Course Code and Title: FINP 7 – Credit and Collection

Professor: Dave Kieth J. Lappay

Elisa Victoria
Mark Corpuz
Teresita Fernandez
Lesson Number: 8
Topic: Introduction to Financial Reports and Analysis (2)

Learning Objectives:

At the end of this lesson, the student should be able to:

1. discuss the four (4) fundamental financial ratios,
2. compute the figures from financial statement using financial ratios, and
3. Interpret the results of financial ratios computations.

Pre-Assessment
Direction: Read the questions carefully. Provide the answers in the separate sheet of paper/s.

1. What are four (4) fundamental financial ratios?

2. What is difference between current ratio and quick asset ratio?
3. How do you explain the average collection period from accounts receivable?

Lesson Presentation:

There are different users of financial statements.

Financial statement analysis can be used by
managers, equity investors, creditors, regulators,
labor unions, employees, the public, and
potential investors and creditors. Financial
statement analysis is used for investment and
credit decisions. It is also for regulating
companies such as what the Energy Regulatory
Commission does for power distribution copanies
and other energy companies (Cayanan, 2018).

Financial statement analysis is definitely used by

management for monitoring performance and for
identifying strategies to further improve the
company’s operations and credibility (Financial
Photo Credit: By goir, Financial Statement Analysis

ratio analysis, n.d.). The following financial ratios will

Link: https://www.shutterstock.com/image-photo/financial-statement-analysis-233598418

be discussed:
• Profitability Ratios
• Efficiency Ratios
• Liquidity Ratios
• Leverage Ratios

1. Profitability ratios are used to measure the company’s profitabilty

• Return on Equity (ROE) measures the amount of net income earned in relation to stockholders’ equity.
ROE = (Net Income / Stockholders’ Equity) x 100
= (2 659 087 / 12 478 559 ) x 11
= 21.31%
• Return on Assets (ROA) measures the ability of a company to generate income out of its resources.
ROA = (Net Income / Total Assets) x 100
• Gross Profit Margin measures the ability of a company to cover its cost of goods sold from its sales.
Gross Profit Margin = (Gross Profit / Sales) x 100
• Operating Profit Margin measures the amount of income generated from the core business of a company.
Operating Profit Margin = (Operating Income / Sales) x 100
 • Net Profit Margin measures how much net profit a company generates for every peso os sales or
revenues that it generates.
Net Profit Margin = (Net Income / Sales) x 100
2. Efficiency Ratios also known as turnover ratios measure the management’s efficiency in utilizing the assets
of the company.
• Total Asset Turnover Ratio measures the company’s ability to generate revenues for every peso of asset
invested.
Asset Turnover Ratio = Sales / Total Assets
= 52 501 085 / 22 298 020
= 2.35
• Fixed Asset Turnover Ratio measures the company’s ability to generate revenues for every peso of fixed
assets such as property, plang, and equipment.
Fixed Asset Turnover Ratio = Sales / PPE
• Accounts Receivable Turnover Ratio measures the efficiency by which accounts receivable are managed.
Accounts Receivable Turnover Ratio = Sales / Accounts Receivable
Average Collection Period = 360 days / Accounts Receivable Turnover Ratio
• Inventory Turnover Ratio measures the company’s efficiency in managing its inventories.
Inventory Turnover Ratio = Cost of Sales / Inventories
Days’ Inventories = 360 days / Inventory Turnover Ratio
• Accounts Payable Turnover Ratio provides information regarding the rate by which trade payables are
paid.
Accounts Payable Turnover Ratio = Cost of Sales / Trade Accounts Payable
Days’ Payable = 360 days / Accounts Payable Turnover Ratio

3. Liquidity Ratios measure the ability of a company to pay maturing obligations from its current assets. •
Current Ratio measures current assets that can be converted to cash within a year and current liabilities.
Current Ratio = Current Asset / Current Liabilities
` = 9 262 331 / 7 819 461
= 1.18
• Quick Asset Ratio also measures a company’s liquidity less inventories.
Quick Asset Ratio = (Cash+Current Accounts Receivable+Short-term Marketable Securities) / Current
Liabilities or
Quick Asset Ratio = (Current Assets - Inventories) / Current Liabilities

4. Leverage Ratios show the capital structure of a company, that is, how much of the total assets of a company
is financed by debt and how much is financed by stockholders’ equity.
• Debt Ratio measures how much of the total assets are financed by liabilities.
Debt Ratio = Total Liabilities / Total Assets
= 9 819 461 / 22 298 020
= .44
• Debt to Equity Ratio is a variation of debt ratio and compares total liabilities to equity.
Debt to Equity Ratio = Total Liabilities / Total Stockholders’ Equity
• Interest Coverage Ratio provides information if a company has enough operating income to cover interest
expense.
Interest Coverage Ratio = Earnings Before Interest and Taxes (EBIT) / Interest Expense
Tables:
Application:
Direction: Read the questions carefully. Provide the answers in the separate sheet of paper/s.

1. Compute for the remaining formulas in the four fundamental financial ratios.

Evaluation:
Direction: Read the questions carefully. Provide the answers in the separate sheet of paper/s.
1. What is your evaluation when a company has a debt ratio of 0.5 or less than 0.5?

Generalization:

Financial ratio analysis is performed by comparing items in the financial statements. The resulting ratio can be
interpreted in a way that is more insightful than looking at the items separately. It offers entrepreneurs a way to
evaluate their company's performance and compare it to other similar businesses in their industry. Ratios
measure the relationship between two or more components of financial statements. They are used most
effectively when results over several periods are compared.

Reinforcement:
Direction: Read the questions carefully. Provide the answers in the separate sheet of paper/s.

1. Make a research of at least one (1) company and look for its financial statement then make an analysis
based on the four fundamental financial ratios.

References:

Online:

Cayanan, A. S. (2018). Business finance. Manila: Rex Bookstore. Retrieved from Investopedia.
Financial ratio analysis. (n.d.). Retrieved from Accountingverse:
https://www.accountingverse.com/managerial-accounting/fs-analysis/financial-ratios.html

Books:

Croushore, D. (2014). Money and banking, 2nd Edition. Cengage Learning.

Medina, R. (2014). Money, credit, and banking. Unlimited Books Library Services Pub., Inc.
Pagoso, Cristobal M. (2014). “Money, credit and banking”. Rex Book Store. Manila