Fundamentals of Accountancy, Business, and Management 2

Fundamentals of
Accountancy, Business
& Management 2
SLA No. 5 (Week 6-7): Financial
Statement Analysis
At the end of the topic, students should be able to:
1. Solve exercises and problems that require computation and

interpretation using horizontal analysis, vertical analysis and
financial ratios
2. Using the downloaded sample financial statements, perform
the horizontal and vertical analysis; compute the various
financial ratios and interpret it thereafter
What is Financial
statement (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:
1. HORIZONTAL ANALYSIS
- It is also called trend analysis, is a technique for evaluating
a series of financial statement data over a period of time
with the purpose of determining the increase or decrease
that has taken place (Weygandtet.al 2013).
- It uses financial statements of two or more periods.
- All line items on the FS may be subjected to horizontal analysis.

- 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
• Percentage change = (Balance of Current Year-Balance of

Prior Year) / (Balance of Prior Year)
In a simpler statement, we can derive a formula for horizontal
analysis as follows:
CURRENT YEAR AMOUNT - PREVIOUS YEAR AMOUNT

PREVIOUS YEAR AMOUNT
ILLUSTRATIVE EXAMPLE
The following information was taken from the comparative income
statement of Lino Gaw Company for the year 2016 and 2017. Analyze
the following using Horizontal Analysis.
2014 2015
SALES P175,000 P250,000
Cost of Sales (100,000) (125,000)
Gross Profit P75,000 P125,000
% change of SALES = CURRENT YEAR AMOUNT - PREVIOUS YEAR AMOUNT
= P250,000-175,000
175,000
% change of SALES = 42.86%
Interpretation: The sales in 2015 increased by P75,000 or

42.86% from the sales of the previous year
% change of COST of SALES = CURRENT YEAR AMOUNT - PREVIOUS YEAR AMOUNT
= P125,000-100,000
100,000
% change of COST OF SALES = 25%
Interpretation: The cost of sales in 2015 increased by P25,000 or 25% from the cost of
sales of the previous year
% change of GROSS PROFIT = CURRENT YEAR AMOUNT - PREVIOUS YEAR AMOUNT
= P125,000-75,000
75,000
% change of GROSS PROFIT = 66.67%
Interpretation: The cost of sales in 2015 increased by P50,000 or 66.67%

from the gross profit of the previous year
2. VERTICAL ANALYSIS
- This is also called as the common-size analysis and it
expresses each financial statement item as a percentage of
a base amount (Weygandt et. al., 2013)
For the Statement of Financial Position, the base amount is the TOTAL
ASSETS.
For the Income Statement, the base amount is *NET SALES
*NET SALES is the residual amount after deducting SALES DISCOUNTS and SALES RETURNS
& ALLOWANCES from the amount of GROSS SALE
Illustrative Example
lllustrative Example
Working Capital is the difference between current assets and
current liabilities.
Example:
Mina Thay’s current assets revealed an amount of P450,000
and its current liabilities amounted to P150,000 thus the working
capital is P300,000 (P450,000-P150,000).
3. RATIO ANALYSIS
• Ratio is a mathematical expression of the relationship of one item to another. It
provides an information of how well the company and its business units are performing
• Turnover refers to the number of times an item is used or disposed of
Illustrative Example
The following are the condensed balance sheet and income statement taken from the records of Dina Eng’s Company for the
year ended December 31, 20xx.
Dina Eng’s Company

Balance Sheet
As of the year ended December 31, 20xx
Cash P200,000 Accounts Payable P300,000

Accounts Receivable 400,000 Notes Payable 400,000
Inventory 250,000 Dina Eng, Capital 700,000
Equipment 550,000
TOTAL ASSETS P 1,400,000 TOTAL LIABILITIES AND EQUITY P1,400,000
Dina Eng’s Company
Income Statement
For the year ended December 31, 20xx
Sales P900,000
Cost of Goods Sold 400,000)
Gross Profit P500,000
Operating Expenses (200,000)
Operating Income P300,000
Interest expense (80,000)
NET INCOME P280,000
A. 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.
✔ GROSS PROFIT RATIO

✔ OPERATING INCOME RATIO
✔ NET PROFIT RATIO
✔ RETURN ON ASSET (ROA)
✔ RETURN ON EQUITY (ROE)

2. OPERATIONAL EFFICIENCY RATIOS
- measure the ability of the company to utilize its assets.
✔ ASSET TURNOVER
✔ FIXED ASSET TURNOVER
✔ INVENTORY TURNOVER
✔ ACCOUNTS RECEIVABLE TURNOVER

3. FINANCIAL HEALTH RATIOS
- These ratios look into the company’ solvency and liquidity.
✔ DEBT RATIO
✔ EQUITY RATIO
✔ DEBT TO EQUITY RATIO
✔ INTEREST COVERAGE RATIO
✔ CURRENT RATIO
✔ QUICK RATIO OR ACID TEST RATIO

THANK YOU.

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Fundamentals of

1. Solve exercises and problems that require computation and

- It uses financial statements of two or more periods.

- All line items on the FS may be subjected to horizontal analysis.

• Peso change = Balance of Current Year-Balance of Prior Year

• Percentage change = (Balance of Current Year-Balance of

CURRENT YEAR AMOUNT - PREVIOUS YEAR AMOUNT

Interpretation: The sales in 2015 increased by P75,000 or

% change of COST OF SALES = 25%

% change of GROSS PROFIT = 66.67%

Interpretation: The cost of sales in 2015 increased by P50,000 or 66.67%

Dina Eng’s Company

Cash P200,000 Accounts Payable P300,000

✔ GROSS PROFIT RATIO

✔ RETURN ON EQUITY (ROE)

✔ FIXED ASSET TURNOVER

✔ ACCOUNTS RECEIVABLE TURNOVER

✔ DEBT TO EQUITY RATIO

✔ INTEREST COVERAGE RATIO

✔ QUICK RATIO OR ACID TEST RATIO

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