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:
Comparison
Bases
Characteristics
Tools of
Analysis
◆
Liquidity
◆
Intracompany
◆
Horizontal
◆
Profitability
◆
◆
Vertical
◆
Solvency/leverag
e
Industry
averages
◆
Ratio
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◆
Intercompany
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Basics of Financial Statement Analysis
Ratio analysis
Liquidity
Measures shortterm ability of the
company to pay its
maturing obligations
and to meet
unexpected needs
for cash.
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Profitability
Measures the
income or
operating success
of a company for a
given period of
time.
Solvency
Measures the ability
of the company to
pay its long and
short-term
obligations
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Basics of Financial Statement Analysis
Ratio Comparison
Cross Sectional
Analysis
Involves
comparison of the
firms’ financial
ratios to those of
other firms in its
industry at the
same point in time.
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Benchmarking
Type of cross
sectional analysis in
which the firms’ ratio
are compared to
those of key
competitor or group of
competitors that it
wishes to emulate.
Time Series
Analysis
Evaluation of the
firms’ current to past
performance to
assess the firm’s
progress. Develop
trends by using
multiyear
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 shortterm 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 shortterm 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
receivables
P100,000
2. Accounts receivables In days
turnover
= Net sales/Ave. accounts
= P 750,000 /
= 7.5 times
= 365 / Accounts receivable
= 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.
ratio – indicates the proportion of assets financed
with debt.
◆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, priceearnings, 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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