CHAPTER 2: REVIEW OF FINACIAL STATEMENT PREPARATION,

ANALYSIS AND INTERPRETATION

1. PROFITABILITY RATIO

a. Return to Equity
Net income/ Stocksholders’ Equity x 100%

2017 2018
Return to Equity= (3,800/142,400) x 100% Return to Equity= (7,840/190,800) x100%
Return to Equity= 2.67% Return to Equity= 4.11%

Interpretation:

Return to Equity in 2017 is 2.67% to 1 while that of 2018 is 4.11%. This indicates
that the return of capital in year 2018 is greater than in year 2017. But, still both
years shows good result in return to equity since its results is greater than 1.

b. Return on Assets
Operating Income/ Total Assets x 100%

2017 2018
Return on Assets= (8,000 /234,800) x 100% Return on Assets= (9,640/281,200) x 100%
Return on Assets= 3.41% Return on Assets= 3.34%
Interpretation:

Return on Assets in year 2017 is 3.41% to 1 while that of year 2018 is 3.34%. This
entails that the usage of company’s resources and assets are good to generate
income.

c. Gross Profit Margin

Gross Profit/ Net Sales x 100%

2017 2018
Gross Profit Margin= (65,000/170,000) x 100% Gross Profit Margin= (70,400/ 190,400)
Gross Profit Margin= 38.24% x100%
Gross Profit Margin= 36.98%
Interpretation:
 Gross Profit Margin in year 2017 is 38.24% while that of year 2018 is 36.98%.
There were decrease in ratio and entails that the mark- up on goods purchased is
not maintain or increase which is not good to absorb operating expenses.

d. Operating Profit
Operating Income/ Net Sales x 100%

2017 2018
Operating Profit Margin= (8,000/170,000) x 100% Operating Profit Margin= (9,640/ 190,400) x 100%
Operating Profit Margin= 4.71% Operating Profit Margin= 5.06%

Interpretation:

Operating Profit Margin for 2017 is 4.71% while that of 2018 is 5.06%. There
were increase in ratio and entails that the remaining income in both year is good
and the management is effective in handling its expenses.

e. Net Profit Margin

Net Income/ Sales x 100%

2017 2018
Net Profit Margin= (3,800/170,000) x 100% Net Profit Margin= (7,840/ 190,400) x 100%
Net Profit Margin= 2.24% Net Profit Margin= 4.12%

Interpretation:

Net Profit Margin for 2017 is 2.24% while that of 2018 is 4.12%. It seems that in
2017, it was half of 2018 ratio. Management should consider cut on expenses if
they want to improve net income for the future operations.

f. Return on Assets Ratio

Net Income/ Total Assets x 100%

2017 2018
Return on Assets Ratio= (3,800/234,800) x 100% Return on Assets = (7,840/ 281,200) x 100%
Return on Assets Ratio= 1.62 % Return on Assets= 2.79%

Interpretation:
 Return on Assets for 2017 is 1.62% while that of 2018 is 2.79%. There were
increase in ratio and indicates that the utilization of company’s assets was fully
utilized to generate income.

2. LIQUIDITY RATIOS
A. Current Ratio
Current Assets/ Current Liabilities

2017 2018
Current Ratio= 103,800/ 52,400 Current Ratio= 68,600/ 25,400
Current Ratio= 1.98 Current Ratio= 2.70

Interpretation:

Current Ratio in year 2017 is 1.98 to 1 while that of 2018 is 2.70. This entails that
the company has the ability to pay its short term liabilities. Current ratio for 2018
is increased signifying more liquidity for the company although the company is
liquid enough in 2017.

B. Acid- Test Ratio

Current Assets― Inventories/ Current Liabilities

2017 2018
Acid- Test Ratio= (103,800− 32,000) / 52,400 Acid- Test Ratio= (68,600− 26,000) / 25,400
Acid- Test Ratio= 71800/ 52,400 Acid- Test Ratio= 42,600/25,400
Acid- Test Ratio= 1.37 Acid- Test Ratio= 1.68
Interpretation:

Acid- Test Ratio for year 2017 is 1.37 to 1 while that of 2018 is 1.68. This means
that for 2018 the company has 1.68 of current assets that can be used to pay
every peso current liability while for 2017 the company has 1.37 of current
assets to cover every peso of current liability that fall due.

3. LEVERAGE FINANCIAL RATIOS

A. Debt Ratio
Total Liabilities/ Total Assets

2017 2018
Debt Ratio= 92,400/ 234,800 Debt Ratio= 90,400/ 281,200
Debt Ratio= 0.39 Debt Ratio= 0.32

Interpretation:
 Debt Ratio for 2017 is 0.39 while that of 2018 is 0.32. This went slightly lower in
2018 than 2017 which means that the company does not rely heavily on external
borrowings. But still the company’s assets for both years is mostly finance by the
OE.

B. Debt to Equity Ratio

Total Liabilities/ Shareholders’ Equity

2017 2018
Debt to Equity Ratio= 92,400/ 142,400 Debt to Equity Ratio= 90,400/ 190,800
Debt to Equity Ratio= 0.65 Debt to Equity Ratio= 0.47

Interpretation:

Debt to Equity Ratio for year 2017 is 0.65 while that of 2018 is 0.47. This means
that in 2018 for every P1 financed by the owner is the assets of the business,
0.47 was financed by the creditors. While in 2017, for every P1 financed by the
owner is the assets of the business 0.65 was financed by the creditors.

C. Coverage Ratio
EBIT/Interest expenses

2017 2018
Interest Coverage Ratio= 7,600/ 6,800 Interest Coverage Ratio= 14,040/ 4,800
Interest Coverage Ratio= 1.12 Interest Coverage Ratio= 2.93

Interpretation:

Coverage Ratio for year 2017 is 1.12 while that of 2018 is 2.93. This indicates
that the company has the ability to pay its interest expenses easily.

4. Efficiency Ratios
A. Total Assets Turnover Ratio
Net sales/ Total Assets

2017 2018
Total Assets Turnover Ratio= 170,000/ 234,800 Total Assets Turnover Ratio= 190,400/ 281,200
Total Assets Turnover Ratio= 0.72 Total Assets Turnover Ratio= 0.68

Interpretation:
 Total Asset Turnover Ratio for year 2017 is 0.72 while that of 2018 is 0.68. This
indicates that the usage of the company’s total asset is not efficient to generate
income.

B. Fixed Assets Turnover Ratio

Sales/PPE

2017 2018
Fixed Assets Turnover Ratio= 170,000/ 121,800 Fixed Assets Turnover Ratio= 190,400/ 200,800
Fixed Assets Turnover Ratio= 1.40 Fixed Assets Turnover Ratio= 0.95

Interpretation:

Fixed Assets Turnover Ratio for the year 2017 is 1.40 while that of 2018 is 0.95.
This indicates that the previous year which is 2017 the company’s fixed assets
was well used. While in year 2018 the company’s fixed assets is not efficiently
used to generate income, for it decreases 0.45.

C. Accounts Receivables Turnover Ratio

Sales/ Accounts Receivable

2017 2018
Accounts Receivables Turnover Ratio= 170,000/ Accounts Receivables Turnover Ratio=190,400/
41,800 38,000
Accounts Receivables Turnover Ratio= 4.07 Accounts Receivables Turnover Ratio= 5.01
Interpretation:

Accounts Receivable Turnover Ratio for year 2017 is 4.07 while that of 2018 is
5.01. This entails that the company was able to collect receivables 4.07 times in
2017 and 5.01 times in 2018.

360 Days/ Accounts Receivable Turnover Ratio

2017 2018
Average Collection Period= 360/ 4.07 Average Collection Period= 360/ 5.01
Average Collection Period= 88.45 or 88 Days Average Collection Period= 71.86 or 72 Days

Interpretation:
 Average Collection Period for year 2017 is 88 days while that of 2018 is 72 days.
This depends on the credit terms extended by the company to its customers. For
instance, the company’s term of credit is 100 days, then average collection
period for both years is favorable since it is less than 100 days’ credit term. Thus,
the company is effective in collecting its receivables but it still depends.

D. Inventory Turnover Ratio

Cost of Goods Sold/ Inventories

2017 2018
Inventory Turnover Ratio= 105,000/ 32,000 Inventory Turnover Ratio= 120,000/ 26,000
Inventory Turnover Ratio= 3.28 Inventory Turnover Ratio= 4.62

Interpretation:

Inventory Turnover Ratio in year 2017 is 3.28 times while that of in 2018 is 4.62
times. This entails that the company was able to sold its inventory 3.28 time in
year 2017 and 4.62 times in year 2018.

360 Days/ Inventory Turnover Ratio

2017 2018
Days sales in Inventory Ratio= 360/ 3.28 Days sales in Inventory Ratio= 360/ 4.62
Days sales in Inventory Ratio= 109.76 or 110 Days Days sales in Inventory Ratio= 77.92 or 78 Days

Interpretation:

Days sales in Inventory Ratio in year 2017 is 110 days while that of in 2018 is 78
days. This show the number of days a company carry on to inventory before selling.
In year 2017 it takes 110 days and in year 2018 it takes 78 days.

E. Accounts Payable Turnover Ratio

Cost of Goods Sold/ Accounts Payable

2017 2018
Accounts Payable Turnover Ratio= 105,000/ Accounts Payable Turnover Ratio= 120,000/25,400
52,400 Accounts Payable Turnover Ratio= 4.72
Accounts Payable Turnover Ratio=2.00
Interpretation:

Accounts Payable Turnover Ratio in year 2017 is 2.00 while that of 2018 is 4.72.
This entails that the company in year 2017 pay its account payable 2.00 times
while in year 2018 is 4.72 times.

360 Days/ Accounts Payable Turnover Ratio

2017 2018
Days Payable Outstanding= 360/ 2.00 Days Payable Outstanding= 360/ 4.72
Days Payable Outstanding= 180 Days Days Payable Outstanding= 76.27 or 76 Days

Interpretation:

Days Payable Outstanding in year 2017 is 180 days while that of 2018 is 76 days.
This shows the number of days of the company to pay its accounts payable.
Thus, in year 2017 the company will pay its accounts payable in 180 days and in
year 2018 is 76 days.

5. OPERATING CYCLE AND CASH CONVERSATION CYCLE

A. Days Inventories + Days Receivables

2017 2018
Operating Cycle= 110+ 88 Operating Cycle= 78+ 72
Operating Cycle= 198 Days Operating Cycle= 150 Days

Interpretation:

Operating Cycle in year 2017 is 198 days while that of 2018 is 150 days. This
entails that the company in year 2017 covers the period from the merchandise is
brought to the time the proceeds from the sales are collected is 198 days and in
year 2018 it decreases 48 days which is 150 days. Thus, the company may have a
problem regarding to its receivable management or inventory management
since it results higher or longer operating cycle.

B. Operating Cycle ― Day Payable

 2017 2018
Cash Conversion Cycle= 198− 180 Cash Conversion Cycle= 150− 76
Cash Conversion Cycle= 18 Days Cash Conversion Cycle= 74 Days

Interpretation:

Cash Conversion Cycle for 2017 is 18 days while that of 2018 is 74 days. This
indicates that the year 2017 it takes 18 days to collect receivables from the time
the cost of the merchandise sold actually paid and in 2018 it takes 74 days. In
year 2017 the company will wait after 18 days for it to have cash and in 2018 is
74 days.

Financial Statement of of M/s Kapoor and Co. as of December 31, 2017, and December 31,

2018.

1. Which year shows more profitability?

In year 2018 the M/S Kapoor and Corporation indicates more profitability since its ratio
shows favorable result of its profit than year 2017.

2. What year the company is more liquid?

In year 2018 the M/S Kapoor and Corporation indicates more liquidity because in that
year its ratios show higher result. For if the value is higher, then the company is more
liquid and it entails that the company can easily pay its debts.

3. How the company finance the business assets in 2017 and 2018?
In 2017 and 2018 the M/S Kapoor and Corporation assets were mostly finance by the
Owner’s Equity. Since, it indicates higher shareholder equity compared to liabilities for
its ratio shows lesser than 1.

4. Which year the company shows more efficiency?

In year 2017 the M/S Kapoor and Corporation shows more efficiency since its ratio
shows higher result than year 2018. For if value is higher the assets and resources are
well utilized.

5. How long is the cash conversation cycle of the business?

It takes 18 days of cash conversion cycle for the year 2017. While, in year 2018 it takes
74 days.