FINANCIAL STATEMENT ANALYSIS
What is Financial Statement Analysis?
• It is the evalua tion of the firm’s past
performance, present condition, a nd business
potential
• It provides informa tion on the profitability of
the business firm, its a bility to meet company
obligations, the safety of investment in the
business, and the effectiveness of
ma nagement in running the firm.
FS Analysis Tools and Techniques
Horizontal Analysis (trend or index analysis)
o involves the com parison of figures shown in
the financial statements of two or more
consecutive periods. The difference in the
am ount between the two periods is ca lculated,
and the percenta ge cha nge from one period to
the next is computed using the earlier period as
the ba se period.
o 𝑪𝒉𝒂𝒏𝒈𝒆 = 𝑴𝒐𝒔𝒕 𝒓 𝒆𝒄𝒆𝒏𝒕 𝒗𝒂𝒍𝒖𝒆 −𝑩𝒂𝒔𝒆 𝒑𝒆𝒓𝒊𝒐𝒅 𝒗𝒂𝒍𝒖𝒆
𝑩𝒂𝒔 𝒆𝒅 𝑷𝒆𝒓𝒊𝒐𝒅
o If the base year is equa l to zero or negative ,
then percentage cha nge cannot be computed.
VERTICAL ANALYSIS
➢ the process of comparing figures in the
financial statements of a single period. It
involves the conversion of figures in the
statements of a single period. It involves the
conversion of figures in the statements to a
common base. This is accom plished by
expressing all figures in the statem ents as
percentages of an importa nt item such a s total
assets (in the balance sheet) or net sales (in the
income sta tement). These converted statements
are called common-size statements or
percentage composition statements
➢ Percenta ge composition statements are used
for com paring; multiple yea rs of data from the
sam e firm, companies tha t are different in size,
and compa ny-to-industry averages.
RATIO ANALYSIS
➢ the development of mathematical relationships
am ong a ccounts in the financial statements.
Ratios are calculated from these statements to
provide users and analysts with relevant
information a bout the firm’s liquidity,
solvency, and profitability
BASIC RULES ON RATIO CALCULATIONS
• When calculating a ratio using the balance
sheet a mounts only, the numerator and
denominator should be based on amounts as of
the balance sheet date. The same is true for
ratios using only income statement numbers.
Exception: calculation of growth ratios.
• If a n income statement amount and a ba lance
sheet amount are used to calculate a ratio, the
balance sheet amount should be expressed a s
an a verage for the period represented by the
income statement amount.
• If the beginning balance of a balance sheet
account is not a vailable, the ending ba lance is
normally used to represent the average balance
of the a ccount.
• If sa les and/or purcha ses a re given without
ma king the distinction as to whether m ade in
cash or on credit, assumptions are made
depending on the ratio being calculated
➢ Turnover ratios: sales a nd purchases
are made on credit
➢ Cash flow ratios: Sales and purchases
are made in cash
• Generally, the number of days in a month or
year is not critical to the analysis: a year may
have 360 days, 52 weeks, a nd 12 months,
alternatively, a year may be com prised of 365
calendar days, 300 working days, or any
appropriate number of days.
Financial Ratios
Tests of Liquidity
Current ratio (Banker's
ratio)
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
Quick Ra tio (Acid-Test
Ratio)
𝑄𝑢𝑖𝑐𝑘 𝐴𝑠𝑠𝑒𝑡𝑠
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
