FMPR2 Module Booklet
FMPR2 Module Booklet
FMPR2 Module Booklet
Preface
This learning module is conceptualized and come into fruition as the answer to con-
tinuous learning despite the COVID-19 pandemic using the blended learning mo-
dalities. This was conceived as a vital tool in delivering learning and foster under-
standing of financial analysis as instrumental in the decision-making of every busi-
ness organization.
The module is broadly divided into four units. Each unit begins with course learn-
ing outcomes and specific learning outcomes and is divided into lessons that were
interrelated with each other. Each lesson starts with warm up activities and end
with learning activities. There are also Units with case analysis as provided for in
the major performance output of the course syllabus.
Unit I discusses the conceptual framework of financial reporting. There are two les-
sons that covers the fundamental requirements of the Framework and the different
Standards on financial presentation and reporting.
Unit II presents the financial statement analysis process. It also presents the most
common tools and techniques as well as the sample illustration of interpretation
and conclusion. There are four lessons that will enable the learners to analyze the
operating performance of the business relative to its liquidity, profitability, activity,
asset and debt utilization.
Unit III contains equity valuation as an important basis for a business decision-
making. There are two lessons that presents the basic concepts as well as the differ-
ent valuation methods.
Unit IV provides simple steps on preparing a presentation that serves as the final
requirement of the subject. Practical steps and tips are provided for the learners to
apply.
The authors hope that the student’s yearning for better understanding on financial
analysis will be addressed by this module.
-Marichu B. Montecillo,DM
I FEATURES
Lesson I
Course Learning Outcome: Examine the financial reporting standards applicable to Philippine
business.
Summarize the financial reporting standards from International Financial Reporting Standards (IFRS)
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Michael Koss simultaneously held 5 senior management positions: Vice Chairman, Chief
Executive, Chief Operating Officer, President, and Chief Financial Officer. Koss had little
or no educational background or experience in the areas of accounting or finance and
allegedly delegated important responsibilities typically performed by the CFO to Sachde-
va on a regular basis.
Koss Corporation’s control environment appears to have been remarkably relaxed and its
corporate board rarely changed. Excluding a member added in 2006 and founder John
Koss, board members had an average tenure of 27 years.
Unlike the proxy statements of typical public companies, Koss made no mention of any ac-
counting expertise among audit committee members.
Because it was a small company, Koss was not subject to a section of the Sarbanes-Oxley
Act that requires outside auditors to evaluate a company’s internal controls over finan-
cial reporting. During the embezzlement, Koss’s audit fees were reduced by half from
$114,900 in 2007 to $63,600 in 2008. In 2006, Sachdeva co-chaired a fundraising gala
for Big Brothers Big Sisters with one of Koss’s outside auditors.
Required:
1. Assume that you are a member of the audit team. Identify the fraud risk factors for
misappropriation of assets that were present at Koss Corporation.
2. Is it appropriate for one individual to hold 5 significant senior management posi-
tions all at the same time in a publicly traded company? Why or why not?
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Lesson II
Horizontal Analysis
Lesson III
Vertical Analysis
Lesson IV
Ratio Analysis
2. Explain the concept of financial statement analysis and its importance to different
users
3. Discuss the steps in performing financial statement analysis
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LESSON INTRODUCTION TO
FINANCIAL STATEMENT
I ANALYSIS
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Definition
Financial statement analysis is the process of evaluating the company’s financial performance and its
overall financial health in order to arrive a better and reliable decision.
1. Investors
2. Management 6. Tax Authorities
4. Lenders 8. Researchers
5. Suppliers 9. Government
Below are the most common objectives that diverse users of financial statement are interested:
1. Profitability. As an objective of analysis, profitability refers to capacity of the firm to generate suffi-
cient revenue that will result to a positive and ample profit.
2. Liquidity or Short-term Solvency. This objective refers to the capacity of the firm to pay its currently
maturing obligation.
3. Stability or Long-term Solvency. This refers to the paying capacity of the firm to settle its long-term
obligations.
4. Asset Utilization. It is also called Activity. This refers to how efficient the company in utilizing their
resources.
5. Debt utilization. It is also called Leverage. This refers to the overall debt status of the firm.
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Limitations of Financial Statement Analysis
1. It does not consider changes in purchasing power of currencies.
2. It does not consider inconsistencies and dissimilarities in accounting principles, policies,
and procedures used by the firms in the industry.
3. Financial data is not adjusted for price changes or inflation/deflation mainly because the
cost principle is used to prepare financial statements.
4. Differences in fiscal year ends making comparison of companies’ difficult if the industry is
cyclical.
5. The diversity of the companies’ operation make it difficult to classify for comparison pur-
poses.
Differences in accounting methods, such inventory and depreciation methods, makes compar-
ison difficult for companies.
Interpretation of FS
Analysis
Conclusion
Recommendation
Accessibility is an important factor when selecting what standard to choose. The information
which is quickly retrievable at a least cost should be the choice in the analysis.
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Practical Steps in Financial Statement Analysis
1. Know the firm first.
Know their vision and mission, strategies, organizational structure and their nature of opera-
tion. Knowledge on the company background is essential prior to the conduct of the analysis.
2. Know the objective/s of the analysis.
Determine what the company’s wants you to assess. It can the liquidity, profitability, solvency
or other objectives, if not all objectives of the financial analysis.
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Learning Activities
Activity 1. Identify the different tools used in financial statement analysis based from
the results presented below.
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LESSON
HORIZONTAL ANALYSIS
II
Provided below are data extracted from the annual financial re-
port of Berry Bags Inc. for the comparative year 2019 and 2018. Based
from your learnings in your prerequisite subjects, you are to compute
for the change in amount and the percentage change. After computing,
you are to answer the questions presented after the table.
How much is the difference is the company’s operating income from 2018 to 2019?
__________________
Self Assessment
After answering the warm-up activity above:
Did you find it easy to calculate the required figures?
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The importance of having a reliable basis for decision making can-
not be undermined in modern business world. Without sufficient data
that will help give meaning to the figures in the financial statement can
either me or break a company. This is why companies resort to different
tools and techniques in analyzing their financial statement for it to be
useful in the decision making.
Definition of Horizontal Analysis
Horizontal analysis, also called dynamic analysis or trend analysis, is the comparison of fi-
nancial information of a company with historical financial information of the same company
over a number of reporting periods.
Purpose of Horizontal Analysis
The main purpose is to see if the numbers are high or low in comparison to past records,
which may be used to investigate any causes for concern. For example, certain expenditures
that are high currently, but were well under budget in previous years may cause the man-
agement to investigate the cause for the rise in costs; it may be due to switching suppliers or
using better quality raw material.
Advantages Disadvantages
Company can review its performance in The aggregated information expressed in the financial
comparison to the previous periods statements may have changed over time
Allows investors and analysts to see what Changes can cause variances to creep up when account
has been driving a company's financial balances are compared across periods.
performance over a number of years
Enables to spot trends and growth pat- It can be manipulated to show comparisons across peri-
terns such as seasonality. ods.
Comparative study of financial statements is the comparison of the financial statements of the
business with the previous year’s financial statements.
The comparative balance sheet shows the different assets and liabilities of the firm on different
dates to make comparison of balances from one date to another. The comparative balance sheet
has two columns for the data of original balance (increase/decrease) in figures. The fourth column
may be added for giving percentages of increase or decrease. When looking into the liquidity position
of a concern, the analyst should examine the working capital in both the years. Working capital refers
to the excess of current assets over current liabilities. When looking into the long-term financial posi-
tion of the concern, the changes in fixed assets, long-term liabilities and capital one should be exam-
ined. When profitability is the concern of the analyst, the study of increase or decrease in profit will
help the interpreter to observe whether the profitability has improved or not.
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Yushua Corporation
Comparative Statement of Financial Position
As of December 31, 2018 and 2019
Current Assets
Non-current Assets
Liabilities
Current Liabilities
Non-current Liabilities
Equity
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Interpretation
The comparative balance sheet of the company reveals that during 2019 there has been an
increase in fixed assets by 110,000 or 13.49%. This increase could be due to additional
purchases of fixed assets. Mortgage Payable have relatively increased by Php 50, 000 and
Ordinary shares has increased by Php 200, 000. The increase in ordinary shares is due to
the additional issuances of shares for the year 2019. The increase in both ordinary shares
and mortgage payable indicates that the company financed its fixed assets acquisition from
the long-term sources.
On the other hand, the current assets have increased by Php 152, 000 or 26.67%. A signifi-
cant increase in marketable securities by Php 100,000 or 40% was due to the increase in
short-term investments of the company. Cash has increased by Php 20,000 due to the col-
lection of customer accounts and additional borrowings of the company. Moreover, the cur-
rent liabilities have increased only by Php 20,000 or 12.9%. This further confirms that the
company has used long-term finances even for the current assets resulting into an im-
provement in the liquidity position of the company.
Retained earnings have decreased from Php 330,000 to Php 222,000 or 32.73% which
shows that the company has utilized surplus for the payment of dividends to shareholders
either in cash or by way of bonus. The overall financial position of the company is favora-
Yushua Corporation
Operating Expenses:
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Interpretation
The comparative income statement given above shows that there has been an increase in net
sales of 14.65%. The cost of goods sold has increased by 11%. This has resulted in increase of
gross profit by 19.4%. Operating expenses have increased by 8%. The increase in gross profit
is sufficient to cover the operating expenses. There is also an increase in net profit after tax of
Php 38000 or 42.22%.
It is concluded from the above analysis that there is sufficient progress in the performance of
the company and the overall profitability of the company
is favorable.
Trend Analysis
The trend analysis is a technique of studying several financial statements over a series of
years. In this analysis, the trend percentages are calculated for each item by taking the figure
of that item for the base year taken as 100. Generally the first year is taken as a base year.
The analyst is able to see the trend of figures, whether moving upward or downward
In brief, the procedure for calculating trends is as:
– One year is taken as a base year which is generally is the first year or last year.
Illustration:
The following are data extracted from the Income Statement of Will Barry Enterprise, Inc.
Net Sales Php 200,000 Php 190,000 Php 249,000 Php 260,000
Trend Analysis
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Interpretation
On the whole, 2016 was not a favorable year but the recovery was made during 2017. In this
year, there is increase in sales as well as profit. Figures from 2016 when compared with 2015
reveal that the sales have come down by 5%. However, the cost of goods sold and the expens-
es have decreased only by 1.8% and 3% respectively. This has resulted in decrease in Net
profit by 12%. The position was recovered in 2017 with a positive growth in both 2017 and
2018. Moreover, the increase in profit by 31.3% (2017) and 50.6% (2018) is much more than
the increased in sales by 20% and 30% respectively.
Learning Activities
Activity 1.
Fill in the blanks with appropriate word/words :
1. Comparative statement is a _______________ for financial statement analysis.
2. _______________ is the comparison of the financial statement of business
with the previous years financial statement.
3. Comparative ______________ shows the different assets and liabilities of
the firm on different dates to make comparison of balance from one
date to another.
4.___________________ income statement gives an idea of the progress of a
business over a period of time.
5. When computing for the percentage change in comparative statement, the change in
amount is divided by the ________________.
6. Change in amount for comparative statement is also called ______________________.
Securities
Total Assets PHP 1,547,000 PHP 1,285,000 Total Liabilities and PHP 1,547,000 PHP 1,285,000
Equity
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Research-based Activity
Form a group with 4 members. A FB Messenger group is created for you to interact with
your classmates. You can reach them out in forming your group. Follow the directions
specified below for your activity.
Choose an existing public corporation (which means corporations that are listed in the
Philippines Stock Exchange), research and extract the comparative financial statements of
this corporation. Compute the change in amount and change in percentage of the firm’s
financial statement. After computing, make an assessment on the company’s liquidity, sol-
vency and profitability. Submit your output in our google classroom. For those who have
difficulties in accessing the google classroom, you may upload your output via the FB Mes-
senger group created for the class.
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With a clear idea on how your funds are circulating, you can further improve how you allocate your fi-
nances among your assets and also save a lot of money by cutting down some of your big expendi-
tures.
LESSON
Vertical Analysis
Vertical analysis is done by analysing a financial statement of a particular period, where each
line item in an income statement is listed as a percentage of another item. This is used to have
an insight into the relative proportions of account balances. Vertical analysis is also a great
help for trend analysis in seeing relative changes in accounts over time.
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Provided below are data extracted from the annual financial report
of Berry Bags Inc. for the comparative year 2019 and 2018. Based from
your learnings in your prerequisite subjects, you are to compute for the
common size percentage for 2018 and 2019. After computing, you are to
answer the questions presented after the table.
Self Assessment
After answering the warm-up activity above:
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Vertical analysis is also called static analysis because it is carried out for a single time period.
Assets
Current Assets
Non-current Assets
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Liabilities
Current Liabilities
Non-current Liabilities
Shareholder’s Equity
Interpretation
Most of the company’s resources are allocated in the non-current assets which at 70.15% of
its assets. Only more a third of the assets is allocated to current assets at 29.85%. In the
similar manner, 27.9% of the total resources have been provided by the creditors, and the
remaining 72.1% have been sourced from the shareholders and earnings of the company.
The company does did not use financial leverage to finance the acquisition of property, plant
and equipment, and in handling operations.
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Let’s answer this one!
https://www.chegg.com/homework-help/questions-and-answers/please-
provide-excel-spreadsheet-comparative-income-statement-vertical-analysis
-please-att-q12729695#question-transcript
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Here!
Instruction: Please provide an EXCEL SPREADSHEET of a VERTICAL ANALYSIS of the
Tractor Supply Company. A sample of expected output is shown below.
Vertical Analysis
2015 2014 2015 2014
Account Name
Vertical Analysis
2015 2014 2015 2014
Account Name
https://www.chegg.com/homework-help/questions-and-answers/please-provide-
excel-spreadsheet-comparative-income-statement-vertical-analysis-please-att-
q12729695#question-transcript
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Select at least 5 account titles to interpret from the Comparative Statement of Financial
Position based on the result of your analysis.
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Select at least 5 account titles to interpret from the Comparative Statement of Financial
Performance based on the result of your analysis.
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LESSON
IV RATIO ANALYSIS
Before starting the lesson, let’s have a warm up activity!
B A L A N C E S H E E T D G H
G J F G H J T J I K U H S C C
S H J G J C S L J H S A E W E
J D C N G A A G A S X P H F S
A S S E T S S M C D C R B N D
J D S A A H X N Y F M O H D F
V M F L N F S T J S B F S A R
W R E G G D I N V E N T O R Y
F S H F K U J N H A E R C A J
V M D H Q T G J V S A A H T F
S J S E L K U R S E B Z S I J
V F D G B B M K A G K L E O K
P R O F I T C M H J D S T S B
S F B N K L J S D N H S F N X
V D D H L I A B I L I T I E S
SELF-ASSESSMENT
How did you find the activity? Was it easy or difficult?
Were the concepts familiar to you?
Introduction
The goal of financial management is to maximize the stockholders’ wealth through the current value of
the existing stock (Ross et al., 2008). A common mistake in financial management is the belief that the
finance manager should maximize the firm’s accounting profits. Nonetheless, accounting profits should
not be discarded as they directly affect the firm’s stock price. In the same manner that accounting infor-
mation is presented in the financial statements, it is an important tool to understand why the company
is performing the way it is and as a forecasting device as to where it is going.
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Ratio analysis is a form of Financial Statement Analysis that is used to obtain a quick
indication of a firm's financial performance in several key areas.
CAUTION!
“Using ratios and percentages without considering the underlying causes may be
LIQUIDITY RATIOS
Liquidity ratios are group of ratios that measure the ability of the business to pay their short-
term obligation. These ratios utilize the current assets and current liabilities for analysis.
Liquidity as an objective answers the question: “Does the company has enough current to pay
its current obligations?”
The most common ratios used in assessing the liquidity of the firm are
the following:
1. Current Ratio
Current Ratio
Current ratio is also called banker’s ratio. It indicates the extent to which current liabilities
are covered by current assets. It is the most commonly used measure of liquidity of compa-
nies. The formula of current ratio is:
Current Ratio=
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Interpretation:
A 2:1 current ratio means that the company has Php2.00 current assets that it can use to pay
for every Php1.00 current obligation. This current ratio entails that the company has more
than enough capacity to settle its short-term obligations. Therefore, the company is consid-
ered to be liquid.
Quick Ratio
Quick Ratio reflects the firm’s ability to pay its short-term obligations. Thus, the higher the
quick ratio, the more liquid the firm is. It is a more severe test of immediate solvency; test of
ability to meet demands from current assets.
Quick Ratio =
Interpretation:
Quick acid test ratio allows one to focus on a more immediate measure of liquidity by adding
cash, accounts receivable and marketable securities. The firm assumes that the accounts re-
ceivables are properly managed and collected in a short period of time. The higher the value
the more liquid the firm is.
ACTIVITY RATIOS
Activity Ratios or Asset Management Ratios measure the firm’s efficiency in managing its as-
sets. These ratios are used to determine how rapid various accounts are converted into sales
or cash. Generally, a high turnover ratio is associated with good asset management and a low
turnover ratio with bad asset management.
This estimates how fast the accounts receivable is converted into cash during the year. It
measures how efficient the collection of the accounts receivable.
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Interpretation
In general, the higher the turnover, the better. It means that the firm’s customers are
prompt payers. However, an excessively high ratio may indicate that the company’s credit
policy is too strict, with the company not tapping the potential for profit through sales to
customers in higher risk classes. On the other hand, an extremely low accounts receivable
turnover means that the company is too lax in its credit policy.
This measures the efficiency of the firm’s collection policy by computing the number of days
to collect the receivables.
Interpretation
The higher days for a sale to be converted into cash, there exists a risk that customer’s ac-
counts may become uncollectible. One of the possible causes of such increase is that the
company is more lenient in selling on credit to customers. The firm must be able to check or
possibly think of revising its policy with regard to granting credit.
Inventory Turnover
This shows the efficiency of the firm in handling its inventory. It measures how fast the in-
ventory is turned into sales. A low inventory turnover rate may point to overstocking obsoles-
cence, or deficiencies in the product line or marketing effort.
Inventory Turnover =
Interpretation
If the inventory turnover declines, this indicates a problem with regard to stocking goods. An
attempt should be made to determine whether an increase in the inventory is caused by un-
salable items.
In this ratio, it measures the average number of days to sell or consume the average invento-
ry. The higher the number of days, the greater risk of obsolescence.
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Operating Cycle
The operating cycle measures the time it takes to convert the inventories and receivables to
cash. Hence, a short operating cycle is desirable.
Operating Cycle =
Interpretation
If the operating cycle is longer, this is an unfavorable trend since an increased operating cycle
means that a considerable amount of money is tied up in non-cash assets. The firm must look
into the possibility of reducing the operating cycle to improve its liquidity. Too much funds
tied in the inventory and receivables lead to an increased cost of doing business due to loans.
This measures the firm’s ability to generate sales successfully. A low asset turnover ratio may
be due to many factors, and it is important to identify the underlying reasons. For example,
the value of investment in assets excessive when compared with the value of the input? If so,
the company might want to consolidate its present operation, perhaps by selling some of its
assets and putting the proceeds in a high-return investment or using them to expand into a
more profitable area.
Interpretation
A high total asset turnover indicates an efficient asset management. However, since total as-
set turnover is composed of current and fixed assets, all other ratios like inventory turnover,
receivable turnover are part of the analysis in the total assets turnover.
Interpretation
A high total asset turnover indicates an efficient asset management. However, since total
asset turnover is composed of current and fixed assets, all other ratios like inventory
turnover, receivable turnover are part of the analysis in the total assets turnover.
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LEVERAGE RATIO
Leverage Ratios indicate up to what extent the firm has financed its investments by borrow-
ing. Firms that use debt financing rather than equity financing increase the risk of the firm.
The more debt they incur, the higher their leverage ratio is and the higher the financial risk
they face.
Debt Ratio
This ratio shows the portion of the total assets financed by the creditors. The provider of
funds other than the stockholders prefers to see a low debt ratio because there is a greater
chance for creditors to collect their receivables when the firm goes bankrupt.
Debt Ratio =
Debt-to-Equity Ratio
This measures the proportion of the total liabilities to the invested capital. A high debt-to-
equity ratio means that the firm financed the assets mostly by debt. A low ratio means that
the firm paid for the assets by means of capital infusion by the stockholders.
Debt-to-Equity Ratio =
This reflects the number of times the earnings before tax and interest expense cover the in-
terest expense. It measures how capable the firm is in paying its interest obligations. The in-
crease on the times-interest earned ratio is a positive indicator that the firm is capable of
paying its maturing interest obligations.
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PROFITABILTY RATIOS
Return on Investment
This measures the income generated for every peso investment made in the firm.
The higher the income generated per peso investment, the better.
Return on Investment =
Return on Equity
This measures the rate of return earned on common stock equity. Stockholders in-
vest in a firm with the expectation of a return on their money.
Return on Equity =
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Earnings Per Share
This measures the income generated per common stock held. It is computed by divid-
ing net income after tax minus the preferred stock dividend requirement by the num-
ber of shares of common stock outstanding. Earnings per share is a useful indicator
of the firm’s profitability. However, earnings per share tends to be lower when there
are more common shares issued. For this reason, firms prefer accumulating funds by
issuing bonds so as not to dilute the earning per share.
Ratio analysis is a very useful tool when working with the figures presented in the fi-
nancial statements. It helps identify the firm’s strengths and weaknesses. However,
despite the numerous uses of financial ratios, they have also have their limitations.
Some of which are listed as follows:
Variation in the practices and methods in the application of accounting from one
firm to another may result in a meaningless comparison of financial ratios.
Although financial ratio has a predictive value, ratios are still static and a mere
estimate of the future
Transactions are recorded based on acquisition costs and do not consider the
effects of inflation
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Financial ratio analysis is essential in comparing firms belonging to the same indus-
try. Firms whose activities are well diversified are too difficult to be classified in an
industry.
Although industry averages are published, at times, it is difficult to use them because
of the complexities of the different sectors belonging to the industry.
A ratio does not shoe its major components; thus, it is incorrect and misleading to in-
terpret a particular ratio without considering its composition.
Activity No. 1
For item 1-15, use the following data.
ABC Coporation
Statement of Financial Position
December 31, 2019
LIABILITIES AND
ASSETS EQUITY
Cash P50,500 Accounts Payable P65,000
Accounts Re-
ceivable 52,000 Long-term Debt 75,500
Inventories 60,500 Common Stock 53,500
Fixed Assets 137,000 Retained Earnings 106,000
TOTAL LIABILITIES AND
TOTAL ASSETS P300,000 EQUITY P300,000
ABC Coporation
Income Statement
December 31, 2019
Sales P450,000
Cost of Sales (324,000)
Gross Profit P126,000
General and Administrative Expenses (27,500)
Earnings Before Interest and Tax 98,500
Interest Expense (12,000)
Earnings Before Tax 86,500
Tax (30%) (25,950)
Net Income P60,550
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Compute for: (Show your solutions. DOUBLE RULE YOUR FINAL ANSWERS)
Take note: You may use only the current year without averaging.
Current Ratio
Inventory Turnover
Return on Equity
Debt Ratio
Return on Assets
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Time Interest Earned Ratio
Return on Equity
Operating Cycle
Research-based Activity
From the financial statement that you used in your research based activity for the Module II
Lesson 2 and 3, you are required to compute for the two ratio under each of the following ob-
jectives:
1. Liquidity 3. Activity 5. Debt Utilization
2. Profitability 4. Asset Utilization
After computing for the ratio, make an interpretation, conclusion and recommendation from
the results of the computation. Submit your output in our google classroom. For those who
have difficulties in accessing the google classroom, you may upload your output via the FB
Messenger group created for the class.
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III I
INTRODUCTION TO
EQUITY VALUATION
Write five words that you can associate with the words provided below. You are
given 10 minutes to finish this activity.
5. Investment
After answering the warm-up activity above: Were you able to correctly assess
the information based from your prior knowledge?
What are the challenges that you have met while answering the questions?
Introduction
Analysts gather and process information to make investment decisions, including buy and
sell recommendations. What information is gathered and how it is processed depend on the
analyst and the purpose of the analysis. Throughout finance, one rule always holds true.
The general belief is that the value of any asset or security is exactly equal to the discounted
present value of all the cash flows that can be derived from it in future periods. Using this
principle, one can easily value securities like debt. This is because they have a finite exist-
ence. The cash flows derived from them can be easily predicted. However, equity valuation is
not so simple. Equity represents a partnership in the business. As such, it represents an
attempt to value cash flows which are uncertain and unpredictable.
Equity valuation refers to the process of determining the fair market value of equity securi-
ties. It also refer to all tools and techniques used by investors to find out the true value of a
company’s equity. It is often seen as the most crucial element of a successful investment de-
cision.
Importance of Equity Valuation
Systemic. Equity valuation therefore is the backbone of the modern financial system. It ena-
bles companies with sound business models to command a premium in the market. On the
other hand, it ensures that companies whose fundamentals are weak witness a drop in their
valuation.
Individual. On a micro level, equity valuation is beneficial for the entire stock market ecosys-
tem. Markets receive information every moment and make an attempt to factor the financial
effect of this information in the stock price. Individual estimates of the effect vary and as
such different people may come up with different stock prices.
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Process of Conducting Equity Valuation
Equity valuation is followed differently by different individuals. The following are the processes
of equity valuation.
Understand the macroeconomic factors and the industry: No company operates in vacuum.
The performance of every business is influenced by the performance of the economy in
general as well as the industry in which it operates.
Make a reasonable forecast of the company’s performance: Mere extrapolation of the com-
pany’s current financial statements does not constitute a good forecast. A good forecast
takes into account how the company may change its scale of production of the forth-
coming future. Then, it also takes into account how changes in this scale will affect the
costs.
Select the appropriate valuation model: There are multiple valuation models available. All
these valuation models do not necessarily lead to the same conclusion. Therefore, it is
the job of the analyst to understand which model would be most appropriate given the
type and quality of data available.
Arrive at a valuation figure based on the forecast: Apply the valuation model and come up
with an exact numerical value which according to the analyst defines the worth of the
business. Investors prefer a range so that they clearly know what their lower and upper
bounds for bidding should be.
Take action based on the arrived valuation: Finally, the analyst has to give a buy, sell or
hold recommendation based on the current market price and what analysis shows is
the intrinsic worth of the company.
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Estimating the Market Sentiment
The idea is to arrive at a fair valuation and then compare them with the values prevalent
in the market. If the market is overvaluing most of the stocks, then investors are expecting
a positive future and the sentiment is positive. The converse of this is also true. Hence, eq-
uity valuation can be used as a tool to read the market.
Listing Of Private Businesses
Private businesses and capital markets have a symbiotic relationship. When a private busi-
ness initially lists itself on the market and becomes a public company, it faces a problem.
Using equity valuation models, analysts can arrive at a relatively precise price supported by
facts and data which is usually acceptable to both the counterparties involved in the trade.
Mergers and Acquisitions
There is also considerable ambiguity over the price to be paid when mergers and acquisi-
tions happen. Both individual entities need to be valued and then the combined entity
needs to be valued. Then gains from merging the business or “synergy” have to be found
out. Based on the bargaining power and the risk-reward bearing agreement of the venture,
a fair valuation can be arrived at which is acceptable to both the acquirer and the acquired.
To sum it up, valuation is the lifeblood of financial services. All sorts of organizations, from
merchant banks to portfolio management companies need this knowledge. Also, it is an im-
perfect knowledge hence companies are willing to spend more and more money to hire peo-
ple they believe have a good understanding of the concept of valuation.
Learning Activity
Activity 1. True or False. Write True if the statement is true and False if otherwise.
____________1. It refers to all tools and techniques used by investors to find out the true value of a
company’s equity.
____________2. Equity valuation enables companies with sound business models to command a premi-
um in the market.
____________3. Individual estimates of the effect of financial information do not vary and as such dif-
ferent people may come up with different stock prices.
____________4. The performance of every business is not influenced by the performance of the economy
in general as well as the industry in which it operates.
____________5. All the valuation models do not necessarily lead to the same conclusion.
____________6. The analyst has to give a buy, sell or hold recommendation based on the current mar-
ket price and what analysis shows is the intrinsic worth of the company.
____________7. Any investor must always have their own estimate of value of the stock, which they de-
rive from their very own equity valuation model.
___________10. Investment value is the amount of money an investor would pay for a property.
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LESSON
EQUITY VALUATION
II
Part-I. Identification. This is to test whether you still remember the
basic terms on equity valuation that you have learned in your
previous related subjects. Identify the term or concept each
statement is referring.
Self-assessment
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In general:
If Intrinsic Value > Market Price, the stock is undervalued. The investor will want to buy the stock.
If Intrinsic Value = Market Price, the stock is fairly valued. The investor is neutral about the stock
price.
If Intrinsic Value < Market Price, the stock is overvalued, and investor expects its price to fall.
The analyst can use a variety of models to estimate the intrinsic value of equities. One such model is
the Dividend Discount Model. Under this model the value of a stock is calculated as the present val-
ue of all future dividends from the stock.
Balance sheet methods are the methods which utilize the balance sheet information to value a com-
pany. These techniques consider everything for which accounting in the books of accounts is done.
In this method, book value as per balance sheet is considered the value of equity. Book value means
the net worth of the company. Net worth is calculated as follows:
Net Worth = Equity Share capital + Preference Share Capital + Reserves & Surplus – Miscellaneous
Expenditure (as per B/Sheet) – Accumulated Losses.
Example: If,
Then,
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Liquidation Value Method
In liquidation cost method, liquidation value is considered the value of equity. Liquidation value is the
value realized if the firm is liquidated today.
Liquidation Value = Net Realizable Value of All Assets – Amounts paid to All Creditors including Pref-
erence Shareholders.
Example: If
Then
= Php 49,896,000
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The model's assumptions are that: (i) the dividend growth rate is constant; the growth rate cannot equal or
exceed the required rate of return; the investor's required rate of return is both known and constant. In
practice, a company's earnings and growth rates are not known and not constant.
a. Multi-stage Dividend Discount Models:
P=D(1+g)/(1+k) + D(1+g)(1+g)/(1+r)(k-g)
Where: P=security\'s price; D=dividend payout ratio; g=dividends\' expected growth
rate; k=required rate of return.
The model's assumptions are that: (i) the dividend growth rate is constant; the growth rate cannot equal or
exceed the required rate of return; the investor's required rate of return is both known and constant. In
practice, a company's earnings and growth rates are not known and not constant.
a. Multi-stage Dividend Discount Models:
P=D(1+g)/(1+k) + D(1+g)(1+g)/(1+r)(k-g)
Where: P=security\'s price; D=dividend payout ratio; g=dividends\' expected
growth rate; k=required rate of return.
Multistage models can accommodate any number of patterns of future streams of expected divi-
dends. Spreadsheets enable the analyst to build and analyze many permutations on such models.
However, care must be taken when choosing the model's inputs, lest the results become meaning-
less.
Example: As per market price data, JFC is on track for a full year dividend pay out of Php1.95 per
share. JFC puts the five-year annual dividend growth at 3.51%. If the required rate of return is 10%
and the previous day’s closing stock price of JFC was Php36.67. What is the value of JFC shares?
Given:
Based on the dividend growth rate of 3.51%, the model says that JFC should be worth 30.59. Based
from the closing price of JFC, it appears that the shares are overvalued.
Example: What would be the current price of a stock when dividends are expected to grow at a 25%
rate for three years, then grow at a constant rate of 5%, if the stock’s required return is 13% and next
year’s dividend will be Php4.00?
The idea to solve this problem is to assume that you hold the stock for three years and sell the stock
at the end of year 3. After year 3, the dividends have a constant growth rate of 5%. By observ-
ing this constant growth rate of dividends, you can use the dividend growth model to calcu-
late the stock price at year 3, which is P3=Div4/(r-g), where r=13% and g =5%.
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Then the current stock price is the present value of three dividends received in each year in
the next three years, and the stock price at year 3.
This model is based on free cash flows of the company. Similar to above model, it discounts the
free future cash flows of the company to arrive at an enterprise value. To find the value of equity,
value of debt is deducted from enterprise value
Discounted cash flow methods include dividend discount models and free cash flow models.
Lastly, relative valuation methods are a price to earnings ratios, price to book value ratios, price
to sales ratios etc.
This model is based on free cash flows of the company. It discounts the free future cash flows of
the company to arrive at an enterprise value. To find the value of equity, value of debt is deduct-
ed from enterprise value.
When valuing a company, it’s important to distinguish between the Enterprise Value and Equity
Value. The Enterprise Value is the value of the entire business without taking its capital structure
into account. Equity Value is the value attributable to shareholders, which includes any excess
cash and exclude all debt and financial obligations.
The type of value you’re trying to arrive at will determine which cash flow metric you should
use.
Use FCFF to calculate the net present value (NPV) of the enterprise.
Earnings multiple or Relative Valuation methods are also called comparable methods because
they use peers or competitors value to derive the value of the equity. The importance here is of
deciding which factor to be considered for comparison and which companies should be consid-
ered peers. Following are the well-known methods used for such comparison.
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1.Price to Earnings
The P/E looks at the relationship between the stock price and the company’s earnings. The P/E is
the most popular metric of stock analysis, although it is far from the only one you should consider.
You calculate the P/E by taking the share price and dividing it by the company’s EPS.
For example, a company with a share price of Php40 and an EPS of 8 would have a P/E of 5
(Php40 / 8 = 5).
What does P/E tell you? The P/E gives you an idea of what the market is willing to pay for the com-
pany’s earnings. The higher the P/E the more the market is willing to pay for the company’s earn-
ings. Some investors read a high P/E as an overpriced stock and that may be the case.
Example:
Assume there is a company whose publicly traded stock price is Php 20 and it has 100,000 outstand-
ing equity shares. The book value of the company is Php1,500,000. The Market-Book ratio is com-
puted as follows:
Here, the market perceives a market value of 1.33 times the book value to company.
*Share price= the number of outstanding shares multiplied by the share price
The lower the P/S ratio, the more attractive the investment. Price-to-sales provides a useful measure
for sizing up stocks. If a company isn't earning a profit yet, investors can look at the P/S ratio to de-
termine whether the stock is undervalued or overvalued. If the P/S ratio is lower than comparable
companies in the same industry that is profitable, investors might consider buying the stock due to
the low valuation.
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Example: A company has 1,000,000 outstanding shares at Php 30.00 per share, while its total reve-
nue for the year is Php 18,000,000. The P/S ratio is calculated as follows:
= 1.67
All things being equal, a low P/S is good news for investors, while a very high P/S can be a warn-
ing sign.
Learning Activities:
Activity 1. Multiple Choice. In a separate sheet/ word document, write the letter of your choice. For
the computation, provide the solution for each problem.
1.According to the dividend discount model, the current value of a stock is equal to the:
2.If a stock’s P/E ratio is 13.5 at a time when earnings are Php3 per year, what is the stock’s current
price?
A) Php 4.50
B) Php 18.00
C) Php 22.22
D) Php 40.50
3. A stock paying Php 5 in annual dividends sells now for Php 100 and has an expected return of
20%. What might investors expect to pay for the stock one year from now?
A) Php 182.00
B) Php 186.00
C) Php 115.00
D) Php 110.00
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4.How much should you pay for a share of stock that offers a constant dividend growth rate of 10%,
has a discount rate of 16%, and pays a dividend of Php 3 next year?
A) Php 42.00
B) Php 45.00
C) Php 45.45
D) Php 50.00
6.What should be the price for a common stock paying Php 3.50 annually in dividends if the growth
rate is zero and the discount rate is 8%?
A) Php 22.86
B) Php 28.00
C) Php 42.00
D) Php 43.75
8.What is the expected constant growth rate of dividends for a stock currently priced at Php 50, that
is expected to pay a dividend of Php 5 next year, and has a required return of 20%?
A) 13%
B) 10%
C) 11%
D) 12%
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9.If the (current) dividend yield is 5% and the stock price is $25, what will the year three dividend
be if dividends grow at a constant 6%?
A) Php 1.33
B) Php 1.40
C) Php 1.58
D) Php 1.67
10. What would be the current price of a stock when dividends are expected to grow at a 25%
rate for three years, then grow at a constant rate of 5%, if the stock’s required return is 13%
and next year’s dividend will be Php 4.00?
A) Php 61.60
B) Php 62.08
C) Php 68.62
D) Php 79.44
Part-II. True or False. Write True if the statement is true and False if otherwise. (2 points each)
Unlike interest payments on debt which are tax deductible, dividends must be paid out of after-
tax income.
The priority of the claims against the assets of the firm belonging to debt holders, preferred
stockholders, and common stockholders is the same.
The value of the equity securities, as with other assets, is based upon the discounted value of
their expected future cash flows.
Stocks which are experiencing the above pattern of growth are called constant growth stocks.
The use of preference shares as a source of financing over ordinary shares increases the probabil-
ity of bankruptcy for the firm.
The dividends on preferred stock, like the coupon payments on debt, are generally fixed.
There are stocks whose dividends are growing at a rate which mirrors the long-term growth rate of
the economy.
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Activity 2. Case Analysis. This activity is your major output for this module. You are to read the
case presented and present your output in a separate paper/ Microsoft word. Format of the case is
attached below as well as the rubric for grading. Submit the case analysis output in our google
classroom/ fb group chat.
The company recorded $923 million in revenue and $423 million in EBITDA in the last twelve
months (LTM) as of this case study, and currently trades at LTM revenue and EBITDA multiples of
10x and 22x, respectively.
Its stock price has increased dramatically over the past year, rising from $60 per share to over
$170 per share before it fell back down to the $130-$140 range recently.
The company’s growth has been driven by strong sales of its key product, Xyrem, a patentpro-
tected “orphan drug” for treating cataplexy and excessive daytime sleepiness (EDS) in patients with
narcolepsy. As of the end of the company’s most recent fiscal year, Xyrem was treating 11,250 pa-
tients. The company also sells and develops other drugs, but Xyrem comprises 66% of its sales. The
key risk factor is that the company’s patents on Xyrem expire in 5-6 years’ time and it is unable to
make up lost revenue by discovering or acquiring other viable drugs; generics may come to the mar-
ket even sooner than that due to several pending lawsuits.
The “Bull Case” for JAZZ is that Xyrem continues to grow rapidly in both pricing and volume;
once the patents expire, it is able to make up the difference by shifting into other products. The
“Bear Case” is that the company is not able to replenish its drug pipeline, or that Xyrem sales fall
rapidly due to earlier-than-expected generics.
Your job is to decide which of these views, if any, is correct, and to then make an investment
recommendation (for the hedge fund / asset management and equity research cases), or a client rec-
ommendation on the company’s best options going forward.
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Identification of Identifies and under- Identifies and under- Identifies and under- Identifies and un-
the main issues stands all the main stands most of the stands some of the derstands few of the
and/or prob- issues in the case main issues in the main issues in the main issues in the
lems. study. case study. case study. case study.
Analysis of the Insightful and thor- Insightful and thor- Insightful and thor- Incomplete analysis
key issues. ough analysis of all the ough analysis of most ough analysis of some of the key issues
key issues. of the key issues. of the key issues.
Alternative solu- Alternatives cover all Alternatives cover most Alternatives cover Incomplete analysis
tions and/or the key issues with of the key issues some of the key issues of alternatives with
options. method to evaluate all with method to evalu- no evaluation
equally. with method to evalu- ate.
ate.
Observations Well-reasoned, Solid, well-thought out Shallow observations Superficial
and/or recom-
mendations on logical, relevant observations and rec- and recommendations observations and
effective solu- ommendations on ef- on effective solutions
tions. observations and fective solutions to to recommendations
many of the problems/ on effective solu-
recommendations on issues. some of the tions to a few of the
effective solutions to problems/issues.
most of the problems/ problems/issues.
issues.
Writing Writing is totally free of There are few spelling There are several There are many
grammar and spelling or grammatical errors.
Skills/ errors. spelling or grammati- spelling errors and
Professional Most ideas are clearly cal errors. grammatical
Clear, concise and presented and refer-
Presentation. creative ences are used. Some ideas are mistakes. Ideas are
hard to follow.
presentation of ideas Clearly presented.
and properly References are not
References are used.
referenced.
sporadic or not used.
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Lesson I
Analysis Presentation
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LESSON
The result of financial statement analysis is useless if not communicated to the users and
decision makers. Financial data has a reputation for being boring and a financial presen-
tation can make even the experienced professional feel anxious.
It is important to prepare ahead of time your financial presentation. You also need to cre-
ate a financial data presentation you’re excited to give, the one that holds the interest of
your audience instead of making them feel uninterested.
Giving meaning to your numbers, making your financial information visual and interesting
to look at and engaging with your audience will help ensure your finance meetings become
the interesting and would make audience looking forward to the next presentation.
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Add a picture, shape, or chart
1. Select Insert.
2. To add a picture:
Select Picture.
Browse for the picture you want and select Insert.
To add a shape, art, or chart:
Select Shapes, Icons, SmartArt, or Chart.
Select the one you want.
https://support.microsoft.com/en-us/office/create-a-presentation-in-powerpoint-422250f8-5721-
4cea-92cc-202fa7b89617
The following are tips to make a financial presentation interesting and make sure people listen to what
you have to say.
When you plan your financial analysis presentation, plan to tell the who, what, when, where
and why behind the numbers. Data will appeal to people's analytical brains, but to maintain
their interest you also have to use examples to explain who the numbers affect, where the fig-
ures come from and why they are important. But, remember this: keep it simple.
Guy Kawasaki's 10-20-30 rule is simple: a presentation should include: ten slides, last twenty
minutes, and use thirty point font. By following this process, you keep the presentation concise
and it forces you to get to the point. This sets up ideal conditions for your audience to tune in
to what you're saying.
Make sure your handouts and slides don’t detract from what you're saying. Remember that you
and what you have to say are the main event. Keep your slides simple and then expand and ex-
plore with your own commentary.
Too much text will kill any presentation. People just don't respond to blocks of
Once you’ve planned what to say and what materials you will use, you have to know how you're
going to say it. This means learning to communicate with your audience by taking some tips
from the masters. How you talk affects how people listen, so work on your public speaking abili-
ties even if you only present in the meeting room.
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Learning Activity
Research-based Activity
In your previous lessons, you are asked to form a group with 4 members and choose an existing public
corporation (which means corporations that are listed in the Philippine Stock Exchange), research and
extract the comparative financial statements of this corporation. You are also required to conduct a
financial statement analysis using the following tools: horizontal analysis, vertical analysis, and ratio
analysis. After the computations, you also asked to interpret the results thereof and make necessary
conclusions and recommendations.
From the research based activity you have on financial analysis, you are to present a 10-minute finan-
cial statement analysis of the company that you have chosen. After the presentation, your instructor/
professor will be asking questions to validate the results of your analysis. This activity will serve as
your final requirement for this subject. The financial statement presentation will utilize Powerpoint or
other presentation templates/software. The final presentation will be through google meet, zoom, face-
book room, whichever is convenient. In case of connectivity issues, you can make a video of your group
making the financial statement presentation and send it in the google classroom. Take note of the tips
provided above so you will be able to provide an interesting presentation.
Recommendation
The interpretation of the horizontal, vertical, and ratio analysis will be presented orally while the slides
for the figures under which tools are presented. In no case, the interpretation will form part of the
slides. Therefore, members of the group tasked to present must show mastery of the interpretation.
The rubrics for grading the presentation and the financial statement analysis is presented below.
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References:
Aduana, N. L. (2015). Financial Statements: Preparation, Presentation, Analysis, and Interpretation. Quezon City,
Philippines: C & E Publishing, Inc.
Anastacio, M.F.L.,Dacanay R.C., & Aliling L.E.(2010). Fundamental of Financial Management with Industry-Based
Perspective. Quezon City, Phils.:Rex Book Store,Inc.
Asset management ratios. Retrieved from https://www.readyratios.com/reference/asset/
Conceptual Framework of Financial Reporting Retrieved from www.ifrs.org https://www.ifrs.org/issued-
standards/list-of-standards/conceptual-framework/
Equity Valuation: Concepts and Basic Tools. Retrieved from https://www.cfainstitute.org/en/membership/
professional-development/refresher-readings/2020/equity-valuation-concepts-basic-tools
Financial Ratios Cheat Sheet. Retrieved from https://corporatefinanceinstitute.com/resources/ebooks/financial-
ratios-cheat-sheet/
Fuhrmann, R. (2020, May 2020). The Comparables Approach to Equity Valuation. Retrieved from https://
www.investopedia.com/articles/investing/080913/equity-valuation-comparables-approach.asp
Gibson, C. (2009). Financial Reporting and Analysis 11th Edition. Cengage Learning. USA.
Gitman, L. J., & Joenhnk, M. D. (2005). Princiiples of Managerial Finance. Singapore: Pearson Education, Inc.
Henry, E., Robinson, T. & van Greuning, J.H. (2011). Financial Analysis Techniques. CFA Insitute. Retrieved from
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How to Create a PowerPoint Presentation. Retrieved from https://www.instructables.com/id/How-to-Create-a-
PowerPoint-Presentation/
Lam, N., Yuen, KP., & Kwong, J. (2016). Advanced Financial Reporting: An IFRS Perspective. Singapore. McGraw
Hill Education (Asia)
List of IFRS Standards. Retrieved from https://www.ifrs.org/issued-standards/list-of-standards/
Mcgowan, C., Billah, N. & Yakob, N. (2015). Liquidity Analysis of Selected Public-Listed Companies in Malaysia.
Issues in Economics and Business. 1. 1. https://www.researchgate.net/
publication/281222971_Liquidity_Analysis_of_Selected_Public-Listed_Companies_in_Malaysia
Palepu, K. G., Bernard, V.L., & Healy, P.M. (1996). Business Analysis and Valuation: Using Financial Statements:
Text and Cases. Ohio: South-Western College Publishing.
Ross, S. A., Westerfield, R. W., Jaffe, J., & Jordan, B. D. (2008). Modern Financial Management. New York:
McGrawHill Irwin.
Said, H. B.(2013). Impact of Ownership on Debt Equity Ratio: A Static and a Dynamic Analytical Framework. Inter-
national Business Research,6,6
Samuel, J. M., Wilkes, F.M., & Brayshaw, R. E. (1999). Financial Management and Decision-making. London: Inter-
national Thomson Business Press.
Subramanyam, K.R. & Wild, J.J. (2009). Financial Statement Analysis 10 th Edition. Boston: McGraw Hill Irwin
Timbang, F. L. (2015). Financial Management Part I. Quezon City, Philippines.: C & E Publishing, Inc.
Trounce, D. (2019, September 9). How To Turn a Powerpoint Presentation Into a Video. Retrieved from https://
helpdeskgeek.com/office-tips/how-to-turn-a-powerpoint-presentation-into-a-video/
https://www.cfainstitute.org/membership/professional-development/refresher-readings/2019/financial-
statement-analysis-an-introduction
http://8thinktank.com/business/5-effective-steps-in-analyzing-financial-statements/
https://study.com/academy/lesson/equity-valuation-definition-process.html
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