity
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AgriBusiness, Inc.
Income Statement
For the Year Ended December 31, 2016
Revenue
Cash Sales 38,200
Charge Sales 180,600
Other Revenue 12,900
231,700
Expenses
Salaries and Wages 70,800
Marketing 22,250
Administrative Costs 31,900
Materials and Supplies 24,800
Other Expenses 19,100
Total Expenses 168,850

Net Income 62,850


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 In a balance sheet, both sides of the


statement must be in balance
 Right-hand side shows the total of
liabilities and owner’s equity to show
that they equal the value of the assets
on the left-hand side
Ex.
ASSETS
AgriBusiness, Inc. Balance Sheet
LIABILITIES
December 31, 2016
Cash 35,850 Accounts Payable 103,300
Investments 40,000 Payroll Taxes 22,000
Accounts Receivable 42,375 Mortgage 126,800
Buildings/Equipment 370,000 TOTAL LIABITIES 252,100
Owner’s Equity 236,125
Total Liabilities and
Total Assets 488,225 Owner’s Equity 488,225
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Maintaining Financial Records


 Accuracy
 Current
 Technology use
 Data files transfer easily
 Software capabilities
 What-if comparisons
 Mathematical calculations
 Updates records
 Comparisons