Luzviminda S. Payongayong Ryan C. Roque Olivia C. AyuyaoFINANCIAL MANAGEMENT ~N oD, | esi LUZVIMINDA S. PAYONGAYONG, CPA RYAN C. ROQUE, CPA, MBA OLIVIA C. AYUYAO, CPA, MBAFINANCIAL MANAGEMENT TABLE OF CONTENTS CHAPTER TOPIC PAGE 1 Introduction to Financial Management 1 2 Financial Statements Analysis 1 3 Working Capital and Cash Management a 4 Receivable Management 87 5 Inventory Management 105 6 Short Term Financing Management 15 7 Financial Planning 139 8 Time Value of Money 167 9 Capital Budgeting 193 10 Long-Term Financing Decisions 249 11 Risk and Rates of Return mmAbout the Authors LUZVIMINDA S. PAYONGAYONG Certified Public Accountant Candidate, Master in Business Administration Polytechnic University of the Philippines College of Business and Administration Graduate School Graduate, Bachelor of Science in Commerce - Major in Accounting Polytechnic University of the Philippines Manila Formerly: Assistant Professor II Polytechnic University of the Philippines, College of Accountancy and Finance Lecturer ‘De La Salle University Lecturer Colegio de San Juan De Letran CPA Reviewer UE CPA Review Center CPA Reviewer PUP CPA Review CenterRYAN C. ROQUE Certified Public Accountant Doctor in Business Administration (in Progress) Polytechnic University of the Philippines College of Business and Administration Graduate School Graduate, Master in Business Administration Major in Financial Management Polytechnic University of the Philippines College of Business and Administration Graduate School Graduate, Bachelor of Science in Accountancy Polytechnic University of the Philippines Manila Director Polytechnic University of the Philippines Property and Supply Management Office Lecturer Polytechnic University of the Philippines College of Business and Administration Graduate School Assistant Professor I/MAS Reviewer Polytechnic University of the Philippines College of Accountancy and Finance MAS Reviewer National University Formerly: Faculty Researcher PUP Office of the Vice President for Research, Extension and Development Assistant Professor 3 De La Salle University Associate Professor Level 10 La Consolacion College ManilaOLIVIA C. AYUYAO Certified Public Accountant Graduate, Master in Business Administration De La Salle University Manila Graduate, Bachelor of Science in Commerce ~ Major in Accounting Polytechnic University of the Philippines Manila Formerly: Associate Professor II Polytechnic University of the Philippines College of Accountancy and Finance Audit Officer Internal Audit Group of Philippine National Bank Lecturer De La Salle University Manila Lecturer Philippine Christian University ManilaINTRODUCTION TO FINANCIAL MANAGEMENT Learning Objectives: 1. Define finance management and the three key elements to the process of financial management. 2. Identify the major areas and opportunities available in the field of finance. 3, Determine and compare the legal forms of business organization. ‘4. Describe the managerial finance function and its relationship to economics and accounting, 5, _ Determine the roles of the financial manager. 6 Identify the goal ofthe firm, corporate governance, the role of ethics, and the agency issue. 7, Discuss business taxes and their importance in financial decisions. Introduction Finance plays an important role in the student's professional and even personal life. Each chapter ofthis book emphasizes the relevance of the topic to majors in accounting, management, marketing, operations and information systems. In this chapter, the students were introduced int the field of finance and the opportunities in the financial services and managerial finance. Te basic legal forms of business organization such as the sole proprietorship, partnership, and corporation are described and diferentiated from each other. The strengths and weaknesses of these three basic legal forms of organizations were identified. The managerial finance function is defined and compared with economics and accounting; The financial manager’ goals, which are to maximize the shareholders’ wealth and to preserve stakeholder wealth, soars iscussed, The role of ethics in achieving these goals is presented. The chapter then summarizes the three key activities ofthe financial manager. It also includes discussion of the agency problem the conflict that exists between managers and owners ina large corporation. Financial Management Financial Management is about preparing, directing and managing the money activities ofa company such as buying, selling and using money to its best results to maximize wealth or produce best value for money. Basically, it means applying general management concepts to the cash of the company. Pertaking a commercial business as the most common organizational structure, the key objectives of financial management would be to create wealth for the business, generate cash and provide an adequate return on investment bearing in mind the risks that the business is taking, and the resources invested ‘Personal finand®'s deals with an individuals’ decisions concerning the - spending and investing _of income, It includes the answers as to how much oftheir earnings should they spend, how much “should they save, and how should they invest their savings. Business finance involves same type of decisions focusing on_how: the firms raise. money. from investors, How to invest money to ear a profit, and hoi to reinvest profits in the business or distribute them back to investors. 7rt Man: There are three key elements to the process of financial management. These are the financial planning, financial control and financial decision making. Thing penis 1. Financial Planning. Management need to ensure that enough funding is available at the right ws time to meet the needs of the business. In the short term, funding, may be needed to invest in equipment and stocks, pay employees and fund sales made on credit. In the medium and long term, funding may be required for significant additions to the productive capacity of the business or to make acquisitions. This links in with the financial decision-making Process and forecasting. . Financial control helps the business ensure that the objectives are being met. Financial control determines if assets are secured and_being used efficiently. It also identifies if the management act in the best interest of shareholders and in accordance with business rules. . Financial decision making. The key aspects of financial decision-making include investment, financing and dividends. Investments must be financed in some way. However, there are “always financing alternatives that can be considered, which will depend on the type of source, period of financing, cost of financing and the net present returns generated. The key financing decision is whether profit earned by the business should be retained instead of distributing to shareholders via dividends. Dividends that are too high may cause the business to starve of funding to reinvest in growing revenues and profits further. Scope of Financial Management Financial management has a wide scope. It includes the following five ‘A’s as stated by Dr.$. C. Saxena: Anticipation. The financial needs of the company are being estimated. That is, it finds out how ‘much finance is required by the company. Acquisition. It collects finance for the company from different sources. Allocation. It uses this collected or acquired finance to purchase fixed and current assets.for the company. 4. Appropriation. It distributes part of the company profits among the shareholders, debenture holders, and some are kept ass reserves. 5. Assessment, It also means controlling all the financial activities of the company. It checks if the objectives are met, If not, it determines what can be done about it. x PE Finance Areas and Career Opportunities The following are the major areas in the field of finance: 1. Financial service - the one concerned with the design and delivery of advice and financial products to individuals, businesses, and governments. Career opportunities: within the areas of banking, personal financial planning, investments, real estate, and insurance‘Chapler 1 Introduction ial Man 3 2 Managerial finance - concerned with the duties of the financial manager working in a business. This encompasses financial planning, or budgeting, extending credit to customers or other credit administration function, investment evaluation and analysis, and obtaining of funds for a firm. Managerial finance is the management of the firm's funds within the firm. Career opportunities: financial analyst, capital budgeting analyst, and cash manager. The recent global financial crisis and subsequent responses by governmental regulators, increased global competition, and rapid technological change also increase the importance and complexity of the financial manager's duties. Increasing globalization has increased demand for financial experts who can manage cash flows in different currencies and protect against the risks that naturally arise from international transactions. The following are the professional certifications in finance: 1. Chartered Financial Analyst (CFA) - a graduate-level course of study focused largely on the investments side of finance. This is offered by the CFA Institute. 2. Certified Treasury Professional (CTP) - this program requires students to pass a single exam that is focused on the knowledge and skills needed for those working in a corporate treasury department. 3, Certified Financial Planner (CFP) - Students should pass a 10-hour exam covering a wide range of topics related to personal financial planning in order to obtain CFP status. 4, American Academy of Financial Management (AAFM) - This administers certification programs for financial professionals in a wide range of ficlds. Their certifications include the Charter Portfolio Manager, Chartered Asset Manager, Certified Risk Analyst, Certified Cost ‘Accountant, Certified Credit Analyst, and many other programs. 5, Professional Certifications in Accounting - include Certified Public Accountant (CPA), Certified Management Accountant (CMA), Certified Internal Auditor (CIA), andl many other programs, Through studying or preparing to pass certification exams, employees and/or other professionals can continue their eduction beyond ther undergraduate degree, The study will be focused on one area of finance, which is likely to be that needed to do their job better. Furthermore, employers could advertise the additional training of their employes, thus, atractng more businesses. Legal Forms of Business Organization Sole proprietorship is the most common form of business organizations Iisa business owned by one person and operated for his or her own profit. He is legally responsible for the debts and taxes of the business and very involved in its day to day activities. This i the most common form of business organization. Many sole proprietorships operate in the wholesale, retail, service, and construction industries. ‘There are various advantages in forming a sole proprietorship. It is simple and the owner has freedom to make all decisions and enjoy all the profit. It has minimal legal restrictions and government regulation. It can be discontinued with great ease and the tax rate is relatively at the minimum. However, the owner may lack expertise or experience to run business. The owner may also incur unlimited liability. Generally, the owner has relatively limited availability of outside financing,rt Mane fit. This is based i i two or more people and operated for prof Ay a nip They are legally responsible for the debts and taxes eement called Article of Co-Partnerst : f I Of the business Partners must agree upon amount each partner will ctr 1 the ote percentage of ownership of each partner, share of profits of each partner, duties partner wi oS ip’ Typical partnership the responsibility each partner has for the partnership’ ‘Ss debts. y : ae ee pista coves such as medical and dental practices, accounting, architectural and law firms. 285 Sinn oe With a partnership form of business organization, | mens t corporation. Ti patie there are combined talents, more available am pone Sa sane skill. In terms of available financing, it can raise more capital for the firm he a ee aaa Ee However, there is unlimited liability for general partners and limited life for the firm. a “ dissolved when a partner withdraws or dies, and it is difficult to liquidate or transfer ee ra or more heads may be better for the firm but there is also a possibility of divided authority lead to possible disagreement on major decisions and issues. an th corporation is an entity cased by law. Corporations have the legal powers of an individual in that itcan sue and be sued, make and be party to contracts, and acquire property in its own name. It is a publicly or privately-owned business entity that is separate from its owners and has legato own property and do business in its own name. But the stockholders are not responsible for the del ts OF Siness. A corporation is governed by the Board of Directors, in case of a profit organization, or Board of Trustees in case of not-for-profit organization. Some advantages of forming a corporation include the limited liability of stockholders and perpetual life. There is ease of transferring ownership, expansion obtaining resources or financing. Corporations are bound by relatively more government regulations/restrictions and maybe expensive to organize, For accounting purposes, all forms of business entities are considered separate entities. However, the corporation is the only form of business that is a separate legal entity. there is ease of organization compared to Finance, Economies and Accounting Economics is a study of choice. Itis a social science that deals with individual or collective économic activites such as production, consumption, distribution and transfer of money and wealth, me a oe on the fact that our resources are scarce and need to deliberately and systematically Finance isthe study of financial allocation and answers the questions like whe ere ‘why Is fen considered a form of applied econo, Rims opeaie within the cater and they must be aware ofthe economic principles changes in economic activity, and econorahe ey Marginal cost-benefit analysis is the padly anne oe le that oe, secre poly, finance. This principle reminds the decision makers to chovse and take Satay ate eee tavea net advantage, which means thatthe added benefis exceed the added comme. Wil One of the major differences inthe focus of finance and accounting is that accountai use the anal athe while in finance, the emphasis is on cash flows. Accoumtare Cnn, fenues at the point of sale and expenses wher eae no fa ‘ tin Onticohe ea eee psy oy ‘ou iin aah will flow into or out cach teppildieg ne 4 inflows and outflows of revenues when cash s collected and expenses when actually paid,yl Itductn fo Fnncél Mragomend Goals of the Firm and the Role of the Finance Manager Decision rule for managers: Only take actions that are expected to increase the share price! This rule means that whenever the financial manager decides or choose between or among alternatives, after assessing the risks and the returns, only actions that would increase share price shall be accepted. Otherwise, the alternative/s shall be rejected. ‘The goal ofa firm, and therefore of all managers, isto maximize shareholders’ wealth. This can be measured by share price. An increasing price per share of common stock relative tothe stock market ‘asa whole indicates achievement of this goal. Given the following opportunities, which investment is preferred? Earnings per Share Investment | _Year1 Year2 Year3 Total A 714.00 10.00 24.00 28.00 B 6.00 10.00 14.0 30.00 Based on the information provided, the choice is not obvious. Profit maximization is not consistent with wealth maximization. It may not Jead to the highest possible share price due to the following reasons: 1 Timing is important—the receipt of funds sooner rather than later is preferred. Project B is expected to provide the higher overall increase in earnings, thus, is the more profitable project. But since the goal of the firm is to maximize value, and therefore, timing must be considered to determine which projects superior. Profit maximization may lead to value maximization, but it is not an absolute case. . Profits do not necessarily result in ‘nsh flows monilable to stockholders. In finance, cash is king, It is not ooenal fora firm to be profitable yet experience a cash crunch, They might have so much profit but less do not have enough cash to continuously run the business. The most common. aac is when expenses have a shorter due date than expected revenue. In such cases, the firm must arrange short-term financing to meet its debt obligations ‘before the revenue arrives. on fais to acount for risk. Risk i the chance that actual outcomes may differ from expected outcomes Financial managers must consider both risk and return because of Thar nerse effect onthe share price ofthe firm. Increased risk may decrease the share price, while increased return i likely to increase the share price. 3. Profit maximiza Financial managers administer the financial affairs of all types of businesses such a5 private and publi, large and smal, pofitseeking and not-for-profit. Typically, he handles a firm's cash, investing Surplus funds when available and securing outside financing when needed. He also oversees a firm’s persion plans and manages critical risks related to movements in foreign wren values, interest vee and commodity pres. The treasurer in mature frm must make decisions with respect lo‘ai handling financial planning, acquisition of fixed assets, obtaining funds to finance fixeq managing working capital needs, managing the pension fund, managing foreign exchange ss distribution of corporate earnings to owners. The two key activities that the financial manager does as related to a firm’s balance sheet are the following: 1. Investment decisions. The finance manager defines the most efficient level and the of assets. Investment decisions deals with the items that appear on the asset balance sheet. bet structure section of the 2. Financing decisions: The finance manager determines and maintains the proper combination of short- and long-term financing. Also, he raises the needed financing in the most economical manner. Financing decisions generally refers tothe items that appear onthe liability and equity section of the balance sheet, Corporate Governance, Ethics and Agency Issues Corporate governance is a system of organizational control that defines and establishes the responsibility and accountability of the major participants in an organization. Shareholders, board of directors, managers and officers of the corporations, and other stakeholders are the major participants included here. An organizational chart is an example of a broad arrangement of corporate governance, More detailed responsibilities would be established within each part of the organizational chart. Business ethics are the standards of conduct or moral judgment that apply to persons engaged in industry or commerce. Violations of these standards in finance include, but not limited to misstated financial statements, misleading financial forecasts or projections, fraud, bribery, kickbacks, insider trading, excessive executive compensation, and options backdating. Bad publicity generally results to negative impacts on a firm. Ethics programs seek to reduce lawsuits and judgment costs, uphold and preserve a positive corporate image, build trust and confidence of the shareholders, and to gain the loyalty and respect of all stakeholders. The expected result of such programs is to positively affect the firm's share price. Shareholders are the owners of a corporation, and they purchase stocks because they want to earn a good return on their investment without undue risk exposure. In most cases, shareholders elect directors, who then hire managers to run the corporation on a day-to-day basis. Because managers are supposed to be working on behalf of shareholders, they should pursue policies that enhance shareholder value. Also, to achieve this goal, the financial manager would take only those actions that were expected to make a major contribution to the firm’s overall profits. When managers deviate from the goal of maximization of shareholder wealth by putting theit personal goals above the goals of shareholders, this results to agency problems and issues. This kind of Problems increases agency costs. Agency costs are the costs borne by shareholders due to the ute and avoidance of agency problems. Both cases represent a reduction in the shareholders’ weal The agency problem and the associated agency costs can be reduced with the following: 1. Properly constructed and implemented corporate governance structure. This should be designed to institute a system of checks and balances to reduce the ability and incentives of ‘management to deviate from the goal of shareholder wealth maximization.Ghapler 1 Introduction to Financial Manogemont§ 2 .. Market forces such as shareholder crusading from large inst Structured expenditures thru compensation plans. This maybe the most popular way to deal with the agency problem but this is the most expensive cin It could ee caine or performance plans. Incentive plans tie management performance to share price. managers take actions that maximize stock, they could be given stock options giving them the right to purchase stock at a set price. This incentive plan may not be favorable because of market behavior that has a substantial impact on share price and is beyond the control of the management. That's why performance plans are more popular today. In this plan, compensation is based on performance measures, such a earnings per share and/or its growth, or other return ratios. Managers may receive performance shares and/or cash bonuses when the set performance goals are attained. fitutional investors. Institutional investors hold large quantities of shares in many of the corporations in their portfolio. The power of institutional investors far exceeds the voting power of individual investors. Managers of these institutions should be active in the monitoring, ‘of management and vote their shares for the benefit of the shareholders, This can lessen or avoid the agency problem because these sment to take actions that maximize shareholder wealth, groups can put pressure on manager ‘They may use their voting power to elect new directors who are aligned with thes objectives and will act to replace poorly or non-performing managers. “Threat of hostile takeovers, It occurs when a company or group not supported by existing management atiempts to acquire the firm. Because the acquirer looks for companies that are poorly managed and undervalued, this treat provokes managers to act in the best welfares of the firm's owners.NG ‘Chapter 1 Introduction to Financial Management ot ay 1, TRUE-FALSE STATEMENTS Write “True” ifthe statement is true. Otherwise, write “False”, iy fears management is concerned with allocating, raising and controlling the funds of the rm. 2. ‘The money market is created by a financial relationship between the suppliers and demanders of short-term debt securities maturing in one year or less 3, The primary economic principle used in managerial finance is marginal cost-benefit analysis, the principe that financial decisions should be made, and actions taken only when the added costs exceed the added benefits. 4. Financial managers actively manage the financial affairs of many types of business — financial and non-financial, private and public, for-profit and not-for-profit. 5, The issuance of commercial paper is in the area of investment decision. 6. Finance is concerned with the process institutions, markets, and instruments involved in the transfer of money among and between individuals, businesses and government. 7. Managerial finance is concerned with design and delivery of advice and financial products to individuals, business, and government. 8. The purchase of a new plant or properties for an expansion program is in the area of financing decision. 9. The corporate controller is the officer responsible for the firm’s accounting activities, such as corporate accounting, tax management, financial accounting, and cost accounting. 10. One advantage of forming a corporation is that you have limited liability. 11. Corporations face fewer regulations than sole proprietorships. 12. One disadvantage of being a sole proprietor is that you should pay corporate taxes, even though you don’t realize the benefits of being a corporation. 13. Corporations generally face fewer regulations than sole proprietorships do. 14. Corporate shareholders have unlimited liability. 15, It is usually easier to transfer ownership in a corporation than it is to transfer ownership in a sole proprietorship. 16. Stockholders are personally responsible for the liabilities of the corporation if it is unable to pay. 17. Normally, stockholders can only sell their ownership interests when the corporation is terminated. 18, Partners are personally responsible forthe liabilities of the partnership if itis unable to pay. 19. Partners can normally transfer their partnership interests with ease. 20. A corporation is characterized by separate legal existence, transferability of ownership and limited liability. Il MULTIPLE CHOICE QUESTIONS Encircle the letter that corresponds to the best answer. 1. He or she is the one responsible in making investment, financial, and dividend policy-making decisions of a firm. a. stockholder c. employee b. finance manager d. creditor 2 Itis one of the objectives of financial management. a. maximize earnings maximize the size ofthe firm bi maximize cash flows dd. maximize firm value/ stock price3. The choice to issue shares of stocks or long-term bonds falls under a. investment decision . financing decision b, dividend decision d._ none of the above 4. The issuance of commercial papers inthe area of a. investment decision . financing decision b. dividend decision d. none of the above 9. Which of the following is true about the finance managers as compared with the accountants? a. They devote attention primarily to decision making through analysis of financial data. b. They operate on an accrual basis, recognizing revenues at the point of sale and expenses when incurred. They focus on the actual inflows and outflows of cash, recognizing revenues when actually received and expenses when actually paid. 4. Allof the above »._ Which of the following is the best measure to ensure that management decisions are in the best interest of the stockholders? a. fire managers who are inefficient b. remove management's perquisites tie management compensation to the level of dividend per share 4._ tie management compensation to the performance of the company's common stock price 7. In planning and managing the requirements ofa firm, the financial manager is concerned with a. the mix and type of assets, but not the type of financing utilized b._ the type of financing utilized, but not the mix and type of assets the mix and type of assets, the type of financing utilized, and analysis in order to monitor the financial condition 4. the acquisition of fixed assets, allowing someone else to plan the level of current assets required, and the market value ofthe share & Marginal analysis states that financial decisions should be made and actions should be taken only when a. benefits equal costs ._ added benefits are greater than zero b. added benefits exceed added costs d, marginal revenue equals marginal cost 9._ By concentrating on cashflows within a firm, the financial manager should be able to a. avoid insolvency . control the share price b. prepare tax returns ._ maintain public relations 10. Finance is a. theart and science of managing money b. theartofmerchansngproducsand services c. the system of verifying, analyzing, and recording business tra : d._ the science ofthe production, distribution, and consumption of goods and services11. Which of the following isa duty of a financial manager in a business firm? a. auditing financial records controlling the stock price b, raising financial resources d. developing marketing plans 12, The primary goal ofa financial manager is. a, minimizing risk b._ maximizing profit minimizing return d. maximizing wealth 13, Corporate owners receive return a. through interest earnings and earnings per share b. through capital appreciation and retained earnings c._ by realizing gains through increases in share price and cash dividends d._ by realizing gains through increases in share price and interest earnings 14. Which of the following is nota principle of basic financial management? a. Profits king . Efficient capital markets b. Risk/return tradeoff d. Incremental cash flow counts 15. Itis concerned with allocating, raising and controlling the funds of the firm. a. finance . financial management b, management accounting d. budgeting 16. This refers to two or more persons binding themselves to contribute money, property, or industry to a common fund, with the intention of dividing profits between or among themselves © corporation a. sole proprietorship b. partnership d. none of the above 17. It is a weakness of a sole proprietorship a. unlimited life c. limited liability . easy to form d. limited access to capital 18. Which of the following is not an essential characteristic of a corporation? a. Itis an artificial being c. Itenjoys the right of succession b. It is created by the operation of law d._ It divides profits among the stockholders 19. Which ofthe following statements is an advantage of a sole proprietorship? a. Itcannot raise a large amount of capital. b. Ithas unlimited liability. The life ofthe business is dependent on the life of the owner. d._Itiseasy to make a decision 20. A business partnership is formed for the purpose of a. contributing money, industry, property contributing money b. contributing money and property 4. profitFINANCIAL STATEMENTS ANALYSIS: Learning Objectives 1. Understand the objectives of financial statement analysis, and its limitations, 2. Use the analytical techniques in financial statements analysis: a, Horizontal analysis b. Trend analysis Vertical analysis 4. Ratio analysis, 3. Prepare and interpret common- size financial statements, 4. Compute the various financial ratios, turnover and their interpretations and how to use them for profit planning. et Introduction Financial statements provide the basic source of information by managers and other interested Parties outside the organization regarding its financial conditions and results of operations. Financial statements communicate the firm's financial strengths and weaknesses as well as its performance for the current period. Though financial statements are primarily prepared for extemal users (Stockholders, investors, government agencies, etc), managers find it equally useful for their making decisions such as performance evaluation, developing operating plans and any other matters related to their operating activities. Although financial statements are based on historical accounting information, which reflects transactions and other events that affected the firm, it would help the users in predicting future, as. indicated by the trend analysis. A potential lender or investor could assess the company's overall financial strength, income and growth potential as well as the financial effects on some matters that required future decisions. The company's ability to repay obligations and distribution of returns on investments are the primary concerns of the potential lenders and investors. Overview of Financial Statements The four key financial statements are: 1. Balance Sheet - the purpose ofthe balance sheet isto present a summary of the assets owned by firm, its liabilities, and its net financial position at a given point in time. The assets are often referred to as investments and the liabilities and owner's equity as financing. 2. Income Statement - provides a financial summary of a company’s operating results during a specified period. : 3. Cash Flow Statement - provides a summary of the firm's operating, investment, and financing cash flows and reconciles them with changes in its cash and marketable securities during the peti. It also tes together the income statement and previous and current balance sheets. 4, Statement of Retained Earnings - reconciles the net income earned during a given year, and any cash dividends paid, with the change in retained earnings between the start and the end of that year.‘Chapter 2 Financial Statements Analysis ‘The basic structure of each of these statements and their relationships: FINANCIAL STATEMENT RELATIONSHIPS Balance Sheet Balance Sheet Beginning (12-31-x1) Ending (1231-32) Linilies Liabilities ASSETS = + ASSETS = + Capital Capital “Transactions daring the period From 12-3L-x1 to 12-31-32 Income Statement For the yearended Dec. 31, 20:2 Revenues eamed /Gains (Cash Flow Statement For the yearend! Dec. 31, 2032 Cash balance beginning + Cash inflows in 2052 = Cash outflows in 2052 = Cash balance cading _ Cash balance 1231-2 Cash balance 123texl__ =a In this chapter, analysis will be focused on these two statements, balance sheet and income statements. The most widely used techniques in financial statement analysis are: 1. Comparative analysis a. horizontal analysis . trend analysis c. vertical analysis 2. Ratio or Component analysis including turnovers. Cautions About Financial Statements Analysis Managers should look beyond the ratios. They should consider the technological changes, industry trends, consumer tastes and various economic factors. Here are some cautions about using financial ratios:(Ghoplor 2 Financial Stotoments Anais 00h . Ratios that reveal large deviations from the norm merely indicate the possibility of a problem. .A-single ratio does not generally provide enough information from which to judge the overall performance ofthe firm, 3, The ratios being compared should be calculated using financial statements dated at the same point in time during the year, 4. Itis preferable to use audited financial statements. 5, The financial data being compared should have been developed in the same way. 6. Results can be distorted by inflation. Comparative Analysis An item on a financial statement has little meaning by itself. The meaning of the numbers can be enhanced by drawing comparisons. Percentage changes and relative ratios are widely used in comparative and trend analyses. Horizontal analysis is comparing two periods and becomes trend analysis if extended to three or more periods having the earliest year as the base period. Vertical analysis, also known as common-size statements is analysis of the component parts of a single statement in a given period. The analyst must have in mind that these percentage changes and ratios are only indicators of the performance or financial condition of the company: No single measure could tell us more. To give ‘a more meaningful interpretation, these financial measures must be compared between periods and between other companies within the same industry but, most preferably, a comparison between companies of the same size and capacities. Using the industry norm or standards could also add sense to the interpretation, Horizontal Analysis Horizontal analysis is a technique for evaluating a series of data over a period time to determine the increase or decrease that has taken place, expressed as either an amount o a percentage. The peso changes (increase or decrease) are normally presented in each item as well as their percentage changes. ‘Quantifying peso changes over time serves to highlight the changes that are the most important economically. Quantifying percentage changes over time serves to highlight the changes that are the most unusual. The following simple rules should be observed: 1. Tocompute forthe peso changes, current year less prior year, To compute for the percentage changes, peso change divided by the prior year (serve as the base figure). If there is no amount in prior year, no percentage change will be shown, as a matter of rule in mathematics, 3. To compute for the ratio presentation, current year divided by the prior year. Again ifthe base year is zero oF no amount in prior year, no ratio will be shown in the analysis, thus, peso amount presentation is important.Beomedetal uke fog JAMES CORPORATION COMPARATIVE BALANCE SHEET DECEMBER 31, Year 2 and Year 1 Changes, Increase (Decrease) Peso Year2 | Year1_| Amount | % | Ratio ‘ASSETS Current Assets: Cash. 2400] 2,100 300] 143%! 14 Marketable Securities 1,350 900 450| 500%] 150 Accounts Receivable, net 36000} 23,000} 3,000] 9.1%] 109 Inventory 60,000] 51,000] 9,000] 176%) 118 Prepaid Expenses 750 900, (150) | -16.7% | _ 0.83 Total Current Assets 700,500 | 87,900 | 12,600[ 14.3% | 1.14 ‘Long-Term Investments 1,300. 1,650 (150) | -9.1%] 0.91 Property and Equipment Land 18,000 18,000 * 0.0% 1.00 Building net 165,000 | 156,000) 9,000] 58%] 1.06 Equipment, net 75,000| _69,000| 6000 87% | 1.09 Total Property and 258,000 | 243,000 | 15,000) 62% | 1.06 Equipment TOTAL ASSETS 360,000 332550 27450 8.3% 1.08 LIABILITIES & STOCKHOLDERS’ EQUITY ‘Current Liabilities: ‘Accounts Payable 22500) 21,150} 1,350/ 64%} 1.06 Accrued Expense 6,600) 6300 300} 48%} 1.05 Notes Payable 10,900| 8,700] 2.200] 253%] 1.25 Total Current Liabilities 40,000 | 36,150 3.850 [107% | 1.17 Long Term Liabilities 110,000 { _108,000|___2,000} 1.9% | 1.02 Total Liabilities 150,000] 144.150 [5,850 [41% | 1.04 Stockholders’ Equity Preferred Stock, P100 par,8% | 18,000] 18,000 -| 00%} 1.00 Common Stock, P10 par value | 75,000] 72,000] 3000| 42%} 1.04 ‘Additional paid in Capital 12000/ 11,400 600} 53%) 1.05 Retained Earnings 105,000| _87,000| _18,000| 20.7%} 1.21 Total Stockholders’ Equity [ 210,000 | 188,800 | 21,600 | 11.5% | 11 TOTAL LIABILITIES & STOCKHOLDERS’ EQUITY | 360,000] 332,550] 27450| 8.3% | 1.08(Chace 2 Financial ' 5 JAMES CORPORATION COMPARATIVE INCOME AND RETAINED EARNINGS STATEMENT FOR THE YEARS ENDED DECEMBER 31, Year 2 and Year 1 Changes Increase (Decrease) Peso Year2 | Year1 | Amount % Ratio Net Sales 261,000] 246,000] 15,000] 61%) 1.06 Cost of Sales 182,790 169,050 13,740| 8.1% | 1.08 Gross Profit 78210| 76,950 1,260) 1.6%) 1.02 Operating Expenses 21,000 | 20,100 900| 45%] 7.04 Net Operating Income 57,210 | 56,850 360) 06%) 1.01 Interest Expenses 12,090 | 11,670 420| 3.6% | 1.04 Net Income Before Tax 5,120] 45180! (60)| 01%] 100 ‘Tax Expense 11280| 11400| @20)|_ 11%} 0.99 | Net Income 33840 | 33,780 0} 02%) 1.00 Add Retained Earnings, beg. | _87,000| 68460| 18540] 271% | 1.27 | Total 120840 [102,240 | 18,600| 182% | 1.18 | Dividends 15840| 15240| 600 39%| 108 | Retained Earnings, ending 105,000 | _ 87,000 18,000 | 20.7% | 1.21 Net Operating Income 33,840 | 33,780 60) 02%] 1.00 Dividends to Preferred 1440 1440 =| 0.0%| 1.00 | Stock Net Income Available to 32400 | 32340 60} 0.2%] 1.00 Common | Dividends to Common 14400 | 13,800 600| 43%] 108 Stock Net Income 1800 [18540] (640) | -29%| 097 JAMES CORPORATION COMPARATIVE INCOME AND RETAINED EARNINGS STATEMENT FOR THE YEARS ENDED DECEMBER 31, Year? and Year 1 COMMON SIZE PRESENTATION Year1 [| Year2 | Year2 | Yeari Net Sales 261,000 246,000 100.0% | 100.0% Less Cost of Sales 182,700| 169,050 | 70.0% | 68.7% Gross Profit 720| 76950| 300% | 31.3% Less, Operating Expenses 2000| 20,100] 8.0% 8.2% Net Operating Income 57.210| 56850] 21.9% | 23.1% Less, Interest Expenses 1209| _11670| 46%] 4.7% | Net Income 45100| 45180| 173% | 184% Less, Tax Expense 11780| 11400] 43% | 46% Net Income 33840| _33,780| 13.0% | 137%hs 2 Fro Selon Abt ATION JAMES: CORPOR! | COMPARATIVE COMMON For the balance sheet, Total Assets and Total Liabilities & Capital are both: considered 100% and rear item in the particular section are presented as a certain percent of the total. In James Corporation, Cash is 78% of total assets while Accounts Payable represents 6.3% of total liabilities and stockholders’ equity.hae 2Eranc Steers oie ic . Each item in the i > For the Income Statement, Net Sales : eae ni Set en a statement represents a certain percent of sal sales, Ratio Analysis it lyst develop his interpretation as to the Many rated je i he bla Financia statements report both the fins rtcrn penne ie omer ta Tab of faa cee is in the fact that they can be used to ree Rae fine ‘earnings and dividends, thus, an analysis of the firm's ratios is ee EL I kabenent Sinise lysis, The ratios are designed to show relationships between seleey eo Fe indance, Company X might have debt of P5 milion and intrest charges of PAKH Housand, while Compary Y gh have debt of P50 million and interest charges of PA mi oes wih ep mer stronger? The true burden of these debts, and the companies’ ability to spay ec etna (1) by comparing each firm’s debt to its assets and (2) by comparing se i Se He income it has available for payment of interest. Such comparisons are Ww! . ‘The three major areas that concern the users of financial statements are: 1. Stability 2. Solvency o liquidity, and 3. Profitability. Analyzing ratios as a whole could be more meaningful, even though they are computed individual, the totality of it could give the final interpretation about the company's financial and operating conditions. The following are the most common ratios used by financial analysts: ‘Analyzing the Balance Sheet A. Liquidity Ratios These are ratios that show the relationship of the company’s cash and other current assets to its current liabilities. Liquidity is the number one concern of most financial analysts, This will indicate whether the firm can meet its maturing obligations. ‘The most common liquidity ratios and their procedural computations are: 1. Working Capital = Current assets minus current liabilities This is the excess of current assets over current liabilities, To some, working capital is used to designate current assets only as the amount intended for day to day operations of the business. Thus, the use of the term net working capital is more appropriate. The bigger the net working capital the better as it would mean more current assets are available for operations. 2. Current Asset Ratio = Current assets divided by current liabilities This is the basic test of liqui idity of the firm. This will determine the of working capital or the ability tom iitaal Bt et current obligations. The higher the current asset ratio, thebetter, as this would mean there are more current assets available for paying its current obligations. 3, Quick (Acid) Test Ratio = Quick assets divided by current liabilities Quick or acid test ratio is a more stringent test of ability to pay current obligations as they come due. Quick assets are: Cash and cash equivalents, marketable securities, short-term notes and accounts receivables. In this regard, inventory and prepaid expenses are not included in the computation of quick asset ratio as inventories are typically least liquid among the current assets, while, prepaid expenses are not convertible to cash. Though the analyst must do a careful analysis since accounts receivable could be converted into cash later than inventory. It is in the case of aged accounts receivable which are normally considered as bad debts. The opposite could be observed wherein inventory can be converted to cash earlier than accounts eile in the case of cash sales. The higher the quick asset ratio, the better liquidity position of the firm. Asset Management Ratios ‘These are set of ratios, which measures how effectively a firm is managing its assets. These ratios are also called asset utilization ratio, which pertains to how effectively the firm utilized its assets to earn profits, ‘These ratios are designed to answer questions like: + Does the total amount of each type of asset as reported on the balance sheet seem maintained at a reasonable level? «© Will too high or too low current assets in relation to the projected or actual operating levels affect profitability? Normally companies borrow or.obtain capital from other sources to acquire assets. Ifa company has too many assets acquired through borrowings te interest expenses willbe to0 high and, hence the profits will be lower. On the other hand, if assets are too low, profitable sales may be lost. Therefore, managing these assets, particularly current assets will help the firm avoid borrowing funds to finance operations. The most common asset management ratios are: 4. Accounts Receivable Turnover = Netsales on account divided by average A/R* *Average A/R™= (Beg + End) divided by 2 ‘This will measure the efficiency of collections. How fast collections are being made. Whenever possible, monthly balances of accounts receivable is used in determining average ‘accounts receivable. The net sales used as numerator are assumed to be all credit sales only, ‘The higher the turnover, the better, this would mean a greater number of times receivable is reinvested for more profit. 2, No.of daysin A/R or Average collection period ™ 365 days( in a year) divided by AR Turnoveree ee ea. i . Average AR divided by the ‘Average Daily Sales fi This is to measure the number alee i shorter the collection period, the better 19 opportunites, which mean additional income, Cost of Sales divided by Average Inventory irm invests in accounts receivable. qT), pany as it could present reinvestmen, 3, Inventory Turnover = i 2 Average Inventory = (Be8 + End) divided by it i inventory turnovers are used to determine how fast ae Telit the inventory turnover, the better, as this would mean more number of measure. The er, tl , times inventory is reinvested and more profit will be realized. ; ea pest |. No.ofdays in Inventory or Average Selling perio «Neen days(ina year) divided by Inventory Turnover ‘This determines the number of days’ in inventory is held as stock before it will be sold. ‘The shorter the number of days itis held on stock, the better it will be as it means more number times it is reinvested by the firm. For a manufacturing firm, the number of days and turnover will be determined for each item in the inventory, such as the finished goods, the work in process and raw materials inventory. Finished goods turnover is computed by dividing the cost of sales by the average finished goods inventory + Work in process turnover is computed by dividing the cost of goods manufactured by the average work in process, + Raw materials tumover is computed by dividing the raw materials used by the average raw materials inventory. 5. Fixed Assets Turnover or Fixed Assets Utilization Ratio = Sales divided by Net Fixed Assets 6, Total Assets Turnover = Sales divided by Total Assets These two measures determine the number of times investments in assets are reinvest in sales. The more the oe ‘ibe a co number of times it turnover, means the higher profit the company C. Debt Management Ratios or ‘Financial Leverage These ratios will measure the extent financial leverage. Some it Fat these are: 'ge. Some important implica to which firm uses its debt financing or the so-clle! tions could be raised in managing financial leversChapter 2Financiel StotementsAnaysis a * By raising funds through debt, the owners can maintain control ofthe firm with limited investment. * Creditors look to the equity, or owner-supplied funds, to provide a margin of safety, that is if the owners have provided only a small proportion of the total financing, the risks of the enterprise are borne mainly by its creditors. Financial leverage raises the expected rate of return to stockholders for two reasons: * Since interest is deductible, the use of debt financing lowers the tax and leaves more of the firm’s operating income available to its investors. * If the rate of return on assets (income before tax divided by the total assets) exceeds the interest rate on debt, as it generally does, then a company can use debt to finance assets, pay the interest on the debt, and have something left over for its stockholders. Normally, firms with relatively high debt ratios are exposed to more risk of losses when the economy is in a recession, but they also have higher expected returns when the economy booms. Conversely, firms with low debt ratios are less risky, but they also forego the opportunity to leverage up their return on equity. The prospects of high returns are desirable, but investors are reluctant to risk. Therefore, decisions about the use of debt require firms to balance higher expected returns against increased risk Determining the optimal amount of debt for a given firm is a complicated process. That is why this chapter will simply look at the procedures on how to: examine the firm’s debt ratio as to the extent to which borrowed funds have been used to finance assets, and «review income statement ratios to determine the number of times fixed charges are covered by operating profits. These two ratios are complementary and must be analyzed at the same time. 1. Debt to Total Asset Ratio = Total Debt divided by Total Assets This is the ratio of total liabilities to total assets, As discussed earlier, it measures to ‘what extent that portion of the total assets provided by the creditors. 2 Debt to Equity Ratio = Total Liabilities divided by Total Stockholder's Equity It measures the resources provided by the owners in the business. It provides information on the equivalent amount provided by creditors for every PI provided by the owners. 3. Times-Interest-Earned Ratio = —_EBIT* divided by the Interest Charges *EBIT - Earnings Before Interest and Taxes‘Ghacter 2 Financial Satements Anas This measures the ability of the firm to meet its annual interest payments. It wit aly measure the extent to which operating income can decline before the firm is unable to mee, annual interest costs, Failure to meet this obligation can bring legal action by the firm creditors, possibly resulting in bankruptcy. s Note that earnings before interest and taxes, rather than net income is used in numerator. This is because interest is a deductible cost, and the ability to pay current interest i not affected by taxes. # 4. Fixed ChargeCoverage = (EBIT+ Fixed Charges) divided by (Interest Charges + Fixed Charges) This ratio is like the “times interest eared ratio”, but it is more inclusive in Tecognizes that many firms incur many fixed charges. As many firms lease assets, retirement fund contributions, sinking funds contribution, and incur long-term obligations under lease contracts. Leasing has become widespread in certain industries making this ratio a must ig ‘many financial analysts. Fixed charges are defined as interest plus annual fixed charges, that it 5. Cash Flow Coverage Ratio = (BIT + Fixed Charges + Depreciation) divided by [Interest Charges + Fixed Charges + (Preferred Stock Dividends/(I-tax rate) + (Debt Repayment/1-tax rate)] This ratio shows the margin by which the firm’s operating cash flows cover its financial requirements. Normally, firms with preferred stocks require paying preferred dividends as well as its annual repayments of principal on loans. Depreciation is added back to EBIT, sinceit was deducted from income to arrive at EBIT without cash outflow. Dividing an after-tax number by (I-tax rate) is often called “grossing up” the net after-tax number. Because preferred dividends and loan payments must be made from income remaining after payment of income taxes, dividing by (I-tax rate) “grossed up” the payments and shows the before-tax amounts necessary to produce a given after-tax amount. For instance, to pay P10,000 of preferred dividends and the tax rate is 40%, we need 16,667 computed as follows: [P10,000 /(1-40)]. To prove, P16667 earnings before income at (EBIT) less the tax of P6,667 (P16,667 x 40%) will give us P10,000. 6. Book Value of Securities. = Value of each security* divided by each number of shares outstanding “Securities are bonds, preferred stocks and common stocks 7. Capitalization Ratios = the proportion of the face value of a particular type of security to the company's to equity (creditors' and owners' equities). This is normally applicable only to long term debi“Analyzing the Income Statement D. Profitability Ratios ‘These ratios would show the net result ofthe policies and decisions the management did in the current period. The combined effects of liquidity, asset management, and debt management on operating resulls wil be analyzed using these ratio. 1. Profit Margin = Net Income available to Common Stock divided by Sales 2 Retumon ales = Netincome divided by Net Sales 3, Return on Total Assets (ROA) = Net Income available to Common Stock divided by Average Total Assets or = (Net Income plus Interest Expenses net of its tax effect) divided by Average Total Assets ‘Average Total Assets = (TA beg + TA, end) divided by 2 4. Return on Common Equity (ROE) = Net Income available to Common Stock divided by the Average Common Stock Equity Basic Earning Power = —_EBIT divided by Average Total Assets This ratio indicates the ability of the firm’s assets to generate operating income. This ratio shows the raw eaming power of the firm's assets, before the influence of taxes and leverage, and its useful for comparing firms with different tax situations and diferent degrees of financial leverage. 6. Eamings Per Share (EPS) or Basic EPS = (Net Income Available to Common Stockholders before Extraordinary Items net of its tax effect) divided by Weighted Average Number of Shares Outstanding 7, Dividend PerShare = Dividends Paid to Common Stock divided by Common Shares Outstanding & Dividend Pay-OutRatio = Dividends Per Share of Common Stock divided by Earnings Per Share “This measures the amount of dividend paid for every P1 earnings or the percentage of distributed earnings in relation to EPS.Star 2 wi Sati hy Analyzing the Retained Earnings E. Market Value Ratios This is a set of ratios that relate the firm's stock price to its earnings and book value These ratios give the management an indication of what investors think of the companys performance and prospects. If the firm's liquidity, asset management, debt management profitability ratios are all good, then, its market value ratios will be high, and its stock price ore to beas high it can be. 1. Price-Earnings Ratio = —_- Market Price Per Share of Common Stock divided by Eps This ratio shows the peso amount investors will pay for every P1 of current earnings, 2. Market-Book Ratio - Market Price Per Share divided by Book Value Per Share This ratio of a stock’s market price to its book value gives another indication of how i regard the company. Companies with relatively high rates of return on equity generally sell at higher multiples of book value than those with low returns. 3, Dividend Yield Ratio = Dividends Per Share of Common Stock divided by Market Price Per Share This ratio measures the rate of return on actual dividend distribution to common stockholders. Note: All of these turnover and ratios could be more meaningful if they are compared to the industry standards so that the analyst could assess the performance ofthe company in relation to its competitors. . Illustrative Problem Financial Statements Analysis of James Corporation Year2 Year1 1. Working Capital Current Assets 100,500 87,900 Less, Current Liabilities 40,000 36,150 Working Capital 2.60500 P51,750 2. Current Asset Ratio Current Assets P100,500 87,900 Current Liabilities 40,000 36,150 CAR 26:1 2.43 31 3. Quick Asset Ratio Quick Assets 39,750 36,000 Current Liabilities 40,000 36,150 QAR 99:1 99:1Grint 2Fiancio Siemens Anavsis lg s . Accounts Receivable Turnover Net sales / Ave. A/R = P261,000 / {(36,000 + 33,000)/2 = 756 times 3. No, of Days in A/R 365 days / 756 = 48.28 days or Ave. A/R / average daly sales 34,500 / (P261,000 / 365 days)= 48.25 days 5. Inventory Turnover = Cost of Sales / Ave. Inventory = P187,790 / [(P60,000 + 51,000) /2] = 3.38 times No, of Days in Inventory = 365 days /3.38 = 108 days or Ave. Inventory / average daily cost of sales 187,290 / (P187,790 / 365 days)= 108 days 3. Debt Equity Ratio Total Liabilities P150.000 P144.150 Total Stockholders’ Equity 210000 188,800 Debt Equity ratio M1 76:1 . Book Value of Securities Preferred Stock = P18,000/(P18,000/ P100) P18,000/180 shares = P100 per share ‘Common Stock = P192,000 / (P75,000 / P10) = P192,000 / 7,500 shares = P2560 per share But if book value is computed to serve as a backing of Long-Term liabilities, Preferred stocks in case of liquidation, computational procedure would be as follows: Total Assets ‘P360,000 Less, Current Liabilities 40,000 Net Assets backing the claims of bondholders 320.000 Book Value per Bond/Notes = Net Assets available divided by of Bond Outstanding = P320,000 / 110 = P2,909 per share of P1,000 bond outstanding Net Assets Backing Bonds P320,000 Less, Bonds Payable/Notes 110,000 ‘Net Assets Backing Preferred Stock P210.000Chapter 2 Financiol Statements Ane!ysis ir Book Value Per Share of P/S = Net Assets available divided by No. of P/S Outstanding, = P210,000 / 180 shares = P1,667 per share of P100 par value Preferred Stock Net Assets Backing Preferred Stock 210,000 Less, Preferred Stock —18,000 Net Assets Backing Common Stockholders 192.000 Book Value Per Share of C/S= Net Assets Available divided by No. of Common Shares Outstanding = P192,000/ 7,500 shares = 25,60 per share of P10 par common stock Notice that the book value per share in No. 9s the same at P2560. 10. Capitalization Ratios, Proportion of the Face Value of a particular security: Amount Percentage Long Term Notes P110,000 Me Preferred Stock 18,000 6% ‘Common Stock -192,000 60% Totals Promo = 100 ‘11. Return on Sales = Net Income / Net Sales = P33,840 / P261,000 = 12.96% 12. Return on Assets = —_Net Income Before Interest, net of tax / Ave. T.A . (33.840 + P8,463) / [(P360,000 + P332,550) /2] (P33,840+ 8,463) / P346,250 = 12.21% Interest net of tax: Interest Expense PL Assume tax rate 0f30% a Interest net of tax effects Baus 13, Return on Equity Net income available to CS / Average total SE (P33,840 - PI 440)/[(P192,000 + P170,800)/2 (P33,840 - P1,440)/P 181,400 somes : 14, Interest Coverage = [Operating Income or EBIT terest Expense s P57,210/P12,090 = 4.73 times.(Chapter 2 Financial Sialemenis Anaysig = 15, Preferred Stock Coverage = (Net Income after Interest and After Tax) Divide by Stated Preferred Stock Dividends = P33840/P1440 = 23.50times 16. Earnings Per Share = Net Income/No. of C/S Outstanding (simple) = (P33,840 -PA40) / 7,500 shares = P4.32 per share 17. Price Earnings Ratio = Market Value Per Share/EPS = P195 / P4.32 = 45.13 18. Dividend Pay Out = Dividend Per Share of CS/EPS (P14,400 /7,500)/P432 = 44.44% 19. Dividend Yield = —_ Dividend Per Share/Market Price Per Share = PLO/PISS = ~— 10% Notes to Financial Statements Published financial statements are accompanied by notes. These narratives provide greater detail of information that is included very concisely in the financial statements, Many people find some notes to be complicated. Nevertheless, they can be extremely important, and should be viewed as an integral part of the financial statements, Information typically disclosed in the notes includes: > Details of the inventory costing and depreciation methods used. > Contingent liabilities and pending lawsuits > Long term leases, ifany. > Terms of executive employment contracts, profit sharing programs, pension plans, and stock ‘options granted to employees. Note that if you really want to analyze a set of financial statements thoroughly don't pass over the "Notes to Financial Statements". Limitations of Financial Statement Analysis Financial statements and the financial ratios derived from them are but a single source of information about a company. Like any management accounting information, financial ratios serve only as an attention-directing device. The ratios raise questions more often than they answer them. An analyst must follow up the financial statement analysis with in-depth research on a company's management styles its history and trends, the industry, and the national and international economies in which the firm operates. Further, as financial statements are historical costs, inflation could badly distort balance sheets particularly depreciation charges and inventory costs which affect profit. Thus, a ratio analysis for one firm for several periods or different companies of different ages must be interpreted with extra care and judgementhate 2s Sten eh i i It. One of them is variations in . veral factors make financial analysis difficul i cai snougine ‘As in the case of different methods of inventory valuations and depreciation, om bien differences in reported profits for identical firms, and a good financial analyst must be able to adj to these differences so that he or she can make valid comparisons among companies. Again, ang bbe more meaningful if we make comparisons. analysis g Another is timing. An action is taken at one point in time, but its full effects ca accurately measured until some later period. As the cash account isthe steering wheel of every i the effects of the cash flow cycle could be accurately measured at a different time. Cash depleted as a result of acquisition of fixed assets to boost production and sales activities and neti vas recognized at the same period though collection of cash again could be done at a later period, AAs such, at that same period, current asset ratio may seem not good, but profit seems beter is also difficult to generalize whether a particular ratio is “good” or “bad”. For instance, a high curry, ratio may indicate strong liquidity position which in fact illiquid since most of its current asset isin the form of non-moving inventory or in the form of aged accounts receivable. Even excessive cash in good as cash itself is a non-earning asset. Therefore, financial statement analysis must be interpreted as a whole, co-relating is weaknesses and strengths rather individual ratios.‘Ghooter 2 Financial Statements Anaysis 0 L aa tor STATEMENTS Write “True” if the statement is true and write “False” if the statement is Ise. 1, One limitation of vertical analysis is that it cannot be used to compare two companies that are significantly different in size, 2, The sale of used equipment at book value for cash will increase earnings per share. 3. An increase in the number of shares of common stock outstanding will decrease a company's price-earnings ratio if the market price per share remains unchanged. Ifa company's acid-test ratio increases, its current ratio will also increase. Short-term borrowing is not a source of working capital Altention directing is one of the many basic objectives of financial statement analysis. Since financial statements are summary of historical data, it cannot be used to predict the future for management decision making purposes. 8, The ratio that shows the margin by which the firm’s operating cash flows cover its financial requirements is the cash flow coverage ratio. 9. Companies with relatively high rates of return on equity generally sell at higher multiples of book value than those with low returns, 10. [Ifthe firm's liquidity, asset management, debt management and profitability ratios are ll good, then, its market value ratios will be high, and its stock price is expected to be as high it can be. 11. A high current asset ratio is always an indication of strong liquidity position. 12. In trend analysis, percentage figures are usually computed by using the most recent year as a ‘base. NS 13. Common-size statements are statements of companies of similar size and operations, 14. An extremely high current ratio may be an indication that receivables and inventories are excessive. 15. Trend percentages in financial statements would be an example of vertical analysis. 16. A common-size statement is one that shows the separate items appearing on it in percentage form, with each item stated as a percentage of some total of which that item isa part. 17. Ifearnings remain unchanged and the price/earnings ratio goes up, then, one would expect the market price of a stock to go down. 18, Investors seeking capital gains would like the dividend pay-out ratio to be high. 19. Dividing the market price of share of stock by the dividends per share gives the price/earnings ratio. 20. Book value per share isnot a good predictor of either earnings potential or debt paying ability. 21. In computing the dividend yield ratio, the investor should use the current market price for the stock, rather than the price that he or she paid for it. 22. If the return on total assets is greater than the after-tax cost of long-term debt, then, leverage is positive, and the common stockholders will benefit. 23. The inventory turnover is computed by dividing sales by average inventory. 24. Companies that experience high earning on some occasions and suffer losses on other occasions should rely heavily on the use of financial leverage. 25. Ifa company’s return on total assets is substantially higher than its cost of borrowing, then, the common stockholders would normally want the company to havea high debt/ equity ratio. 26. Comparisons within a company are often useful to detect changes in financial relationships and significant trends. 7, Comparisons with other companies provide insight into a company’s compelitive postion.28. Comparisons with industry averages provide information about a company’s Telative Peston within the industry. 5 29, Horizontal ana is a technique for evaluating financial statement data that expresses ay item in a financial statement as a percent of a base amount. at e 30. Comparisons of company data with industry averages provide information about a companys relative position within the industry. ir 31. Horizontal, vertical and ratio analyses are the basic tools of financial statement analysis, 32. Horizontal analysis is a technique for evaluating a financial statement item in the current yer with other items in the current year, ; 3B. aoe ompany has sales of P110 in 2008 and PIS4 in 2007, the percentage increas i sls fm, 2007 to 2008 is 140%. : 34. In horizontal analysis, if an item has a negative amount inthe base year, and a Positive amount in the following year, no percentage change fr that item can be computed. 35. A primary purpose of vertical analysis isto observe trends over a three-year period. 36. Vertical analysis i a technique for evaluating a series of financial statement data over a period to determine the increase (decrease) that has taken place. 37. Using vertical analysis of the income statement, a company's net income as a percentage of net Sales is 10%; therefore, the cost of goods sold as.a percentage of sales must be 90%. 38. Liquidity ratios measure the ability of the enterprise to survive over a long period of time. 39. A solvency ratio measures the income or operating success of an enterprise for a given period. 40. Receivable turnover is useful in assessing the Profitability of receivables, 41. The inventory turnover ratio measures the number of times on average the inventory was sold during the period 42. Inventory turnover isa measure of liquidity that focuses on efficient use of inventory. 43. Profitability ratios are frequi ently used as a basis for evaluating managements operating effectiveness. wu. ‘The retum on assets ratio will be greater than the rate ectity ifthe company has been succesful in trading on thy 45. From a creditor's point of view, the higher the total debt thatthe company may be unable to pay its obligations, g ie equity at a gain. . to total assets ratio, the lower the risk MULTIPLE CHOICE QUESTIONS Encircle the letter that. Corresponds to the best answer. 1. Which ofthe following below generally isthe most Useful in analyzing companies of diferett sizes? a. audit report b. trend analysis price-level accounting |. comparative statements >» common-sized financial statements ep 2. Abalance sheet that displays only com, 7 tend analysis? MPOnERE percentages called ._ trend balance sheet . condensed balance sheet . comparative balance sheet common-sized balance sheet eaogep28. Comparisons with industry averages provide information about a company’s relative Post, within the industry, | 29. Horizontal metre is a technique for evaluating financial statement data that expresses, item in a financial statement as a percent of a base amount. Fos | 30. Comparisons of company data with industry averages provide information about a company relative position within the industry. met 31. Horizontal, vertical, and ratio analyses are the basic tools of financial statement analysis, 32. Horizontal analysis isa technique for evaluating a financial statement item in the current ie with other items in the current year. 33. If a company has sales of P110 in 2008 and P154 in 2007, the percentage increase in sales eat 2007 to 2008 is 140%. : 34. In horizontal analysis, if an item has a negative amount in the base year, and a positive. ‘amount in the following year, no percentage change for that item can be computed, 35. A primary purpose of vertical analysis is to observe trends over a three-year period, 36. Vertical analysis is a technique for evaluating a series of financial statement data over a period to determine the increase (decrease) that has taken place. 37. Using vertical analysis of the income statement, a company’s net income as a Percentage of net sales is 10%; therefore, the cost of goods sold as a percentage of sales must be 90%. 38. Liquidity ratios measure the ability of the enterprise to survive over a long period of time, 39. A solvency ratio measures the income or operating success of an enterprise for a given period. 40. Receivable turnover is useful in assessing the profitability of receivables. 41. The inventory turnover ratio measures the number of times on average the inventory was sold during the period. 42. Inventory turnover is a measure of liquidity that focuses on efficient use of inventory. 43. Profitability ratios are frequently used as a basis for evaluating management's operating effectiveness. 44. The return on assets ratio will be greater than the rate of return on common stockholders’ equity if the company has been successful in trading on the equity ata gain, 45, From a creditor's point of view, the higher the total debt to total assets Tatio, the lower the risk that the company may be unable to Pay its obligations, Il. MULTIPLE CHOICE QUESTIONS Encircle the letter that corresponds to the best answer. 1. Which of the following below generally is the most useful in analyzing companies of dilfere* sizes? a. audit report b. trend analysis ©. price-level accounting d. comparative statements €. common-sized financial statements 2. A balance sheet that displa a. trend analysis b. trend balance sheet ¢. condensed balance sheet 4. e ys only component Percentages is called |. comparative balance sheet . common-sized balance sheet| Chagtee2nonc Satements Anais x 3. In horizontal analysis each item is expressed as a percentage of the a. base year figure b. total assets figure ¢. net income figure d._ retained earnings figure e. alloftheabove . The acceleration in the collection of receivables will tend to cause the accounts receivable turnover to a. decrease b. increase ¢. remain the same d. either increase or decrease . A company with P80,000 in current assets and P20,000 in current liabilities pays 2 P10,000 current liability. As. result of this transaction, which of the following is correct? a. Current ratio will decrease b. Working capital will decrease cc. Current ratio will increase d. Both AandB e. BothBandC . Roselyn Corp has a 2 to 1 current ratio. This ratio would increase if a. Thecompany wrote off an uncollectible receivable b. Thecompany purchased inventory on open account c. Apreviously declared stock dividend were distributed dd, The company sold merchandise on open account that earned a normal gross margin “A measure of the company’s long term debt paying ability is a. Operating cycle b. Return on assets c. Dividend out ratio d. Times interest earned ratio Financial ratio, which assess the profitability of a company, include all ofthe following except: a. Returnon sales b. Gross profit rate . Eamings per share d. Dividend yield ratio 1. Kevin Inc. has a current ratio of 0.65 to 1. A cash dividend declared last month is paid this month. What is the effect of this dividend payment on the current ratio and working capital respectively? a. Rise and decline b. Rise and no effect c. Decline and no effect d. Noeffect on both ratios“ | ‘Ghapler 2 Financial Satements Analysis, 10. A high receivable turnover ratio indicates a. The company’s sales have increased b. Customers are making payments quickly c. A large portion of the company’s sales are on credit } d. Many customers are not paying the company’s receivables 11. The percentage change in total assets between two balance sheet dates is an example of a. vertical analysis, . horizontal analysis. ¢. capital analysis. 4. profitability analysis. 12, The tools and techniques used to analyze financial statements are divided into broad categories including all the following except: capital analysis, vertical analysis. horizontal analysis. ratio analysis, pose 13, The percentage change in any individual item shown on comparative financial statements is calculated by dividing the peso amount of the change from the base-period to the current period by: a. the amount shown for the current period. b. the sum of the current period amount and the base-period amount. «the average ofthe amounts shown for the base period and the current period, d._ the base-period amount. 14, The act that sales increased by P20,00 from 2017 to 2018 would most likely be revealed by: a. horizontal analysis. ». vertical analysis. ratio analysis. d. liquidity analysis. 15, Horizontal analysis involves the study of a._ percentage changes in te balances shown in comparative financial statements, b. the percentage amount of various financial statement amounts compared to a total amoutt on the financial statement. ¢. the change in key financial statement ratios over a certain ime frame or horizon. d. the interrelationship between the income statement and balance: sheet. 16, When preparing a horizontal analysis of financial statements, subtract the a+ later year amount from the earlier year amount and divide by the later year amount. * carir year amount from the later year amount and divide bythe ater year amount ¢. earlier year amount from the later year amount and divide by the earlier year amount. |. later year amount from the earlier year amount and multiply by the earlier year ‘amount. s Se ad‘Chapler 2 Financial Statements Analysis. 33 17, When calculating trend percentages, all percentages shown are relative to: a. an average index calculated forall the years shown, 'b. the current year. the base year. d. the immediately preceding year, 18, Under which of the following cases may a percentage change be computed? a. The trend of the amounts is decreasing but all amounts are positive. b. There is no amount in the base year. c. There sa negative amount in the base year and a negative amount in the subsequent year. There isa negative amount in the base year and a positive amount in the subsequent year. 19, Horizontal analysis is a technique for evaluating a series of financial statement data over a period. a thathas been arranged from the highest number to the lowest number. b. that has been arranged from the lowest number to the highest number. . todetermine which items are in error. . to determine the amount and/or percentage increase or decrease that has taken place. 20. Horizontal analysis of comparative financial statements includes the a. development of common size statements. . calculation of liquidity ratios. calculation of peso amount changes and percentage changes from the previous to the current year. |. evaluation of financial statement data that expresses each item in a financial statement as a percentage of a base amount. 21. Ratios are most useful in identifying causes. 4, relationships. 22. Short-term creditors are usually most interested in assessing a. solvency. b. liquidity. c. marketability. 4. profitability. 23, Acommon measure of liquidity is a. return on assets. », receivable turnover. profit margin. 4. debt to equity. 24. A common measure of profitability is a. the acid test or quick ratio.tements Ane b. current cash debt coverage ratio. ‘ . return on common stockholders’ equity ratio. d. debt to total assets. 25. A common measure of long-term solvency is a. cash debt coverage ratio. b. current ratio, © asset tumover ratio, 4. inventory turnover, 26, Return on assets rato is most closely related to a. profit margin and debt to total assets rato, b. profit margin and asset turnover ratio, times interest earned and debt to stockholders’ equity ratios, profit margin and free cash flow. 27. Return on common stockholders’ equity rato is most closely related to a. gross profit rate and operating expenses to sales ratio, ._ profit margin and free cash flow, : times interest earned and debt to stockholders’ equity ratios. 4. return on asset ratio and leverage (debt to total asset ratio), 28. Long-term creditors are usually most interested in evaluating a. liquidity. ity. ©. profitability. solvency. 29. Which one of the following would be considered a I a. Receivable turnover b. Return on total assets ©. Current cash debt coverage ratio d. Debt to total asset ratio long-term solvency ratio? 30. Stockholders are most interested in evaluating a. liquidity. 31. The current ratio is a. calculated by dividing current liabilities by current assets, ». used to evaluate a company's liquidity and short-term debt ¢. used toevaluatea company’s solvency and long a. calculated by subtracting current liabilities from 32. A company with P60,000 in current assets and P40,000 in current liabilities pays PLanour® liability. Asa result of this transaction, the current ratio and working capital will a. both decrease. : b. both increase. paying ability. term debt paying ability. Current assets,Chapter 2 Fipancial Statements Analys§ 00S increase and remain the same, respectively, dd. remain the same and decrease, respectively. 33, The receivable turnover and inventory turnover ratios are used to analyze a. long-term solvency. b. profitability. c. liquidity. d. leverage. 34. A high receivables turnover ratio indicates a. customers are making payments quickly b._allarge portion of the company’s sales are on credit. many customers are not paying their receivables. the company’s sales have increased. 35. The assets turnover ratio measures a. how often a company replaces its assets. b, how efficiently a company uses its assets to generate sales, cc. the portion of the assets that have been financed by creditors. the overall rate of return on assets. 36. The profit margin ratio is calculated by dividing a._ sales by cost of goods sold. b. gross profit by net sales. c. net income by stockholders’ equity. dd. net income by net sales. 37. The debt to total assets ratio measures a. the company's profitability. b. whether interest can be paid on debt in the current year. the proportion of interest paid relative to dividends paid. d. the percentage of the total assets provided by creditors. 38. Trading on the equity (leverage) refers to the | a. amount of working capital. |b. amount of capital provided by owners. c. use of borrowed money to increase the return to owners. | umber of times interest is earned. 39, A company that is leveraged is one that | a, hasa high earnings per share. |b. contains debt financing. contains equity financing. d. hasa high current ratio.— (haolr 2 Financia Statements Anos 40, A weakness of the current ratio is difficulty ofthe calculation. b pincanes sete tea ane assets itis rarely used by sophisticated anal : SL iteanbe expressed ava percentage asaate, or 38. proportion i in the 41, A supplier to a company would be most interested in ‘a, asset turnover ratio, b,_ profit margin ratio, current ratio, 4. earnings per share, 42. Which one of the following ratios would not likely be used by a short-term creditor in evaluating whether to sell on credit to a company? a. Current ratio b. Inventory turnover ratio ©. Asset turnover ratio d. Receivables tumover ratio 43. Ratios ae used as tools in financial analysis a. instead of horizontal and vertical analyses. sscscauan ate 4 ‘because they can provide information that may not be apparent from inspection individual ‘components of the financial statements, _ because even singe ratios by themselves are quite meaningful, 4, because they are prescribed by GAAP. ‘4. The ratios that are used to determine a company's short-term debt paying ability are asset turnover, times-interest-earned, current ratio, and receivables turnover b. times-interest-earned, inventory turnover, current ratio, and receivables turnover G_times.interest-earned, acid-tst ratio, current ratio, and inventory turnover d. current ratio, acid-test ratio, Teceivables turnover, and inventory turnover note payable. id the boris transaction have on Sweet Company’scurrent ratio?) PY What effect did a. The ratio remained unchanged, b. The change inthe current rato cannot be determined, © Therratio decreased, . . The ratio increased, 46. A liquidity ratio measures the wi b. ability of the enterprise to survive over €. tortienn shinny ‘ " ihpconieis aac ea 'y of the enterprise to pay its Maturing obligations and to meet unexpec™ 4. number of times interest is earned,‘Chapter 2 Financial Statements Anaysis 47. equal amounts are added to the numerator and the denominator of the current ratio and the ratio is over one, the ratio will always increase. . decrease. stay the same. | equal zero, 48. If a company has a current ratio of 1.2:1, what respective effects will the borrowing of cash by short-term debt and collection of accounts receivable have on the ratio? oP po Short-term Borrowing Collection of Receivable a. Increase Noeffect b. Increase Increase c. Decrease Noeffect d. Decrease ‘Decrease 49. A general rule to use in assessing the average collection period is a. that it should not exceed 30 days. b. itcan be any length as long as the customer continues to buy merchandise. c. that itshould not greatly exceed the discount period. 4. thatit should not greatly exceed the credit term peri 50. The inventory turnover is calculated by dividing a. cost of goods sold by the ending inventory. . cost of goods sold by the beginning inventory. ._ cost of goods sold by the average inventory. d. average inventory by cost of goods sold. TIL MULTIPLE CHOICE PROBLEMS Encircle the letter that corresponds to the best answer. 1. A company reported P18,000 of net income for 2016, P24,000 for 2017, and P26,000 for 2018. The percentage change in net income from 2017 to 2018 was: a. 200%. b. 30.00%. . 100%. d. 833%. 2. Assuming the inventory balance at the end of 2016 is P20,000 and it has increased by 15% since the end of 2015, the balance at the end of 2015 (rounded to the nearest whole peso) was: a. P17,000. b. P18,000. c. P1636, 4. P17391. 3. _Iyear one equals P700, year two equals P742, and year three equals P770, the percentage to be assigned for year three in a trend analysis, assuming that year one is the base year, is a. 110%. b. 106%.haat 2 Finan Setements Ana , < 91%. d. 100%. 4. Assume the following sales data for a company: 2020 1,000,000 2019 900,000 2018 750,000 2017 600,000 | 1f 2017 is the base year, what isthe percentage increase in sales from 2017 to 20182 a. 125% b. 167% | « 2% d. 20% | 5. A company had a balance in the Accounts Receivable account of P780,000 at the beginning of the year and a balance of P820,000 at the end of the year. Net credit sales during the yea | amounted to P5,840,000, The average collection period of the receivables in terms of days was | a. 30days, b. 365 days, c. 100 days. | d. 50days. | 6 A company had a balance in the Accounts Receivable account of P780,000 at the beginning o the year and a balance of P820,000 at the end of the year. Net credit sales during the yeat amounted to P5,840,000. The receivable turnover ratio was | a. 7.1times. b. © d. Use the following information for: questions 7-8. sectbldon of Porn nie income of 7250000 and paid dividends to cot 50,00 shares Barner Con on The Weighted average number of shares outstanding in 2 is Exchange, "poraton' common stock i selling for P50 per share on the Makati 7. The comy a2 b. 8 times. © 10times, d. 5 times, pany’s price-earnings ratio is 8 The company’s payout rato for 2029 is @ P5 per share, b. 25%,(niacin 2 co WK. d. 125%. 9. Cliff Company reported the following on its income statement: Income before income taxes _—P420,000 Income tax expense 120,000 Net income 390,000 Ananalysis of the income statement revealed that interest expense was P80,000. The company’s times-interest-earned ratio was a. Stimes. b. 5.25 times. c 625 times. d. Stimes. 10. A company has a receivables turnover ratio of 10, The average net receivables during the period are P400,000. What is the amount of net credit sales forthe period? a. P40,000 b. 4,000,000 . Ps80,000 4. P520,000 11. A company has an average inventory on hand of P60,000 and its average days in inventory is 29.2 days. What is the cost of goods sold? a. P750,000 b. PL,752,000 c. P1,680,000 d. P876,000 12, Net sales are P1,500,000, beginning total assets are P700,000, and the asset turnover is 3.0. What is the ending total asset balance? a. 500,000 300,000 . P700,000 4. 400,000 Use the following information to answer questions 13-20. The following information pertains to Greenwich Company. Assure that ll balance sheet amounts represent both average and ending balance figures. Assume that all ales were on credit. Assets Cash and short-term investments P. 40,000 Accounts receivable, net 55000 Inventory 20000 Property, plantand equipment 210,000 Total Assets. 235.000Liabilities and Stockhol iders’ Equi ty 00 Current ibilt 55,000 Long-term liabilities Sheil euityomran 000 TTotal Liabilities Stockholders’ Equity 25,000 ‘Income Statement = 0 Cost of goods sold 45,000 Gross margin 40,000 Operating expenses —20,000 Net income 20,000 Number of shares of common stock 6000 Market pric of common stock P20 Dividends per share 9 Cash provided by operations 30000 13, Whatis the current ratio for this company? a 142 », 080 « 116 4. 060 14. Whats the receivable tumover for this company? a. 28times b. 2times © 3d times 4. 3times 15, What is the inventory turnover for this ‘company? a. 2 times b. 225 times © 1time d. 0.44 time 16, What is “ stigma b. 105% G 17% d. 26.7% 17. Whatis the Profit margin for this company?(ante 2Fncia Salenerts Anaba _d a. 42.86% b, 18.75% « B5% d. 15.0% 418, Whatis the return on common stockholders’ equity for this company? a 133 b. 5% c B3% d. 533% 419, Whatis the price earnings ratio for this company? a. times b, 25times c. Btimes d. 4 times 20. Whatis the current cash debt coverage ratio for this company? a, 05 times b. 3times c. 033 times 4. 0.14 times 21. Acompany has the following balance sheet information in 000: Current Assets 4,000 Current Liabilities 1,000 Long term Assets 8,000 Long term Liabilities 2,000 ‘Common Stock 4,000 Retained Earnings 5,000 ‘There was no interest expense and no dividends were declared. What is the debt/equity ratio at year-end? a. 400% b, 7% c. 300% d. 33% 2. A company’s net accounts receivable were P250,000 at December 31, 2016 and P300,000 at December 31, 2017. Net cash sales for 2017 were P100,000 and the accounts receivable turnover ratio for 2017 was 5. What were the company's total net sales for 20172 a. 1,350,000 b. PLA75,000 . P1,375,000 d. 1,500,00023, Financial records of a company reveal the following: Net sales P180,000 Cost of goods sold 129,000 Ending inventory 5,000 Beginning inventory 35,000 Assuming a 360-day year, what was the average day’ to sell inventory? a. 60days b. Bdays c. 70days d. 90 days 24, Assuming that the company has an average inventory of P80,000, sales of ‘560,000 and a cost of sales of P480,000, What is the inventory turnover ratio? a B b. 6 a7 ad 25. A company reported net income of P10,000 and paid cash dividend on common stock of P2 per share on each of 2,000 shares outstanding. What is the EPS? a. P5.00 b. P3.00 PAO d. P20 26. A company’s income statement showed no extraordinary items but showed a net income of 50,000. There are 100,000 common shares outstanding during the period. Dividends totaled 20,000 was declared and paid. ‘What is the EPS of the company? a. P5.00 b. PO50 «P30 d. PO30 27. Assume liabilities total P25,000; average common stockholders’ equity totals P80,000; expenses total P43,000 and return on common stockholders’ equity is 12%. Total revenues earned for the a. P9600 b. 52,600 cc. P33,400 4. P77,600 28.A company has a total assets of P80,000 and stockholders’ equity of P60,000. Total current liabilities is P10,000. The debt to equity ratio is: a. 07501 b. 017t01c. 033t01 d. 13to1 From the following information answer the next questions 29-31: ‘The stockholders’ equity section had the following balances both beginning and ending: Preferred Stock, P100 par, 8% 100,000 Common Stock, 20 par 60,000 ‘Additional Paid in Capital, common 150,000 Retained Earnings 30,000 During the year, Joy reported interest expense of P4,000, earned net income of P36,800 after taxes at the rate of 30% and had an average total assets of P400,000. 29. The return on total assets during the year is: a, 102% b, 95% c 99% d, 9.2% 430. The return on common stockholders equity is: a. 61% b, 153% < 48% 4. 12% 31, The earnings per share is: a. PI227 b, P9.60 c PIs d. P7.20 432. The company uses the allowance method for bad debts. During the year, the company charged 30,000 to bad debts expense, and wrote-off P25,000 of uncollectible accounts receivable. ‘These transactions resulted in a decrease in working capital of a. PO b. P25,200 c. P4800 4. 30,000 33. The company's net accounts receivable were 500,000 at December 31, 2016 and P600,000 at December 31, 2017. Net cash sales for 2017 were P200,000. The accounts receivable turnover for 2017 was 5.0. What was the company’s net sales for 2017? a. P2,950,000 b. 3,200,000 cc. P3,000,000 d. 5,500,000(Chapter 2 Financial Statements Analysis. “ 34. During the year, a company purchased P2,000,000 of inventory. The cost of goods sold for any ‘was P2,200,000 and the ending inventory at December 31, 2017 was P400,000. What was the inventory turnover for the year? a. 40 times b, 53 times c. 44times d. 11.0 times Use the following information for question 35-38: ‘The management of a company is preparing its plans for the year 2017. The average assets to be employed for the year are estimated at P2,600,000 with 20% of this amount borrowed at no interest cost. Materials and labor cost for the year is budgeted at P4,000,000 while operating cost is ‘estimated at P1,500,000. All sales are to be billed at 162.5% of materials and labor cost. Income tax rate is at an average of 35% of income before income tax. 35. The estimated rate of return on sales for 2017 is a. 100% b. 14.20% c. 125% d. 27.86% 36, The estimated rate of return on average total assets for 2017 is a. 200% b. 31.25% c 20% d. 40.50% 37, The expected asset turnover for 2017 is: a. 1.50 times b. 3.36 times c. 2.50 times d. 375 times 38. The rate of return on stockholders! equity for 2017 is: a. 200% b, 31.25% c. 250% 4. 4050% Use the following information for questions 39-40: ‘The building of Emerald, Inc. was flashed by flood thea destroying its inventories and its financial and accounting records. The recent priot year, however, the company maintained the following relationshi the data on its financial statements: * a mae “ee Gross margin on net sales 40% Net income on net sales 10% Accounts receivable turnover (sales / ending A/R) 8 per yearcoal 2Fiacil Soments nays gs Inventory turnover (Cost of sales/Ending inver Current Asset ratio peesine rence) oe _ Acid test ratio 2to1 Quick asset composition: Cash * Marketable securities 30% ‘Accounts receivable o% ‘Asset turnover (sales/year-end Total Assets) apetyer Ratio of total assets to Intangible assets 20to1 Ratio of accumulated depreciation to cost of fixed assets 1to3 ‘The company had a net income of P120,000 for the year. Accounts were reconstructed based on the above given information. 39. What is the balance of the cash account? a. P25,000 ‘b. P35,000 c. P20,000 d. P30,000 40, Whats the accounts receivable, net balance? a. P100,000 b. 150,000 c. P125,000 d. P200,000 41. Gottlob Corporation's most recent income statement appears below: Sales (ll on account) Cost of goods sold Gross margin Selling and administrative expenses Net operating income Interest expense Net income before taxes Income taxes, Net income The profit margin percentage is closest to A. 874%. B. 124%. C. 16.9%. D. 421%. {2 rica Trading Corp had net income of P3 million in 2015. Using the 2015 financial elements as the base data, net income decreased to 70% in 2013 and increased by 150% in 2014. The respective net income reported by the company for 2016 and 2017 are:Fin ‘A, 900,000 andi 72,250,000 B. 900,000 and P7,500,000 C. 2,100,000 and P5,250,000 D, 2,100,000 and P7,500,000 43, During 2017, Dumapias Company purchased P900,000 of inventory. The cost of goods sold f, 2017 was P960,000, and the inventory on December 31, 2016 was P180,000. What was the inventory turnover for 20172 A. 5.0 times B. 53times C. 6.0times D. 64 times 44, The following financial data have been taken from the records: ‘of Salido Company: What will happen to the current and quick ratios, respectively, Accounts receivable Accounts payable Bonds payable, due in 10 years Cash Interest payable, due in 3 months Inventory Land Notes payable, due in 6 months P 200,000 80,000 500,000 100,000 5,000 440,000 800,000 250,000 if Salido Company uses cash to pay 50% ofits accounts payable and collected % of its accounts receivable? A. Both ratios will increase B. Both ratios will decrease C. Only the current ratio will increase D. Only the quick ratio will increase 45. UrTum Game Lounge had the following data in its balance sheet on December 31, 2020: Accounts payable Accounts receivable Accrued liabilities Cash Income tax payable Inventory Marketable securities Notes payable, due in 3 months Prepaid expenses The amount of working capital for the company is. A. P211,000 B. 336,000 C. 351,000 D. 361,000 P 145,000 110,000 4,000 90,000 10,000| greptee2Financis! SalomenisAnay CD 146, The times interest earned ratio of Chikel Company is 55 times. The interest expense for the year ‘was P20,000 and the company’s tax rate is P40%, The company’s net income is: A B, 42,000 C, 54,000 D. 66,000 1. Selected information for Quarteros Corp as December 31 isas follows: 2019 2020 Preferred stock, 8%, par P100 250,000 _P250,000 nonconvertible and noncumulative ‘Common stock 700,000 800,000 Retained earnings 150,000 370,000 Net income 120,000 240,000 Quartero's return on common stockholders’ equity for 2020 is A. 17% B. 19% Cc uk D. Be 3. The current assets of Sabkiel Enterprise consist of cash, accounts receivable and inventory. The ‘gross profit rate is 40%. The following information is available. Credit sales 75% of total sales Inventory turnover 5 times Working capital 1,120,000 Current ratio 2.60 to1 Quick ratio 1301 Average collection period 40 days Working days 360 days Theestimated average inventory amount is: A. P700,000 B. P840,000 C. P945,000 D. 980,000 Using the information in #48, what is the amount of cash sales? A. PLA58,333 B, 1,968,750 © P5833,333 D. P7875,000Shooter 2 Finan! Sttoments Ana Ig 50. 3h. 53. Crandall Company's net income last year was ?60,000. The company paid preferred dividends gg 10,000 and its average common stockholders’ equity was P480,000. The company’s retum gy ‘common stockholders’ equity for the year was closest to A. 21%, B. 104%, Cc 125%, D. 14.6%. Ardor Company's net income last year was 500,000. The company has 143,700 shares of common stock and 30,000 shares of preferred stock outstanding. There was no change in the number of common or preferred shares outstanding during the year. The company declared ang paid dividends last year of PI per share on the common stock and P0.70 per share on the preferred stock. The earnings per share of common stock is closest to A, 9233, B, P3119. C. 7333, D. P37. . The following information relates to Konbu Corporation for last year: Price earnings ratio 15 Dividend payout ratio 30% Earnings per share PS What is Konbu's dividend yield ratio for last year? A. 20% B. 45% C. 90% D. 20% Richmond Company has 100,000 shares of P10 par value common stock issued and outstanding and 10,000 shares of 10%, P100 par value preferred stock. Total stockholders’ equity is P2,800,000 and net income for the year is P800,000. During the year Richmond paid *2 per share in dividends on its common stock. The market value of Richmond's common stock is P28. Whats the price-earnings ratio? A3 B &. D. oN Using information from #53, determine the return on common equity. A. 125% Be 143% C. 5.0% D. 286%| Qhapler 2Financial Statements Anaveis 55. rae pemaees from #53, determine the dividend payout ratio, B, 125% ©, 250% D. 286% 56. The following reflected form the records of Salvacion Company: Earnings before interest and taxes 1,250,000 Interest expense 250,000 Preferred stock dividends 200,000 Dividend pull-out ratio 40% Share outstanding throughout 2015 Preferred 20,000 shares Common 5,000 shares Income tax rate 40% Price earnings ratio 5 times The dividend yield ratio is A. 0.08 B. 012 c. 040 D. 0.50 57. Cedric Corp has a current ratio of 26 to 1. The minimum desired ratio is 5 to 1. At present, the net working capital is P40,000. How much current liabilities must be paid to achieve the minimum current ratio? A. P10,000 B. P15,000 C. P20,000 D. P25,000 58. Consolo Jon's net income forthe most recent year was P609,000. A total of 100,000 shares of common stock and 200,000 shares of preferred stock were outstanding throughout the year. Dividends on common stock were P2.05 per share and dividends on preferred stock were P1.50 pershare. The earnings per share of common stock is closest to A. 9205 B, pag C. 7509 D. 78.09 59. Bary Corporation's net income last year was 2,604,000. The dividend on common stock was 250 per share and the dividend on preferred stock was ®2.40 per share. ‘The market price of common stock atthe end ofthe year was P73.50 per share, Throughout the year, 300,000 shares of ‘common stock and 100,000 shares of preferred stock were outstanding. The priceeamings ratio is losest toA. 7.88 B. 8.68 C. 847 D. 9.33 60. Armtson Corporation's net income last year was 7,975,000. The dividend on common stocky, 8.20 per share ‘and the dividend on preferred stock was P3.50 per share. The market Price common stock at the end of the year was P59.10 per share. Throughout the year, 500,000 shares ‘common stock and 200,000 shares of preferred stock were outstanding, The dividend payout ray is closest to A. 0139 B. 0.246 Cc. 0514 D. 0564 PROBLEMS 21 The following table shows selected data for Romulo Corporation for the past four years ended ‘December 31: 2019 [2018 | 2007 | 2016 Net credit sales 20300 |P18400 | Pi7,200 | P15,500 Cost of goods sold 9500 | 10300 | 9,500 | 8900 Inventory 13,000 | 12,200 | 8,700 | 9.500 Net accounts | 7,500] 6800 | 7,200 | 7,000 receivable Instructions: a. What was the accounts receivable turnover for 2019? b. What was the inventory turnover for 2018? 22 From the given data, calculate the following ratios for the Salvacion Corporation for 2017. a. current ratio B. quick ratio c debt to total assets ratio d. profit margin ratio Accounts payable 74,000 Accounts receivable 75,000 Cash 125,000 Inventory 90,000 Short-term investments 60,000 Short-term notes payable 40,000 Notes payable (due in 2019) 50,000oper 2 Financ! Siotamonts Anaya Total assets 469,000 Total liabilities 185,000 Net sales 240,000 Net income 31,500 ‘Comparative information taken from the 7RS Company financial statements jsshown below: 2020 2019 (@) Accounts receivable 175,000 140,000 (@)_ Retained earnings 30,000. (40,000) (Sales 855,000 750,000 (@)_ Operating expenses 170,000 200,000 (@) Income taxes payable 200 20,000 instructions: 1L. Calculate the peso changes for each item and indicate whether the change is increase of decrease 2. Calculate the percentage change from 2019 to 2020. 24 The following items were taken from the | financial statements of Kam’s Korner, Inc., over a three year period: Ttem 2020 2019 2018 Net Sales 226,000 -P212,000 200,000 Cost of GoodsSold 150,000 140,000 136,000 Gross Profit P 76,000 P 72,000 P 64,000 Instructions: Using horizontal analysis and 2018 as the base yeas, compute the trend percentages for net sales, cost of goods sold, and gross profit. Explain whether the trends are favorable or unfavorable for each item. 25 Selected information from the comparative financial statements of UrTurn Company for the year ended December 31 appears below: 2018 2017 ‘Accounts receivable (net) P 175,000 200,000 rey 130,000 150,000 assets 1,100,000 800,000 Current abilities 140,000 110,000 Long-term debt 410,000 300,000 Net credit sales 300,000 700,000‘Chapter 2 Financial Statements Analysis ‘ ——2 Cost of goods sold 600,000 530,000 Interest expense 40,000 25,000 Income tax expense 0,000 29,000 Net income 150,000 85,000 Net cash provided by operating activities 220,000 135,000 Instructions: Answer the following questions relating to the year ended December 31, 2018. Sho, computations 1. The inventory turnover ratio for 2018 is. 2. The number of times interest earned ratio in 2018 3. The receivables turnover ratio for 2018 is. 4. 5. |. The return on assets ratio for 2018 is. 5. The current cash debt coverage ratio for 2018 is 26 UrProf Corporation had the following comparative current assets and current liabilities: 12-31-2018 12-31-2017 Current assets Cash P 25,000 P 30,000 Marketable securities 40,000 10,000 Accounts receivable 60,000 95,000 Inventory 110,000 90,000 Prepaid expenses 35,000 20,000 Total current assets P.270,000 245,000 Current liabilities ‘Accounts payable 120,000 110,000 Salaries payable 40,000 30,000 Income tax payable 10,000 15,000 Total current liabilities P170,000 ‘155,000 During 2018, net credit sales and cost of goods sold were P475,000 and P250,000, respectively. Net cash provided by operating activities for 2018 was 120,000, Instructions: Compute the following liquidity measures for 2018: a. Current ratio b. Current cash debt coverage ratio c. Receivables turnover d. Inventory turnover 27 The balance sheet for Violeta Corporation at the end of the current year includes the following: Bonds payable, 6% ... 5,000,000 6% Preferred stock, P100 par 1,000,000 Common stock, P10 par 2,000,000oor 2 Financial Swlemenis Arabs sl Income before income taxes was P950,000 and income tax expense for the current year mounted to P285000. Cash dividends paid on common stock were P2000, and the common he sas selling for P40 per share at the end of the year, There were no ownership changes during the year. «tions: Determine each of the following: ‘a, Number of times that bond interest was earned. b, Earnings per share for common stock. ‘c. Price-earnings ratio. str GGEM Corporation had net income of P4,000,000 in 2017. Using 2017 as the base year, net come decreased by 40% in 2018 and increased by 110% in 2019 structions: Compute the net income reported by GGEM Corporation for 2018 and 2019. “ ‘The following ratios have been computed for the RMO Company for 2018, Profit margin ratio 20% Times interest earned ‘12times Receivable turnover ratio 5 times Acid-test ratio 141 Current ratio 251 Debt to total assets ratio 24% ‘The 2018 financial statements of the company with missing information was presented on the vent page: Use the above ratios and information from RMO Company financial statements to fill in the nissing information on the financial statements, Follow the sequence indicated. Show computations hat support your answers. ‘Comparative Balance Sheet December 31. Assets 2018 27 Tash P 25,000 P 35,000 Marketable securities 15,000 15,000 Accounts receivable (net) 2 6 50,000 ventory a) 50,000 *roperty, plant, and equipment (nel) 200000 160,000 Total Assets B2 © EsoGeneeREewmel Someta Li and stockholders’ equi Accounts payable P? @ P2500 Short-term notes payable 35,000 30,000 Bonds payable 2 (10) 20,000 Common stock 200,000 200,000 Retained earnings 47,000 35,000 Total Liabilities and Stockholders’ Equity P? (11) 310,000 Income Statement For the Year Ended December 31, 2018 Expenses: Depreciation expense Interest expense Selling expenses Administrative expenses .. Total expenses. Income before income taxes Tax expense Net income 210 RED Corporation has issued common stock only. The company has been successful and has a gross profit rate of 20%. The information shown below was taken from the company's financial ‘statements. Beginning inventory P- 482,000 Purchases 4,146,000 Ending inventory ? Average accounts receivable 700,000 Average common stockholders’ equity 3,500,000 Sales (all on credit) 5,200,000 Net income 420,000 Instructions: Compute the following: a. Receivables turnover b. Average number of days required to collect the accounts receivable. c. The inventory turnover d. Average days in inventory. e. Return on common stockholders’ equity.