11 SENIOR HIGH SCHOOL

FABM 2
Quarter 3 – Module 6
Computing and Interpreting
Financial Ratios
FABM 2 – Grade 11
Alternative Delivery Mode
Quarter 3 – Module 6: Computing and Interpreting Financial Ratios
First Edition, 2020

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 11

FABM 2
Quarter 3 – Module 6
Computing and Interpreting
Financial Ratios
Introductory Message
For the facilitator:
Welcome to the Grade 11 Fundamentals of Accountancy, Business, &
Management 2 Alternative Delivery Mode (ADM) Module on Computing and
Interpreting Financial Ratios!
This module was collaboratively designed, developed and reviewed by
educators both from public and private institutions to assist you, the teacher
or facilitator in helping the learners meet the standards set by the K to 12
Curriculum while overcoming their personal, social, and economic
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2
For the learner:
Welcome to the Grade 11 Fundamentals of Accountancy, Business, &
Management 2 Alternative Delivery Mode (ADM) Module on Computing and
Interpreting Financial Ratios!
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3
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4
 I

Financial analysis is the process of examining a company’s performance in the context

of its industry and economic environment to arrive at a decision or recommendation. Often, the
decisions and recommendations addressed by financial analysts pertain to providing capital to
companies—specifically, whether to invest in the company’s debt or equity securities and at
what price.
Sometimes it is not enough to say that a company is in good or bad financial health,
especially if you are trying to compare that company with another one. To make comparisons
easier, it helps to assign numbers to “health.”
Financial ratios allow us to look at profitability, use of assets, inventories, and other
assets, liabilities, and costs associated with the finances of the business. We can also use them
to learn how quickly people pay their bills, how long it takes the company to recover its costs
for new equipment, how much cash the company has relative to its debt, and its return (profit)
on every money the company invests.
Now, in this lesson we will completely focus on Computing and Interpreting Financial
Ratios such as Current Ratio, Working Capital, Gross Profit Ratio, Net Profit Ratio, Receivable
Turnover, Inventory Turnover, Debt-to-Equity Ratio, and the like.
LEARNING COMPETENCY:
• Compute and Interpret Financial Ratios such as Current Ratio,
Working Capital, Gross Profit Ratio, Net Profit Ratio, Receivable
Turnover, Inventory Turnover, Debt-to-Equity Ratio, and the like
(ABM_FABM12-Ig-h-14)

OBJECTIVES:

K: Identify the different financial ratios and solve exercises and

problems that require computation and interpretation using various
financial ratios.

S: Computes various financial ratios and interprets the level of

profitability, efficiency, and financial health (liquidity and solvency)
of the business.

A: Shows appreciation and understanding on the importance of

computing and interpreting financial ratios in the business.

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 I

Pre-assessment:
Directions: Identify what is asked in each item. Write the letter of the correct answer in your
notebook.
1. Which ratio or ratios measure the overall efficiency of the firm in managing its investment
in assets and in generating return to shareholders?
a) Gross profit margin and net profit margin.
b) Return on investment.
c) Total asset turnover and operating profit margin.
d) Return on investment and return on equity.
2. An inflow of cash would result from which of the following?
a) The increase in an asset account other than cash.
b) The decrease in an asset account other than cash.
c) The decrease in an equity account.
d) The decrease in a liability account. It is an expenditure.
3. What is the first step in an analysis of financial statements?
a) Check the auditor’s report.
b) Check references containing financial information.
c) Specify the objectives of the analysis.
d) Do a common size analysis.
4. How would short-term investments in marketable securities be classified?
a) Cash. b) Operating activities.
c) Financing activities. d) Investing activities.
5. What is a serious limitation of financial ratios?
a) Ratios are screening devices.
b) Ratios can be used only by themselves
c) Ratios indicate weaknesses only.
d) Ratios are not predictive.
6. What is the most widely used liquidity ratio?
a) Quick ratio b) Current ratio c) Inventory turnover d) Debt ratio
7. How would payments for taxes be classified?
a) Operating outflow. b) Operating inflow.
c) Investing outflow. d) Financing outflow.
8. What is a creditor’s objective in performing an analysis of financial statements?
a) To decide whether the borrower can repay interest and principal on borrowed funds.
b) To determine the firm’s capital structure.
c) To determine the company’s future earnings stream.
d) To decide whether the firm has operated profitably in the past.

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9. Which of the following items is included in the adjustment of net income to obtain cash
flow from operating activities?
a) Depreciation expense for the period.
b) The change in deferred taxes.
c) The amount by which equity income recognized exceeds cash received.
d) All of the above.

10. What type of accounts are notes payable and current maturities of long-term debt?
a) Cash accounts. b) Operating accounts.
c) Financing accounts. d) Investing accounts.

’s In

Task 1

Data for Tionx Trading Company are given below:

2019 2020
Assets
Current Assets ₱ 192,375 ₱ 265,500
Property, Plant, and Equipment 937,508 967,500
Other Assets 152,618 159,750
___________________________________________________________

Total Assets 1,282,500 1,392,750

Liabilities and Capital

Total Current Liabilities 220,590 225,450

Long term Debt 491,198 460,250
Owner’s Capital 570,713 706,950
___________________________________________________________

Total Liabilities and Capital ₱ 1,282,500 ₱ 1,392,750

Direction: In your notebook,

a. Prepare a common-size Statement of Financial Position for 2019 and 2020 for Tionx
Trading Company.
b. Prepare a horizontal analysis for Tionx Trading Company.

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 ’s New

Task 2
Recall the businesses that you have thought off in the previous session (Financial Analysis 1).
In your notebook, write the businesses that you have imagined.

Are the following matters important in your imagined businesses:

1. How fast can you sell your inventory?

2. How many days does it take to collect receivables from your customers?
3. How much revenue is generated for each peso of asset invested in your business?
• The answers to these questions may be derived from the financial statements in your
previous lesson.

is It

Financial Statement (FS) Analysis is the process of evaluating risks, performance,

financial health, and prospects of a business by subjecting financial statement data to
computational and analytical techniques with the objective of making economic
decisions(White et.al 1998).There are three kinds of FS analysis techniques:
- Horizontal analysis
- Vertical analysis
- Financial ratios
(Note: this lesson will focus on ratio analysis.)

Ratio analysis expresses the relationship among selected items of financial statement
data. The relationship is expressed in terms of a percentage, a rate, or a simple proportion
(Weygandtet.al. 2013). A financial ratio is composed of a numerator and a denominator. For
example, a ratio that divides sales by assets will find the peso amount of sales generated by
every peso of asset invested. This is an important ratio because it tells us the efficiency of
invested asset to create revenue. This ratio is called asset turnover. There are many ratios used
in business. These ratios are generally grouped into three categories:

(a) profitability,
(b) efficiency, and
(c) financial health.

a. Profitability ratios measure the ability of the company to generate income from the use of
its assets and invested capital as well as control its cost.

8
The following are the commonly used profitability ratios:
- Gross profit ratio reports the peso value of the gross profit earned for every peso of
sales. We can infer the average pricing policy from the gross profit margin.
- Operating income ratio expresses operating income as a percentage of sales. It
measures the percentage of profit earned from each peso of sales in the company’s core
business operations (Horngren et.al. 2013). A company with a high operating income
ratio may imply a lean operation and have low operating expenses. Maximizing
operating income depends on keeping operating costs as low as possible (Horngren
et.al. 2013).
- Net profit ratio relates the peso value of the net income earned to every peso of sales.
This shows how much profit will go to the owner for every peso of sales made.
- Return on asset(ROA) measures the peso value of income generated by employing
the company’s assets. It is viewed as an interest rate or a form of yield on asset
investment. The numerator of ROA is net income. However, net income is profit for
the shareholders. On the other hand, asset is allocated to both creditors and
shareholders. Some analyst prefers to use earnings before interest and taxes instead of
net income. There are also two acceptable denominators for ROA – ending balance of
total assets or average of total assets. Average assets is computed as beginning balance
+ ending balance divided by 2.
- Return on equity(ROE) measures the return (net income) generated by the owner’s
capital invested in the business. Similar to ROA, the denominator of ROE may also be
total equity or average equity.

Sample Financial Statements to be used for the computations:

Cash ₱ 200,000
Accounts Receivable 400,000
Inventory 250,000
Equipment 550,000
Total Assets 1,400,000

Accounts Payable 300,000

Notes Payable 400,000
Owner, Capital 700,000
Total Liabilities and equity ₱ 1,400,000

Sales ₱ 900,000.00
Cost of Goods Sold 400,000.00
Gross Profit 500,000.00
Operating Expenses 200,000.00
Operating income 300,000.00
Interest Expense 20,000.00
Net Income ₱ 280,000.00

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 Name of Ratio Formula Sample Computation
𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡 500,000
Gross profit margin 𝑥 100 𝑥 100 = 55.56%
𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠 900,000
𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐼𝑛𝑐𝑜𝑚𝑒 300,000
Operating income Margin 𝑥 100 𝑥100 = 33.33%
𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠 900,000
𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒 280,000
Net Profit margin 𝑥 100 𝑥100 = 31.11%
𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠 900,000
𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒 280,000
Return on Assets 𝑥 100 𝑥 100 = 20%
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐴𝑠𝑠𝑒𝑡𝑠 1,400,000
𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒 280,000
Return on Equity 𝑥 100 𝑥 100 = 40%
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐸𝑞𝑢𝑖𝑡𝑦 700,000

b) Operational efficiency ratio measures the ability of the company to utilize its assets.
Operational efficiency is measured based on the company’s ability to generate sales from the
utilization of its assets, as a whole or individually. The turnover ratios are primarily used to
measure operational efficiency.

- Asset turnover measures the peso value of sales generated for every peso of the
company’s assets. The higher the turnover rate, the more efficient the company is in
using its assets.
- Fixed asset turnover is indicator of the efficiency of fixed assets in generating sales.
- Inventory turnover is measured based on cost of goods sold and not sales. As such
both the numerator and denominator of this ratio are measured at cost. It is an indicator
of how fast the company can sell inventory. An alternative to inventory turnover is
“days in inventory”. This measures the number of days from acquisition to sale.
- Accounts receivables turnover the measures the number of times the company was
able to collect on its average accounts receivable during the year. An alternative to
accounts receivable turnover is “days in accounts receivable”. This measures the
company’s collection period which is the number of days from sale to collection.

10
 Financial Health Ratios investigate the company’s solvency and liquidity ratios. Solvency
refers to the company’s capacity to pay their long-term liabilities. On the other hand, liquidity
ratio intends to measure the company’s ability to pay debts that are coming due (short term
debt).

- Debt ratio indicates the percentage of the company’s assets that are financed by debt.
A high debt to asset ratio implies a high level of debt.
- Equity ratio indicates the percentage of the company’s assets that are financed by
capital. A high equity to asset ratio implies a high level of capital.
- Debt to equity ratio indicates the company’s reliance to debt or liability as a source of
financing relative to equity. A high ratio suggests a high level of debt that may result in
high interest expense.
- Interest coverage ratio measures the company’s ability to cover the interest expense
on its liability with its operating income. Creditors prefer a high coverage ratio to give
them protection that interest due to them can be paid.
- Current ratio is used to evaluate the company’s liquidity. It seeks to measure whether
there are sufficient current assets to pay for current liabilities. Creditors normally prefer
a current ratio of 2.

11
- Quick ratio is a stricter measure of liquidity. It does not consider all the current assets,
only those that are easier to liquidate such as cash and accounts receivable that are
referred to as quick assets.

12
 ’s More

Task 3

Directions: Prepare Profitability ratios, Efficiency ratios, and Financial Health ratios in your
activity notebook. Use the following data statements given below.

C&F Store
Statement of Financial Position
As of December 31
2019 2020

Cash ₱ 110,000 ₱ 87,400

Accounts Receivable 90,000 69,920
Inventory 129,000 218,500
Prepaid Rent 12,000 4,370
Delivery Van 550,000 493,810
Total Assets ₱ 891,000 ₱ 874,000

Accounts Payable ₱ 75,000 ₱ 67,298

Loan Payable 400,000 393,300
Anistle Cruz, Capital 416,000 413,402
Total Liabilities and Equity ₱ 891,000 ₱ 874,000

C&F Store
Statement of Comprehensive Income
For the period ending December 31

2019 2020
Sales ₱ 810,000.00 ₱ 686,000.00
Cost of Goods Sold 348,300.00 301,750.00
Gross Profit 461,700.00 384,250.00
Operating Expenses 234,900.00 205,800.00
Interest Expense 40,500.00 17,150.00
Net Income ₱ 186,300.00 ₱ 161,300.00

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Understanding on the Importance of Computing and Interpreting Financial
Ratios in the Business

Managing a company, organization or enterprise can be a challenging task. Along with

the day-to-day activities of running the company, it is vital to evaluate performance on a regular
basis to ensure success. Analyzing the financial and operational condition of the organization
to understand strengths and weaknesses helps leadership determine where improvements or
changes can be made. The good news is that company performance information can easily be
gleaned through financial ratios. Financial ratios use information contained in the financial
statement to evaluate performance effectiveness in key areas. Here we provide a summary of
key ratios, what they measure, and what value they can bring to your organization.
Financial ratios are important tools for quantitative analysis. Certain ratios are available
to evaluate both short- and long-term financial and operational performance, making them
useful at identifying trends in the business and providing warning signs when it may be time
to make a change. There are also specific ratios that can measure important variables essential
to one industry or another. By evaluating ratios, a business can benchmark itself against similar
companies and understand its strengths, weaknesses, threats and areas of opportunity.

I Have Learned

Complete the following statements. Write your statements in your activity notebook.

1. As an ABM student, I have learned that _______________________.

2. As an ABM student, I have realized that_______________________.

3. Using the knowledge I have learned in this lesson, I will apply

_______________________.

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 I Can Do

Task 4
Veery Beery Company
Statement of Comprehensive Income
For the Year-ended December 31

2019 2020
Sales ₱ 10,040,000 ₱ 8,760,000
Cost of Goods Sold 5,680,000 5,860,000
Gross Profit 4,360,000 2,800,000
Operating Expenses 1,160,000 1,680,000
Operating Income 3,200,000 1,220,000
Interest Expense 100,000 28,000
Net Income ₱ 3,1000,000 ₱ 1,192,000

Veery Beery Company

Statement of Financial
For the Year-ended December 31
2019 2020
Cash ₱ 400,000 180,000
Short-term investments 5,600,000 1,800,000
Accounts receivable 1,480,000 1,060,000
Inventory 1,380,000 1,640,000
Other Current Assets 8,860,000 4,680,000
Total Current Assets 10,860,000 5,040,000
Equipment 6,800,000 5,200,000
Total Assets ₱ 17,660,000 10,240,000
Accounts Payable ₱ 6,600,000 2,620,000
Notes Payable - long term 2,460,000 2,120,000
Owner, Capital 8,600,000 5,500,000
Total liabilities and equity ₱ 17,660,000 10,240,000

Requirements:

a. Compute for the company’s profitability and operating efficiency ratios for 2020. b.
Compute for the financial health ratios of the company in 2020 and 2019.

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I. Directions
Multiple Choice. Write the letter of the correct answer in your notebook.
(For numbers 1 to 5) The financial statements of Merdana Trading Ltd. are given below:
2019 2020
Cash and Cash Equivalents ₱ 12,250 ₱ 10,470
Receivables 9,065 8,055
Inventory 6,620 5,300
Prepaid Expenses 8,545 10,600
Total Current Assets 36,480 34,425
Other Assets 92,500 78,685
Total Assets ₱ 128,980 ₱ 113,110

Total current liabilities 36,150 42,335

Long-term Liabilities 23,990 18,960
Mercedes Aldana, Capital 68,840 51,815
Total Liabilities and Equity ₱ 128,980 ₱ 113,110

Sales ₱ 104,705
Cost of Sales 32,275
Gross Profit 69,430
Selling Expenses 35,325
Administrative Expenses 12,815
Operating Income 21,290
Interest Expense 1,050
Net Income ₱ 20,240

1. Which statement best describes Merdana Trading Ltd.’s acid-test ratio?

a. Greater than 1 b. Equal to 1
c. Less than 1 d. None of the above
2. Merdana Trading Ltd.’s inventory turnover during 2020 was (amounts rounded)
a. 6 times. b. 7 times
c. 8 times. d. Not determinable from the data given.
3. During 2020, Merdana Trading Ltd.’s days’ sales in receivables ratio was (amounts rounded)
a. 34 days b. 30 days
c. 32 days d. 28 days
4. Which measure expresses Merdana Trading Ltd.’s times-interest-earned ratio? (amounts
rounded)
a. 54.7% b. 20 times
c. 34 times d. 32 times

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5. Merdana Trading Ltd.’s rate of return on equity can be described as
a. 33.55% b. 16.72%
c. 35.29% d. None of the above
6. Merdana Trading Ltd.’s rate of return on asset can be described as
a. 33.55% b. 16.72%
c. 35.29% d. None of the above
7. Merdana Trading Ltd.’s gross profit rate can be described as
a. 34% b. 19%
c. 20% d. 66%

(Advance Computation): Alice’s Cupcakes

Direction: Fill in the missing data in Alice’s Cupcake’s Statement of Comprehensive Income
using the following ratios:
a. Inventory turnover is 3.50. Beginning inventory was ₱4,250 and ending inventory was
₱4,050.
b. Net profit margin is 11%.

The incomplete Statement of Financial Position of Alice’s Cupcakes is given below:

Net Sales ₱ 28,800.00

Cost of goods sold ________?
Selling and admin expenses 7,320.00
Interest expense ________?
Other Expenses 600.00
Income before taxes 5,300.00
Income tax expense ________?
Net Income ₱ ________?

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Glossary

Ratio analysis - expresses the relationship among selected items of financial statement data.
The relationship is expressed in terms of a percentage, a rate, or a simple proportion
(Weygandtet.al. 2013).

Profitability ratios - measure the ability of the company to generate income from the use of
its assets and invested capital as well as control its cost.

Gross profit ratio – reports the peso value of the gross profit earned for every peso of sales.
We can infer the average pricing policy from the gross profit margin.

Operating income ratio – expresses operating income as a percentage of sales. It measures

the percentage of profit earned from each peso of sales in the company’s core business
operations (Horngren et.al. 2013).

Net profit ratio - relates the peso value of the net income earned to every peso of sales. This
shows how much profit will go to the owner for every peso of sales made.

Return on asset(ROA) )- measures the peso value of income generated by employing the
company’s assets.

Return on equity(ROE) – measures the return (net income) generated by the owner’s capital
invested in the business.

Operational efficiency ratio – measures the ability of the company to utilize its assets.
Operational efficiency is measured based on the company’s ability to generate sales from the
utilization of its assets, as a whole or individually.

Asset turnover – measures the peso value of sales generated for every peso of the company’s
assets.

Fixed asset turnover – is indicator of the efficiency of fixed assets in generating sales.

Inventory turnover – is measured based on cost of goods sold and not sales. As such both the
numerator and denominator of this ratio are measured at cost.

Accounts receivables turnover - the measures the number of times the company was able to
collect on its average accounts receivable during the year.

Financial Health Ratios - investigate the company’s solvency and liquidity ratios. Solvency
refers to the company’s capacity to pay their long-term liabilities. On the other hand, liquidity
ratio intends to measure the company’s ability to pay debts that are coming due (short term
debt).

21
Debt ratio – indicates the percentage of the company’s assets that are financed by debt. A high
debt to asset ratio implies a high level of debt.

Equity ratio – indicates the percentage of the company’s assets that are financed by capital. A
high equity to asset ratio implies a high level of capital.

Debt to equity ratio – indicates the company’s reliance to debt or liability as a source of
financing relative to equity. A high ratio suggests a high level of debt that may result in high
interest expense.

Interest coverage ratio – measures the company’s ability to cover the interest expense on its
liability with its operating income.

Current ratio – is used to evaluate the company’s liquidity. It seeks to measure whether there
are sufficient current assets to pay for current liabilities.

Quick ratio – is a stricter measure of liquidity. It does not consider all the current assets, only
those that are easier to liquidate such as cash and accounts receivable that are referred to as
quick assets.

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References

Fundamentals of Accountancy, Business, And Management 2

Teaching Guide for Senior High School. Published by the Commission on Higher Education,
2016 Chairperson: Patricia B. Licuanan, Ph.D. (Page 78- 95)

What is Financial Ratio Analysis? Accessed: January 6, 2021

https://courses.lumenlearning.com/wmopen-introbusiness/chapter/financial-ratio-analysis/.
Lumen – Introduction to Business [Deprecated]

Introduction to Financial Statement Analysis? Accessed: January 6, 2021

https://www.cfainstitute.org/en/membership/professional-development/refresher-
readings/introduction-financial-statement-analysis. © 2021 CFA Institute.

Pre-assessment. Financial Ratios. Accessed: January 7, 2021

http://web.nacm.org/cap_acap_materials/cap/fsa1_10th/exams/FSAI_EXAM2_Solutions_Fra
ser_10th.pdf. ©2013 NACM

WHY ARE FINANCIAL RATIOS IMPORTANT? Accessed: January 13, 2021

https://www.seldenfox.com/our-insights/articles/financial-ratios-important/.
by Brian J. Eagan, CPA. January 2018. © 2021 Selden Fox, LTD.

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