Financial Statement PowerPoint, Study notes of Financial Statement Analysis

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FINANCIAL

STATEMENTS:

Tools for decision making

OBJECTIVES

 (^) Appreciate the importance of financial analysis as analytical process.  (^) Discuss the three basic decision areas dealt with by managers and the items involved in these decisions.  (^) Explain the steps in analyzing financial statements.  (^) Differentiate horizontal analysis from vertical analysis and appreciate their importance in business decision-making.  (^) Demonstrate how to prepare a common-size balance and income statement and analyze the changes therein.  (^) Explain the different profitability ratios and their importance in decision-making and solve problems using them.  (^) Discuss the limitations of financial statements and financial statement analysis.

FINANCIAL ANALYSIS

 Deals with the understanding of the relationship between financial concepts and daily decision-

making.

 It is both an analytical and judgmental process which helps answer questions in managerial

context.

BASIC DECISION AREAS OPERATION FINANCE INVESTMENT

INVESTMENT DECISION

 (^) Refers to deciding what assets to acquire, be they current assets as marketable securities or non-current assets as property, plant or equipment and long-term investments in stocks and bonds.  (^) It includes the decisions relative to projects to undertake or business to enter to.  (^) Current available resources and new founding obtained can be utilize to fund: a) Working capital – working capital budget for operating expenses and payment for current liabilities. b) Property plant and equipment- capital budgeting- capital expenditure intended for long-term assets and projects. c) Major spending programs- e.g. research and development, product or service development, promotional and advertising programs or long-term investment alternatives for excess funds so that cash can be converted into an earning asset.

FINANCING DECISION

 (^) Refers to decision that involves funding investments and operations over the long run.  (^) Includes decisions that relate to the companies capital structure, debt-equity mix, funding sources, dividend policies, cost of capital, among others.

STEPS IN ANALYZING THE FINANCIAL STATEMENTS  (^) Understanding the information provided in the financial statements- any reader of the financial statements, especially the manager, who is to make decisions to benefit the enterprise, needs to have a basic knowledge of finance in its contextual meaning to avoid confusion and misleading or wrong decisions, which are sometimes, fatal to the business.  (^) Drawing logical conclusion based on the data presented- i.e., financial statements for two or more periods are necessary before one can make a decision on how the business is performing or how the condition of the company is changing. Comparative analysis of sales or revenue and expenses can help the manager decide on where the company needs improvement-sales, manufacturing or expenses.  (^) Making the appropriate decision on the course of action to take- After drawing logical conclusion, the manager or user of the financial statements is now able to determine the course of action to take to correct what needs correction and the steps necessary to redirect company efforts towards the goals that the company has set.

VERTICAL ANALYSIS

 (^) Refers to the type of analysis where one number is compared to another to identify significant relationships. TWO TYPES OF VERTICAL ANALYSIS:

1. Common-size Statements or Percentage Analysis- Show the relationship between items in a single statement, either in the balance sheet or in the income statement. It shows the percentage relationship of an element of the financial statement to a significant total amount in the financial statement.
2. Ratio Analysis- Compares one figure to another. Also it compares one period with another period.  (^) Profitability ratios indicate whether the company is earning or not  (^) Liquidity ratio indicates if the company is able to pay its maturing obligations.  (^) Long-term debt ratio indicate the ability of a firm to pay its liabilities in the long run.

PROFITABILITY RATIOS

 (^) Return on Owners’ Investment (ROI)- Sometimes referred to as ROE. It relates income or profit after income tax to the total stockholders’ equity. The average is computed by adding the beginning and the ending balances and dividing it by two.  (^) Profit margin- also known as return on sales, (ROS) is the ratio of income to net sales.  (^) Return on Assets- Is a measure of asset utilization.

LONG-TERM DEBT RATIOS

 (^) Debt ratio- relates total liabilities to total assets.  (^) Stockholders’ ratio- relates total stockholders’ equity to total assets.  (^) Debt-equity ratio- relates the total liabilities to total stockholders’ equity.  (^) Interest coverage ratio- indicates the company’s ability to pay its interest on its obligation.

LIMITATIONS OF FINANCIAL

STATEMENTS ANALYSIS

1. Data are reported at historical costs.
2. Data are all in monetary terms.
3. Financial statements use estimates.
4. Financial statements use judgments.
5. Financial statements are interim in nature.
6. Financial statements assume stable monetary.

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