Financial Statement Analysis antonio jaramillo dayag

Financial statement analysis - this involves the assessment and evaluation of the
firm’s past performance, its present condition, and future business potentials.
The analysis serves to provide information about the following:
 Profitability of the business firm
 Ability to meet its obligations
 Safety of investment in the business
 Effectiveness of management in running the firm.
Limitations on Financial Statement Analysis:
1. Problem with percentage increases and decreases
2. Differences between companies
3. Differences in accounting methods and estimates
4. Valuation problem
5. Use of averages
6. Lack of information
The tools and techniques used in Financial Statement Analysis are:

I. Vertical analysis which shows the relationships of the items in the same
year or it is the process of comparing figures in the financial statements
of a single period. It is also referred to as “static measure”. It
includes:

a. Common-size statements. It involves converting of figures in the

statements to a common base. This is accomplished by expressing all
figures in the statements as percentages of an important item such as
total assets (in the balance sheet) or total or net sales (in the income
statement). These converted statements are called common-size
statements or percentage composition statements.

b. Financial ratios (refer to enumerated formulas on next page). It

involves development of mathematical relationships between accounts in
the financial statements. Ratios can assist stockholders, short-term
creditors, and long-term creditors in assessing the well-being of a
firm. Ratios calculated from these statements provide users and analysts
with relevant information about the business firm’s liquidity and
activity (or effectiveness), solvency, and profitability.
II. Horizontal analysis which shows the changes or tendencies of an item for 2
or more years; also referred to as “dynamic measure”. Horizontal analysis
uses peso and percentage changes to highlight trends. Horizontal analysis
involves placing two or more yearly statements side by side and analyzing
changes between years.

a. Comparative statements - showing changes in absolute amount and

percentages
b. Trend percentages
1. Peso Change
2. Percentage change

III. Use of special reports or statements

a. Gross Profit / Net Income Variation Analysis
b. Statement of Cash Flows

What income figure should be used to determine profitability?

1. Net income from continuing operations, excluding extraordinary items,
disposals of segments of business, and cumulative effects of changes in
accounting principles.
2. Include dividends and interest earned on investments in net income, if the
said investments are included in asset base.
3. Use income before interest and tax if the intention is to measure
operational performance.
4. Use net income (after interest and tax) if the intention is to evaluate
total managerial effort
Financial Ratios page 2
 TESTS OF LIQUIDITY (Liquidity refers to the company’s ability to pay its current
liabilities as they fall due.)
It is a measure of adequacy of
Current Ratio working capital. It is the
Current Assets
(Banker’s Ratio) primary test of solvency to meet
Current Liabilities
(Working Capital Ratio) current obligations from current
assets. Rule of Thumb 2:1.
Quick Assets(Cash, It measures the number of times
Quick Ratio Short-term investments that the current liabilities could
(Acid Test Ratio) & A/R, net) be paid with the available cash
Current Liabilities and near-cash assets.
It is the time required to
complete one collection cycle from
Accounts Receivables Net (Credit) Sales
the time receivables are recorded,
Turnover (RTO)* Average Receivables
then collected, to the time new
receivables are recorded again
It indicates the average number of
Average Age of 360 days days during which the company must
Receivables Receivables Turnover wait before receivables are
collected.
Cost of Goods Sold It measures the number of times
Inventory Turnover
Average Merchandise that the inventory is replaced
(ITO)*
Inventory during the period
It indicates the average number of
Average Age Of 360 days days during which the company must
Inventory Inventory Turnover wait before the inventories are
sold.
Raw Materials Cost of Materials Used
Turnover (RMITO)* Average Raw Material Inventory

Work-in-Process Cost of Goods Manufactured

Turnover (WPITO) Average Work in Process Inventory

Finished Goods Turnover Cost of Goods Sold

(FGITO)* Average Finished Goods Inventory
Sum of average ages of receivables, raw materials, goods in
(Days in) Operating
process, and finished goods inventories (for manufacturing
Cycle firms)
Trade Payables Turnover Net Credit Purchases
(PATO) Ave. Trade Payables
No. of working days in It indicates the length of time
Average Age of Trade
______a year_____ during which payables remain
Payables
Payables Turnover unpaid.
Current Assets Turnover Cost of Sales +
(CATO)* Operating Expenses
It measures the movement and
**can also be net sales (excluding
utilization of current assets to
if depreciation and depreciation and meet operating requirements.
amortization are not amortization)**
clearly identified Average Current Assets
Cost of Sales +
Working Capital
Operating Expenses
Turnover (CATO)
(excluding It measures the movement and
**can also be net sales
depreciation and utilization of current assets to
if depreciation and meet operating requirements.
amortization)**
amortization are not
Average Working
clearly identified
Capital
* ratios that also indicate Activity or Asset Management Efficiency
 TESTS OF SHORT-TERM SOLVENCY OR SHORT-TERM FINANCIAL POSITION
It indicates relatively liquidity
Working Capital to Working Capital
of total assets and distribution
Total Asset Total Assets of resources employed.
Defensive Interval Current Liabilities Measures coverage of current
Ratio Cash & Cash Equivalent liabilities
Net Credit Purchases
Measures efficiency of the company
Payable Turnover Average Accounts
in meeting the accounts payable
Payable
 Reflects extent of the utilization
Fixed Assets to Long- Fixed Assets of resources from long-term debt.
term Liabilities Long term Liabilities Indicative of sources of
additional funds.

 RATIOS USED TO EVALUATE LONG-TERM STABILITY (Solvency refers to the ability to pay
its debts, current or non-current including interests and dividends))or FINANCIAL
POSITION
Total Liabilities Proportion of assets provided by
Debt-Equity Ratio Total Stockholders’ creditors compared to that provided
Equity by owners.
Total Liabilities Proportion of total assets provided
Debt Ratio
Total Assets by creditors
Total Stockholders’
Proportion of total assets provided
Equity Ratio ________Equity______
by owners.
Total Assets
Measures the proportion of owners’
equity to fixed assets.
Fixed Assets to Total Fixed Assets
Indicative of over or under
Equity Total Equity investment by owners and weakness
in trading on the equity
Fixed Assets to Total Fixed Assets (Net) Indicates possible over-expansion
Assets Total Assets of plant and equipment
Fixed Assets Turnover
Net Sales Tests roughly the efficiency of
(FATO)
Ave. Fixed Assets management in keeping plant
considered also as an properties employed.
(Net)
Activity Ratio
Equity Turnover (ETO) Tests roughly the efficiency of
Net Sales
considered also as an management in keeping ownership
Ave. SHEquity employed.
Activity Ratio
Common Stock Equity Measures recoverable amount in the
Book Value Per Share –
Common Shares event of liquidation if assets are
Common Stock
Outstanding realized at their book values
EBIT/NIBIT It determines the extent to which
Times Interest Earned
Interest Expense (IE) operations cover interest expense.
Net Income After Taxes It indicates ability to provide
Times Preferred
Preferred Dividends dividends to preferred
Dividend Requirements
Requirement stockholders.
Net Income before
Taxes and Fixed
Charges
Number of Times Fixed Measures ability to meet fixed
Fixed Charges (Rent +
Charges Earned charges.
Interest) + Sinking
Fund payment before
Taxes}
Measures efficiency of the firm to
Total Assets
Capital Intensity Ratio generate sales through employment
Net Sales of its resources.

 TEST OF PROFITABILITY
Measures profit generated after
Gross Profit
Gross Profit Margin consideration of cost of goods
Net Sales sold.
Operating Profit Measures profit generated after
Operating Profit Margin
Net Sales consideration of operating costs.
Measures net profit generated
Sales Margin/Profit
Net Income after consideration of all
Margin/Rate of Return
Net Sales expenses relative to net
on Net Sales (RONS) sales/income by owners
Measures net profit generated
Rate of Return on Net Income after consideration of all
Current Assets (ROCA) Average Current Asset expenses relative to current
assets
Measures net profit generated
Rate of Return on Fixed Net Income after consideration of all
Assets (ROFA) Average Fixed Assets expenses relative to fixed assets
(property, plant and equipment)
 Rate of Return on Net Income Efficiency with which assets are
Assets (ROTA/ROA) Average Assets used to operate the business.
Measures the amount earned on the
Rate of Return on Net Income
owners’ or stockholders’
Equity (ROE/ROSHE) Average SHEquity investment.
Rate of Return Per ROCA
Shows profitability of each
Turnover of Current Current Assets
turnover of current assets.
Assets Turnover
Net Income – Preferred
Dividends (if any)
Measures the amount of net income
Earnings Per Share Weighted Average
earned by each common share
Common Shares
Outstanding
Operating Activities
Measures the ability of the firm
Cash Flow Margin Cash Flow
to translate sales to cash
Net Sales

 MARKET TESTS
Price-Earnings Ratio Market Price Per Share It indicates the number of pesos
(P/E) Earnings Per Share required to buy P1 of earnings
Measures the rate of return in the
Dividend Per Share
Dividend Yield investor’s common stock
Market Price Per Share investments.
Common Dividend Per
It indicates the proportion of
Dividend Pay-Out ________Share_______
earnings distributed as dividends
Earnings Per Share
Problems
I – Horizontal Analysis – Increase – Decrease method (Financial
Statement Analysis using Comparative Statements)
Balance Sheet
Change
Peso %
2005 2006
Assets
Cash and equivalents 14,000 16,000 2,000 14.29%
Receivables 28,800 55,600 26,800 93.06%
Inventories 54,000 85,600 31,600 58.52%
Prepayments and others 4,800 7,400 2,600 54.17%
Total current assets 101,600 164,600 63,000 62.01%
Property, plant & equipment - net
of dep. 30,200 73,400 43,200 143.05%
Total assets 131,800 238,000 106,200 80.58%
Liabilities and Equity
Notes payable to banks 10,000 54,000 44,000 440.00%
Accounts payable 31,600 55,400 23,800 73.32%
Accrued liabilities 4,200 6,800 2,600 61.90%
Income taxes payable 5,800 7,000 1,200 20.69%
Total current liabilities 51,600 123,200 71,600 138.76%
Share capital 44,600 44,600 0 0.00%
Retained earnings 35,600 70,200 34,600 97.19%
Total equity 80,200 114,800 34,600 43.14%
Total liabilities and equity 131,800 238,000 106,200 80.58%
Income Statement Change
Peso %
2005 2006
Net sales 266,400 424,000 157,600 59.16%
Cost of goods sold 191,400 314,600 123,200 64.37%
Gross profit 75,000 109,400 34,400 45.87%
Selling, general and administrative
expenses 35,500 58,400 22,900 64.51%
Income before income taxes 39,500 51,000 11,500 29.11%
Income taxes 12,300 16,400 4,100 33.33%
Net income 27,200 34,600 7,400 27.21%
Financial Ratios page 5

II – Horizontal Analysis – Trend Analysis

 Year 5 Year 4 Year 3 Year 2 Year 1
Sales P5,625 P5,400 P4,950 P4,725 P4,500

Cash P 64 P 72 P84 P 88 P 80
Accounts receivable 560 496 432 416 400
Inventory 896 880 816 864 800
Total current assets P1,520 P1,448 P1,332 P1,368 P1,280

Current liabilities P 390 P318 P324 P330 P300

The following is the trend analysis:
Year 5 Year 4 Year 3 Year 2 Year 1
Sales 125.0 120.0 110.0 105.0 100.0

Cash 80.0 90.0 105.0 110.0 100.0

Accounts receivable 140.0 124.0 108.0 104.0 100.0
Inventory 112.0 110.0 102.0 108.0 100.0
Total current assets 118.8 113.1 104.1 106.9 100.0

Current liabilities 130.0 106.0 108.0 110.0 100.0

Interpretation using Trend Analysis:
Sales: The sales are increasing at a steady rate, with a particularly
strong gain in Year 4.

Assets: Cash declined from Year 3 through Year 5. This may have been
due to the growth in both inventories and accounts receivable.
In particular, the accounts receivable grew far faster than
sales in Year 5. The decline in cash may reflect delays in
collecting receivables. This is a matter for management to
investigate further.

Liabilities: The current liabilities jumped up in Year 5. This was probably

due to the buildup in accounts receivable in that the company
doesn’t have the cash needed to pay bills as they come due.

III – Vertical Analysis (Preparing a Common-size Income Statement)

Year 3 Year 2 Year 1
Sales $120,000 100.0% $90,000 100.0% $100,000 100.0%
Cost of goods sold (55,000) 45.8 (47,000) 52.2 (48,000) 48.0
Operating expenses:
Marketing expense (7,000) 5.8 (7,000) 7.8 (6,000) 6.0
R&D expense (15,000) 12.5 (4,000) 4.4 (10,000) 10.0
Administrative
expense (20,000) 16.7 (22,000) 24.4 (20,000) 20.0
Operating income 23,000 19.2% 10,000 11.1% 16,000 16.0%
Interest expense (3,000) 2.5 (5,000) 5.6 (3,000) 3.0
Income before income
taxes 20,000 16.7% 5,000 5.6% 13,000 13.0%
Income tax expense (8,000) 6.7 (2,000) 2.2 (5,000) 5.0
Net income $ 12,000 10.0% $ 3,000 3.3% $ 8,000 8.0%

Interpreting a Common-Size Income Statement

In Year 2, overall profitability declined for many reasons. Cost of goods sold,
marketing expense, administrative expense, and interest expense all increased as a
percentage of sales. A partial explanation for these increases could be that
Company A has a large element of fixed costs in its cost structure. Thus, costs
don’t decline very much when sales volume declines. The only two expenses to
decline as a percentage of sales were R&D and income tax (because of lower
income). The decline in R&D expense is symptomatic of a company that is trying to
maintain profitability in the short run. Of course, if R&D dries up in the long
run, the company will slowly lose its advantage in the market place.

Financial Ratios page 6

Year 3 saw a reversal of all of the bad trends in Year 2. Cost of goods sold,
marketing expense, administrative expense, and interest expense all decreased as a
percentage of sales. R&D expense increased as a percentage of sales, perhaps to
make up for the temporary decline in Year 2.

IV – Vertical Analysis (Preparing a Common-size Balance Sheet)

Year 3 Year 2 Year 1
Cash $ 2,000 1.7% $ 2,000 2.2% $ 1,000 1.0%
Accounts receivable 5,000 4.2 11,000 12.2 5,000 5.0
Inventory 10,000 8.3 16,000 17.8 10,000 10.0
Current assets $17,000 14.2% $29,000 32.2% $16,000 16.0%
Property, plant, and
equipment (net) 50,000 41.7 45,000 50.0 40,000 40.0
Total assets $67,000 55.8% $74,000 82.2% $56,000 56.0%

Interpreting a Common-Size Balance Sheet

In Year 2, total assets were 82.2% of sales, compared to just 56.0% of sales in
Year 1. This indicates a decrease in efficiency because more assets are needed for
each dollar of sales. In Year 2, each asset was used less efficiently than it was
in Year 1. Cash, accounts receivable, inventory, and net property, plant, and
equipment all increased as a percentage of sales.

In Year 3, total assets were 55.8% of sales, compared to 82.2% of sales in Year 2
and 56.0% of sales in Year 1. This indicates a substantial increase in efficiency
compared to Year 2 because fewer assets are needed for each dollar of sales. In
Year 3, each asset was used more efficiently than it was in Year 2. Cash, accounts
receivable, inventory, and net property, plant, and equipment all decreased as a
percentage of sales.
V- Financial Ratios
The following financial statements for ABC Company are given below:
Balance Sheet
December 31, 2012
Current Assets: Liabilities
Cash P 15,000 Current Liabilities P 200,000
Marketable securities 6,000 Bonds payable, 10% ___300,000
Accounts rec’ble, net 160,000 Total Liabilities P 500,000
Merchandise inventory 300,000 Equity:
Prepaid expenses _____9,000 Ordinary Share,P5 par P 100,000
Total Current Assets P 490,000 Retained earnings ___700,000
Property and eqpt., net ___810,000 Total Equity P 800,000
Total Assets P1,300,000 Total Liab. and Equity P1,300,000
Income Statement
For the year Ended, December 31, 2012
Sales P2,100,000
Less: Cost of goods sold 1,260,000
Gross margin P 840,000
Less: Operating expenses (including
depreciation & amortization of
P60,000) ___660,000
Net Operating Income P 180,000
Less: Interest expenses ____30,000
Net income before taxes P 150,000
Less: Income taxes ____45,000
Net income P 105,000

The following balances at beginning of the year are as follows: Accounts receivables (net),
P140,000; Inventory, P260,000, Property and equipment (net), P830,000. All sales are on
account. Dividends paid for the year amounted to P63,000 and the year-end (market) price
per share amounted to P63.(Use 365 days)
Required:
1. Working Capital 13. Debt ratio
2. Current ratio 14. Equity ratio
2. Acid-test (quick) ratio 15. Debt to equity ratio
3. Working capital to Total Assets 16. Book value per share
4. Accounts receivable turnover 17. Times interest earned
5. Average Collection period or 18. Gross profit margin
Number of days’ sales in receivables 19. Operating profit margin
(average and end of the year balances) 20. Sales margin (or rate of
Financial Ratios page 7
6. Inventory turnover return on net sales or
7. Number of days’ sales in inventory profit margin)
(Days supply in inventory – in terms 21. Return on assets
of average and end of the year balances) 22. Return on equity
8. Operating cycle 23. Return on fixed assets
9. Payables Turnover 24. Return on current assets
10. Current Assets Turnover (Based on Net 25. Price-earnings ratio
Sales & Cash, cost and expenses) 26. Dividend per share
11. Fixed Assets turnover 27. Dividend yield
12. Assets Turnover 28. Dividend payout
29. Book-to-market ratio

VI – Manufacturing (Inventory Turnover 21-30)

The following are data taken from Clayburgh Corporation’s records for the years
ended December 31, 2012 and 2011:
2012 2011
Finished goods inventory P 60,000 P 40,000
Goods in process inventory 60,000 65,000
Raw materials inventory 60,000 40,000
Sales 400,000 340,000
Cost of goods sold 225,000 230,000
Cost of goods manufactured 260,000 250,000
Raw materials used in production 150,000 130,000

Determine the following for 2012:

1. Finished goods inventory turnover
2. Work in process inventory turnover
3. Raw materials inventory turnover

VII – Dupont (Formula) Analysis (21-28)

Financial information relating to two different companies follows:
Company A Company B
Net sales P 60,000 P 28,000
Net income 9,600 1,850
Total assets 155,400 21,500
Total equity 61,000 11,300

Determine the following:

1. Return on sales
2. Asset turnover
3. Asset-to-equity ratio
4. Return on assets
5. Return on equity

VIII – Incomplete Records (21-30)

The December 31, 2009, balance sheet of Cooper’s Inc. and additional information
follow. These are the only accounts on Cooper’s balance sheet.
Assets Liabilities
Cash P 25,000 Accounts payable P ?
Accounts rec’ble, net ? Inc. taxes pay. (curr) 25,000
Inventory ? Long-term debt ?
Prop., plant & eqpt, net 294,000 Common stock 300,000
_________ Retained earnings ________?
P 432,000 P ?

Additional information follows:

Current ratio (at year-end), 1.5 to 1
Total liabilities divided by total stockholders’ equity, 0.8
Inventory turnover based on sales and ending inventory, 15 times
Inventory turnover based on cost of goods sold and ending inventory, 10.5 times
Gross margin for 2009, P315,000.

Determine the following:

1. What was the December 31, 2009 balance in Accounts payable?
2. What was the December 31, 2009 balance in Retained earnings?
3. What was the December 31, 2009 balance in Inventory?
4. What was the December 31, 2009 balance in Accounts receivable?
5. What was the December 31, 2009 balance in Long-term debt?
Financial Ratios page 8
 IX
Lambda, Inc. presents only the following figures from its balance sheet. You
are to calculate the amounts represented by question marks (?) from the
additional information given:
Assets
Cash P 37,500
Accounts Receivable (net) ?
Inventory ?
Plant and Equipment (net) 441,000
P 648,000
Liabilities & Stockholders’ Equity
Accounts Payable (Trade) P ?
Income Tax Payable, current 37,500
Long-term Debt ?
Common stock 450,000
Retained Earnings ?___
P ?___
Additional information:
Current ratio, at year-end 1.5 : 1
Total liabilities divided by total stockholders’ equity 0.8
Inventory turnover based on sales and ending inventory 15 times
Inventory turnover based on
cost of goods sold and ending inventory 10.5 times
Gross margin for 2012 P450,000
Determine the following:
1. What was the balance in trade accounts payable?
2. What was the balance in retained earnings?
3. What was the balance in the inventory account?
4. What was the balance of accounts receivable?
5. What was the balance of long-term debt?
X
La Bekha Corporation asked you to interpret the following rations provided by its
accountant:
Acid test ratio 1.2
Times interest earned 8
Gross margin ratio 40%
Inventory turnover 6 times
Debt to equity ratio .9: 1
Ratio of operating expenses to sales 15%
Total stockholders’ equity on December 31, 2012 was P900,000. Gross margin for
2011 amounted to P600,000. Beginning balance of merchandise inventory was
P200,000. The company’s long-term liabilities consisted of bonds payable with
interest at 15%. You decided to reconstruct the company’s financial statements
based on the limited information given to serve as basis for further analysis.
1. Operating income was computed at:
2. Bonds payable totaled:
3. The total current liabilities would be:
4. The company’s total current assets amounted to:
XI – Incomplete Records (4C4)
The following ratios and other data pertain to the financial statements of the
Boolacan Company for the year ended December 31, 2009:
Current ratio 1.75 to 1
Acid-test ratio 1.27 to 1
Working capital P33,000
Fixed assets to equity ratio .625 to 1
Inventory turnover (based ending inventory) 4x
Gross profit percentage 40%
Earnings per share P0.50
Average age of outstanding accounts
receivable (365 days) 73 days
Common shares outstanding 20,000 share no par
Earnings for the year as a percentage of
common share 25%
The company has no prepaid expenses, deferred, intangible assets or long-term
liabilities.

Reconstruct the balance sheet and income statement for the year 2009.
Financial Ratios page 9
 XII – Equity Ratios (21-16)
Fargo Paint Corporation reported the following information:
2012 2011
10% bonds payable P 600,000 P 600,000
Common stock, P1 par 200,000 150,000
Additional paid-in capital 1,750,000 1,250,000
Retained earnings 300,000 100,000
Net income 280,000 130,000
Dividends 80,000 80,000
Year-end stock price per share 20 24
Determine the following:
1. Return on equity
2. Times interest earned (ignore income taxes)
3. Earnings per share
4. Dividends payout ratio
5. Price-earnings ratio
6. Book-to market ratio
XIII
1. If net credit sales for the year is P15,000,000 and average accounts
receivable is P3,000,000, how many days of sales are in accounts receivable
on the average? What is the receivables turnover?

2. If the cost of goods sold is P7,200,000 and average inventory of merchandise

is P800,0000, how many days of sales are in inventory on the average? What
is the inventory turnover?

3. If accounts receivable should be collected in 40 days and inventory turns

over six times per year, how long is the operating cycle?

4. What is the return on sales if the asset turnover is 2.6 and 13 percent is
earned on assets?

5. Sales for the year were P28,000,000 and the average asset investment was
P8,000,000. Determine the asset turnover.

6. Assets are turned over 0.8 times in earning 15 percent on the sales pesos.
What is the return on assets?

7. If shareholders’ equity is equal to 60 percent of total liabilities and

shareholders’ equity. What is the rate of return on shareholders’ equity if
9 percent is earned on total assets invested?

8. The return on assets was 16 percent, and 8 percent was earned on net sales.
What was the asset turnover?

9. The return on assets has been computed at 14 percent. The net income was
P840,000 and the asset turnover was 2. Determine the amount of sales and
return on sales.

10. If the total cost of operations, excluding income tax, amounts to

P2,600,000, compute sales if net income is 5 percent of sales. The income
tax has been computed at P250,000.

11. The return on sales has remained at 6 percent for the past two years. The
asset turnover in the first year was 2.4 and declined to 1.8 in the second
year. Compute the return on assets for each of the two years.

12. Net sales for the year were P9,600,000. Assets turned over 1.2 times during
the year. Cost of goods sold and operating expenses, including income tax,
amounted to P8,880,000. Compute the return on net sales and on total assets.

13. The per share market price of Far East shares on January 1, 2012 was P60
and on December 31, 2012 was P72. Net income for 2012 was P48,000. Dividends
to the preference shareholders for the year totaled P12,000, and dividends
of P2.50 per share were paid on the 6,000 ordinary shares outstanding during
the year. The price-earnings ratio for Far East at year end was:

Financial Ratios page 10

 14. Francis Corporation’s debt to equity ratio is 0.6 to 1. Current liabilities
total P120,000 and long-term liabilities total P360,000. If Francis Company
has working capital equal to P140,000 total assets must equal:

15. Karen Company’s net accounts receivable were P430,000 on December 31, 2012
and P480,000 on December 31, 2013. Cash sales during 2013 were P175,000. The
accounts receivable turnover for 2013 was 5. Karen Company’s total sales for
2013 were:

16. The average stockholders’ equity for Bettina Company for 2012 was
P2,000,000. Included in this figure is P200,000 par value of 8% preference
share, which remained unchanged during the year. If the return on ordinary
shareholders’ equity was 12.5% during 2012, net income was:

XIV – Relationships
1. Expreseed as a percentage, what would be a company’s current ratio if: net
fixed assets are P1,230,000; current assets, P368,400; current liabilities,
P120,000; other liabilities, P65,000.
2. Assuming cost of goods sold is P494,500, beginning inventory is P120,000;
and ending inventory, P110,000 – the turnover of inventory for the year
would be:
3. What would be the company’s equity-debt ratio if: current liabilities are
P362,000; long-term liabilities – P448,000’; common stock paid-in P800,000;
and retained earnings – P658,000.

XV - Effects of transactions on ratios (18-22)

Indicate the effects of each of the following transactions on the company’s current ratio, acid-test ratio, and debt ratio.
There are three possible answers: increase (+), decrease (-), and no effect (0). Before each transaction takes place, the
current ratio is greater than 1 to 1 and the acid-test ratio is less than 1 to 1.
Effects on.
Current Acid- Debt
Ratio Test Ratio
Ratio
Example: An account payable is paid. + - -
1. Bought inventory for cash. _____ _____ _____
2. A sale is made on account; cost of sales is
less than selling price _____ _____ _____
3. Issued long-term bonds for cash. _____ _____ _____
4. Sold land for cash at its book value. _____ _____ _____
5. Marketable securities held as temporary
investments are sold at a gain. _____ _____ _____
6. Issued common stock in exchange for plant _____ _____ _____
assets.
7. Collected an account receivable. _____ _____ _____
8. Issued long-term debt for plant assets. _____ _____ _____
9. Declared, but did not pay, a cash dividend. _____ _____ _____
10. Paid the dividend in item 9. _____ _____ _____
11. Paid a short-term bank loan. _____ _____ _____
12. Recorded depreciation expense. _____ _____ _____

XVI - Effects of transactions – returns ratios (18-17)

Indicate the effects of each of the following transactions on the company’s (a) ROS, (b) ROA, and (c) EPS. There are three
possible answers: (+) increase, (-) decrease, and (0) no effect. Before each transaction takes place, the ratios are as follows:
(a) ROS, 10%; (b) ROA, 5%; (c) EPS, $0.25.
Effects on.
(a) (b) (c)
ROS ROA EPS
1. Sell a plant asset for cash, at twice the _____ _____ _____
asset’s book value
2. Declare and issue a stock dividend. _____ _____ _____
3. Purchase inventory on account. _____ _____ _____
4. Purchase treasury stock for cash. _____ _____ _____
5. Acquire land by issuing common stock. _____ _____ _____

Financial Ratios page 11

XVII - Return on assets and return on equity (18-13)
Z-Way Corporation had ROS of 5% and sales of P24 million. Interest expense is P0.3
million; total assets are P16 million; the debt ratio is 40%. There is no
preferred stock. Ignore taxes.
1. Determine income, ROA, and ROE.
2. Suppose the company could increase its ROS to 6% and keep the same level
of sales. What would net income, ROA, and ROE be?
3. Suppose that the company reduced its debt ratio to 20% by retiring debt. New
common stock was issued to finance the retirement, keeping total assets at
P16 million. Net income is P1.35 million because of lower interest expense
that now totals P0.15 million. What are ROA and ROE?

XVIII – Earning-Power Model - (Profitability-Efficiency-Leverage) (18-19 old)

The following data summarize results for ABC Company:
Sales……………………………………………………………………………………………………… P 6,000
Net income………………………………………………………………………………………… 400
Total assets…………………………………………………………………………………… 4,500
Stockholders’ equity……………………………………………………………… 2,000
ROE…………………………………………………………………………………………………………… 20%

Required: Calculate the ROE using the three-factor expression or the earning-power
model.

XIX – Earning-Power Model (CMA Adapted)

JJ and Company has debt ratio of 0.50, a total assets turnover of 0.25, and a
profit margin of 10%. The president is unhappy with the current return on equity,
and thinks it could be doubled. This could be accomplished (1) by increasing the
profit margin to 14%, and (2) by increasing debt utilization. Total assets
turnover will not change. What new debt ratio, along with the 14% profit margin,
is required to double the return on equity?

XX
Cash Flow Adequacy Ratio – it is a ratio based on cash flow from operations gives
a more direct indication of a company’s ability to generate sufficient cash to
satisfy predictable cash requirements.

The following information available for AAA Corporation (use 365 days):
2012 2011
Net income P 180,000 P 205,000
Depreciation expense 100,000 80,000
(Increase) decrease in noncurrent assets 60,000 (231,500)
Increase (decrease) in current liabilities ( 91,000) 371,000
Cash from operating activities P 249,000 P 424,500

Long term asset purchases P 300,000 P 230,000

Long-term debt repayments 200,000 0
Dividends paid 102,000 145,000
Average current liabilities 40,000 50,000
Average total liabilities 80,000 70,000
Capital expenditures 100,000 120,000
Net sales 2,000,000 2,400,000
Cash 40,000 60,000
Marketable securities 50,000 20,000
Receivables 10,000 15,000
Cost of goods sold 1,500,000 1,800,000
Cash operating and other expenses 60,000 80,000
Total liabilities 500,000 480,000

Determine the following for 2011 and 2012:

1. Cash flow adequacy ratio.
2. Current cash debt coverage ratio.
3. Cash debt coverage ratio.
4. Free cash flow.
5. Cash flow margin.
6. Cash flow liquidity ratio.
7. Cash flow to total debt