Financial Ratio Analysis

Learner's Module in Fundamentals of

Accountancy and Business Management 2
Quarter 1 ● Module 7

DENVER G. ALIWANA
Developer

Department of Education • Cordillera Administrative Region

NAME:____________________________ GRADE AND SECTION: ____________

TEACHER: ________________________ SCORE: _________________________
 DEPARTMENT OF EDUCATION
Cordillera Administrative Region
SCHOOLS DIVISION OF BAGUIO CITY
Military Cut-off, Baguio City

Published by
Learning Resource Management and Development System

COPYRIGHT NOTICE
2020

Section 9 of Presidential Decree No. 49 provides:

“No copyright shall subsist in any work of the Government of the Philippines.
However, prior approval of the government agency of office wherein the work is
created shall be necessary for exploitation of such work for profit.”

This material has been developed for the implementation of K-12 Curriculum
through the DepEd Schools Division of Baguio City – Curriculum Implementation
Division (CID). It can be reproduced for educational purposes and the source must be
acknowledged. Derivatives of the work including creating an edited version, an
enhancement or a supplementary work are permitted provided all original work is
acknowledged and the copyright is attributed. No work may be derived from this
material for commercial purposes and profit.

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 PREFACE

This module is a project of the DepEd Schools Division of Baguio City through
the Curriculum Implementation Division (CID) which is in response to the
implementation of the K to 12 Curriculum.

This Learning Material is a property of the Department of Education, Schools

Division of Baguio City. It aims to improve students’ academic performance specifically
in Accountancy and Business Management.

Date of Development : August 2020

Resource Location : DepEd Schools Division of Baguio City
Learning Area : ABM
Grade Level : 12
Learning Resource Type : Module
Language : English
Quarter/Week : Q1/W7
Learning Competency/Code : 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 (ABM_FABM12- Ig-
h-14)
:

iii
 ACKNOWLEDGEMENT

The developer would like to express his deep and sincere gratitude to those
who contributed significantly in the development of this learning material.

The developer is grateful to the following individuals for the motivation as well
as the moral and technical support in the crafting of this module: our assistant school
head in the Senior High department, Janet B. Pascua and our school’s supervisory
office led by our school principal, Madam Brenda M. Cariño.

To my colleagues in the ABM group of Baguio City National High School,

Baguio City National Science High School, Guisad Valley National High School,
Eastern La Trinidad National High School for the fruitful collaboration and for sharing
their knowledge and expertise as I develop this learning resource.

Development Team
Author/s: Denver G. Aliwana
Illustrator: Marilyn Degay-Bugatti (Label Icons)

School Learning Resources Management Committee

Brenda M. Cariño School Principal
Editha L. Laop Subject/ Learning Area Specialist
Sherwin L. Fernando School LR Coordinator

Quality Assurance Team

Francisco C. Copsiyan EPS – Mathematics
Niño M. Tibangay PSDS – District III

Learning Resource Management Section Staff

Loida C. Mangangey EPS – LRMDS
Victor A. Fernandez Education Program Specialist II - LRMDS
Christopher David G. Oliva Project Development Officer II – LRMDS
Priscilla A. Dis-iw Librarian II
Lily B. Mabalot Librarian I

CONSULTANTS

JULIET C. SANNAD, EdD

Chief Education Supervisor – CID

CHRISTOPHER C. BENIGNO
Asst. Schools Division Superintendent

MARIE CAROLYN B. VERANO, CESO V

Schools Division Superintendent

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 TABLE OF CONTENTS

COPYRIGHT NOTICE ................................................................................................ii

PREFACE .................................................................................................................. iii
ACKNOWLEDGEMENT .............................................................................................iv
TABLE OF CONTENTS ............................................................................................. v
What I Need to Know ................................................................................................. 1
What I Know ............................................................................................................... 2
Lesson: Financial Ratio Analysis ................................................................................ 4
What’s In .................................................................................................................... 4
What’s New ................................................................................................................ 5
Activity: The Power of Ratios ............................................................................... 5
What Is It .................................................................................................................... 6
What’s More ............................................................................................................. 14
Activity 1: Finding the missing pieces. ............................................................... 14
Assessment 1: ................................................................................................... 15
Activity 2: Charts to contrast! ............................................................................. 15
Assessment 2: ................................................................................................... 15
What I Have Learned ............................................................................................... 16
What I Can Do .......................................................................................................... 17
Activity 1: Kapamilya or Kapuso? ...................................................................... 17
Activity 2: I have an Idea!.................................................................................. 18
Post-Assessment ..................................................................................................... 19
Additional Activity ..................................................................................................... 21
Activity: Online Calculators ................................................................................ 21
ANSWER KEY ......................................................................................................... 22
REFERENCES ......................................................................................................... 23

v
 What I Need to Know

Hello learner! This module was designed and written with you in mind. This was
designed to guide you towards your mastery of skill in analyzing and interpreting the
financial statements using financial ratios.
While going through this module, you are expected to:
1) explain financial ratios;
2) compute financial ratios, and;
3) interpret financial ratios.
By the way, always remember to use a separate sheet of paper for you to write
your answers on the different activities presented in this learning module. DO NOT
ANSWER here directly.
Now, here is an outline of the different parts of your learning module. The
descriptions will guide you on what to expect on each part of the module.

Icon Label Description

This states the learning objectives that you need
What I need to know
to achieve as you study this module.

This is to check what you already know about the

What I know
lesson on this module. If you answered all the
questions here correctly, then you may skip
studying this module.
This connects the current lesson with a topic or
What’s In
concept necessary to your understanding.

This introduces the lesson to be tackled through

What’s New
an activity.

This contains a brief discussion of the learning

What Is it
module lesson. Think of it as the lecture section
of the lesson.
These are activities to check your understanding
What’s More
and to apply what you have learned from the
lesson.
This generalizes the essential ideas tackled from
What I have Learned
this module.
This is a real-life application of what you have
What I Can Do
learned.

This is an evaluation of what you have learned

Post-Assessment
from this learning material.

Additional Activity This is an activity that will strengthen and fortify

your knowledge about the lesson.

1
 What I Know
PRE-TEST: If you answer all the test items correctly in this pretest, then you may
skip studying this learning material and proceed to the next learning module.

MULTIPLE-CHOICE

Direction: Choose the letter of the correct answer. Write your answers on the spaces
provided before each number. You may need your calculator in this part.

_____ 1. This is a set of ratios that measures the ability of an enterprise to pay
short-term obligations.
A. Activity ratios
B. Liquidity ratios
C. Profitability ratios
D. Solvency ratios
_____ 2. What set of ratios do Debt-to-Asset Ratio belong?
A. Activity ratios
B. Liquidity ratios
C. Profitability ratios
D. Solvency ratios
_____ 3. Which of these is NOT a quick asset?
_ A. Accounts Receivable
_ B. Cash
C. Inventories
D. Prepayments
_____ 4. What is the equity-to-asset ratio if the debt-to-asset ratio of a firm is
0.40?
A. 0.30
B. 0.40
C. 0.50
D. 0.60
_____ 5. The formula for this ratio is current assets divided by current liabilities.
A. Asset Ratio
B. Current Ratio
C. Debt Ratio
D. Liability Ratio
_____ 6. ABC Company reported a gross profit of P58,380 and net sales of P
139,000. What is the gross profit ratio?
A. 0.42
B. 0.58
C. 1.19
D. 2.38

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_____ 7. The income statement of a BCD Company shows a net income of
P18,070 and net sales of P139,000. What is net profit ratio?
A. 0.13
B. 0.18
C. 0.36
D. 0.42
_____ 8. For June 2020, CDE Sari-Sari Store has credit sales of P75,250. The
_ beginning and ending balances of receivables are P26,000 and
_ P17,000 respectively. What is the receivables turn-over ratio?
A. 1.75
B. 2.89
C. 3.50
D. 4.43
_____ 9. For the month of July 2020, DEF Trading has a net sale of P287,000.
The beginning balance of inventory is a P50,000 while the ending is
P32,000. What is the inventory turn-over ratio?
A. 5.74
B. 7.00
C. 8.97
D. 9.00
_____ 10. In the balance sheet of EFG Merchandising, total assets is P580,000,
total liabilities is P150,000 and total equity is P430,000. What is the
equity-to-asset ratio?
A. 0.26
B. 0.48
C. 0.74
D. 1.35
_____ 11. What does a current ratio of 1.00 mean?
A. Current assets are higher than current liabilities
B. Current assets are lower than current liabilities
C. Current assets are equal to current liabilities
D. Current assets are equal to quick assets
_____ 12. The 2018 inventory turn-over ratio of FGI Trading was 7.5. In 2019, it
increases to 9. What does this mean?
A. The cycle of selling and replenishing inventory is faster in 2018
B. The cycle of selling and replenishing inventory is faster in 2019
C. The cycle of collecting and selling on account is faster in 2018
D. The cycle of collecting and selling on account is faster in 2019
_____ 13. What does a gross profit ratio of 0.30 mean?
_ A. Gross profit is 30 cents for every peso of sales
_ B. Gross profit is 70 cents for every peso of sales
C. Gross profit is 3 pesos for every peso of sales
D. Gross profit is 7 pesos for every peso of sales

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 _____ 14. GIH Company has an equity-to-asset ratio of 0.60. What does this
mean?
A. The company has P0.60 assets for every peso of liability
B. The company has P0.60 equity for every peso of liability
C. 60% of the total assets of the company came from creditors
D. 60% of the total assets of the company came from the owners
_____ 15. The current ratio and quick ratio of a business entity are both 1.75.
What does this mean?
A. The company is not liquid
B. The company is not profitable
C. The company has no inventories
D. The company has high levels debts

Lesson: Financial Ratio Analysis

What’s In
Recall in the previous lessons two of the methods used in analyzing financial
statements- the vertical and horizontal analysis. You have learned that vertical
analysis uses only one financial statement while horizontal analysis requires at least
two consecutive statements. In both methods, comparisons and analysis are made
using similar statements. Income statement with another income statement and
balance sheet with another balance sheet.

In this module, you will learn the third method which is ratio analysis. In this
method, you will be computing proportions of one item in relation to another item in
either the income statement or the balance sheet. Unlike in the two earlier methods,
ratio analysis might require you to obtain data from two different statements.

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 What’s New

Activity: The Power of Ratios

Directions: Read the story below.

Alfred was instructed by his mother to buy rice. At the store, Alfred saw two
quantities of sinandomeng rice – a small pack and a bigger pack. These were the price
tags:

Sinandomeng Rice Sinandomeng Rice

6 Kilograms 10 Kilograms
Php 288.00 Php 460.00

Alfred thought that neither money nor quantity is a factor in making decisions
at this moment. He looks at the tags once more to see which one he will buy.

Which offers a better deal?

It might be difficult to tell which is a better deal because the more expensive
pack has also more rice in it. However, if we divide the price of each pack with the
quantity, we see that the smaller pack costs 48 pesos per kilogram (P288.00 / 6 kg =
P48.00 per kilogram), while the larger pack costs 46 pesos per kilogram (P460.00 / 10
kg = P46.00 per kilogram). The larger pack actually costs lesser per kilogram of
content.

What have we done here? We actually determined the ratio of price over
quantity. This illustrates the power of ratios in helping us analyze set of data such as
those we encounter in the financial statements.

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 What Is It
Financial Ratio Analysis

Ratio analysis utilizes amounts in the financial statements to assess the

financial health of a business entity.

We can group financial ratios into four broad categories: (1) liquidity ratios,
(2) solvency or leverage ratios, (3) activity ratios and, (4) profitability ratios. Each
of these will be discussed in the succeeding parts of this module.

1. Liquidity Ratios

These ratios measure the ability of a business entity to meet its maturing
financial obligations. The focus is on short-term solvency as if the business entity is to
be liquidated today. To undergo liquidation means the business will cease operating
and assets will be converted to cash to be distributed to creditors and owners. There
are two common measures of liquidity – current ratio and quick ratio.

Who uses liquidity ratios? Creditors and suppliers are interested with these
ratios to determine if the business can pay what it owes them.

a. Current Ratio (CR)

Description: Provides an indication of an entity’s ability to pay its current
liabilities with current assets
Formula: 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠 (𝐶𝐴)
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑅𝑎𝑡𝑖𝑜 =
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 (𝐶𝐿)
Interpretations:  If CR > 1, the firm is liquid
 If CR < 1, the firm is not liquid

b. Quick Ratio (QR) or Acid Test Ratio

Description: Similar to current ratio but with the use of quick assets (current
assets with the exception of inventories). Inventories are deducted
from the current assets when solving for the QR since they are the
least liquid and their liquidation value is often uncertain.
Formula: 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠 (𝐶𝐴) − 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑖𝑒𝑠
𝑄𝑢𝑖𝑐𝑘 𝑅𝑎𝑡𝑖𝑜 =
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 (𝐶𝐿)
Interpretations:  If, QR > 1, the firm is liquid
 If, QR < 1, the firm is not liquid

Let’s solve sample problem #1 to illustrate current ratio and quick ratio.

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Sample Problem #1: The financial information of ABC Company is presented below.
Solve for the current ratio and quick ratio.

Current Assets Current Liabilities

Cash 104,000 Trade Payables 80,000
Receivables 60,000 Taxes Payable 22,000
Inventories 150,000 Short-term loans 150,000
Prepaid Assets 50,000 Other Payables 28,000
Total Current Assets 364,000 Total Current Liabilities 280,000

Illustrative Example 1: Current Ratio

Solution:

𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠 (𝐶𝐴)

𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑅𝑎𝑡𝑖𝑜 =
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 (𝐶𝐿)
364,000
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑅𝑎𝑡𝑖𝑜 =
280,000
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑅𝑎𝑡𝑖𝑜 = 𝟏. 𝟑

Interpretation:
The business is liquid. It can pay its financial obligations. Current assets
are sufficient to pay current liabilities.

Take Note:
A very high current ratio (>2) may not always be favorable. Although
this means that the business entity is very liquid, this might be an indication
of inefficient use of assets. It’s possible that the firm has too much
receivables which may prove uncollectible in the future. Or perhaps the firm
has so much cash kept idle in the bank or in the vaults.

Illustrative Example 2: Quick Ratio

Solution:

𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠 (𝐶𝐴) − 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑖𝑒𝑠

𝑄𝑢𝑖𝑐𝑘 𝑅𝑎𝑡𝑖𝑜 =
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 (𝐶𝐿)
364,000 − 150,000
𝑄𝑢𝑖𝑐𝑘 𝑅𝑎𝑡𝑖𝑜 =
280,000
𝑄𝑢𝑖𝑐𝑘 𝑅𝑎𝑡𝑖𝑜 = 𝟎. 𝟕𝟔

Interpretation:
On the basis of quick assets, the business is not liquid. Quick assets are
insufficient to pay current liabilities.

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2. Solvency Ratios

These ratios measure the relative amount of funds provided by creditors (debt
financing) and owners (equity financing). The focus is on long-term solvency. Here,
you will learn debt ratio and equity ratio.
.
a. Debt Ratio (DR) or Debt-to-Asset Ratio
Description: Measures how much of a firm’s asset base is financed by debts or
borrowings
Formula: 𝑇𝑜𝑡𝑎𝑙 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
𝐷𝑒𝑏𝑡 𝑅𝑎𝑡𝑖𝑜 (𝐷𝑅) =
𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠
Interpretations:  For every peso of asset, ______(DR) is financed by
creditors.
 If, DR < 0.3, this is the optimal level for most industries
 If, DR > 0.3, the firm might face future solvency problems

b. Equity Ratio (ER) or Equity-to-Asset Ratio

Description: Measures how much of a firm’s asset base is financed by the
owners
Formula: 𝑇𝑜𝑡𝑎𝑙 𝑂𝑤𝑛𝑒𝑟 ′ 𝑠 𝐸𝑞𝑢𝑖𝑡𝑦
𝐸𝑞𝑢𝑖𝑡𝑦 𝑅𝑎𝑡𝑖𝑜 (𝐷𝑅) =
𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠
Interpretations:  For every peso of asset, ______(ER) is financed by
owners.
 If, ER > 0.7, this is the optimal level for most industries
 If, DR < 0.7, the firm might face future solvency problems

Let’s solve sample problem #2 to illustrate debt ratio and equity ratio.

Sample Problem #2: The financial information of DEF Company is presented below.
Solve for the debt ratio.

Total Assets P 900,000

Total Liabilities 360,000
Owner’s Equity 540,000

Illustrative Example 3: Debt Ratio

Solution:
𝑇𝑜𝑡𝑎𝑙 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
𝐷𝑒𝑏𝑡 𝑅𝑎𝑡𝑖𝑜 =
𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠
360,000
𝐷𝑒𝑏𝑡 𝑅𝑎𝑡𝑖𝑜 =
900,000
𝐷𝑒𝑏𝑡 𝑅𝑎𝑡𝑖𝑜 = 𝟎. 𝟒

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 Interpretation:
For every peso of asset. P0.40 of it is financed by creditors.

Take Note:
There is no ‘ideal’ value for debt ratio. This must be interpreted together
with cost of borrowing. A high debt ratio means the business relies mainly on
borrowings. This poses a problem on the firm’s future liquidity and solvency
if interest is high.

Illustrative Example 4: Equity Ratio

Solution:
𝑇𝑜𝑡𝑎𝑙 𝑂𝑤𝑛𝑒𝑟 ′ 𝑠𝐸𝑞𝑢𝑖𝑡𝑦
𝐸𝑞𝑢𝑖𝑡𝑦 𝑅𝑎𝑡𝑖𝑜 =
𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠
540,000
𝐸𝑞𝑢𝑖𝑡𝑦 𝑅𝑎𝑡𝑖𝑜 =
900,000
𝐸𝑞𝑢𝑖𝑡𝑦 𝑅𝑎𝑡𝑖𝑜 = 𝟎. 𝟔

Interpretation:
For every peso of asset. P0.60 of it is financed by the owners.

3. Activity Ratios

These set of ratios are also called Turn-over Ratios or Asset Management
Ratios. They measure the efficiency of the business in utilizing assets such as
inventories and fixed assets to maximize revenues. In this module, you will learn
Receivables Turn-over Ratio and Inventory Turn-over Ratio.
.
a. Receivables Turn-over Ratio
Description: Measures the efficiency of a business in collecting credit sales
extended to customers. The ratio indicates the number of times a
business engages in the cycle of extending credit sales and
collecting the same.
Formula: 𝑁𝑒𝑡 𝐶𝑟𝑒𝑑𝑖𝑡 𝑆𝑎𝑙𝑒𝑠
𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠 𝑇𝑢𝑟𝑛 − 𝑜𝑣𝑒𝑟 𝑅𝑎𝑡𝑖𝑜 =
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠

𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒, 𝑏𝑒𝑔𝑖𝑛𝑛𝑖𝑛𝑔 + 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒, 𝑒𝑛𝑑

𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒 =
2
Interpretations:  A higher receivables turn-over ratio is preferred. This is an
indication that the business has more cash sales or
receivables are collected on time.
 A lower receivables turn-over ratio suggests problems in
collection policies.

9
 Let’s solve sample problem #3 to illustrate accounts receivable turn-over ratio.
Sample Problem #3: GHI Company has the following information from its
financial statements for the year 2019. Solve for the receivables turn-over ratio.

Net Credit Sales P 675,000

Receivables, beginning 50,000
Receivables, ending 40,000

Illustrative Example 5: Receivables Turn-over Ratio

Solutions:
Solving for Average Receivables:
𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒, 𝑏𝑒𝑔𝑖𝑛𝑛𝑖𝑛𝑔 + 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒, 𝑒𝑛𝑑
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒 =
2
50,000 + 40,000
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒 =
2
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒 = 45,000

Solving for Receivables Turn-over Ratio

𝑁𝑒𝑡 𝐶𝑟𝑒𝑑𝑖𝑡 𝑆𝑎𝑙𝑒𝑠
𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠 𝑇𝑢𝑟𝑛 − 𝑜𝑣𝑒𝑟 𝑅𝑎𝑡𝑖𝑜 =
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦
675,000
𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠 𝑇𝑢𝑟𝑛 − 𝑜𝑣𝑒𝑟 𝑅𝑎𝑡𝑖𝑜 =
45,000
𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠 𝑇𝑢𝑟𝑛 − 𝑜𝑣𝑒𝑟 𝑅𝑎𝑡𝑖𝑜 = 𝟏𝟓

Interpretation:
The business has extended and collected credit sales at a rate of 15
times in a year.

b. Inventory Turn-over Ratio

Description: Measures the efficiency of a business in selling and replenishing
inventories. This indicates the number of times in a year that the
business purchased and sold inventories.
Formula: 𝐶𝑜𝑠𝑡 𝑜𝑓 𝐺𝑜𝑜𝑑𝑠 𝑆𝑜𝑙𝑑
𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑇𝑢𝑟𝑛 − 𝑜𝑣𝑒𝑟 𝑅𝑎𝑡𝑖𝑜 =
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦

𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦, 𝑏𝑒𝑔𝑖𝑛𝑛𝑖𝑛𝑔 + 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦, 𝑒𝑛𝑑

𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 =
2
Interpretations:  A higher inventory turn-over ratio is preferred. This is an
indication that the business inventories are being sold and
replenished efficiently at a faster rate.
 A lower inventory turn-over ratio suggests problems in selling
goods. Inventories are ‘slow-moving.’

10
 Let’s solve sample problem #4 to illustrate inventory turn-over ratio.

Sample Problem #4: JKL Company has the following information from its
financial statements for the year 2019. Solve for the inventory turn-over ratio

Cost of Goods Sold P 925,000

Inventory, beginning 30,000
Inventory, end 400,000

Illustrative Example 6: Inventory Turn-over Ratio

Solution:
Solving for Average Inventory:
𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦, 𝑏𝑒𝑔𝑖𝑛𝑛𝑖𝑛𝑔 + 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦, 𝑒𝑛𝑑
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 =
2
30,000 + 400,000
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 =
2
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 = 215,000

Solving for Inventory Turn-over Ratio

𝐶𝑜𝑠𝑡 𝑜𝑓 𝐺𝑜𝑜𝑑𝑠 𝑆𝑜𝑙𝑑
𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑇𝑢𝑟𝑛 − 𝑜𝑣𝑒𝑟 𝑅𝑎𝑡𝑖𝑜 =
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦
925,000
𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑇𝑢𝑟𝑛 − 𝑜𝑣𝑒𝑟 𝑅𝑎𝑡𝑖𝑜 =
215,000
𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑇𝑢𝑟𝑛 − 𝑜𝑣𝑒𝑟 𝑅𝑎𝑡𝑖𝑜 = 𝟒. 𝟑𝟎

Interpretation:
The business has purchased and sold goods at a rate of 4.30 times in a
year.

Take Note:
In order to have a meaningful interpretation of turn-overs ratios, they can
be compared with the normal operating cycle of a business, to past ratios or
to ratios of similar companies within the industry.

4. Profitability Ratios

These are metrics used to evaluate the firm’s ability to generate profit relative
to costs, assets and equity. The goal of these ratios is to assess whether the business
is over or underspending and if investments are generating the desired profits. Gross
Profit Ratio and Net Profit Ratio are the two ratios that you will be learning in this
module.

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a. Gross Profit Ratio (GPR)
Description: Shows the proportion of gross profit to net sales. This is also
known as Contribution Margin Ratio. This shows the sufficiency of
contribution margin or mark-up on sales to cover operating
expenses.
Formula: 𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡
𝐺𝑃𝑅 =
𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠
Interpretations:  A higher GPR is preferred. This is an indication of the
firm’s ability to generate profit from sales.
 A lower GPR suggests problems with mark-up or
contribution margin. Mar-up maybe

b. Net Profit Ratio (NPR)

Description: Shows the proportion of net profit or net income to net sales. It
shows how much net income is generated for every peso of net
sales.
In the case of service businesses, this ratio shows how much net
income is generation for every peso of service revenue.
Formula: 𝑁𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡 𝑜𝑟 𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒
𝑁𝑃𝑅 =
𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠
Interpretations:  A higher NPR is preferred. This is an indication of higher
net income from sales.
 A lower NPR is an indication of low profitability.

Let’s solve sample problem #5 to illustrate GPR and NPR.

Sample Problem #5: MNO Company has the following information from its
financial statements for the year 2019. Solve for the GPR and NPR.

Net Sales P 325,000

Cost of Goods Sold 100,000
Gross Profit 225,000
Total Expenses 124,250
Net Income 100,750

Illustrative Example 7: Gross Profit Ratio

Solution:
𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡
𝐺𝑃𝑅 =
𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠
225,000
𝐺𝑃𝑅 =
325,000
𝐺𝑃𝑅 = 𝟎. 𝟔𝟗

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 Interpretation:
For every peso of net sales, the business was able to generate P 0.69
in gross profit.

Illustrative Example 8: Net Profit Ratio

Solution:

𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒
𝑁𝑃𝑅 =
𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠
100,750
𝑁𝑃𝑅 =
325,000
𝑁𝑃𝑅 = 0.31

Interpretation:
For every peso of net sales, the business was able to generate P 0.31
in net profit or net income.

Take Note:
In order to have a meaningful interpretation of profitability ratios, they can
be compared with the normal profits, to past profit ratios or to ratios of similar
companies within the industry.

Let us now apply what you have learned by doing the What’s More section of
this module.

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 What’s More
Activity 1: Finding the missing pieces.

Directions: Complete the equations of current ratio for the four different companies.
Pick the values from the treasure box. The first equation has been done for you.

Solving for #1:

𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑅𝑎𝑡𝑖𝑜 =
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
180,000
1.25 =
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
180,000
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 =
1.25
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 = 𝟏𝟒𝟒, 𝟎𝟎𝟎

Equation
Company
Current Assets ÷ Current Liabilities = Current Ratio

Alpha 180,000 ÷ (1) 144,000 = 1.25

Beta 250,000 ÷ 225,000 = (2)

Charlie (3) ÷ 350,000 = 1.60

Delta (4) ÷ 450,000 = (5)

TREASURE BOX

1.11 0.90
405,000 560,000
144,000
14
Assessment 1:
Directions: Compare the current ratios of the four companies then answer the
questions that follow.

1. Which company has the highest current ratio? ________

2. Which company has the lowest current ratio? ______________
3. Which company is the most liquid? ___________
4. Which company is the least liquid? ______________

Good job! You may now proceed to the next activity.

Activity 2: Charts to contrast!

Directions: The composition of Net Sales (Cost of Sales and Gross Profit) of
companies A and B are presented below. Solve for the Gross Profit Ratio (GPR) for
each company by writing on the spaces provided. Use this GPR formula.

𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡
𝐺𝑃𝑅 =
𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠

Company A Company B
Net Sales = 450,000 Net Sales = 680,000
Cost
of Gross Cost
Gross Profit of
Sales,
Profit , Sales,
150,0
, 350,0 330,0
00
300,0 00 00
00

1. GPR = __________________ 2. GPR = __________________

Assessment 2:

Directions: Answer the following questions.

1. In terms of amount, which company has higher gross profit? _______________

2. Which company has a higher GPR?________________________________
3. With the same level of expenses, which company is more profitable?
___________

Well-done in this second activity for this part! You may now proceed to the next
section of this module.

15
 What I Have Learned
Activity: Learning T-Chart

Directions: Place the different types of ratios to the left or right side of the T-chart
based on how you understood and mastered them. The left side is for the ratios that
you can demonstrate mastery of. Meanwhile, the right side is for the ratios in which
you demonstrated a low level of mastery.

1. Current Ratio
2. Quick Ratio
3. Debt-to-Asset Ratio
4. Equity-to-Asset Ratio
5. Inventory Turn-over Ratio
6. Receivables Turn-over Ratio
7. Gross Profit Ratio
8. Net Profit Ratio

#YES #HELP
I can solve and interpret these ratios I have problems with these ratios

16
 What I Can Do
Activity 1: Kapamilya or Kapuso?

Directions: Read the article below. As an avid fan or a loyal supporter of either of the
two networks, you might be interested to know how much profit they generate as it
may affect your decision to continue watching their shows. Highlight the important
financial information you would be needing in computing for the net profit ratio or net
income ratio of both networks. Answer the questions that follow.

Stocks to Watch: ABS-CBN, GMA earnings

AUGUST 19, 2019 1:30 AM PHT
RALF RIVAS

Are you a Kapamilya or a Kapuso? We look into their financials to check which
company has earned and grown more over the years.

MANILA, Philippines – Which network is better and watched by more Filipinos,

ABS-CBN or GMA?

The two networks have been fighting it out for decades to nab the No. 1 spot,
offering a hodgepodge of drama, action, and comedy.

Financials
It's a tight race for the two networks in the 1st half of 2019. ABS-CBN earned
P1.47 billion, a massive 98% jump from the P741 million a year ago. Meanwhile,
GMA saw a 10% increase in its net income to P1.34 billion from P1.2 billion.

Historically, the Kapamilya network earns more than the Kapuso network, except
in 2018 where GMA earned P2.27 billion while ABS-CBN had P1.91 billion.

In terms of size, ABS-CBN is much bigger than GMA.

In the 1st half of 2019, total revenues of ABS-CBN stood at P20.8 billion, while
GMA had P7.9 billion.

(Article published in www.rappler.com)

Answer these questions:

1. What is the net income ratio of ABS-CBN for the first half of 2019? (round
off answer to the nearest hundredth)____________
2. What is the net income ratio of GMA for the first half of 2019? (round off
answer to the nearest hundredth) ____________
3. Which network is more profitable in terms of amount of net income? ______
4. Which network is more profitable in terms of net income ratio? ______

17
Activity 2: I have an Idea!

Directions: Your neighborhood bakery has low inventory turn-over ratio. This means
that the products of the business are slow-moving. This resulted to having stale and
throw-away goods which are translated to financial losses for the business. The owner
approached you for some advice knowing that you are an ABM student who can help
him.

Suggest and explain one way to increase inventory turn-over ratio. Explain in no more
than three sentences. You will be graded based on this rubric:

5 points – Suggestion is feasible and well-explained

4 points – Suggestion is feasible but with minor lacking details
3 points – Suggestion is good but may not be applicable to the given situation

_________________________________________________________________________
_________________________________________________________________________
_________________________________________________________________________
_________________________________________________________________________
_________________________________________________________________________

Good Job. You are almost done with the module.

18
 Post-Assessment

MULTIPLE-CHOICE.

Direction: Choose the letter of the correct answer. Write your answers on the spaces
provided before each number. You may need your calculators in this part.

_____ 1. This is a set of ratios that focuses on the long-term liquidity of an

enterprise.
A. Activity ratios
B. Liquidity ratios
C. Profitability ratios
D. Solvency ratios
_____ 2. What set of ratios do Equity-to-Asset Ratio belong?
A. Activity ratios
B. Liquidity ratios
C. Profitability ratios
D. Solvency ratios
_____ 3. Which of these is a quick asset?
_ A. Cash
_ B. Inventories
C. Land
D. Payables
_____ 4. What is the equity-to-asse ratio if the debt-to-asset ratio of a firm is
0.50?
A. 0.30
B. 0.40
C. 0.50
D. 0.60
_____ 5. The formula for this ratio is current assets divided by current liabilities.
A. Asset Ratio
B. Current Ratio
C. Debt Ratio
D. Liability Ratio
_____ 6. ABC Company reported a gross profit of P80,620 and net sales of P
139,000. What is the gross profit ratio?
A. 0.42
B. 0.58
C. 1.19
D. 2.38

19
_____ 7. The income statement of a BCD Company shows a net income of
P19,370 and net sales of P149,000. What is net profit ratio?
A. 0.13
B. 0.18
C. 0.36
D. 0.42
_____ 8. For the month of June 2020, CDE Sari-Sari Store has credit sales of
_ P75,250. The beginning and ending balances of receivables are
_ P26,000 and P17,000 respectively. What is the receivables turn-over
ratio?
A. 1.75
B. 2.89
C. 3.50
D. 4.43
_____ 9. For the month of July 2020, DEF Trading has a net sale of P369,000.
The beginning balance of inventory is a P50,000 while the ending is
P32,000. What is the inventory turn-over ratio?
A. 5.74
B. 7.00
C. 8.97
D. 9.00
_____ 10. In the balance sheet of a firm, total assets is P580,000, total liabilities
is P150,000 and total equity of P430,000. What is the equity ratio?
A. 0.26
B. 0.48
C. 0.74
D. 1.35
_____ 11. What does a current ratio of 0.80 mean?
A. Current assets are higher than current liabilities
B. Current assets are lower than current liabilities
C. Current assets are equal to current liabilities
D. Current assets are equal to quick assets
_____ 12. The 2018 inventory turn-over ratio of FGI Trading was 7.5. In 2019, it
increases to 12. What does this mean?
A. The cycle of selling and replenishing inventory is faster in 2018
B. The cycle of selling and replenishing inventory is faster in 2019
C. The cycle of collecting and selling on account is faster in 2018
D. The cycle of collecting and selling on account is faster in 2019
_____ 13. What does a gross profit ratio of 0.30 mean?
_ A. Gross profit is 30 cents for every peso of sales
_ B. Gross profit is 70 cents for every peso of sales
C. Gross profit is 3 pesos for every peso of sales
D. Gross profit is 7 pesos for every peso of sales

20
 _____ 14. GIH Company has a debt-to-asset ratio of 0.60. What does this mean?
A. The company has P0.60 assets for every peso of liability
B. The company has P0.60 equity for every peso of liability
C. 60% of the total assets of the company came from creditors
D. 60% of the total assets of the company came from the owners
_____ 15. The current ratio and quick ratio of a business entity are both 1.75.
What does this mean?
A. The company is not liquid
B. The company is not profitable
C. The company has no inventories
D. The company has high levels debts

Additional Activity

Activity: Online Calculators

Directions: Go to either of these two websites. These sites provide a financial

calculator to help you in computing financial ratios. Test the ratios by inputting dummy
amounts. http://depts.washington.edu/buslib/ratios/index.php
https://www.calcxml.com/calculators/financial-ratio-analysis#

21
 ANSWER KEY
What I know Post-Assessment
Multiple-Choice
16. Multiple-Choice
16.
C 15. C 15.
D 14. C 14.
A 13. A 13.
B 12. B 12.
C 11. B 11.
C 10. C 10.
B 9. D 9.
C 8. C 8.
A 7. A 7.
A 6. B 6.
B 5. B 5.
D 4. C 4.
C 3. A 3.
D 2. D 2.
B 1. D 1.

What’s More
Activity 1: Finding the Missing Pieces
0.90 5.
405,000 4.
560,000 3.
1.11 2.
144,000 1.

Assessment 1:
Delta 4.
Charlie 3.
Delta 2.
Charlie 1.

Activity 2: Charts to Contrast

0.51 2.
0.67 1.

Assessment 2:
Company A 3.
Company A 2.
Company B 1.

What I can do

Activity 1: Kapamilya of Kapuso?

GMA 4.
ABS-CBN 3.
0.17 2.
0.07 1.

Activity 2: I have an Idea

Answers may vary

22
 REFERENCES
Aliling, Leonardo E. Fundamentals of Basic Accounting. Quezon City: Rex Bookstore,
2013.
Ferrer, Rodiel C., and Zeus Vernon B. Millan. Fundamentals of Accountancy, Business
and Management Part 2. 2nd ed. Baguio City: Bandolin Enterprise, 2018.
Franklin, Mitchell. Principles of Accounting, Volume 1: Financial Accounting. Houston,
Texas: Rice University. May 2019. https//openstax.org/details/books/financial-
accounting-principles
Manalaysay, Benedick G. Fundamentals of Accountancy, Business and Management
2. Mandaluyong City: Anvil Publishing, 2017.
Rivas, Ralf. Rappler. Stocks to Watch: ABS-CBN, GMA earnings. August 19, 2019.
https://rappler.com/business/abs-cbn-gma-earnings-stocks-to-watch-august-
19-23-2019

For inquiries or feedback, please write or call:

Department of Education-Schools Division of CAR
(Office Address, Wangal, LTB)
Telefax:
Email Address:

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