MODULE 3

FINANCIAL STATEMENTS ANALYSIS – A SUMMARY

1. GOAL OF ACCOUNTING
• To provide information that allows decision makers to understand and evaluate the results of business
decisions. That is to provide information in order to make decisions. Managers analyze financial
statements to evaluate past financial performance and make future decisions

2A. LEVELS OF ANALYSIS – VERTICAL

• It focuses on important relationships between items on the same financial statement. These items are
compared vertically, from one account balance against another and are typically expressed as
percentages to reveal the relative contributions made by each financial statement item
• Line items on the Balance Sheet are generally expressed as a percentage of total assets.
• Line items on the Income Statement are generally expressed as a percentage of net sales

2B.LEVELS OF ANALYSIS – HORIZONTAL

• It is conducted to help financial statement users recognize important financial changes that unfold over
time. It compares information horizontally, from one period to the next, with the general goal of
identifying significant sustained changes. These changes are typically described in terms of peso
amounts and year-over-year percentages. To compute for the percentage increases/decreases:
Current year – Base year
Base year

Problem 1.
If year one equals P500,000.00, year two equals P525,000.00, and year three equals P560,000.00, the
percentage to be assigned for year three in a trend analysis, assuming that year one is the base year is:
P560,000.00 – P500,000.00
P500,000.00
= 112%

Problem 2.
Assume the following sales data for a company:
YEAR SALES
2013 400,000.00
2014 625,000.00
2015 750,000.00
2016 800,000.00
What is the percentage increase in sales from 2013 to 2014, assuming that 2013 is the base
year?
625,000.00 – 400,000.00
400,000.00
= 56.25%
2C. LEVELS OF ANALYSIS – RATIO ANALYSIS
• Conducted to understand relationships among various items reported in one or more of the financial
statements. It shows the evaluation of the company’s performance given the level of other company’s
resources
• For meaningful analysis, ratios are best compared with both historical and industry averages
o Profitability ratios
- relate to the company’s performance in the current period. It shows the company’s ability to
generate income
o Liquidity ratios
- relate to the company’s short term survival. It shows the company’s ability to use current assets
to repay liabilities as they become due. It measures the short term ability of the enterprise to pay
its obligations and to meet unexpected needs for cash
o Solvency ratios
- relate to the company’s long run survival. It shows the company’s ability to repay lenders when
debt matures and to make the required interest payments prior to the date of maturity

2C1. LEVELS OF ANALYSIS – RATIO ANALYSIS – PROFITABILITY RATIOS

1. Net profit margin or return on sales:
- Net income/Net sales
2. Return on total assets:
- Net income/Average total assets
3. Return on equity:
- Net income/average shareholders’ equity
4. Gross profit percentage
- (Net sales-COGS)/Net sales
5. Asset turnover
- Net sales/average total assets
6. Fixed asset turnover
- Net sales/average net fixed assets
7. Earnings per share
- Net income (for CS)/Ave # of CS outstanding
8. Price/Earnings ratio
- Stock market price/Earnings per share
9. Dividend yield
- Dividend per share/Price per share
10. Dividend pay out
- Common dividend per share/Earnings per share
Problem 3.
Balance Sheet Income Statement
Cash 100.00 Sale 3,000.00
A/R 200.00 Cost of goods -1,600.00
Inventory 50.00 Gross profit 1,400.00
Net fixed assets 600.00 Operating exp -970.00
950.00 Operating inc 430.00
A/P 140.00 Interest exp -30.00
Long term debt 300.00 IBIT 400.00
Capital stock 260.00 Income tax -200.00
RE 250.00 Net income 200.00
950.00 RE beg 150.00
Dividends -100.00
RE end 250.00
What is the company’s profit margin?
Solution:
Net Income/Net Sales = 200.00/3,000.00 x 100%
= 6.67%
What is the company’s return on assets?
Solution:
Net Income/Average Total Assets = 200.00/950.00 x 100%
= 21.05%

Problem 4.
Company had P15M in sales, while total fixed costs were held to P6M. The firm’s total assets averaged
P20M and the debt to equity ratio was calculated at 0.60. If the firm’s EBIT is P3M, the interest on all debt
is 9%, and the tax rate is 40%, what is the return on equity?
Solution:
Average Shareholder’s Equity = 20,000,000 x (1+0.60)
= 20,000,000 x 1.60
= 12,500,000
Debt = 20,000,000 – 12,500,000
= 7,500,000
Interest of Debt = 7,500,000 x 9%
= 675,000
Earnings Before Tax = 3,000,000 – 657,000
= 2,335,000
Earnings After Tax = 2,325,000 x 40%
= 930,000
Net Income = 2,325,000 – 930,000
= 1,395,000
Net income/average shareholders’ equity = 1,395,000/12,500,000 x 100
= 11.16%
Problem 5.
What is the company’s asset turnover ratio for the year?
Quick asset 208,000.00
Acid test ratio 2.6 to 1
Current ratio 3.5 to 1
Net sales for the year 1,800,000.00
Cost of sales for the year 990,000.00
Average total assets for the year 1,200,000.00
Solution:
Net sales/average total assets = 1,800,000.00/1,200,000.00
= 1.50 times

Compute for the gross profit/gross profit percentage using the information contained Problem 3
Solution:
(Net sales-COGS)/Net sales = (1,800,000.00 – 990,000.00)/ 1,800,000.00
= 810,000.00/1,800,000.00
= 45%

Problem 6.
On it’s year end financial statements, Corporation showed sales of P3M, net fixed assets of P1.3M, and
total assets of P2M. What is the company’s fixed asset turnover?
Solution:
Net sales/average net fixed assets = 3,000,000/1,300,000
= 2.3 times
QUESTION
What type of ratio is earnings per share?
ANSWER: Profitability ratio

Problem 7.
A company has 150,000 shares outstanding on January 1. On March 1, 75,000 additional shares were
issued through a stock dividend. Then on November 1, the company issued 60,000 shares for cash. The
number of shares to be used in the denominator of the EPS calculation for the year is
Solution:
Outstanding Shares + Additional Shares = 150,000 + 75,000
= 225,000
Problem 8.
Excerpts from Corporations most recent FS:
Year 2 Year 1
Net income 230,000 200,000
CD paid on PS 28,000 12,000
CD paid on CS 100,000 42,000
WANOSO 245,000 105,000
EPS is reported on Year 2 IS as?
Solution:
Net income (for CS)/Ave # of CS outstanding = (230,000 – 28,000)/245,000
= 202,000/245,000
= P.82/share
Problem 9.
Company’s common stock is presented below for the fiscal year May 31, 2019:
Common stock outstanding 750,000
Stated value per share 15.00
Market price per share 45.00
2018 dividends per share 4.50
2019 dividends per share 7.50
Basic earnings per share 11.25
Diluted earnings per share 9.00
Compute for the price earnings ratio?
Solution: (NOT SURE DITO)
Stock market price/Earnings per share = 45.00/11.25
= 4.00
OR
Stock market price/Earnings per share = 45.00/9.00
= 5.00

Problem 10.
Company paid a regular quarterly dividend of P.20 per share and had earnings of P3.20 per share. The
market price of Company stock at the end of the period was P40.00 per share. What was the Company’s
dividend yield?
Solution:
Dividend per share/Price per share = 0.80/40.00
= 2.00%

Problem 11.
Company paid out ½ of last years earnings in dividends. Company’s earnings increased by 20% and the
amount of its dividends increase by 15% in the current year. Company’s dividend payout ratio for the
current year is
Solution: Let X = Net Income
Total Dividend = 50%X
Earnings Increase by 20% = 120%X
Dividends Increase by 15% = 115%
Common dividend per share/Earnings per share = (115% x 50%X)/120%X
= 57.5%X/120%X
= 47.9%
2C2. LEVELS OF ANALYSIS – RATIO ANALYSIS – LIQUIDITY RATIOS
11. Current ratio
- Current assets/Current liabilities
12. Quick ratio
- Quick assets/Current liabilities
13. Cash ratio
- (Cash + Marketable Securities)/Current Liabilities
14. Receivables turnover
- Net credit sales/Average receivables
15. Days sales outstanding
- Number of days in a year/Receivable turnover
16. Inventory turnover
- Cost of goods sold/Average inventory
17. Days in inventory
- Number of days in a year/Inventory turnover`
18. Goods in process inventory
- CGM/Average work in process inventory
19. Days in operating cycle
- Days in AR + Days in inventory
20. Trade payables turnover
- Net credit purchases/Average trade payables`
21. Days in trade payables
- Number of days in a year/Payables turnover
22. Cash conversion cycle
- Days in operating cycle – Average age of trade receivables
23. Current asset turnover
- Cost of sales + OPEX (exclude non cash)
Average current assets
Problem 12.
AR 400,000.00
AP 260,000.00
BP due in 10 years 600,000.00
Cash 200,000.00
IP, due in 3 months 20,000.00
Inventory 800,000.00
Land 500,000.00
Short term Prepaid Expense 80,000.00

Required:
What is Company’s current ratio?
Current assets/Current liabilities = 400,000+200,000+800,000+80,000/260,000+20,000
= 1,480,000/280,000
= 5.29

What is Company’s quick ratio?

Quick Assets/Current liabilities = (400,000+200,000)/280,000
= 600,000/280,000
= 2.14

What is Company’s working capital?

Current assets – Current Liabilities = 1,480,000-280,000
= 1,200,000

What will happen to the current ratio if the Company uses cash to pay 25% of the accounts payable?
= 400,000+(200,000x75%)+800,000+80,000/(260,000x125%)+20,000
= 400,000+150,000+800,000+80,000/325,000+20,000
= 1,430,000/345,000
= increase to 4.14

What will happen to quick ratio if the Company uses cash to pay 25% of the accounts payable?
= (400,000+150,000)/ 345,000
= 550,000/280,000
= increase to 1.96
Problem 13.
A financial analyst has obtained the following:
Cash P200,000.00, Marketable securities P100,000.00, Accounts receivable, net P300,000.00, Inventories,
net P480,000.00, Prepaid expenses P120,000.00, Accounts payable P250,000.00, Income Taxes
P50,000.00, Accrued liabilities P100,000.00, Current portion of long term debt P200,000.00. Calculate the
Company’s cash ratio
Solution:
(Cash + Marketable Securities)/Current Liabilities = (200K+100K)/(250K+50K+100K+200K)
= 300,000/600,000
= 0.5

Problem 14.
The year end financial statements of Company is as follows. 10% of Company’s net sales are in cash
Year 1 Year 2 Year 3
Net sales 1,500 units at P100 1,200 units at P100 1,200 units at P125
Ending Inv 100 units at P50 100 units at P50 100 units at P50
Ave A/R P12,500.00 P12,000.00 P14,000.00
Net income P18,750.00 P9,400.00 P26,350.00
What are the receivables turnover ratios for Year 2 and 3
Solution:
Year 2: Net credit sales/Average receivables = 120,000x90%/12,000
= 108,000/12,000
=9
Year 3: Net credit sales/Average receivables = 150,000x90%/12,000
= 135,000/14,000
= 9.64

Problem 15.
15. The following inventory and sales data are available for the current year for the Company. Company
uses 365 day a year when computing ratios.
December 30, 2019 December 30, 2018
Net credit sales P6,205,000.00
Gross receivables 350,000.00 320,000.00
Inventory 960,000.00 780,000.00
What is the average number of days to collect accounts receivable in 2019?
Solution:
Net credit sales/Average receivables = 6,205,000/350,000
= 17.73
Number of days in a year/Receivable turnover = 365/17.73
= 20 days
Problem 16.
The year end financial statements of Company is as follows. 10% of Company’s net sales are in cash
Year 1 Year 2 Year 3
Net sales 1,500 units at P100 1,200 units at P100 1,200 units at P125
Ending Inv 100 units at P50 100 units at P50 100 units at P50
Ave A/R P12,500.00 P12,000.00 P14,000.00
Net income P18,750.00 P9,400.00 P26,350.00
What is the Company’s inventory turnover ratios for year 2 and 3?
Solution:
Year 2: Cost of goods sold/Average inventory = (1,200x50)/[(5,000+5,000)/2]
=60,000/5,000
= 12
Year 3: Cost of goods sold/Average inventory = (1,200x50)/[(5,000+5,000)/2]
=60,000/5,000
= 12

Problem 17.
The following inventory and sales data are available for the current year for the Company. Company uses
365 day a year when computing ratios.
December 30, 2019 December 30, 2018
Net credit sales P6,205,000.00
Gross receivables 350,000.00 320,000.00
Inventory 960,000.00 780,000.00
COGS 4,380,000.00
What is the average number of days to sell inventory in 2019?
Solution:
Cost of goods sold/Average inventory = 4,380,000/960,000
= 4.56
Number of days in a year/Receivable turnover = 365/4.56
= 80 days (pero 72 days sagot ni sir :’))

Problem 18.
Company computed the following items from its financial records for the current year:
Current ratio 2 is to 1
Days sales in inventory 54 days
Days sales in receivables 24 days
Days purchases in accounts payables 36 days
Compute for the Company’s operating cycle
Solution:
Days in AR + Days in inventory = 24 + 54
= 78 days
Problem 19.
20. The Controller of Company has gathered the ff:
Beginning Ending
Inventory P6,400.00 P7,600.00
Accounts receivable 2,140.00 3,060.00
Accounts payable 3,320.00 3,680.00
Total sales were P85,900.00, of which P62,400.00 were credit sales. COGS is P24,500.00. Compute for the
Company’s payables turnover ratio for the year
Solution:
Net credit purchases = 24,500+7,600-6,400
= 25,700
Average accounts payables = (3,320+3680)/2
=3,500
Net credit purchases/Average accounts payables = 25,700/3,500
= 7.3 times

2C3. LEVELS OF ANALYSIS – RATIO ANALYSIS – SOLVENCY RATIOS

24. Debt to Assets/Debt Ratio
- Total liabilities/Total assets
25. Times interest earned
- Earnings Before Interest and Taxes/Interest Expense
26. Debt to equity ratio
- Total liabilities/Total SHE
27. Equity ratio
- Total shareholders equity/Total assets
MODULE 4
FINANCIAL PLANNING AND FORECASTING

1. ADDITIONAL FINANCING NEEDED (AFN)

• The amount of external capital (interest bearing debt and preferred and common stock) that will be
necessary to acquire the required assets.
• It is the total amount of new interest bearing debt and preferred and common stock the firm must
issue to support its planned growth.

1A. AFN EQUATION

• An equation that shows the relationship of external funds needed by a firm to its projected increase in
assets, the spontaneous increase in liabilities, and its increase in retained earnings
• Additional funds needed = Projected increase in assets – Spontaneous increase in liabilities – Increase
in retained earnings
AFN = (A0*/S0)S – (L0*/S0)S – M(S1)(1 – Payout)

PROBLEM 01 - QUESTION
Carter Corporation’s sales forecast are expected to increase from 5M in 2015 to 6M in 2016, or by 20%. Its
assets totaled 3M at the end of 2015. Carter is at full capacity, so its assets must grow in proportion to
projected sales. At the end of 2015, current liabilities are 1M, consisting of 250,000 of AP, 500,000 of NP
and 250,000 of Accrued Liabilities. Its profit margin is forecasted to be 5%, and the forecasted retention
ratio is 30%. Use the AFN equation to forecast the additional funds Carter will need for the coming year.
Solution:
AFN = (A0*/S0)S – (L0*/S0)S – M(S1)(1 – Payout)
= (3M/5M)(1M) – (500,000/5M)(1M) - .05(6M) (.30)
= 600,000 – 100,000 – 90,000
= 410,000

PROBLEM 02 - QUESTION
Refer to Problem 01, what additional funds would be needed if the company’s year end 2015 assets had
been 4M? Assume that all other numbers are the same. Why is the AFN different from the one you found
in Problem 01?
Solution:
AFN = (A0*/S0)S – (L0*/S0)S – M(S1)(1 – Payout)
= (4M/5M)( 1M) – (500,000/5M)( 1M) – (.05)(6M)(.30)
= 800,000 – 100,000 – 90,000
= 610,000
The capital intensity ratio is measured as A 0*/S0. This firm’s capital intensity ratio is higher than
that of the firm in Problem 01; therefore, this firm is more capital intensive—it would require a
large increase in total assets to support the increase in sales.
PROBLEM 03 - QUESTION
Chua Chang & Wu Inc. is planning its operations for next year, and the CEO wants you to forecast the firm's additional
funds needed (AFN). Data for use in your forecast are shown below. Based on the AFN equation, what is the AFN for the
coming year?

Last year's sales = S0 $200,000 Last year's accounts payable $50,000

Sales growth rate = g 40% Last year's notes payable $15,000
Last year's total assets = A0* $135,000 Last year's accruals $20,000
Last year's profit margin = PM 20.0% Target payout ratio 25.0%

Solution:
Last year's sales = S0 200,000
Sales growth rate = g 40%
Forecasted sales = S0 × (1 + g) 280,000
ΔS = change in sales = S1 − S0 = S0 × g 80,000
Last year's total assets = A0* = A0* since full capacity 135,000
Forecasted total assets = A1* = A0* × (1 + g) 189,000
Last year's accounts payable 50,000
Last year's notes payable. Not spontaneous,
so does not enter AFN calculation 15,000
Last year's accruals 20,000
L0* = payables + accruals 70,000
Profit margin = PM 20.0%
Target payout ratio 25.0%
Retention ratio = (1 − Payout) 75.0%

AFN = (A0*/S0)ΔS − (L0*/S0)ΔS − Profit margin × S1 × (1 − Payout)

AFN = 54,000 − 28,000 − 42,000 = −16,000

2. EXCESS CAPACITY ADJUSTMENTS

• Changes made to the existing asset forecast because the firm is not operating at full capacity
• CAPITAL INTENSITY RATIO – the ratio of assets required per dollar of assets (A0*/S)
PROBLEM 04 – QUESTION
Walter Industries has 5B in sales and 1.7B in fixed assets. Currently the company’s fixed assets are
operating at 90% capacity.
(a) What level of sales would Walter have obtained if it had been operating at full capacity?
(b) What is Walter’s target fixed assets/sales ratio?
(c) If Walter’s sales increase by 12%, how large of an increase in fixed assets will the company need to meet
its target fixed assets/sales ratio?
Solution:
Sales = 5,000,000,000; FA = 1,700,000,000; FA are operated at 90% capacity.
a. Full capacity sales = 5,000,000,000/0.90
= 5,555,555,556.
b. Target FA/S ratio = 1,700,000,000/5,555,555,556
= 30.6%.
c. Sales increase 12%; FA =?
S1 = 5,000,000,000  1.12
= 5,600,000,000.
No increase in FA up to 5,555,555,556.
FA = 0.306  (5,600,000,000 – 5,555,555,556)
= 0.306  (44,444,444)
= 13,600,000.

PROBLEM 05 – QUESTION
Last year Wei Guan Inc. had 350 million of sales, and it had 270 million of fixed assets that were used at
65% of capacity. In millions, by how much could Wei Guan's sales increase before it is required to increase
its fixed assets?
Given:
Sales 350M
Fixed Assets 270M
% of capacity utilized .65
Solution:
Sales at full capacity (AS/%Capacity) = 350M/0.65
= 538,461,538.46
Additional sales without adding FA = Full capacity sales – Actual sales
= 538,461,538.46 – 350,000,000.00
= 188,461,538.46

3. SUSTAINABLE GROWTH RATE

• The growth rate a firm can maintain given its capital structure, ROE, and retention ratio.
PROBLEM 06 - QUESTION
Suppose Weatherford Industries has the following ratios: A0*/S0 = 1.6; L0*S0 = 0.4; profit margin = 0.10
and payout ratio = 0.45 or 45%. Sales last year were 100M. Assuming that these ratios will remain constant,
use the AFN equation to determine the maximum growth rate (sustainable growth rate) Weatherford can
achieve without having to employ nonspontaneous external funds.
Solution:
To solve this problem, we define S change in sales and g as the growth rate in sales, and then we
use the three following equations
S = S0g
S1 = S0(1+ g)
AFN = (A0*/S0)S – (L0*/S0)S – M(S1)(1 – Payout)
Set AFN = 0, substitute in known values A0*/S0, L0*/S0, M payout and S0 and then solve for g
0 = (1.6)(100g) – (0.4)(100g) – (0.10)[100 (1 + g)](1 - 0.45)
0 = 120g – (0.10)(100 + 100g)(0.55)
0 = 120g – (10 + 10g)(0.55
0 = 120g - 5.5 – 5.5g
114.5g = 5.5
g = 5.5/114.5
g = .048 or 4.8%
g = maximum growth rate without external financing

PROBLEM 07 – QUESTION
Last year Handorf-Zhu Inc. had 850 million of sales, and it had 425 million of fixed assets that were used at
only 60% of capacity. What is the maximum sales growth rate the company could achieve before it had to
increase its fixed assets?
Given:
Sales 850M
Fixed Assets 425M
% of capacity utilized .60
Solution:
Sales at full capacity (AS/%Capacity) = 850M/0.60
= 1,416,666,666.67
Additional sales without adding FA = Full capacity sales – Actual sales
= 1,416,666,666.67 – 850,000,000.00
= 566,666,666.67
% growth in sales = Additional Sales/Old sales
= 566,666,666.67/850,000,000
= 66/67%