FINANCIAL STATEMENTS ANALYSIS

Financial Ratio-is a comparison in fraction, proportion, decimal or percentage of two significant figures taken
from financial statements.

The ratio can be categorized as follows:

1. Liquidity ratios, which give us an idea of the firm’s ability to pay off debts that are maturing within a year.

2. Asset management ratios, which give us an idea of how efficiently the firm is using its assets.

3. Debt management ratios, which give us an idea of how the firm has financed its assets as well as the
firm’s ability to repay its long-term debt.

4. Profitability ratios, which give us an idea of how profitably the firm is operating and utilizing its assets.

5. Market value ratios, which bring in the stock price and give us an idea of what investors think about the firm
and its future prospects.

Liquidity Ratios

A liquid asset is one that trades in an active market and thus can be quickly converted to cash at the going
market price.

Ratio Formula Significance

Current Ratio Current assets It measures the company’s ability to pay its
Current liabilties current liabilities.
Quick (Acid test) Ratio Quick assets* Quick assets are cash, short term
Current liabilities investments (securities) and accounts
receivable. It measures the number of times
*Quick assets=cash + that the current liabilities could be paid with
marketable securities + the available cash and near-cash assets.
receivable
Exercise 1-Current ratio and Quick ratio. Noah Company reported the following account information:

Accounts Receivable P400,000 Interest Payable, due in 3 months P20,000

Accounts Payable 260,000 Inventory 800,000
Bonds Payable, due in 10 years 600,000 Land 500,000
Cash 200,000 Prepaid Expense 80,000

Required:

1. What is Noah Company’s current ratio? 5.29 to 1

2. What is Noah Company’s quick (acid test) ratio? 2.14 to 1
3. What is Noah Company’s amount of working capital? P1,200,000
4. What will happen to the current ratio if the Company uses cash to pay 25% of the accounts payable?
Increase.
5. What will happen to the quick ratio if the Company uses cash to pay 25%of the accounts payable?
Increase.
Asset Management Ratio

Inventory Turnover Cost of goods sold It indicates how frequently inventory is

Average inventory bought and sold during the year.

Average Age of Number of Days in a Year Measures the average number of days to
Receivables/Average Receivables Turnover collect a receivable.
Collection Period/Days Sales Or
Outstanding Average Accounts Receivable
Average Daily Sales
Days in Inventory/Average of Number of Days in a Year Measures the average number of days that
Inventory Inventory Turnover inventory is held before sale.
Or
Average Inventory
Average Daily Cost of Sales
Fixed Assets Turnover Ratio Net sales Measures the level of use of property,
Average Net Fixed Assets
plant, and equipment.
Total Assets Turnover Ratio Net sales It indicates the amount of sales revenue
Average Total Assets generated for each peso invested in assets
during the period.
Exercise 2-Asset Management Ratios. Sarah Corporation reported the following figures:

2019 2018
Cash and cash equivalents P2,450 P2,094
Receivables 1,813 1,611
Inventory 1,324 1,060
Prepaid expenses 1,709 2,120
Total current assets P7,296 P6,885
Fixed assets 18,500 15,737
Total assets P25,796 P22,622
Total current liabilities P7,230 P8,467
Long-term liabilities 4,798 3,792
Common stock 6,568 4,363
Retained Earnings 7,200 6,000
Total liabilities and equity P25,796 P22,622

Sales P20,941
Cost of Sales 7,055
Operating expenses 7,065
Operating income P6,821
Interest expense 210
Income tax 2,563
Net income P4,048

Required:

1. Sarah Corporation’s inventory turnover during 2019 was (amount rounded) 6 times
2. During 2019, Sarah Corporation’s Average Collection Period (amounts rounded) 30 days
3. What is Sarah Corporation’s Fixed Asset Turnover? (amounts rounded) 1.22 times
4. What is Sarah Corporation’s Total Asset Turnover? (amounts rounded) 0.87 times
5. If Sarah has 360 days in a year in his operating cycle, its days in inventory is 60 days
 Debt Management Ratios

Financial leverage is the use of debt to finance assets and operations.

Total Debt Ratio Total liabilities Measures the percentage of funds provided
Total assets (capital) by creditors.
Times Interest Earned EBIT It indicates how many times the company’s
Interest expense interest expense was covered by its
operating income.

Profitability Ratios

Operating Margin EBIT Measures the percentage of operating

Profit Margin
Return on Total Assets or
Return on Investment
Return on Common Equity
Return on Invested Capital
Basic Earning Power Ratio
Earnings per share
Dividend Payout
Exercise 3-Profitability Ratios. Selected data from Joseph Company’s financial statements for the years
indicated are presented below:
Net Sales income to sales.
Net Income Measures the percentage of net income to
Net Sales sales.
Net Income Indicates whether management is using
Average Total Assets funds wisely.
Net Income-Preferred Measures the return on the carrying amount
Dividends of equity.
Average Common Equity
EBIT(1-T) Measures the total return that the company
Total Invested Capital has provided for its investors.
EBIT Measures the ability of the firm’s asset to
Total Assets generate operating income.
Net Income less pref. div. Peso return on each ordinary share.
Ave. ordinary shares Indicative of ability to pay dividends.
outstanding
Dividends per share Shows percentage of earnings
Earnings per share

2019 Operations 2019 2020

Net Sales P4,175 Cash P32 P28
Cost of Goods 2,880 Trading 169 172
Sold Securities
Gain on Disposal 210 Accounts 210 204
Receivable
Administrative 950 Merchandise 440 420
Expense Inventory
Interest Expense 50 Tangible fixed 480 440
assets
Income Tax 120 Total assets 1,397 1,320
Net Income 385 Current liabilities 370 368
Total liabilities 790 750
Common Stock 226 210
Retained 381 360
Earnings
Required: Compute for the following profitability ratios of Joseph Company for the year 2019:
1. Operating Margin. 13.29% 6. Basic Earning Power. 39.73%
2. Profit Margin. 9.22% 7. Earnings per share P1.77
3. Return on Total Assets. 28.33%
4. Return on Common Equity. 176.61%
5. Return on Invested Capital. 42.36%
Market Value Ratios

Book Value per Share
Market to book ratio
Price-Earnings Ratio
Exercise 4-Market Value Ratios. Information concerning Israel’s common stock is presented below for the
fiscal year ended May 31, 2019:
Equity Measures the amount of net assets
No. Shares Outstanding available to the shareholders of a given
type of stock.
Market Price per Share A measure how high is the shares’ market
Book Value per Share price in relation to book value.
Market Price Measures the relationship between the
Earnings per Share shares’ market price and earnings per
share.

Common stock P11,250,000 2019 dividends per P7.50

outstanding share
No. of shares 750,000 Basic earnings per 11.25
share
Market price per P45 Diluted earnings per 9
share share
2019 dividends per 4.50
share
Required:

1. What is the book value per share in 2019 on Israel’s common stock? P15
2. What is the market to book ratio of Israel’s common stock? 3 times
3. What is the price-earnings ratio for Israel’s Company’s common stock? 4 times