Chapter 3 - Financial Statement Analysis
Financial statement analysis is the process of analyzing a company's financial statements for decision -making purposes.
External users use this to assess and evaluate the financial performance, business value, and over -all condition of the
organization.
Analyzing Financial Statements
In general, financial statements are centered around generally accepted accounting principles (GAAP) in the U.S. These
principles require a company to create and maintain three main financial statements: the balance sheet, the income
statement, and the cash flow statement.
OBJECTIVES OF FINANCIAL STATEMENT ANALYSIS
• Users of financial statement have common requirements where the very objective of financial analysis originate.
• The financial analysis aims to probe the company's:
a. Profitability - the ability of the business to produce a return on an investment based on its resources in
comparison with an alternative investment.
b. Liquidity and Stability
i. Liquidity - the capacity of the business to pay its currently maturing obligations.
ii. Stability or Solvency - the capacity of the business to pay its long-term obligations.
c. Asset utilization or activity - how efficient the company is in managing its resources.
d. Debt-utilization or Leverage - the overall debt status of the company.
The main objective of financial statement analysis is to provide information about the financial position, performance
and changes in financial position of a company that is useful to a wide range of users in making economic decisions. By
examining the past and current financial data, investors can evaluate a company’s performance and financial position as
well as assessing risks. Financial statement analysis yields valuable information about trends and relationships, the
quality of a company's earnings, and the strengths and weaknesses of its financial position.
METHODS OF FINANCIAL STATEMENT ANALYSIS
There are two key methods for analyzing financial statements. The first method is the use of horizontal and vertical
analysis.
• Horizontal Analysis is the comparison of financial information over a series of reporting periods.
○ Comparative Analysis. In the field of accounting, it has been a requirement by the GAAP to present
comparative statements for the current year and the previous year. This facilitates comparison of the
company's financial position and results of operation.
In Comparative Analysis, the balance of the accounts in the financial statements of the previous year is
subtracted from the current year. This would result to a change, either a growth or a reduction.
Percentage of change = Amount of change/Amount in the previous year/base year
○ Trend Analysis. Under this method, the percentage changes are determined for several successive periods
instead of the typical two-year period horizontal analysis.
In computing the trend, the base period (usually the oldest year) amounts are written as 100%. The
percentage relationship of each account in the statements is then computed by dividing each amount by
the base year figure.
Trend percentage = figure of account in the given year/base year figure
• Vertical analysis or Common-size statement analysis is the proportional analysis of a financial statement, where
each line item on a financial statement is listed as a percentage of another item. Every line item on an income
statement is stated as a percentage of net sales, while every line item on a balance sheet is stated as a
percentage of total assets.
The horizontal analysis is using two (2) periods (for comparative) and three (3) or more periods (for trend) in
analyzing the financial statements while the vertical analysis use only one (1) period of financial statement.
In vertical analysis, each account figure is divided by the base figure. It presents the relative size of an account or
item in proportion to the whole (which is the base).
Proportional percentage = account figure/base figure
Base for:
Income Statement = net sales
Balance Sheet = total assets
HORIZONTAL ANALYSIS OF COMPARATIVE STATEMENTS EXAMPLE
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This is the change of
sales from year
2013 to 2014
This is the percentage of
change of sales.
% of change =
(30,000/195,000) * 100
VERTICAL ANALYSIS OF COMMON-SIZE STATEMENTS EXAMPLE
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VERTICAL ANALYSIS OF COMMON-SIZE STATEMENTS EXAMPLE
This is the proportional percentage
of Sales to net Sales
Proportional % =
(225,000/221,160) * 100
The percentage of the
base is always 100%
The base in income
statement is the Net
Sales
TREND ANALYSIS EXAMPLE
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This is the trend
percentage for 2007.
Trend % =
(28,857/24,088) * 100
This is the base year.
The base year is usually the oldest year, however, any year could be the base year upon the discretion of the
management. Please note that if the problem is silent about the base year, we will assume that the base year is the
oldest year. In the case of the example above, the base year is year 2006.
References:
Fundamentals of Financial Management by Ma. Flordeliza L. Anastacio
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