FRAMEWORK FOR FINANCIAL ANALYSIS

1. Analysis of the funds needs of the firm.

2. Analysis of the financial condition and profitability of the firm.

3. Analysis of the business risk of the firm.

 A Financial Manager must consider all three jointly when determining the financing needs of the firm.

 Negotiations with suppliers of capital.

Who analyzes financial statements?

o Internal users (i.e., management)

 Planning, evaluating and controlling company operations

o External users (Investors, Creditors, Regulatory Agencies, Stock Market Analyst)

 Assessing past performance and current financial position and making predictions about the future profitability
and solvency of the company as well as evaluating the effectiveness of management.

Information is available from

• Published annual reports

1. Financial Statements

2. Notes to Financial Statements

3. Letters to stockholders

4. Auditor’s report (independent accountants)

5. Management ‘s discussion and analysis

 • Reports filed with the government

Information is available from

• Other sources

2. Newspapers

3. Periodicals

4. Financial information organizations

5. Other business publications

METHODS OF FINANCIAL STATEMENT ANALYSIS

 HORIZONTAL ANALYSIS

 VERTICAL ANALYSIS

 COMMON SIZE STATEMENTS

 TREND PERCENTAGES

 RATIO ANALYSIS

HORIZONTAL ANALYSIS - Using comparative financial statements to calculate dollar or percentage changes in a financial statement item from
one period to the next.

Example:

The management of Mahal_17 Company provides you with comparative balance sheets of the years ended December 31, 1999 and 1998.
Management asks you to prepare a horizontal analysis on the information.
 MAHAL_17 CORPORATION
COMPARATIVE BALANCE SHEETS
DECEMBER 31, 1999 AND 1998

INCREASE (DECREASE)
1999 1998 AMOUNT %
ASSETS
CURRENT ASSETS

CASH 12,000.00 23,500.00 (11,500.00) -48.9%

ACCOUNTS RECEIVABLE, NET 60,000.00 40,000.00 20,000.00 50.0%

INVENTORY 80,000.00 100,000.00 (20,000.00) -20.0%

PREPAID EXPENSES 3,000.00 1,200.00 1,800.00 150.0%

TOTAL CURRENT ASSETS 155,000.00 164,700.00 (9,700.00) -5.9%

PROPERTY AND EQUIPMENT

LAND 40,000.00 40,000.00

BUILDINGS AND EQUIPMENT, NET 120,000.00 85,000.00 35,000.00 41.2%

TOTAL PROPERTY AND EQUIPMENT 160,000.00 125,000.00 35,000.00 28.0%

TOTAL ASSETS 315,000.00 289,700.00 25,300.00 8.7%

 INCREASE
(DECREASE)
1999 1998 AMOUNT %
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES

ACCOUNTS PAYABLE 67,000.00 44,000.00 23,000.00 52.3%

NOTES PAYABLE 3,000.00 6,000.00 (3,000.00) -50.0%

TOTAL CURRENT LIABLITIES 70,000.00 50,000.00 20,000.00 40.0%

LONG TERM LIABILITIES

BONDS PAYABLE, 8% 75,000.00 80,000.00 (5,000.00) -6.3%

TOTAL LIABILITIES 145,000.00 130,000.00 15,000.00 11.5%

STOCKHOLDERS' EQUITY

PREFFERED STOCK 20,000.00 20,000.00 - 0.0%

COMMON STOCK 60,000.00 60,000.00 - 0.0%

ADDITIONAL PAID IN CAPITAL 10,000.00 10,000.00 - 0.0%

TOTAL PAID IN CAPITAL 90,000.00 90,000.00 - 0.0%

RETAINED EARNINGS 80,000.00 69,700.00 10,300.00 14.8%

TOTAL STOCKHOLDERS' EQUITY 170,000.00 159,700.00 10,300.00 6.4%

TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY 315,000.00 289,700.00 25,300.00 8.7%

 MAHAL_17 CORPORATION
COMPARATIVE INCOME STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1999 AND
1998
INCREASE
(DECREASE)
1999 1998 AMOUNT %

NET SALES 520,000.00 480,000.00 40,000.00 8.3%

COST OF GOODS SOLD 360,000.00 315,000.00 45,000.00 14.3%

GROSS MARGIN 160,000.00 165,000.00 (5,000.00) -3.0%

OPERATING EXPENSES 128,600.00 126,000.00 2,600.00 2.1%

NET OPERATING INCOME 31,400.00 39,000.00 (7,600.00) -19.5%

INTEREST EXPENSE 6,400.00 7,000.00 (600.00) -8.6%

NET INCOME BEFORE TAXES 25,000.00 32,000.00 (7,000.00) -21.9%

LESS INCOME TAXES (30%) 7,500.00 9,600.00 (2,100.00) -21.9%

NET INCOME 17,500.00 22,400.00 (4,900.00) -21.9%

VERTICAL ANALYSIS - For a single financial statement, each item is expressed as a percentage of a significant tool, e.g. all income statement
items are expressed as a percentage of sales.

Example:

The management of Denrel Company asks you to prepare a vertical analysis for the comparative balance sheets of the company.

DENREL COMPANY
BALANCE SHEET (ASSETS)
AT DECEMBER 31, 1999 AND 1998
% OF TOTAL
ASSETS
1999 1998 1999 1998

CASH 82,000.00 30,000.00 17% 8%

ACCOUNTS RECEIVABLE 120,000.00 100,000.00 25% 26%

INVENTORY 87,000.00 82,000.00 18% 21%

LAND 101,000.00 90,000.00 21% 23%

EQUIPMENT 110,000.00 100,000.00 23% 26%

ACCUMULATED DEPRECIATION (17,000.00) (15,000.00) -4% -4%

TOTAL 483,000.00 387,000.00 100% 100%

 DENREL COMPANY
BALANCE SHEET (LIABILITIES & STOCKHOLDERS' EQUITY)
AT DECEMBER 31,1999 AND 1998
% OF TOTAL
ASSETS
1999 1998 1999 1998
ACCOUNTS PAYABLE
WAGES PAYABLE 76,000.00 60,000.00 16% 16%
NOTES PAYABLE 33,000.00 17,000.00 7% 4%
COMMON STOCK 594,000.00 444,000.00 123% 115%
RETAINED EARNINGS 154,000.00 100,000.00 32% 26%
TOTAL 483,000.00 387,000.00 100% 100%
FINANCIAL STATEMENT ANALYSIS

REPORTERS:
DENNIS M. AUJERO
AILEN S. DE LUNA