12

Fundamentals of
Accountancy, Business
and Management 2
Quarter 1 - Module
Week 6&7

SCHOOLS DIVISION OF SURIGAO CITY

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FABM2 - WEEK 5
First Edition, 2020

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Writer: Kurt-Airion H. Sumaylo

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Printed in the Philippines by ______________________________

For the learner:

Welcome to the Fundamentals of Accountancy, Business and Management 2 – Grade 12
Modular Distance Learning (MDL) Self-Learning Module on the Statement of Comprehensive
Income (SCI) of a Merchandising Business!

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.

Writer: KURT-AIRION H. SUMAYLO

School/Station: CARAGA REGIONAL SCIENCE HIGH SCHOOL
Division: Surigao City
Email Address: kurtairionsumaylo1981@gmail.com
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Analysis and Interpretation of Financial

WEEK Statements: Stability, Profitability, and Vertical
6&7 Analyses

Name : ____________________________________________ Section : _______________

Objectives

A. Define the solvency/ stability and profitability measurement levels

B. Identify the different ratios under solvency/ stability and profitability

C. Appreciate the significance of these ratios in business operation

D. Define vertical analyses of financial statements

E. Perform vertical analyses of financial statements of a single proprietorship

F. Appreciate the significance of vertical analyses of financial statements

What I know?

Multiple Choice. Directions: Encircle the letter of the best answer.

1. Which ratios measure the capability of an entity to pay long term obligations as they fall due?
a. liquidity
b. solvency
c. profitability
d. flexibility

2. These are financial ratios that measure the ability of the company to generate income from the
use of its assets and invested capital.
a. liquidity
b. solvency
c. profitability
d. flexibility

Writer: KURT-AIRION H. SUMAYLO

School/Station: CARAGA REGIONAL SCIENCE HIGH SCHOOL
Division: Surigao City
Email Address: kurtairionsumaylo1981@gmail.com
 Page 4

3. Which among the following shows the proportions of equity and debt that a company is using
to finance its assets? It also signals the extent to which shareholder's equity can fulfill
obligations to creditors, in the event a business declines.
a. time interest earned ratio
b. return on assets ratio
c. debt to total assets ratio
d. debt to equity ratio

4. This _________ gives a manager, investor, or analyst an idea as to how efficient a company's
management is at using its assets to generate earnings.
a. return on assets
b. return on equity
c. profit margin
d. debt to equity

5. Which of the following is the ratio of a company's profit (sales minus all expenses) divided by
its revenue?
a. return on assets
b. debt to equity
c. profit margin
d. asset turn-over

Lesson
Analysis and Interpretation of Financial Statements: Solvency /
Stability and Profitability

Solvency / Stability pertains to the company’s ability to meet its long-term obligations. It
provides measures on whether the company’s assets are sufficient to cover for their liabilities. Also,
Stability analysis investigates how much debt can be supported by the company and whether debt and
equity are balanced.

The following are different ratios under solvency:

a. Debt to total assets ratio

The debt to asset ratio, also known as the debt ratio, is a leverage ratio that
indicates the percentage of assets that are being financed with debt. The higher the
ratio, the greater the degree of leverage and financial risk.

b. Debt to equity ratio

The debt-to-equity ratio shows the proportions of equity and debt a company
is using to finance its assets and it signals the extent to which shareholder's equity can
fulfill obligations to creditors, in the event when business declines.

c. Times interest earned ratio

Writer: KURT-AIRION H. SUMAYLO

School/Station: CARAGA REGIONAL SCIENCE HIGH SCHOOL
Division: Surigao City
Email Address: kurtairionsumaylo1981@gmail.com
 Page 5

The times interest earned ratio is also known as the interest coverage ratio
and it’s a metric that shows how much proportionate earnings a company can spend
to pay its future interest costs.

Profitability is a situation in which an entity is generating a profit. Profitability arises when the
aggregate amount of revenue is greater than the aggregate amount of expenses in a reporting period.

Furthermore, different ratios under profitability ratio are the following:

a. Gross profit ratio

The gross profit ratio is a profitability ratio that shows the relationship
between gross profit and total net sales revenue. It is a popular tool to evaluate the
operational performance of the business. The ratio is computed by dividing the gross
profit figure by net sales.

b. Profit margin ratio

The profit margin is a ratio of a company's profit (sales minus all expenses)
divided by its revenue. The profit margin ratio compares profit to sales and tells you
how well the company is handling its finances overall. Profit margin is one of the
commonly used profitability ratios to gauge the degree to which a company or a
business activity makes money. It represents what percentage of sales has turned into
profits.

c. Operating expenses to sales ratio

The operating ratio shows the efficiency of a company's management by

comparing the total operating expense of a company to net sales. The operating ratio
shows how efficient a company's management is at keeping costs low while
generating revenue or sales. The smaller the ratio, the more efficient the company is
at generating revenue versus total expenses.

d. Return on investment or ROI

Return on investment or ROI is a profitability ratio that calculates the profits

of an investment as a percentage of the original cost. In other words, it measures how
much money was made on the investment as a percentage of the purchase price. It
shows investors how efficiently each peso invested in a project is at producing a
profit. Investors not only use this ratio to measure how well an investment performed,
but they also use it to compare the performance of different investments of all types
and sizes.

e. Assets turnover ratio

The asset turnover ratio measures the value of a company's sales or revenues
relative to the value of its assets. The asset turnover ratio can be used as an indicator
of the efficiency with which a company is using its assets to generate revenue.

Writer: KURT-AIRION H. SUMAYLO

School/Station: CARAGA REGIONAL SCIENCE HIGH SCHOOL
Division: Surigao City
Email Address: kurtairionsumaylo1981@gmail.com
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ABC Convenience Store

Take a look at the given figure.
Statement of Financial Position
December 31, 2019 How are you going to evaluate the
data in the given table? What is the
largest component of asset? Why did
Assets you say so?
Cash 100,000 How much percentage of assets are
Accounts Receivable 450,000 financed by equity? Or financed by
debt?
Accrued Income 300,000
To answer those questions,
Inventory 200,000 we need to do a vertical analysis.
Prepaid Expenses 50,000
Long-term Investments 1,250,000 Analysis and Interpretation of
Financial Statements: Vertical
Intangible Assets 500,000 analysis of a Single Proprietorship
Property, Plant, and Equipment 700,000
Total Assets 3,550,000 Vertical analysis, also called
common-size analysis, is a technique
that expresses each financial
Liabilities statement item as a percentage of a
Accounts Payable 250,000 base amount (Weygandt et.al. 2013,
as cited by Monfero et.a. 2016, 65)
Accrued Expenses 100,000
Unearned Income 80,000 In preparing a vertical
ABC Convenience Store
Notes Payable 150,000 analysis of statement of
Statement of Financial Position
Mortgage Payable 500,000 financial position, the total
December 31, 2019
Loans Payable 1,000,000 assets will serve as the base
amount or the 100%. All
Total Liabilities Assets 2,080,000 % the items in the statement of
Cash 100,000 2.82 financial position will be
Accounts Receivable Owner's Equity 450,000 12.68 divided using the base
ABC Equity 1,470,000 amount (Balance of
Accrued Income 300,000 8.45
Total Liabilities and Owner's Equity 3,550,000 Account / Total Assets). It
Inventory 200,000 5.63
is shown in the figure
Prepaid Expenses 50,000 1.41
Long-term Investments 1,250,000 35.21 below:
Intangible Assets 500,000 14.08
(Statement of Financial
Property, Plant, and Equipment 700,000 19.72 Position)
Total Assets 3,550,000 100

The above may be evaluated

Liabilities as follows: The largest
Accounts Payable 250,000 7.04 component of asset is long-
term investment at 35.21%.
Accrued Expenses 100,000 2.82
Prepaid expenses are the
Unearned Income 80,000 2.25 smallest component at
Notes Payable 150,000 4.23 1.41%. On the other hand,
Mortgage Payable 500,000 14.08 58.59% of assets are
financed by debt which is
Loans Payable 1,000,000 28.17
Total Liabilities 2,080,000 58.59
Writer: KURT-AIRION H. SUMAYLO
School/Station: CARAGA REGIONAL SCIENCE HIGH SCHOOL
Division: Surigao City
Email Address: Owner's Equity
kurtairionsumaylo1981@gmail.com
ABC Equity 1,470,000 41.41
Total Liabilities and Owner's Equity 3,550,000 100
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greater than 41.41% of assets ABC Selling Company

that is financed by equity.
Statement of Comprehensive Income
In the statement of For the year ended December 31, 2019
comprehensive income, all the
items will be divided using the %
base amount which is Net Sales
(balance of account/net sales). Net Sales 920,000.00
For example, by showing the Cost of Goods 570,000.00 61.00
various expense line items in the Sold
income statement as a
Gross Profit 350,000.00 38.00
percentage of sales, one can see
how these are contributing to Operating 164,000 17.00
profit margins and whether Expenses
profitability is improving over Net Income 186,000.00 20.00
time. It thus becomes easier to
compare the profitability of a
company with its peers.

(Vertical Analysis of the Statement of Financial Position)

The above may be evaluated as follows: The cost of goods sold is 61% of sales. The company has a
gross profit rate of 38%. Operating expenses is 17% of sales. The company earns income of P 0.20 for
every peso of sales and gross profit generated is Php .38 for every peso of sale.

(Vertical Analysis of the Statement of Comprehensive Income)

Activity

Activity 1
Directions: Identify if the given financial ratio is solvency or profitability. Put a checkmark in the
column provided.

Solvency Profitability
1. Debt to total assets ratio

Writer: KURT-AIRION H. SUMAYLO

School/Station: CARAGA REGIONAL SCIENCE HIGH SCHOOL
Division: Surigao City
Email Address: kurtairionsumaylo1981@gmail.com
 Page 8

2. Gross profit ratio

3. Assets turnover ratio
4. Return on investment
5. Debt to equity ratio
6. Profit margin ratio
7. Times interest earned ratio
8. Operating expenses to sales ratio
9. Return on assets
10. Return on equity

Activity 2:

Directions: Identify the financial ratio being described in each statement. Write your answer in the
space provided.

_____________1. It is a leverage ratio that indicates the percentage of assets that are being financed
with debt.
_____________2. It shows how much profit each peso of common stockholders’ equity generates.

_____________3. The profitability ratio that shows the relationship between gross profit and total net
sales revenue.

_____________4. The profitability ratio that gives a manager, investor, or analyst an idea as to how
efficient a company's management is at using its assets to generate earnings.

_____________5. It measures how much money was made on the investment as a percentage of the
purchase price.

_____________6. This ratio shows the efficiency of a company's management by comparing the total
operating expense of a company to net sales.

_____________7. This determines the proportions of equity and debt a company is using to finance
its assets and it signals the extent to which shareholder's equity can fulfill obligations to creditors, in
the event a business declines.

_____________8. It represents what percentage of sales has turned into profits.

_____________9. Also known as the interest coverage ratio and it’s a metric that shows how much
proportionate earnings a company can spend to pay its future interest costs.

______________10. Pertains to the company’s ability to meet its long-term obligations.

Writer: KURT-AIRION H. SUMAYLO

School/Station: CARAGA REGIONAL SCIENCE HIGH SCHOOL
Division: Surigao City
Email Address: kurtairionsumaylo1981@gmail.com
 Page 9

Generalization
There are four main financial statements. They are: (1) balance sheets; (2) income statements;
(3) cash flow statements; and (4) statements of shareholders' equity. Balance sheets show what a
company owns and what it owes at a fixed point in time.

Post-test

A. Directions: Write the word True if the statement is correct, if it is wrong, change the underlined
word with the correct answer.

1. A low debt-to-equity ratio indicates a lower amount of financing by debt via lenders, versus
funding through equity via shareholders.

2. The higher the ratio, the more efficient the company is at generating revenue versus total
expenses.

3. The return on assets ratio shows how much profit each peso of common stockholders’
equity
generates.

4. The profit margin ratio represents the percentage of sales that has turned into profits.

5. The asset turnover ratio can be used as an indicator of the efficiency with which a company
is using its assets to generate revenue.

References:

Licuanan P. (2016). Teaching Guide for Senior High School

Fundamentals of Accountancy, Business and
Management 1
Specialized Subject I ACADEMIC – ABM
Published by the Commission on Higher Education,

Writer: KURT-AIRION H. SUMAYLO

School/Station: CARAGA REGIONAL SCIENCE HIGH SCHOOL
Division: Surigao City
Email Address: kurtairionsumaylo1981@gmail.com
 Page 10

Accountingtheory(n.d) Retrieved from http://accountingtheory.weebly.com/nature-

and-scope-of-accounting

Writer: KURT-AIRION H. SUMAYLO

School/Station: CARAGA REGIONAL SCIENCE HIGH SCHOOL
Division: Surigao City
Email Address: kurtairionsumaylo1981@gmail.com