FUNDAMENTALS OF ACCOUNTANCY, BUSINESS AND MANAGEMENT 2
ANALYSIS AND INTERPRETATION OF FINANCIAL STATEMENTS


FS Analysis is the process of evaluating risks, performance, financial health, and future prospects of a
business by subjecting financial statement data to computational and analytical techniques with the
objective of making economic decisions (White et.al 1998).
Three kinds of FS analysis techniques:
 Horizontal Analysis
 Vertical Analysis
 Financial Ratios
o Horizontal Analysis, also called as trend analysis, a technique for evaluating a series of financial
statement data over a period with the purpose of determining the increase or decrease that
has taken place (Weygandtet.al 2013).
 Horizontal analysis uses financial statements of two or more periods.
 All line items on the FS may be subjected to horizontal analysis
 Only the simple year-on-year (Y-o-Y) grow this covered in this lesson.
 Changes can be expressed in monetary value (peso) and percentages computed by
using the following formulas:
𝑷𝒆𝒔𝒐 𝒄𝒉𝒂𝒏𝒈𝒆 = 𝐵𝑎𝑙𝑎𝑛𝑐𝑒 𝑜𝑓 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑌𝑒𝑎𝑟 − 𝐵𝑎𝑙𝑎𝑛𝑐𝑒 𝑜𝑓 𝑃𝑟𝑖𝑜𝑟 𝑌𝑒𝑎𝑟
(𝐵𝑎𝑙𝑎𝑛𝑐𝑒 𝑜𝑓 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑌𝑒𝑎𝑟 − 𝐵𝑎𝑙𝑎𝑛𝑐𝑒 𝑜𝑓 𝑃𝑟𝑖𝑜𝑟 𝑌𝑒𝑎𝑟)
𝑷𝒆𝒓𝒄𝒆𝒏𝒕𝒂𝒈𝒆 𝒄𝒉𝒂𝒏𝒈𝒆 (𝒀 − 𝒐 − 𝒀) =
(𝐵𝑎𝑙𝑎𝑛𝑐𝑒 𝑜𝑓 𝑃𝑟𝑖𝑜𝑟 𝑌𝑒𝑎𝑟)
Example:
Sales
2015
2014
P 250,000
P 175,000
✓Peso change = P250,000 - P175,000 = P75,000
✓Percentage change = (P250,000 - P175,000) / P175,000 = 42.86%
✓This is evaluated as follows: Sales increased by P75,000. This represents growth of 42.86%.
o
Vertical Analysis, also called common-size analysis, is a technique that expresses each financial
statement item as a percentage of a base amount (Weygandt et.al. 2013).
 For the SFP, the base amount is Total Assets.
o Balance of Account / Total Assets.
o From the common-size SFP, the analyst can infer the composition of assets and
the company’s financing mix.
Example:
% Of assets
Cash
P 200,000
200,000/1,400,000 = 14.3%

Accounts Receivable
Inventory
Equipment
Total Assets
400,000
250,000
550,000
P 1,400,000
400,000/1,400,000 = 28.6%
250,000/1,400,000 = 17.9%
550,000/1,400,000 = 39.3%
Sum of the components is 100%
Accounts Payable
Notes Payable
P 300,000
400,000
300,000/1,400,000 = 21.4%
400,000/1,400,000 = 28.6%
Owner, Capital
700,000
700,000/1,400,000 = 50.0%
Total Liabilities and equity P 1,400,000
Sum of the components is 100%
✓The above may be evaluated as follows: The largest component of asset is Equipment
at 39.3%. Cash is the smallest component at 14%. On the other hand, 50% of assets are
financed by debt and the other half is financed by equity.
For the SCI, the base amount is Net Sales.
• Balance of Account / Total Sales.
• This will reveal how “Net Sales” is used up by the various expenses.
• Net income as a percentage of sales is also known as the net profit margin.
Example:
% Of assets
Net Sales
P 900,000
Cost of Goods Sold
400,000
400,000/900,000 = 44.4%
Gross Profit
250,000
500,000/900,000 = 55.5%
Operating Expenses
500,000
200,000/900,000 = 22.2%
Net Income
300,000
300,000/900,000 = 33.3%
✓The above may be evaluated as follows:
• The cost of goods sold is 44% of sales. The company has a gross profit rate of
55.5%. Operating expenses is 22% of sales.
• The company earns income of P 0.33 for every peso of sales. Gross profit
generated for every peso of sale is P 0.555
o
Financial ratio analysis expresses the relationship among selected items of financial
statement data. The relationship is expressed in terms of a percentage, a rate, or a simple
proportion (Weygandtet.al. 2013).
 Here is a sample financial statements to be used for the computations.”
Balance Sheet
Cash
Accounts Receivable
Inventory
Equipment
P 200,000
400,000
250,000
550,000
Total Assets
P 1,400,000
Accounts Payable
Notes Payable
Owner, Capital
Total Liabilities and equity
Income Statement
P 300,000
400,000
700,000
Sales
Cost of Goods Sold
Gross Profit
Operating Expenses
Operating income
Interest Expense
P 1,400,000
280,000.00
Net Income

“The first financial ratio is the profitability ratios, measure the ability of the company to
generate income from the use of its assets and invested capital as well as control its
cost.”
Name of Ratio
Definition
Formula
Gross profit
margin
reports the peso value of the gross profit earned
for every peso of sales.
Gross Profit
500,000
Net Sales
900,000
Operating
income margin
It measures the percentage of profit earned
from each peso of sales in the company’s core
business operations (Horngren et.al. 2013).
Operating
Income
300,000
Net Sales
900,000
Net profit margin
This shows how much profit will go to the owner
for every peso of sales made.
Net Income
280,000
Net Sales
900,000
Return on assets
measures the peso value of income generated
by employing the company’s assets.
Net Income
280,000
Average Assets
1,400,000
Return on equity
measures the return (net income) generated by
the owner’s capital invested in the business.
Net Income
280,000
Average Equity
700,000

Name of Ratio
Asset Turnover
Fixed Asset
Turnover
is an indicator of how fast the
company can sell inventory
Days in Inventory
Accounts
Receivable
Turnover
Days in Account
Receivable
measures the number of times the
company was able to collect on
its average accounts receivable
during the year.

Sample Computation
=
0.5556
=
0.3333
=
0.3111
=
0.2
=
0.4
Next will be operational efficiency ratios measures the ability of the company to utilize its
assets. Operational efficiency is measured based on the company’s ability to generate
sales from the utilization of its assets, as a whole or individually. The turnover ratios are
primarily used to measure operational efficiency.”
Definition
measures the peso value of sales
generated for every peso of the
company’s assets.
indicator of the efficiency of fixed
assets in generating sales.
Inventory Turnover
P 900,000.00
400,000.00
500,000.00
200,000.00
300,000.00
20,000.00
Formula
Net Sales
Average Assets
Sample Computation
900,000
=
0.64
1,400,000
Net Sales
Average Fixed Assets
900,000
550,000
Cost of Goods Sold
Average Inventory
365
Inventory Turnover
Net Sales
Average Accounts
Receivable
365
Accounts Receivable
Turnover
400,000
250,000
365
3.6
900,000
400,000
=
1.64
=
1.6
=
101.39
=
2.25
=
162.22
365
2.25
“The last financial ratio is the financial health ratios look into the company’s solvency
and liquidity ratios. Solvency refers to the company’s capacity to pay their long-term
liabilities. On the other hand, liquidity ratio intends to measure the company’s ability to
pay debts that are coming due (short term debt).
Name of Ratio
Definition
Formula
Sample Computation
Solvency Measures
Debt to Equity
Ratio
indicates the company’s reliance to debt or
liability as a source of financing relative to equity.
Total Debt
700,000
Equity
700,000
Debt Ratio
the percentage of the company’s assets that are
financed by debt.
Total Debt
700,000
Total Assets
1,400,000
Equity Ratio
indicates the percentage of the company’s
assets that are financed by capital. A
Total Equity
700,000
Total Assets
1,400,000
measures the company’s ability to cover the
interest expense on its liability with its operating
income
Liquidity
Operating Income
300,000
Interest Expense
20,000
Current Assets
850,000
Current Liabilities
300,000
Quick Assets
600,000
Current Liabilities
300,000
Interest Coverage
Ratio
Current Ratio
It seeks to measure whether there are sufficient current
assets to pay for current liabilities
Quick Ratio
It does not consider all the current assets, only those
that are easier to liquidate such as cash and accounts
receivable that are referred to as quick assets.
=
=
=
=
=
=
1
50%
50%
15
2.83
2
EVALUATION:
A. Complete the table below by getting the Peso Change value and Year-on-Year growth.
JKL Company
Comparative Balance Sheet
For the Year 2015 & 2016
ASSETS
Cash
Accounts Receivable
Trading Securities
Inventories
Prepaid Expenses
Total Current Assets
Total Noncurrent Assets
Total ASSETS
2015
290,000.00
120,000.00
40,000.00
60,000.00
10,000.00
520,000.00
200,000.00
720,000.00
2016
400,000.00
100,000.00
20,000.00
80,000.00
20,000.00
620,000.00
300,000.00
920,000.00
LIABILITIES
Total Current Liabilities
Total Noncurrent Liabilities
Total LIABILITIES
100,000.00
300,000.00
400,000.00
50,000.00
450,000.00
500,000.00
320,000.00
720,000.00
420,000.00
920,000.00
Peso Change
Y-o-Y (%)
Peso Change
Y-o-Y (%)
EQUITY
Owner’s Capital
Total LIABILITIES & EQUITY
JKL Company
Comparative Balance Sheet
For the Year 2015 & 2016
Net Sales
Less: Cost of Goods Sold
Gross Profit
Less: Opeating Expenses
Earnings Before Interest and Taxes
Less: Interest Expense
Net Income Before Tax
Less: Income Tax
NET INCOME
-
2015
700,000.00
100,000.00
600,000.00
50,000.00
550,000.00
10,000.00
540,000.00
162,000.00
378,000.00
-
2016
900,000.00
80,000.00
820,000.00
120,000.00
700,000.00
50,000.00
650,000.00
195,000.00
455,000.00
B. Using the Comparative Balance Sheet of JKL Company, compute for the following financial ratios for
2015 and 2016.
-
Financial Ratios for 2015 JKL Company Balance Sheet.
Gross Profit Margin
Accounts
Receivable
Turnover
Operating Income
Margin
Days in Accounts
Receivable
Net Profit Margin
Debt Ratio
Return on Assets
Debt ot Equity
Ratio
Return on Equity
Equity Ratio
Assets Turnover
Interest Coverage
Ratio
Fixed Asset
Turnover
Current Ratio
Inventory Turnover
Quick Ratio
Days in Inventory
Working Capital
-
Financial Ratios for 2016 JKL Company Balance Sheet.
Gross Profit Margin
Accounts
Receivable
Turnover
Operating Income
Margin
Days in Accounts
Receivable
Net Profit Margin
Debt Ratio
Return on Assets
Debt ot Equity
Ratio
Return on Equity
Equity Ratio
Assets Turnover
Interest Coverage
Ratio
Fixed Asset
Turnover
Current Ratio
Inventory Turnover
Quick Ratio
Days in Inventory
Working Capital
PRACTICE SET!
A. Complete the table below by getting the Peso Change value and Year-on-Year growth.
C&F Store
C&F Store
Statement of Financial Position
Statement of Comprehensive Income
For the period ending December 31
For the period ending December 31
(in Philippine Peso)
(in Philippine Peso)
Cash
Accounts Receivable
Inventory
Prepaid Rent
Delivery Van
2014
110,000
90,000
129,000
12,000
550,000
2013
87,400
69,920
218,500
4,370
493,810
Sales
Cost of Goods Sold
Gross Profit
Operating Expenses
Interest Expense
2014
810,000.00
348,300.00
461,700.00
234,900.00
40,500.00
2015
686,000.00
301,750.00
384,250.00
205,800.00
17,150.00
Total Assets
891,000
874,000
Net Income
186,300.00
161,300.00
Accounts Payable
Loan Payable
Anistle Cruz, Capital
75,000
400,000
416,000
67,298
393,300
413,402
Total Liabilities and Equity
891,000
874,000
Cash
Accounts Receivable
Inventory
Prepaid Rent
Delivery Van
2014
110,000
90,000
129,000
12,000
550,000
Total Assets
891,000
874,000
Accounts Payable
Loan Payable
Anistle Cruz, Capital
75,000
400,000
416,000
67,298
393,300
413,402
Total liabilities and equity
891,000
874,000
Sales
Cost of Goods Sold
Gross Profit
Operating Expenses
Interest Expense
810,000.00
348,300.00
461,700.00
234,900.00
40,500.00
686,000.00
301,750.00
384,250.00
205,800.00
17,150.00
Net Income
186,300.00
161,300.00
-
Vertical
2013
87,400
69,920
218,500
4,370
493,810
Vertical
Y-o-Y (%)
Financial Ratios for 2014 C&F Store Balance Sheet.
Gross Profit
Margin
Accounts
Receivable
Turnover
Assets
Turnover
Interest
Coverage
Ratio
Operating
Income
Margin
Days in
Accoun
Receivable
Fixed Asset
Turnover
Current Ratio
Net Profit
Margin
Debt Ratio
Inventory
Turnover
Quick Ratio
Return on
Assets
Debt ot Equity
Ratio
Days in
Inventory
Working
Capital
Return on
Equity
Equity Ratio