11 SENIOR HIGH SCHOOL

FABM 2
Quarter 3 – Module 4
The Measurement Levels: Liquidity,
Solvency, Stability, and Profitability
FABM 2 – Grade 11
Alternative Delivery Mode
Quarter 3 – Module 4: The Measurement Levels: Liquidity, Solvency, Stability,
and Profitability
First Edition, 2020

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FABM 2
Quarter 3 – Module 4
The Measurement Levels:
Liquidity, Solvency, Stability,
and Profitability
Introductory Message
For the facilitator:
Welcome to the Grade 11 Fundamentals of Accountancy, Business and
Management 2 Alternative Delivery Mode (ADM) Module on The Measurement
Levels: Liquidity, Solvency, Stability, and Profitability!
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 constraints in schooling.
This learning resource hopes to engage the learners into guided and independent
learning activities at their own pace and time. Furthermore, this also aims to help
learners acquire the needed 21st century skills while taking into consideration their
needs and circumstances.
In addition to the material in the main text, you will also see this box in the body
of the module:

Notes to the Teacher

This contains helpful tips or strategies that
will help you in guiding the learners.

As a facilitator, you are expected to orient the learners on how to use this module.
You also need to keep track of the learners' progress while allowing them to manage
their own learning. Furthermore, you are expected to encourage and assist the
learners as they do the tasks included in the module.

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For the learner:
Welcome to the Grade 11 Fundamentals of Accountancy, Business and
Management 2 Alternative Delivery Mode (ADM) Module on The Measurement
Levels: Liquidity, Solvency, Stability, and Profitability!
This module was designed to provide you with fun and meaningful opportunities
for guided and independent learning at your own pace and time. You will be enabled
to process the contents of the learning resource while being an active learner.
This module has the following parts and corresponding icons:
This will give you an idea of the skills or
What I Need to Know competencies you are expected to learn in the
module.

This part includes an activity that aims to

check what you already know about the
What I Know
lesson to take. If you get all the answers
correct (100%), you may decide to skip this
module.

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song, a poem, a problem opener, an activity
or a situation.

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understand new concepts and skills.

This comprises activities for independent

practice to solidify your understanding and
What’s More
skills of the topic. You may check the answers
to the exercises using the Answer Key at the
end of the module.

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What I Have Learned
sentence/paragraph to be filled in to process
what you learned from the lesson.

This section provides an activity which will

What I Can Do help you transfer your new knowledge or skill
into real life situations or concerns.

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 This is a task which aims to evaluate your
Assessment level of mastery in achieving the learning
competency.

In this portion, another activity will be given

Additional Activities to you to enrich your knowledge or skill of the
lesson learned.

Answer Key This contains answers to all activities in the

module.

At the end of this module you will also find:

References This is a list of all sources used in

developing this module.

The following are some reminders in using this module:

1. Use the module with care. Do not put unnecessary mark/s on any part of the
module. Use a separate sheet of paper in answering the exercises.
2. Don’t forget to answer What I Know before moving on to the other activities included
in the module.
3. Read the instruction carefully before doing each task.
4. Observe honesty and integrity in doing the tasks and checking your answers.
5. Finish the task at hand before proceeding to the next.
6. Return this module to your teacher/facilitator once you are through with it.

If you encounter any difficulty in answering the tasks in this module, do not
hesitate to consult your teacher or facilitator. Always bear in mind that you are
not alone.
We hope that through this material, you will experience meaningful learning
and gain deep understanding of the relevant competencies. You can do it!

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 I

Business owners are busy with the day-to-day operations of running a business to the extent
of ignoring any company financial statement analysis. In general, an analysis of Financial Statement
is vital for persons running a business because this analysis tells the business owners where they stand
in their financial environment.

Analysis of Financial Statements is the selection, evaluation, and interpretation of financial

statements data, along with other pertinent information, to assist in investment, financial decision-
making and to show how and where to improve the performance of the business.

The analysis of Financial Statements is an evaluation of:

• A firm’s past financial performance

• Its prospects for the future

Business owners can use company financial analysis both internally and externally. They can
use them internally to examine issues such as employee performance, the efficiency of operations and
credit policies. They can use them externally to examine potential investments and the credit
worthiness of borrowers, among other things.

Most importantly, Financial Analysis points to the financial destination of the business in both
the near future and to its long-term trends.

Analysis can also show a firm’s liquidity, debt and profitability. It can also show how
investors perceive the firm. It can likewise help detect emerging problems and strengths.

Besides analyzing the past performance, analysis helps determine the strategy of a company
in order to move forward.

Now, in this lesson we will completely focus on the measurement levels, namely, liquidity,
solvency, stability and profitability and we will demonstrate an understanding of the importance of
identifying this after.

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 LEARNING COMPETENCY:

• Define the measurement levels namely, liquidity, solvency, stability,

and profitability (ABM_FABM12-Ig-h-12)

OBJECTIVES:
K: Define the measurement levels, namely, liquidity, solvency,
stability, and profitability;

S: Differentiate the measurement levels, namely, liquidity,

solvency, stability, and profitability;
A: Appreciate the importance of identifying the measurement
levels, namely, liquidity, solvency, stability, and profitability.

Pre-assessment:
Directions: Tell whether the following statements given below is a liquidity ratio, profitability
ratio, and solvency ratio. Write the letter of the correct answer in your activity notebook.

a. Liquidity ratio c. Solvency ratio

b. Profitability ratio

1. Working Capital
2. Current Ratio
3. Acid Test Ratio
4. Gross Profit Ratio
5. Accounts Receivable Turnover Ratio
6. Debt to Total Assets Ratio
7. Debt to Equity Ratio
8. Times Interest Earned Ratio
9. Profit Margin Ratio
10. Inventory Turnover Ratio
11. Operating Expenses to Sales Ratio
12. Return on Investment
13. Average Collection Period
14. Asset Turnover Ratio
15. Average Days in Inventory

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 ’s In

Task 1
Recall our previous lesson.
Let us recall what you have learned in our previous lesson by answering the following questions in
your activity notebook.

1. What are the contents of the financial statement?

a. _____________________________________________
b. _____________________________________________
c. _____________________________________________
d. _____________________________________________
e. _____________________________________________

2. What are the three major sections in the Statement Cash Flow?
a. _____________________________________________
b. _____________________________________________
c. _____________________________________________
3. How is this related in our new lesson?
__________________________________________________________________________
__________________________________________________________________________
__________________________________________________________________________
____________________________________________________________________.

’s New

Task 2

In your barangay/municipality, give at least three examples of businesses which you think are
very profitable and three examples of businesses that you think are not profitable. Answers can range
from specific company names to general types of business.

Answer the following questions in your activity notebook.

1. Discuss and reflect why businesses have different levels of profitability?

2. If the business is profitable could we say that it is liquid, solvent and stable business? Why?

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 is It

Measurement Levels

Financial ratios are one of the most common tools of managerial decision making. A ratio is
a comparison of number to another-mathematically, a simple division problem. Financial ratios
involve the comparison of various figures from the financial statements in order to gain information
about a company’s performance.

It is the interpretation, rather than the calculation, that makes financial ratios a useful tool for
business managers. Ratios may serve as indicators, clues, or red flags regarding noteworthy
relationships between variables used to measure the firm’s performance in terms of profitability, asset
utilization, liquidity, leverage, or market valuation.

Different Financial Ratios

I. Liquidity Ratios

Liquidity is the capacity of company to pay its currently maturing obligations. This will
require a good amount of Cash and other liquid assets such as Accounts Receivable, Inventory,
Trading Securities, and Prepaid Assets.
These ratios are very important to short term creditors of a company. These ratios will
determine if the borrowing company is in a position to pay the borrowed principal and interest when
they fall due.
A good liquidity position would encourage banks or financial institutions to lend while a bad
liquidity position may scare off potential creditors.

The following are the different liquidity ratios:

a. Working Capital
Working capital is the difference between current assets and current liabilities. This
is one of the simplest liquidity ratios. A positive working capital is preferred because it
would mean that there are enough current assets to pay all of the current liabilities at the
moment. On the other hand, a negative working capital is to be avoided because it would
mean that the company will surely default on some of their liabilities.

b. Current Ratio
Current ratio is the quotient of current assets divided by current liabilities. As much
as possible, a “whole number” current ratio is preferred.

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c. Acid Test Ratio
Acid Test Ratio is a more strict variation of the current ratio formula. It removes
Inventory and Prepaid Expenses from the numerator. Only Cash, Receivables, and Trading
Securities (also known as Quick Assets) will be left. Generally, Quick Assets are more
liquid than Inventory and Prepaid Expenses. As much as possible, a whole number acid test
ratio should be desired by companies.

d. Accounts Receivable Turnover Ratio

This ratio measures the frequency of conversion of the company’s Accounts
Receivable to Cash. It measures how many times the company was able to collect its
Accounts Receivable from its customers.

e. Average Collection Period

The average collection period states the usual number of the days that it would take
before the company would be able to collect a certain group of receivables. This ratio is
usually connected with the previous A/R Turnover Ratio. In fact, the A/R Turnover Ratio
itself is a component for the computation of the average collection period.
f. Inventory Turnover Ratio
This ratio measures the number of times the company was able to sell its entire
inventory to customers during the year. As much as possible, the goal is to have a high
inventory turnover ratio. By having such, it will mean that the company is being more
effective in selling its inventory to customers.

g. Average Days in Inventory

This ratio computes the number of days that of it will take before a group of
inventory will be entirely sold by the company. This follows the same concept in computing
the average collection period.

h. Number of Days in Operating Cycle

This is the measure on how it will take for the company to transform its inventory back to
cash. This is the combination of the average collection period and the average age of
inventory. The goal is to always have a shorter number of days in the operating cycle. A
shorter number will indicate that the company will have additional cash at an earlier time.

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 II. Solvency Ratios

Solvency ratios measure the capability of an entity to pay long term obligations as they fall
due. Creditors of the company’s long term notes payable and bonds payable will be interested in
knowing its solvency status. There are at least three kinds of solvency ratios.

a. Debt to Total Assets Ratio

As the term implies, this is just the proportion between the total liabilities of the
company with its total assets. The debt ratio shows how much of the assets of the company
were given by creditors. As much as possible, current and prospective creditors would want
a very low debt to total assets ratio. There is a bigger probability of collection in the future if
there are fewer liabilities to pay.

b. Debt to Equity Ratio

Instead of assets, the debt to equity ratio compares the liabilities of the company with
its equity. A small debt to equity ratio would indicate a healthier solvency position for the
company.

c. Times Interest Earned Ratio

The Times Interest Earned Ratio shows the proportion between the Earnings before
Interest and Taxes (EBIT) of the company and its interest expense. It is an indicator on how
many times the EBIT can cover the finance cost of borrowing.
This is related to the solvency situation of the company because interest expense is
always a part of long term borrowing. Creditors will charge interest during the time that the
loan or borrowing is not yet paid.

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 III. Profitability Ratios

One of the primary reasons why stockholders invest in a certain company is the chance to earn
profits. Investors make use of different profitability ratios in choosing from diverse investment
opportunities available. The absolute value of the net income after tax is not sufficient basis to
determine the earning potential of a certain company. This must be understood in relation to other
items in the financial statements. There are at least five profitability ratios that can be used.

a. Gross Profit Ratio

As the term implies, this is the proportion of the gross profit of the company with
its net sales. Gross profit is the difference between the next sales of the company and its
cost of goods sold.

b. Profit Margin Ratio

The profit being mentioned here is the Net Income after Tax (NIAT). This ratio
measures the proportion between the NIAT and the net sales of the company. This is more
precise measure of the company’s profitability because it has already considered the
operating expenses and other expenses of the entity.

c. Operating Ratio
Operating expenses, aside from the cost of goods sold, are the biggest expense
group of every company. It can be further classified into General and Administrative
Expenses and Selling Expenses. These expenses are needed to generate sales for the
period.
This ratio can be computed by dividing the operating expenses by the total net
sales.

d. Return on Investment Ratio

The return on investment ratio has two variations. One is the return on assets and
the other is the return on shareholder’s equity. They only differ in the denominator that is
used in the computation.

d.1 Return on Assets

Before profits can be realized, certain investments need to be made. In this
case, assets will be used for the different projects of the company. The goal is to
generate as much profit based on available assets during the year. Thus, a higher return
on assets is to be desired.
To compute for the return on assets, net income after tax is divided by average
total assets for the year. Total assets can easily be computed by adding the starting
and ending balance of assets and dividing it by two.

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 d.2 Return On Equity
This is a slight variation of the earlier formula. In this case, it is the average
stockholder’s equity that will be used as a denominator. This is a more specific
computation of a company’s profitability because the denominator being used is the
equity coming from stockholders only. When computing the return on assets, the
average total assets being used may come predominantly from creditors. However, the
goal is still to have a higher return on equity.

e. Asset Turnover Ratio

This ratio measures the correlation between the assets owned by the company and
the net sales generated by such properties. It can easily be computed by dividing the net
sales during the period by the average total assets for the year.

IV. Stability

Stability is the long-term counterpart of liquidity. Stability analysis investigates how

much debt can be supported by the company and whether debt and equity are balanced. The
most common stability ratios are the Debt-to-Equity ratio and gearing (also called leverage).

V. Efficiency

Efficiency refers to a company’s ability to be efficient in its operations. Two common

efficiency ratios are, inventory turnover and receivables turnover. Inventory turnover is the
ratio of cost of goods sold to inventory turnover ratio. It means that the company is successful
in converting its inventory into sales. The receivables turnover ratio is the ratio of credit sales
to accounts receivable, which tracks outstanding credit sales. High accounts receivable
turnover means that the company is successful in collecting its outstanding credit balances.

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from 3
’s More

Task 3

Directions: Enumerate the different ratios being test in the following financial ratios found in the
table below. Do it in your activity notebook.

Liquidity Ratio Profitability Ratio Solvency Ratio

Task 4

Directions: From the table above that you have completed, why you think it is important for you to
know the different ratios as an ABM student. Do it in your activity notebook.

________________________________________________________________
________________________________________________________________
________________________________________________________________
________________________________________________________________
______________________________________________________________.

I Have Learned

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

1. As an ABM student, I have learned that the Measurement levels in liquidity, solvency, stability,
and profitability are _______________________.

2. As an ABM student, it is very important for us to learn Measurement levels because

_______________________.

3. Using the knowledge I have learned in this lesson, I will be able to... _______________________.

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 I Can Do

Task 4
Directions: Answer the following questions below. Write your answers on your Activity Notebook.

As an ABM student, show your own understanding in the discussion guided with the following
questions.

1. What is the difference between liquidity ratio, solvency ratio and profitability ratio?
2. When do we say that the business is stable and efficient? Cite an example.

ESSAY RUBRIC
Level of Achievement General Approach Comprehension
Exemplary •Addresses the question. •Demonstrates an accurate and complete
(15 pts quizzes) •States a relevant, justifiable understanding of the question.
answer. •Backs conclusions with data and
•Presents arguments in a logical warrants.
order. •Uses 2 or more ideas, examples and/or
arguments that support the answer.
Adequate •Does not address the question •Demonstrates accurate but only adequate
(10 pts quizzes) explicitly, although does so understanding of question because does
tangentially. not back conclusions with warrants and
•States a relevant and justifiable data.
answer. •Uses only one idea to support the answer.
•Presents arguments in a logical •Less thorough than above.
order.
Needs Improvement •Does not address the question. •Does not demonstrate accurate
(5 pts quizzes) •States no relevant answers. understanding of the question.
•Indicates misconceptions. •Does not provide evidence to support
•Is not clearly or logically their answer to the question.
organized.
No answer (0 pts)

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I. Directions: Multiple Choice. Identify what is asked in each item. Write the letter of the correct
answer in your activity notebook.
1. This ratio measures the frequency of conversion of the company’s Accounts Receivable to
Cash.
a. Current Ratio c. Average Collection Period
b. Accounts Receivable Turnover Ratio d. Working Capital
2. This ratio measures the number of times the company was able to sell its entire inventory to
customers during the year.
a. Inventory Turnover Ratio c. Acid Test Ratio
b. Average Days in Inventory d. Working Capital
3. This shows the proportion between the Earnings Before Interest and Taxes (EBIT) of the
company and its interest expense.
a. Debt to Total Assets Ratio c. Times Interest Earned Ratio
b. Debt to Equity Ratio d. All of these
4. This ratio measures the correlation between the assets owned by the company and the net sales
generated by such properties.
a. Return on Investment c. Return on Equity
b. Return on Assets d. Asset Turnover Ratio
5. This is the proportion of the gross profit of the company with its net
sales.
a. Gross Profit Ratio c. Operating Expenses to Sales ratio
b. Profit Margin Ratio d. Return on Investment
6. This refers to both an enterprise’s ability to pay short-term obligations and a
company’s capability to sell assets quickly to raise cash.
a. Liquidity c. Solvency
b. Stability d. Profitability
7. It refers to a company’s ability to meet long-term obligations.
a. Solvency c. Profitability
b. Efficiency d. Stability
8. This ratios measure a company’s ability to generate profits from its resources
(assets).
a. Profitability c. Solvency
b. Liquidity d. Stability
9. It is the long-term counterpart of liquidity.
a. Profitability c. Efficiency
b. Stability d. Solvency
10. Which of the following categories of ratios could be used to evaluate a
company’s ability to pay back a bank loan?
a. Liquidity ratios c. Solvency ratios
b. Profitability ratios d. All of these
II. Essay.

1. Why it is important to use profitability ratio, solvency ratio, and liquidity ratio in the
analysis and interpretation of a business’ financial statement? Explain briefly.

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 16
What I Know (Pre-assessment)
1. A 6. C 11. B
2. A 7. C 12. B
3. A 8. C 13. A
4. B 9. B 14. B
5. A 10. A 15. A
What’s In (Task 1)
1.a. Statement of Financial Position (Balance Sheet)
b. Statement of Comprehensive Income (Income Statement)
c. Statement of Changes in Equity
d. Statement of Cash Flow
e. Notes, comprising a summary of significant accounting policies and other explanatory information.
2.a. Operating
b. Investing
c. Financing
3. Answer May Vary
What’s New (Task 2)
Answer May Vary
What’s More (Task 3)
Liquidity Ratio Profitability Ratio Solvency Ratio
a. Working Capital a. Gross Profit Ratio a. Debt to Total Assets Ratio
b. Current Ratio b. Profit Margin Ratio b. Debt to Equity Ratio
c. Acid Test Ratio c. Operating Expenses to Sales ratio c. Times Interest Earned Ratio
d. Accounts Receivable Turnover d. Return on Investment
Ratio d. 1 Return on Assets
e. Average Collection Period d. 2 Return on Equity
f. Inventory Turnover Ratio e. Asset Turnover Ratio
g. Average Days in Inventory
h. Number of Days in Operating
Cycle
(Task 4) Answer May Vary
Assessment:
I. Multiple Choice II. Essay
1. B 6. A
2. A 7. A Answer may vary
3. C 8. A
4. D 9. B
5. A 10. C
Glossary
Efficiency - refers to a company’s ability to be efficient in its operations.
Liquidity – refers to the company’s ability to satisfy its short-term
obligations as they come due.
Stability - is the long-term counterpart of liquidity
Solvency ratios - measure the capability of an entity to pay long term obligations
as they fall due.
Profitability – refers to the company’s ability to generate earnings

References

Business Finance, Teaching Guide for Senior High School. (2016). Quezon City: Commission on
Higher Education.

Fundamentals of Accounting, Business and Management 2, Teaching Guide for Senior High
School. (2016). Quezon City: Commission on Higher Education.

Angeles A. De Guzman, D. (2018). Fundamentals of Accountancy, Business & Management 2.

Quezon City: Lorimar Publishing Inc.

Josefina L. Beticon, J. C. (2016). Fundamentals of Accountancy, Business ad Management 2. Quezon

City: Vibal Group Inc.

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