FUNDAMENTALS OF ACCOUNTANCY,

BUSINESS, AND MANAGEMENT 2 MODULE

Module No. 7: Week 7: First Quarter

ANALYSIS AND INTERPRETATION OF FINANCIAL STATEMENTS 2
LEARNING COMPETENCIES
Define the measurement levels, namely, liquidity, solvency, stability, and profitability.

1. Compute and interpret financial ratios such as current ratio, working capital, gross profit
ratio, net profit ratio, receivable turnover, inventory turnover, debt-to-equity ratio, and the like.

CODES: ABM_FABM12Ig-h-12 & ABM_FABM12-Ig-h-14

OBJECTIVES
1. Know the definition of different financial ratios, liquidity, solvency/stability and profitability.
2. Answers the activities about the measurement levels, liquidity, solvency/stability and
profitability.
3. Know the formula in computing financial ratios such as current ratio, working capital, gross
profit ratio, net profit ratio, receivable turnover, inventory turnover, debt-to-equity ratio.
4. Solve for financial ratios such as current ratio, working capital, gross profit ratio, net profit
ratio, receivable turnover, inventory turnover, debt-to-equity ratio.

LET’S RECALL
Excellent! Another accomplished module and another to accomplish. In this
module, it will challenge your mathematical skills. Before we proceed with the
discussion, let us first recall the concepts from your previous modules by answering the
following exercises.

A. Identify the following accounts as what financial statement they can be reflected. Write SFP
for Statement of Financial Position, SCI for Statement of Comprehensive Income, SCE for
Statement of Change in Equity.

1. Gross profit 2. Cash

3. Cost of Goods Sold 4. Net Sales
5. Total Current Asset 6. Accounts Receivable
7. Net Income 8. Total Current Liabilities
9. Total Owner’s Equity 10. Operating Expenses
B. Using SFP below, prepare a horizontal and vertical analysis of 2014 and 2013 Annabelle
Trading Company.

2014 2015
Current Assets P192,375.00 P265,500.00
Property, Plan, and Equipment 937,508.00 967,500.00
Other Assets 152,618.00 159,750.00
Total Assets P1,282,501.00 P1,392,750.00

SHIELA A. BAUTISTA
1 SHS Department
PNHS-Main
 Liabilities
Total Current Liabilities P220,590.00 P225,550.00
Long term Debt 491,198.00 460,250.00
Owner's Capital 570,713.00 706,950.00
P1,282,501.00 P1,392,750.00

LET’S UNDERSTAND
The last and vital phase of the accounting process is the analysis
and interpretation of all the contents in the financial statements. This
interpretation will be beneficial in making economic decisions that will lead
to business’ success. As explained in your previous module, Financial Statement (FS) Analysis
is the process of evaluating risks, performance, financial health, and future prospects of a business
by subjecting financial statement data to computational and analytical techniques with the objective
of making economic decisions(White et.al 1998). There are three kinds of FS analysis techniques
– Horizontal, Vertical, and Financial Ratios. We are than with the first two analysis, therefore, in
this module we will be focused on the ratio analysis.

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

Profitability ratios measure the ability of the company to generate income from the use
of its assets and invested capital as well as control its cost. The following are the commonly used
profitability ratios: -

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

SHIELA A. BAUTISTA
2 SHS Department
PNHS-Main
 E. Return on Equity (ROE) measures the return (net income) generated by the owner’s
capital invested in the business. Similar to ROA, the denominator of ROE may also be
total equity or average equity.

Here are the sample financial statements to be used for the computations:

Operational efficiency ratio measures

the ability of the company to utilize its assets.
Operational efficiency is measured based on the
company’s ability to generate sales from the
utilization of its assets, as a whole or
individually. The turnover ratios are primarily
used to measure operational efficiency.
A. Asset turnover measures the peso
value of sales generated for every
peso of the company’s assets. The higher the turnover rate, the more efficient the
company is in using its assets.
B. Fixed asset turnover is indicator of the efficiency of fixed assets in generating sales.
C. Inventory turnover is measured based on cost of goods sold and not sales. As such
both the numerator and denominator of this ratio are measured at cost. It is an indicator
of how fast the company can sell inventory. An alternative to inventory turnover is “days
in inventory”. This measures the number of days from acquisition to sale.
D. Accounts receivables
turnover the measures the
number of times the
company was able to collect
on its average accounts
receivable during the year.
An alternative to accounts
receivable turnover is “days
in accounts receivable”.
This measures the
company’s collection period

SHIELA A. BAUTISTA
3 SHS Department
PNHS-Main
 which is the number of days from sale to collection.
Financial Health Ratios look into the company’s solvency and liquidity ratios. Solvency
refers to the company’s capacity to pay their long-term liabilities. On the other hand, liquidity
ratio intends to measure the company’s ability to pay debts that are coming due (short term
debt).
A. Debt ratio indicates the percentage of the company’s assets that are financed by
debt. A high debt to asset ratio implies a high level of debt.
B. Equity ratio indicates the percentage of the company’s assets that are financed by
capital. A high equity to asset ratio implies a high level of capital.
C. Debt to equity ratio indicates the company’s reliance to debt or liability as a source of
financing relative to equity. A high ratio suggests a high level of debt that may result
in high interest expense.
D. Interest coverage ratio measures the company’s ability to cover the interest expense
on its liability with its operating income. Creditors prefer a high coverage ratio to give
them protection that interest due to
them can be paid.
E. Current ratio is used to evaluate
the company’s liquidity. It seeks to
measure whether there are
sufficient current assets to pay for
current liabilities. Creditors
normally prefer a current ratio of 2.
F. Quick ratio is a stricter measure of
liquidity. It does not consider all
the current assets, only those that
are easier to liquidate such as cash
and accounts receivable that are referred to as quick assets.

LET’S APPLY

Let us test your understanding in this module. Solve for the Profitability ratio,
Operating Efficiency, and Financial Health of the given SFP and SCI below.

2014 2013
Cash P160,000.00 P137,400.00
Accounts Receivable 140,000.00 119,920.00
Inventory 179,000.00 258,500.00
Prepaid Rent 62,000.00 54,370.00
Truck 600,000.00 543,810.00
Total Assets P1,141,000.00 P1,114,000.00
Accounts Payable P125,000.00 P117,298.00
Loan Payable 450,000.00 443,300.00
Mirah Tan, Capital 466,000.00 553,402.00
Total Liabilities and Equity P1,041,000.00 P1,114,000.00
2014 2013
Sales P860,000.00 P736,000.00
Cost of Goods Sold 398,300.00 351,750.00
Gross Profit 461,700.00 384,250.00
Operating Expenses 214,900.00 195,800.00
Interest Expense 90,500.00 67,150.00
Net Income P156,300.00 P121,300.00

LET’S ANALYZE
SHIELA A. BAUTISTA
4 SHS Department
PNHS-Main
 Using the balances from Iyahmra Company’s statement, solve the financial ratios below.

IyahmRa Company
Find the following ratios:
2019 1. Current Ratio
Cash P32,500.00 2. Quick Ratio
Accounts receivable, net 3. Account Receivable Turnover Ratio
Beginning of year 14,500.00 4. Inventory Turnover Ratio
End of year 17,500.00 5. Gross Profit Ratio
Inventory 6. Net Profit Ratio
Beginning of year 12,500.00 7. Debt to Equity Ratio
End of year 14,500.00
Total current assets 91,500.00
Total current liabilities 44,000.00
Total liabilities 98,000.00
Net Sales on account 434,000.00
Cost of goods sold 155,000.00
Gross Profit 409,000.00
Net Income 84,000.00
Total Owner's Equity P265,000.00

Haddock, M., Price, J., & Farina, M. (2012). College Accounting: A Contemporary Approach, Second Edition. New
York: McGraw-Hill/Irwin.
• D. R. C. Salazar, CPA, 2017. Fundamentals of Accountancy Business and Management 2. Rex Bookstore
First Edition. Pages 33-56
• McDonald’s Corporation 2019 Annual Reports. Pages 33 – 28. Retrieved from:
https://corporate.mcdonalds.com/content/dam/gwscorp/nfl/investor-relations-content/annual-
reports/2019%20Annual%20Report.pdf
LET’S TRY
Great! You are now on the part of the module where we will assess your
mastery of the concept. Answer the following exercises below and write your
answer on the space provided.

Part I. Multiple Choice Problems: For items 1 to 5, based your answers on the
attached statement of Yasha Trading Ltd. below.

1. Yasha Trading Ltd.’s inventory turnover during 2014 was (amounts rounded)
A. 6 times. B. 7 times C. 8 times. D. Not determinable from the data given.
2. Which statement best describes Yasha Trading Ltd.’s acid-test ratio?
A. Greater than 1 B. Equal to 1 C. Less than 1 D. None of the above
3. Which measure expresses Yasha Trading Ltd.’s times-interest-earned ratio? (amounts
rounded)
A. 54.7% B. 20 times C. 34 times D. 32 times
4. Yasha Trading Ltd.’s rate of return on equity can be described as
A. 33.55% B. 16.72% C. 35.29% D. None of the above
SHIELA A. BAUTISTA
5 SHS Department
PNHS-Main
 5. During 2014, Yasha Trading Ltd.’s days’ sales in receivables ratio was (amounts
rounded)
A. 34 days B. 30 days C. 32 days D. 28 days
6. Yasha Trading Ltd.’s gross profit rate can be described as
A. 34% B. 19% C. 20% D. 66%
7. Yasha Trading Ltd.’s rate of return on asset can be described as
A. 33.55% B. 16.72% C. 35.29% D. None of the above

Part II. Problem 1. Using the statements below, compute for the company’s profitability and
operating efficiency ratios for 2014 and financial health ratio in 2014 and 2013

Problem 2. Fill in the missing data in Alice’s Cupcake’s Statement of Comprehensive Income
using the following ratios:

A. Inventory turnover is 3.50. P P

Beginning inventory was
₱4,250 and ending inventory
was ₱4,050.
B. Net profit margin is 11%.

Problem 3. Fill in the missing data by

using the following ratio to complete
Grandma’s Cooking Company’s balance
sheet:
A. Current ratio
is 0.80.
B. Acid-test ratio
is 0.40.

SHIELA A. BAUTISTA
6 SHS Department
PNHS-Main