Financial Statement Analysis

and Overall Interpretation of

Business Results
At the end of this module, I can:
Manifest an understanding of starting and operating a
simple business following the proper financial accounting
practices standards and reporting.
Identify the reasons for keeping business records.
Perform key bookkeeping tasks.
Interpret financial statements (balance sheets, income
statements, cash flow, projections, and summary of sales
and cash receipts).
Prepare an income statement and a balance sheet.
Identify where there is profit or loss for a business.
Generate an overall report on the activity.
Interpret business results and devise a strategic direction.
This module,
Last part of the business plan that
evaluates the overall efficacy or inefficacy
of the marketing and sales strategies and
operational strategies implemented.
It is the checker in a “maker-checker”
concept.
Accounting business transactions are
mandatory. (whether it is flourishing or
losing money)
Income statement, balance sheet, and cash
flow.
The Importance of Keeping Business
Records
Basic Accounting concept of
“SEPARATE ENTITY”
- where the business is a separate
and distinct personality from the
business owner (transactions).
The Importance of Keeping
Business Records
BUSINESS RECORDS
Serve as a powerful analytical tool to:
-Review the past performance of the
business
-Understand the current performance
of the business
-Project future business performance
 The Importance of Keeping Business
Records
BUSINESS RECORDS
Serve as an audit trail where the
entrepreneur can track the transactions of
the past.
It is mandatory that ONLY authorized
accounting personnel or the
entrepreneur himself must pass
accounting entries or accounting
records and maintain a digital copy for
backup purposes.
The Importance of Keeping
Business Records
BUSINESS RECORDS

Passwords- incorporated in digital

copy
Hard copies- kept in a secure place
where they can be accessed by
authorized personnel
BUSINESS RECORDS
Internal control- very important in managing
the business records
Critical functions:
A. Accepting cash
B. Disbursing cash
Each must be assigned to an authorized
employee and recorded in books of business.
These records must be checked by another
person independently to prevent fraud.
Business Transactions- are initially recorded
in a general journal and then in the
general ledger.
General Journal- where initial entries are
recorded and is considered as books of
original accounting entries.
General Ledger- where all the original
accounting entries are transferred to
appropriate accounts (Cash, accounts
receivable, accounts payable, capital).
These appropriate accounts are the
bases of forming basic financial
statements.
With the advent of technology, the
entrepreneur should use
computerized accounting
system because this will make
the accounting processes more
efficient and reliable.
Moreover, these systems and
records can be safely secured for
a long time with a strong
password.
Actual Record Keeping and
Bookkeeping For Business
Most budding entrepreneurs do not
instantly have an accountant or a
bookkeeper because it is too costly.
When the business grows, the
entrepreneur can now hire an accountant
or bookkeeper so that the entrepreneur can
focus on the important management
functions
Actual Record Keeping and
Bookkeeping For Business
However, the entrepreneur must
double check the accounting books to
make sure the accuracy.
In this scenario, the entrepreneur
becomes the checker in the “maker-
checker” accounting concept. Where
the checker should ensure that the
maker did his accounting right.
General Journal to General
Ledger to Financial Statement

ASSETS = LIABILITIES + OWNER’S EQUITY

NET INCOME = GROSS INCOME –
EXPENSES
These are high-level equations.
DOUBLE-ENTRY BOOKKEEPING – requires
a combination of debit and credit for every
accounting entry and to adhere to the balance
sheet and income statement equations.
Preparing Balance Sheet
DEBIT- normal balance of the asset
side

CREDIT- normal balance of liabilities

and owner’s equity.

THE EQUATION MUST ALWAYS BE

BALANCED.
Preparing Income Statement
DEBIT- normal balance of the expense side
CREDIT- normal balance of the income
side

THESE NORMAL BALANCES MUST BE

INCULCATED IN THE ENTREPRENEUR’S
MIND SO HE WON’T GET LOST IN
PREPARING ACCOUNTING ENTRIES.
Summarizing using T-accounts
T-ACCOUNT- is a summary of the debits
and credits for each balance sheet or
income statement account that will be
offset from each other to come up with the
ending balance.
The ending balance of these T-
accounts will be reflected in the general
ledger that will eventually be reflected in
the balance sheet and income statement.
Preparing Cash Flow Statement
The entrepreneur must account
the whereabouts of cash which
could be in a form of receipts or
disbursements from operating
activities, financing activities, and
investing activities.
Normal balances of income statement accounts:
Income – Credit
Expenses – Debit

Normal balances of balance sheet accounts:

Asset – Debit
Liabilities – Credit
Owner’s equity - Credit
 To appreciate actual record keeping
and bookkeeping, let us use the
business of Roainne’s Batutay
Business.

The business started on January 1,

2016. The business needs to record its
transactions for one year and prepare
the basic financial statements for the
year ending 31 December 2016.
STEP 1
 Prepare the accounting entries either manually (using
general journal) or by using an Excel Sheet(Spreadsheet)

1. January 2016. Mr. Ron Lopez and Mrs. Allaine Lopez

started Roainne’s Batutay Business and invested
P200,000. They borrowed this capital from a bank,
payable in three years with an 8% interest per annum.

Dr. Cash 200,000

Cr. Roainne, capital 200,000

Explanation

Cash is a current asset

account; therefore, its increase is
recorded with a debit.
Capital is the owner’s equity
account; therefore, its increase is
recorded with a credit.
2. January 2016. Mr. Lopez went to the
Cabanatuan City Business Permit and
Licensing Office and paid P3,000 for business
registration. Mrs. Lopez, on the other hand,
went to the Department of Trade and Industry
and paid P500 for DTI Permit.

Dr. Business registration expenses 3,500

Cr. Cash 3,500

Explanation

Business registration is an expense

account; therefore its increase is
recorded with a debit.
Cash is credited because its normal
balance is debit, but the transaction
was a decrease in cash.
3. January 2016. Mr. and Mrs. Lopez purchased two
kinds of manufacturing equipment needed to
produce Batutay. They paid P40,000 in cash. They
also bought a larger freezer worth P35,000 in cash.
These pieces of equipment are expected to last for
five years, and the straight line of depreciation will
be used to compute for its net book value.

Dr. Manufacturing equipment 40,000

Dr. Freezer 35,000

Cr. Cash 75, 000

Explanation
Property, plant, or equipment are
noncurrent assets; therefore their
increases are recorded with a
debit.
The example above shows a
compound journal entry because
it involves more than one debit.
4. January 2016. To support the starting capital
expenditures of the business, Mr. and Mrs.
Lopez applied for a bank loan last 15
December 2015 and was approved and
released on 1 January 2016. The loan
amounting Php300 000 is payable in three
years with an 8% interest per annum.

Dr. Cash 300 000

Cr. Loan payable 300 000
Explanation

Loan payable is considered a

long term liability because it is
more than one year and
should be increased with a
credit.
5. January 2016. The couple also purchased a motorcycle
worth Php60 000, a delivery van worth Php450 000, and
a smartphone worth Php30 000. The motorcycle and
delivery van were purchased on account and are payable
for one year. They were given a special installment plan
by the dealer and will pay zero percent interest for 12
months starting 1 February 2016. The monthly
amortization is Php5000 per month for the motorcycle
and Php37 500 for the delivery van. The smartphone was
paid in cash and has an expected life of two years. The
expected life of both motorcycle and delivery van is five
years and will be fully depreciated thereafter. Straight line
depreciation will be applied at the end of every calendar
year.
Dr. Motorcycle 60 000
Dr. Delivery van 450 000
Dr. Smartphone 30 000

Cr. Accounts payable 510 000

Cr. Cash 30 000
Explanation:
Property, plant or equipment are
noncurrent assets; therefore, their increase
is recorded with a debit. Accounts payable
for the motorcycle and delivery van was
recognized because these were purchased
on credit. Increase in accounts payable, a
current liability account, is recorded with a
credit because its normal balance is credit.
6. January 2016. The couple bought all
the items needed for their mini-
restaurant and public market stall as
follows:
 20 chairs Php10 000
 Four tables Php10 000
 Big rice cooker Php2 000
 Frying pan Php1 000
 Two refrigerators Php40 000
The pieces of equipment for the mini-
restaurant are expected to last for three
years. Straight line of depreciation will also
be applied.

Dr. Mini-restaurant furniture and equipment 63 000

Cr. Cash 63 000
7. January 2016. Roainne hired seven people (manpower)
for the business - three for the manufacturing of the
products, two for the public market stall, and three for the
mini-restaurant with respective monthly salaries of Php11
000 each. They are also required to have mandatory 13th
month pay and SSS benefits worth Php5 000 each per
year. Their official start date is 8 January 2016 and will
have their first payroll paid on 15 January 2016. Their
monthly salary will be paid in two installments, every 15th
and every 30th of the month.

No entry. Only financial transactions are recorded in the

books of the business. In this example, no financial
transaction has transpired yet.
8. January 2016. With the assistance of Mr. and
Mrs. Lopez, the manufacturing staff members
started manufacturing batutay. They bought bulk
ingredients in cash from Sangitan public market.
They were able to initially produce 100 kilos of
batutay, and they expect to sell these in two to
three days. Per computation of Mr. and Mrs.
Lopez, the cost per kilo of batutay, which has
about 16pieces, is Php170.
Direct materials 100
Direct labor 40
Manufacturing overhead 30
Cost of goods manufactured 170

Dr. Batutay inventory (Php170 x 100) 17 000

Cr. Cash 17 000
Explanation:

Being a current asset, inventory was

debited to represent the increase.
Salaries payable and utilities payable
are current liability accounts,
therefore, they were increased by a
credit.
9. January 2016. The couple did a competitive analysis
and saw that the current price of batutay in the market is
at an average of Php250. To differentiate themselves and
be competitive, the price of batutay that they will
introduce to the market is Php230. For every kilo of
batutay, they estimate to make Php60 worth of gross
profit. They brought 70 kilos of batutay at the public
market stall because this is where the couple expects that
the majority of sales will come from.
 They left 30 kilos at their home-based location for
the delivery service and mini restaurant.

They officially opened the delivery service and mini

restaurant on 9 January 2016. For the delivery service,
the customer must order a minimum of 1 kilo of raw
batutay which will have the same price Php230 but with a
Php30 delivery charge. The customer can also choose to
order the cooked batutay form the mini restaurant with the
pricing as follows:
 Tosilog
 Tapsilog
 Cornsilog
 Chicksilog
 Sardinsilog
 Tunasilog
 Tuyosilog

Softdrinks and purified water are also served with a

markup of Php10 per serving. Coffee, on the other hand,
is sold for a Php20 markup. The cost of silog meals is
Php50 per meal. The cost of delivery is Php20 per trip.
10. 1 January – 31 December 2016. Roainne was able
to produce additional 20 000 kilos of batutay for the
whole year to supply their public market stall, mini-
restaurant, and delivery service. The other products
in the mini-restaurant are bought in demand, which
means that these are usually sold out at the end of
the week.

Dr. Batutay inventory (Php170 x 20 000) 3 400 000

Cash 3 400 000
 Roainne bought other inventories for the mini-
restaurant business from two suppliers. It paid 800 000 in
cash for the whole year. These inventories consist of
coffee, sugar, cream, soft drinks, purified water, tocino,
eggs, sardines, tuna, tapa, chicken, corned beef,
tuyo(dried fish), rice and garlic.

Dr. Others: inventory 800 000

Cash 800 000
 Roainne was then able to come up with the
following summary of sales and cash receipts data:

15 000 kilos of batutay from the public market stall

1 500 kilos of raw batutay anf 1000 kilos of cooked
batutay from the mini-restaurant
1 000 kilos of batutay from the delivery service,
which means 300 trips for the delivery service
15 000 servings of silog, 10 000 servings of which
are longsilog meals (two pieces of batutay per
serving, which is equivalent to 1 250 kilos x
Php170 = Php212 500)
6 000 servings of coffee
6 000 servings of soft drinks
 It is evident from this data that the business
thrived and that demand grew and grew every month.
The unique selling proposition of Roainne’s Batutay
Business is its efficient and friendly customer service.
The business did not spend much on marketing but
invested on quality service, thereby instigating word of
mouth not just in Cabanatuan City but also in its nearby
municipalities and cities. It also used the power of
social media in promoting its business.
Sample report of Roainne’s Batutay Business
 For easy identification and analysis,
accounting entries must be recorded as the
business transaction happens and from which
business segment they originated. But for the
sake of simple illustration, the following will be
the consolidated entry for these sales and cost of
sales reports.
Dr. Cash 6 514 000
Cr. Sales revenue 6 514 000

Dr. Cost of sale 4 056 000

Cr. Batutay inventory 3 272 500
Cr. Others: inventory 783 500
Batutay inventory computation:
Php2 550 000 + 255 000 + 170 000 + 85 000 +
212 500 = Php3 272 500

Others – inventory computation:

Php6 000 + Php537 500 (750 000 – 212 500) +
120 000 + 120 000 = Php783 500
 For the following transactions, these should ideally
be recorded per month, but for simplicity and
consolidation, the entries will be consolidated for one
year.
31 December 2016
Roainne’s annual lease contract for the public market
stall requires a monthly payment of Php5 000 per
month.
Dr. Rental expense (Php5 000 x 12) 60 000
Cr. Cash 60 000

Depreciation for the manufacturing equipment

and freezer is computed below:
Manufacturing equipment: Php40 000/5 = Php8 000
Freezer: Php35 000/5 = Php7 000
Dr. Depreciation expense: manufacturing equipment
8 000
Dr. Depreciation expense: freezer
7 000
Cr. Accumulated depreciation: manufacturing equipment 8 000
Cr. Accumulated depreciation: freezer 7 000
Depreciation for the motorcycle and delivery van is
computed as follows:
Motorcycle: Php60 000/5 = Php12 000
Delivery van: Php450 000/5 = Php90 000
Dr. Depreciation expense: motorcycle 12 000
Dr. Depreciation expense: delivery van 90 000
Cr. Accumulated depreciation: motorcycle 12 000
Cr. Accumulated depreciation: delivery van 90 000
Depreciation for the mini-restaurant equipment is
computed as follows:
Mini-restaurant equipment: Php63 000/3
= Php21 000
Dr. Depreciation expense: mini- restaurant
equipment 21 000
Cr. Accumulated depreciation: mini-restaurant
equipment 21 000
Depreciation for the smartphone is computed
as follows:
-Smartphone: Php 30 000/2
=Php 15 000
Dr. Depreciation expense: smartphone
Php 15 000
Cr. Accumulated depreciation: smartphone
Php 15 000
Full payment of motorcycle and delivery van is
recorded as follows:
Dr. Accounts payable Php 510 000
Cr. Cash Php 510 000
Payment of salaries for the seven employees with
Php 11 000 monthly salary plus 13th month pay and
SSS benefits.
Dr. Salaries expense (7 x Php 11 000 x 13 months)
Php 1 001 000
Dr. SSS benefits expense (7 x Php 5 000)
Php 35 000
Cr. Cash Php 1 036 000
The principal amount and interest of the bank
loan were paid. Loan amount is Php 300 000 with
8% interest per annum payable in three years.

Dr. Loan payable Php 100 000

Dr. Interest expense Php 24 000

Cr. Cash Php 124 000

The business paid 20% tax based on
net income before tax. In the income
statement below, the net income
before tax (NIBT) is Php 821 500. The
tax due will be Php 821 500 x 20% =
Php 164 300.

Dr. Tax expense Php 164 300

Cr. Cash Php 164 300

Step 2: Calculate the balance of each account
using a T- account or an Excel sheet. The
balances must be chronologically arranged
according to their order in the financial statements.
Balance Sheet Accounts (in Phl peso)
Step 3: Prepare the income statement and
calculate the net profits of the business.
Step 4: Prepare a
balance Sheet and
ensure that the
equation is
balanced.
Step 5: Prepare a cash flow
statement that summarizes the
whereabouts of cash. The
entrepreneur must ensure that
he will not run out of cash in the
course of the business.
Interpretations of Income
Statement, Balance Sheet, and
Statement of Cash Flows
Income statement- the gauge of
the business performance
Balance sheet- the gauge of
financial condition
Cash flow- gauge of liquidity
 Financial statement interpretations of
Roainnes’s Batutay Business
 Income statement- The business performed well on its first year of

operations despite the heavy capital expenditures at the onset. The

business was able to sustain income ratios that are highly acceptable as

follows:

-Gross profit ratio = Gross profit/sales

-P2 098 000/ P 6 054 000= 34%

-This indicates that there are more available funds allocated for other

expenses and profit after deducting cost of sales. The cost of sales in the

first year was managed very well, which could be attributed to efficient

operations and dependable suppliers.

Return on Sales = net income before tax/ sales
-P657 200/ P6 054 000 = 11%
-This indicates that the business performed
well after deducting the cost of sales and
expenses.
Return on Equity = net income after tax/
owner’s equity
Return on assets = net income
after tax/total assets
Php657 200/Php1 057 200 = 62%
Roainne was very successful in
utilizing in its assets because it
made 62% profit for each peso of its
assets
Balance sheet – The purpose of the balance sheet
is not just to show the balance equation but to give
ratios that the entrepreneur can use to analyze the
financial condition of its business. Some of the
ratios that are mandatory to be computed are as
follows:
Current ratio = current assets/current liabilities
Php532 200/0 = 0
The current ratio measures the solvency and liquidity of
the business to pay off its debts and ensure that there is
enough cash to support its operations. It shows that
Roainne was able to manage its current debts on its first
year.
Debt to equity ratio = total liabilities / total capital
Php 200 000 / Php857 200 = 23%
Statement of Cash Flows – The interpretation of
cash flow is the simplest among the three
statements. The objective of any business is to
have a positive cash flow out of its operating,
investing, and financing activities. In the case of
Roainne, it was able to manage its cash flow
well with a remaining balance of Php371 200 at
the end of the year. Cash was primarily the
mode of payment for all transactions. Roainne
also maintains two bank accounts that it
manages on a daily basis. Mr. and Mrs. Lopez
monitor their balances and transaction history
using the banks mobile application.
Overall Interpretation of Business Results
and Devising a Strategic Direction
After interpreting each financial statement one by
one, the last thing to do is to interpret the overall
business results starting with marketing, sales, and
operations. Therefore, the business should devise a
strategic direction for the next year. This strategic
direction is primarily based on the learning and
experience from the first year of operations. The
entrepreneur should retain all the strategies that
worked well while eliminating those that did not
work well and replacing those with something
better.
Overall Interpretation of Business Results
and Devising a Strategic Direction
The first year of operation can also be very reliable
marketing and operations research study, which
can lead to a better strategy for next year and the
succeeding years. The entrepreneur must not stop
researching as research is an iterative process.
Most entrepreneurs become successful only in
their first few years but eventually fail later on
because they were not able to do research.
Competitive analysis, external factor evaluation,
and internal factor evaluation must be performed
ideally every year to assess where the business is.
The strategic direction of the business could be
cost strategies, differential product or service, or a
combination of both.
 Overall Interpretation of Business Results
and Devising a Strategic Direction
The entrepreneur needs to assess his or her marketing
and sales execution simply through return on marketing
investment and through sales reports. The return on
marketing investment is computed by dividing the net
income by the marketing investment. For example, if a
business allocated Php 100,000 for its marketing
activities and generated an increase of Php100,000 in
net income, the return on investment is Php1 for every
Php1 of marketing funds spent. In module 5, the online
clothing business example showed you that marketing
can be cheaper if the internet will be used as a medium.
Some startups leverage on the power of the internet to
promote their products and services because they return
have limited marketing funds.
Overall Interpretation of Business
Results and Devising a Strategic
Direction
The other metric is sales reports. The ultimate objective of a
marketing campaign is to increase sales. Therefore, the
entrepreneur must analyze the effects of marketing
strategies and tactics by looking at the previous sales data
with little or no marketing efforts versus the sales data with
marketing efforts. Nevertheless, the satisfaction of the
objective still lies on the entrepreneur. In the following
example for the online clothing business you first saw in
Module 5, let’s say that the objective of the marketing
campaign is to generate these sales volumes.
 Increase T-shirts sales by 200
 Increase shorts sales by 300
 Increase women’s dress sales by 1 000
 Increase pants sales by 100
 Sales data and variance for 2015 and 2016

Sales Variance Exceeded, Met,

Marketing Tactic 2015 Sales 2016 Sales (Increase or or Below
Data Data Decrease) Objective?

Internet marketing:
social media, web 100 T-shirts 500 T-shirts 400 T-shirts Exceeded
site, and e-mail 100 shorts 400 shorts increase Met
marketing 100 women’s 900 women’s 300 shorts increase Below
campaigns were dresses dresses 800 women’s
launched from 100 pants 300 pants dresses increase Exceeded
January to June 200 pants increase
2016
This goes to show that the internet marketing
campaigns were effective because the sales
figures increased. But, if you look at the data
for women’s dresses, you’ll see that not all
objectives were met. The strategic direction for
next year or the succeeding years is to
continue the Internet marketing campaigns to
boost sales of T-shirts and pants, while
enhancing or improving the campaigns specific
for shorts and women’s dresses. Also the
entrepreneur must look at the competitive
environment and research on the latest
marketing trends, specifically in the online
clothing store and clothing business in general.
The entrepreneur needs to assess his
or her operational execution through
the 4Ms of operations. The following
questions can be used by the
entrepreneur to measure operational
success and by rating each using a
scale from 1 to 5, with 5 being the
highest. The operations metrics are
also given in the table of Assessment
and operational execution, which will
serve as a measurement of
operational success.
Assessment of operational execution
Methods Machines Manpower Materials
 Were the business  Were you able to buy  Are the people fully  Were the materials
model and the most practical but maximized? sourced from at least
processes efficient still efficient machines  Operational metrics: two reliable and cost-
to produce goods or to support your Time-and-motion efficient suppliers?
serve the customers business? study; peak and  Operational metrics:
effectively?  Operational metrics: nonpeak hours; Bulk pricing; quality of
 Operational metrics: Competitors’ capacity planning and materials
Service blueprint; machines; suppliers utilization  Were the materials
manufacturing offerings; suitability of  Are the people happy produced in the most
process time; machines to business to work in the efficient way?
bottlenecks in  Was the latest business?  Operational metrics:
production technology used to  Operational metrics: Distribution process;
 Was the latest operate efficiently? Employee feedback; spoilage; delivery
technology used to  Operational metrics: attrition rate turnaround-time
operate efficiently? Manual processes
 Operational metrics: that can be
Manual processes automated; outdated
that can be and inefficient
automated; outdated technology
and inefficient
technology
 Let’s use again the operations of Roainne’s Batutay Business
Methods Machines Manpower Materials
 Were the business model  Were you able to buy the  Are the people fully  Were the materials sourced
and processes efficient to most practical but still maximized? from at least two reliable and
produce goods or serve efficient machines to support cost-efficient suppliers?
the customers effectively? your business?

Score: 4
Score: 5 Score: 5
 Operational metrics: The
business model used is  Operational metrics: The  Operational metrics: The
manufacturing and service. machines bought were new Score: 3 ingredients are sourced from
The production of and with very practical two reliable suppliers with
longganisa is efficient payment terms  Operational metrics: The very practical prices
being home-based, but the delivery staff is not fully especially when bought in
delivery service is still a maximized on nonpeak hours bulk.
stretch because or days. Also, the other staff
Cabanatuan city is quite members in the public market
large to be covered by one stall are not 100% utilized.
delivery boy

 Do you use the latest technology to operate efficiently?  Are the people happy to work  Were the materials produced
in your business? in the most efficient way?
Score: 4

Score: 4 Score: 5  Operational metrics: The

manufacturing and
 Operational metrics: The business uses the power of mobile  Operational metrics: distribution processes are
technology and social media to assist them in operations. Employees are happy efficient but can still be
However, for the payment system, they can also introduce because the owners are improved such as scheduling
offering credit card payments, as cash is the only mode of taking care of them and they production based on demand
payment. are given competitive salary, or season to avoid spoilage
considering they are in the or underproduction on peak
province. Also, their job is not days.
as stressful as it seems to be
Average scores:
Methods – 4.0; Machines – 4.5 ; Manpower – 4.0 ; Materials – 4.5

Based on this analysis, the business strategic direction next year

and maybe in a few more years is to maintain those with five points
and introduce the following:
 Methods – If the demand grows for the delivery service, aside from
the motorcycle, the delivery van can also be used. The van is idle
when not being used for transferring finished goods from the
manufacturing site to the public market stall and for buying
ingredients from the public market. They can also introduce the
credit card or debit card payment options if the customers demand
so.
 Machines – Introduce point-of-sale terminals for debit and credit
card transactions.
 Manpower – Assign other functions to the delivery staff members
and public market stall staff members during their idle time.
 Materials – Make an efficient production scheduling based on
demand and season.
 THANK YOU!!!
ANDALE LIBREA
AVILA NEGOSO
BAULETE TAN
HINOGUIN