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RESA Material (Financial Statement Analysis)

BS accountancy (University of Cebu)

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ReSA - THE REVIEW SCHOOL OF ACCOUNTANCY

CPA Review Batch 41  May 2021 CPA Licensure Examination  Week No. 18
MANAGEMENT ADVISORY SERVICES C.P. Lee  E.S Arañas  K.L. Manuel

MAS-15: FINANCIAL STATEMENT ANALYSIS

 FINANCIAL STATEMENT (FS) ANALYSIS involves the evaluation of an entity’s past performance,
present condition, and business potentials by way of analyzing the financial statements to obtain
information about, among others, profitability of the business firm, ability to meet company obligations,
safety of investment in the business, and effectiveness of management in running the firm
 HORIZONTAL ANALYSIS is a technique in FS analysis that shows changes of corresponding FS items over
a period of time. Changes in the value of a particular FS item can be analyzed in terms of amount or in
percentage. The percentage change of the amounts is calculated using the earlier period as the base period.

Percentage Change (Δ %) = Most Recent Value – Base Period Value

Base Period Value
Comparisons can be made between an actual amount and a budgeted amount, with the latter serving as
basis or pattern of performance. However, if a zero or negative amount appears in the base year,
percentage change cannot be computed. TREND or INDEX ANALYSIS, a subset of horizontal analysis, uses
an index number of 1.00 for the base period and converts all FS items in the subsequent period as
percentage of the base in order to facilitate better understanding of performance over multiple periods.
 VERTICAL ANALYSIS is the process of comparing figures in the FS of a single period. This is accomplished
by expressing all figures in the FS as percentages of a common base such as total assets (in the balance
sheet) or net sales (in the income statement). These converted statements are called common-size
statements or percentage composition FS, often used for comparing multiple years of data from the same
firm, companies of different size, and company-to-industry averages
 CASH FLOW ANALYSIS is a detailed study in the net change in cash and cash equivalents as a result of
operating, investing and financing activities during the period.
 OPERATING ACTIVITIES are principal revenue-producing activities of the entity and generally relate to
changes in current assets and current liabilities involved in company’s normal operations.
 INVESTING ACTIVITIES are acquisition and disposal of long-term assets and investments not included
in cash equivalents and generally relate to changes in a company’s non-current assets.
 FINANCING ACTIVITIES are result in changes in the size and composition of the contributed equity and
borrowings of the entity and generally relate to changes in long-term liabilities and equity accounts.
 FINANCIAL RATIOS are relationships among accounts found in the FS that provide information about the
firm’s liquidity, solvency, stability, profitability and other aspects of financial situation and potential. Major
categories of financial ratios are: (NOTE: Specific ratios and formulas are found on pages 2 and 3)
 LIQUIDITY RATIOS measure an entity’s ability to meet short-term obligations and provide insights on
present cash solvency. Common examples include net working capital, current ratio and quick ratio.
 SOLVENCY RATIOS, a.k.a. leverage ratios, measure an entity’s long-term financial viability. Common
examples included debt ratio, debt-equity ratio and times interest earned ratio.
 ACTIVITY RATIOS, a.k.a. asset utilization ratios or efficiency ratios, measure an entity’s ability to use its
assets and manage its liabilities effectively in the current period -- how quickly various accounts are
converted into sales or cash. Common examples include turnover ratios and conversions periods.
 PROFITABILITY RATIOS, a.k.a. performance ratios, are used to determine how well an entity can
generate profits from its operations. Common examples include margin ratios and return ratios.
 MARKET VALUE RATIOS, a.k.a. market prospect ratios, are used to help potential investors make equity
investment decisions through the use of trends in earnings, dividends and stock prices. Common
examples include dividend payout ratio, dividend yield and price-earnings ratio.
 The Basic rules in calculating financial ratios include:
 When calculating a ratio using balance sheet (BS) amounts only, the numerator and denominator
should be based on amounts as of the same BS date. The same is true for ratios using only income
statement (IS) numbers. Exception: calculation of growth ratios.
 If an IS amount and a BS amount are used at the same time to calculate a ratio, the BS amount should
be expressed as an average for the time period represented by the IS amount.
 If the beginning balance of a BS account is not available and cannot be computed from the given data,
the ending balance of the account is used to represent the average balance.
 If sales and/or purchases are given without making distinction as to whether made in cash or on credit,
assumptions are made depending on the ratio being calculated:
 Turnover ratios: Sales and purchases are made on credit.
 Cash flow ratios: Sales and purchases are made in cash.
 As a rule, an operating year is assumed to have 360 days, unless specified otherwise.
 A 360-day year is preferred as this is consistent with a 12-month year and a 30-day month;
 Alternatively, a year may be comprised of 365 calendar days, 300 working days or 270 productive
days, or any appropriate number of days (NOTE: exact number shall be specified in problems).
 FS analysis helps in making FINANCIAL FORECASTS, particularly the required ADDITIONAL FUNDS
NEEDED (AFN), determined based on entity’s capital requirements and from a variety of financial ratios.
Required increase in assets   in Sales x (Assets ÷ Sales)
- Spontaneous increase in liabilities   in Sales x (Liabilities ÷ Sales)
- Increase in retained earnings*  Earnings after tax – Dividend payment
ADDITIONAL FUNDS NEEDED from external sources (e.g., creditors, investors)
AFN, a.k.a. External Funds Needed (EFN), may alternatively be computed using the following formulas:
AFN = total changes in equity – internal financing
= (Assets – Liabilities) (% ∆ sales) – (projected sales x profit margin x plowback ratio)

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ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY MAS-15

Week No. 18: FINANCIAL STATEMENT ANALYSIS

 LIQUIDITY RATIOS
RATIO
Net Working Capital
Current Ratio
(Working Capital Ratio)
FORMULA RATIO FORMULA
Current Assets – Quick Ratio Quick Assets
Current Liabilities (Acid Test Ratio) Current Liabilities
NOTE: Quick assets are cash items and other current
Current Assets
assets that can be quickly converted into cash (i.e.,
Current Liabilities
cash, receivables, marketable securities)

 ACTIVITY RATIOS / EFFICIENCY RATIOS / ASSET UTILIZATIO RATIOS

RATIO FORMULA RATIO
FORMULA
Inventory Turnover Cost of Goods Sold 360 days .
Age of Inventory
(for merchandisers) Average Inventory
(Inventory Conversion Period) Inventory Turnover
Net Credit Sales Age of Receivables 360 days .
Receivables Turnover
Average Receivables
(Receivable Collection Period) Receivables Turnover
Net Credit Purchases Age of Payables 360 days .
Payables Turnover
Average Payables (Payable Deferral Period) Payables Turnover
Finished Goods Turnover Cost of Goods Sold Sales .
Assets Turnover
(for manufacturers) Ave. FG Inventory Average Total Assets
Work-in-Process Turnover Cost of Goods Manu. Sales .
Fixed Assets Turnover
(for manufacturers) Ave. WIP Inventory Average Fixed Assets
Raw Materials Turnover Cost of Materials Used Age of Inventory +
Normal Operating Cycle
(for manufacturers) Ave. RM Inventory Age of Receivables
Inventory Turnover FG Turnover + WIP Normal Operating Cycle
Cash Conversion Cycle
(for manufacturers) Turnover + RM Turnover – Age of Payables
NOTE: ‘Age of Receivables’ is also known as Days Sales Outstanding, Number of Days Sales in
Receivable, or Days Receivable.

 SOLVENCY RATIOS / LEVERAGE RATIOS

RATIO FORMULA RATIO FORMULA
Total Liabilities 1 .
Debt Ratio Equity Multiplier
Total Assets Equity Ratio
Total Equity Times Interest Earned EBIT .
Equity Ratio
Total Assets (Interest Coverage Ratio) Interest Payments
Total Liabilities NOTE: Equity multiplier, a.k.a. equity ratio reciprocal,
Debt-Equity Ratio
Total Equity can be computed based on formula: Assets ÷ Equity

 PROFITABILITY RATIOS / PERFORMANCE RATIOS

RATIO FORMULA RATIO FORMULA
Gross Profit Income .
Gross Profit Margin Return on Sales
Sales Sales
EBIT Income .
Operating Profit Margin Return on Assets
Sales Average Assets
Profit Income .
(Net) Profit Margin Return on Equity
Sales Average Equity
What INCOME figure to use?
 If the intention is to measure operational performance, income is expressed as before interest and tax;
alternatively, income before ‘after-tax’ interest may be used to exclude the effect of capital structure.
 If the intention is to evaluate total managerial effort, income is expressed after interest and tax.
 Expressing income after interest but before tax is now rarely applied in business practice.
 Income should include dividends and interest earned if the said investments are included in asset base.
 If used in the context of “Du Pont” technique, income must be expressed after interests, taxes and
preferred stock dividends. The Du Pont model is based on the following formula:

Return on Equity = Return on Sales x Assets Turnover x Equity Multiplier

 MARKET VALUE RATIOS / MARKET PROSPECT RATIOS

Market value ratios are anchored on Earnings per Share (EPS), which is also considered a profitability ratio.
Net Income – Preferred Dividends .
EPS =
Weighted Average Common Shares Outstanding
EPS must be distinguished from common shareholder’s Book Value per Share, which is based on the
formula: Common Shareholders’ Equity ÷ Number of Common Shares Outstanding
RATIO FORMULA RATIO FORMULA
Market Price per Share Dividend Per Share
Price-Earnings Ratio Dividend Payout
EPS EPS
Dividend Per Share Retention Ratio
Dividends Yield 100% - Dividend Payout
Market Price per Share (Plowback Ratio)

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ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY MAS-15

Week No. 18: FINANCIAL STATEMENT ANALYSIS

 OTHER FINANCIAL RATIOS

RATIO FORMULA RATIO FORMULA
Cash_+ Marketable Securities Times Preferred Net Income After Tax
Cash Ratio
Current Liabilities Dividends Earned Preferred Dividends
Quick Assets . Capital Intensity Total Assets
Defensive Interval
Average Capital Expenditures Ratio Net Sales
Operating Cash Flow (CF) . Operating CF + After-Tax
Cash Flow Margin Free Cash Flow
Net Sales Interest – Capital Expenditures

EXERCISES: FINANCIAL STATEMENT ANALYSIS

1. Vertical & Horizontal Analysis
Following are the financial statements of BTS Company:
BTS COMPANY
Condensed Statement of Financial Position
December 31, 2021 (In thousands)
ASSETS LIABILITIES AND EQUITY
Cash P 1,000 Current Liabilities P 500
Non-Cash Current 1,500 Long-term Debts 1,000
Fixed Assets 2,500 Capital Stock 1,500
Retained Earnings 2,000
TOTAL ASSETS P 5,000 TOTAL LIAB. & SHE P 5,000

For 2020: Net sales, P 1,600; CGS, P 1,000; Operating Expenses, P 300; Interests and tax charges, P 200.
For 2021: Net sales, P 2,000; CGS, P 1,300; Operating Expenses, P 300; Interests and tax charges, P 220.
REQUIRED:
1. Prepare 2021 common-size balance sheet and determine:
A) Current ratio B) Debt ratio C) Equity ratio
2. Prepare 2021 common-size income statement and determine:
A) Gross profit margin B) Operating profit margin C) Net profit margin
3. Compute trend percentages for the following:
A) Net sales B) EBIT C) Net income

2. Cash Flow Analysis

The following information is taken from Blackpink Corporation’s accounting records for the recent year.
A) Customer sales receipts for P 870,000
B) Purchased machinery and equipment for P 125,000 cash.
C) Settled income taxes of P 110,000
D) Sold investment securities for P 500,000.
E) Paid dividends of P 600,000.
F) Received rentals of P 105,000.
G) Issued 500 shares of common stock for P 250,000.
H) Paid a sum of P 100,000 due to suppliers and payroll to employees.
I) Purchased real estate for P 550,000 cash that was borrowed from a bank.
J) Paid P 450,000 for treasury shares.
REQUIRED:
1. Net cash provided by operating activities 3. Net cash used in financing activities
2. Net cash used in investing activities 4. Net cash increase or decrease

3. Liquidity Ratios
Twice Company has a current ratio is 2.5 to 1 and an acid-test ratio is 0.9 to 1. Its current assets are
composed of cash, receivables, and inventory with cash and receivables combined amounting to P 270,000.

REQUIRED:
1. Determine the amount of current liabilities
2. Determine the amount of inventory
3. Assuming both the current ratio and the acid-test ratio are currently greater than 1, indicate the
effects of each transaction below by using (+) for increase, (-) for decrease, and (0) for no effect.
Current Ratio Acid-test Ratio
Example: Sell merchandise for cash + +
A) Buy inventory on account _______ ________
B) Pay an account payable _______ ________
C) Borrow cash on a short-term loan _______ ________
D) Issue long-term bonds payable _______ ________
E) Collect an account receivable _______ ________
F) Sell a plant asset for cash at a loss _______ ________
G) Buy marketable securities, for cash _______ ________
H) Sell merchandise on credit _______ ________

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ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY MAS-15

Week No. 18: FINANCIAL STATEMENT ANALYSIS

4. Activity Ratios/Efficiency Ratios

The receivable collection period is 45 days on the average. Annual sales of P 900,000 are spread evenly
throughout the year. Inventory turnover is 4 times. Cash conversion cycle extends up to 100 days.

REQUIRED:
1. Average accounts receivable
2. Operating cycle
3. Payable deferral period

5. Solvency & Profitability Ratios

Net sales total P 100,000. Net profit margin is 12%. Interest charges are earned 6 times. Tax rate is 40%.

REQUIRED:
1. How much is the earnings before interests and taxes?
2. Assuming that inventory age is 30 days and average annual amount of inventory is P 5,000, how
much is the company’s operating expenses?

6. Du Pont Technique
 Return on sales is 5%.
 Return on assets is 10%.
 Return on equity is 25%.
 There is no preferred stock.
REQUIRED: Using Du Pont technique, determine:
1. Assets turnover
2. Equity ratio
3. Equity multiplier
4. Debt-equity ratio

7. EPS, Dividend & IPO Shares

Red Velvet Company decided to go public when its net income available to common shareholders amounted
to P 300,000 while the number of common shares issued and outstanding is 125,000.

REQUIRED:
1. Assume that the pay-out ratio is 60%, how much of the total dividends shall a shareholder owning
10,000 common shares receive?
2. Assume that the pay-out ratio is 60% and the price per share is P 20, what is the dividend yield?
3. Assume that the price-earnings ratio will be set 12 times and 25,000 new shares will be issued:
A) How much is the initial public offering (IPO) per share of the 25,000 new shares?
B) How much is the net proceeds from issuance if underwriter spread is 5%?

8. Additional Funds Needed

EXO Corporation’s sales are expected to increase from P 5,000,000 in 2020 to P 6,000,000 in 2021. Its
assets totaled P 3,000,000 at the end of 2020. Exo has full capacity, so its assets must grow in proportion
to projected sales. At the end of 2020, current liabilities are P 1,000,000 (of which P 300,000 are accounts
payable, P 200,000 accruals and P 500,000 notes payable). The after-tax profit margin is projected to be
10%. The forecasted pay-out ratio is 75%.
REQUIRED:
Determine the additional funds needed from external sources.

9. Financial Ratios
ITZY Merchandising has 1,000,000 common shares outstanding, with each share priced at P 8.00. In 2021,
the company declared dividends of P 0.10 per share. The balance sheet at the end of 2021 showed
approximately the same amounts as that at the end of 2020. The financial statements for Long
Merchandising are as follows:
ITZY Merchandising, Income Statement for 2021 (in thousands)______
Sales P 4,700
Cost of goods sold 2,300
Gross profit P 2,400
Operating expenses:
Depreciation P 320
Other 1,230 1,550
Income before interest and taxes P 850
Interest expense 150
Income before taxes P 700
Income taxes 280
Net income P 420

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ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY MAS-15

Week No. 18: FINANCIAL STATEMENT ANALYSIS

ITZY Merchandising, Balance Sheet at December 31, 2021 (in thousands)

Assets Liabilities and SHE
Cash P 220 Accounts payable P 190
Accounts receivable 440 Accrued expenses 180
Inventory 410 Total current liabilities P 370
Total current assets P 1,070 Long-term debt 1,960
Plant and equipment 5,600 Common stock 1,810
Accumulated depreciation (2,100) Retained earnings 430
Total Assets P 4,570 Total liabilities and SHE P 4,570

REQUIRED: (round-off answers to two decimal places)

1. Current ratio (2.89:1) 11. EPS (0.42)
2. Acid-test ratio (1.78:1) 12. P/E ratio (19.05)
3. Accounts receivable turnover (10.68 times) 13. Dividend yield (1.25%)
4. Inventory turnover (5.61 times) 14. Payout ratio (23.81%)
5. Gross profit margin (51.06%) 15. Debt ratio (50.98%)
6. Operating profit margin (18.09%) 16. Debt-equity ratio (1.04:1)
7. Return on sales (RoS) (8.94%) 17. Times interest earned (5.67 times)
8. RoA – operational performance (18.60%) 18. Cash flow to total debt (31.76%)
9. RoA – total management effort (9.19%) 19. Cash flow margin (15.74%)
10. Return on equity (RoE) (18.75%) 20. Cash ratio (0.59:1)

10. Construction of Financial Statements

The following information is available concerning IU Company’s expected results in 2021 (in thousands
of pesos). Turnovers are based on year-end values.
REQUIRED: Fill in the blanks.
1) Return on sales 6%
2) Gross profit percentage 40%
3) Receivables turnover 5 times
4) Inventory turnover 4 times
5) Current ratio 3:1
6) Ratio of total debt to total assets 40%
Condensed Income Statement
Sales P 900
Cost of sales (A) _____
Gross profit (B) _____
Operating expenses (C) _____
Net income (D) _____
Condensed Balance Sheet
Cash P 30 Current liabilities (H) ____
Receivables (E) ____ Long-term debt (I) ____
Inventory (F) ____ Shareholders’ equity (J) ____
Plant and equipment 670
Total (G) ____ Total (K) ____

WRAP-UP EXERCISES (MULTIPLE-CHOICE QUESTIONS)

,

1. When preparing common-size statements, balance sheet items are generally stated as a percentage of
(1) ______ while income statement items are generally stated as a percentage of (2) ______.
a. (1) total assets (2) net income c. (1) total liabilities (2) net sales
b. (1) total equity (2) net income d. (1) total assets (2) net sales
2. Which type of analysis best facilitates observation of year-to-year trends within a company?
a. Ratio c. Horizontal
b. Vertical d. Intercompany
3. Which one of the following would not be considered a liquidity ratio?
a. Quick ratio c. Return on assets
b. Current ratio d. Inventory turnover
4. How are trade receivables used in the calculations of (1) acid-test ratio and (2) receivable turnover?
a. (1) Denominator (2) Denominator c. (1) Numerator (2) Numerator
b. (1) Numerator (2) Denominator d. (1) Not used (2) Numerator
5. Which ratio is most helpful in appraising profitability?
a. Debt ratio c. Dividend payout
b. Acid-test ratio d. Return on assets
6. Which of the following ratios is most relevant to evaluating solvency?
a. Debt ratio c. Return on assets
b. Dividend yield d. Days’ purchase in accounts payable
7. Return on sales x assets turnover = __________________
a. Return on equity c. Equity multiplier
b. Return on assets d. Equity ratio

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ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY MAS-15

Week No. 18: FINANCIAL STATEMENT ANALYSIS

8. Dividend yield x price-earnings ratio = ________________

a. Dividend per share c. Earnings per share
b. Market price per share d. Dividend payout ratio
9. When a balance sheet amount is related to an income statement amount in computing a financial ratio
(e.g., turnover),
a. The income statement amount should be converted to an average for the year
b. The balance sheet amount should be converted to an average for the year
c. Comparisons with industry ratios are not meaningful
d. Both amounts should be converted to market value
10. Which one of the following provides a spontaneous source of financing for a firm?
a. Debentures c. Mortgage payable
b. Accounts payable d. Accounts receivable

SELF-TEST QUESTIONS – with suggested answers

(Sources: CMA/CIA/RPCPA/AICPA/Various test banks)

1. Horizontal and vertical analyses are techniques used by analysts in understanding the financial statements of
companies. Which of the following is an example of a vertical, common-size analysis?
D a. Commission expense in 2021 is 10% greater than it was in 2020 which serves as base year
b. A comparison in financial ratio between two or more firms in the same industry
c. A comparison in financial ratio between two or more firms in different industries
d. Commission expense in 2021 is 5% of sales
2. The statement of cash flows
D a. Reports the revenues earned and expenses incurred by the firm during the period
b. Shows the company’s total assets, broken down into current and non-current assets
c. Shows the company’s capital structure for a period of time
d. Reports the periodic cash inflows and outflows in operating, investing and financing activities
3. Under the direct method of determining net cash provided by operating activities on the statement of cash flows, a
gain on the sale of plant assets would be:
D a. Added to the amount of operating expenses reported under the accrual basis
b. Deducted from the amount of operating expenses reported under the accrual basis
c. Deducted from the amount of sales reported under the accrual basis
d. Totally ignored since the gain is not a part of sales, cost of goods sold, or operating expenses
4. Jollibee incurred operating expenses amounting to P 265. The following information is also available:
Prepaid expenses, 1/1 P 14
Accrued expenses, 1/1 40
Prepaid expenses, 12/31 21
Accrued expenses, 12/31 36
How much was the cash paid for operating expenses?
D a. P 224 c. P 268
b. P 262 d. P 276
5. Chowking has provided the following 2021 balances for the preparation of the statement of cash flows:
January 1 December 31
Accounts receivable P 11,500 P 14,500
Allowance for uncollectible accounts 400 500
Prepaid rent expense 6,200 4,100
Accounts payable 9,700 11,200
Chowking’s 2021 net income is P 75,000. How much is net cash provided by operating activities?
D a. P 72,700 c. P 74,300
b. P 73,500 d. P 75,700
6. Using the indirect method of computing operating cash flows, decrease in trade receivable is treated as
C a. A cash inflow c. An addition to income
b. A cash outflow d. A deduction from income
7. Which of the following account changes would be classified as a use of funds?
C a. An increase in accounts payable c. A decrease in bonds payable
b. An increase in retained earnings d. A decrease in accounts receivable
8. Short-term solvency is another term for
A a. Liquidity c. Profitability
b. Stability d. Marketability
9. Which of the following ratios best measures short-term solvency?
A a. Quick ratio c. Creditors’ equity to total assets
b. Earnings per share d. Return on inventories
10. Mc Donald Company has current assets of P 400,000 and current liabilities of P 500,000. Mc Donald Company’s current
ratio would be increased by
A a. The purchase of P 100,000 of inventory on account
b. The payment of P 100,000 of accounts payable
c. The collection of P 100,000 of accounts receivable
d. Refinancing a P 100,000 long-term loan with short-term debt
11. Shakey’s Corp. has an acid test ratio of 1.5. Which of the following will cause this ratio to deteriorate?
C a. Sale of equipment at a loss. c. Borrowing short-term loan from a bank.
b. Sale of inventory on account. d. Payment of cash dividends previously declared.

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Week No. 18: FINANCIAL STATEMENT ANALYSIS

12. A company has a current ratio greater than 1:1 and a quick ratio less than 1:1. If all cash was used to reduce
accounts payable, how would these cash payments affect (1) current ratio (2) quick ratio?
C a. (1) Decreased (2) Decreased c. (1) Increased (2) Decreased
b. (1) Decreased (2) Increased d. (1) Increased (2) Increased
13. The issuance of serial bonds in exchange for a building, with the first installment of the bonds due late this year:
D a. Decreases net working capital c. Decreases the quick ratio
b. Decreases the current issue d. Affects all of the answers as indicated
14. If Jonas Co. decides to change from FIFO to LIFO inventory method during a period of rising prices, its
A a. Current ratio would be reduced c. Inventory turnover would be reduced
b. Debt-to-equity ratio would be reduced d. Cash flow would be reduced
15. Which cost flow assumption will result in a higher inventory turnover ratio in an inflationary economy?
B a. FIFO c. Weighted average
b. LIFO d. Specific identification
16. A quick ratio of 2.0, current assets of P 5,000 and inventory of P 2,000 has current liabilities of _____.
A a. P 1,500 c. P 3,500
b. P 2,500 d. P 6,000
17. How is the average inventory balance used in the calculation of each of the following?
Acid-test ratio Inventory Turnover
C a. Numerator Numerator
b. Numerator Denominator
c. Not used Denominator
d. Not used Numerator
18. Selected data from Starbucks are presented below. The difference between average and ending inventories is
immaterial. Current assets are comprised mainly of cash, receivables and inventories.
Current ratio 2.0
Quick ratio 1.5
Current liabilities P 600,000
Inventory turnover (based on cost of sales) 8 times
Gross profit margin 40%

What were Starbuck's net sales for the year?

B a. P 2.4 million c. P 1.2 million
b. P 4.0 million d. P 6.0 million
SOLUTION: Inventory: (2 – 1.5) 600,000 = P 300,000 Cost of goods sold: 300,000 (8) = P 2.4 M
19. Based on the data presented below, what is Goldilock Corporation’s cost of sales for the year?
Current ratio 3.5
Acid test ratio 3.0
Year-end current liabilities P 600,000
Beginning inventory P 500,000
Inventory turnover 8.0

C a. P 1,600,000 c. P 3,200,000
b. P 2,400,000 d. P 6,400,000
SOLUTION: Ending inventory: (3.5 – 3) 600,000 = P 300,000 Average Inventory: P 400,000
Items 20-22 are based on the following information
2019 2020 2021
Accounts receivable, net P 40,000 P 42,500 P 45,000
Inventory 40,000 50,000 45,000
Current assets 120,000 140,000 130,000
Total assets, net 700,000 750,000 725,000
Current liabilities 70,000 80,000 50,000
Cash sales 400,000 420,000 450,000
Credit sales 120,000 125,000 131,250
Costs of sales 310,000 324,000 345,000

20. What should be the age of receivables in 2021?

B a. 110 days c. 130 days
b. 120 days d. None of these
SOLUTION: Receivable turnover: 131,250 ÷ [(45,000 + 42,500)/2] = 3 Age, AR: 360 ÷ 3
21. Determine the number of days in inventory for 2020.
A a. 50 days c. 70 days
b. 60 days d. None of these
SOLUTION: Inventory turnover: 324,000 ÷ [(40,000 + 50,000)/2] = 7.2 Age, Inventory: 360 ÷ 7.2
22. What is the net working capital turnover for 2021?
B a. 9.9 c. 7.15
b. 8.3 d. None of these
SOLUTION: (450,000 + 131,250) ÷ {[(140,000 – 80,000) + (130,000 – 50,000)] ÷ 2}
23. The ratio of sales to working capital is a measure of
C a. Collectibility c. Liquidity
b. Financial leverage d. Profitability

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24. A high sales-to-working-capital ratio could indicate

C a. Unprofitable use of working capital
b. Sales are not adequate relative to available working capital
c. The firm is undercapitalized
d. The firm is not susceptible to liquidity problems
25. The number of days’ sales in receivable is a measure of
D a. Asset value c. Profitability
b. Sales performance d. Liquidity
26. Accounts receivable turnover ratio will normally decrease as a result of
D a. The write-off of an uncollectible account (assume the use of the allowance for doubtful accounts
method)
b. A significant sales volume decrease near the end of the accounting period
c. An increase in cash sales in proportion to credit sales
d. A change in credit policy to lengthen the period for cash discounts
27. To determine the operating cycle for a department store, which one of these pairs of items is needed?
C a. Days’ sales in accounts receivable and average merchandise inventory
b. Cash turnover and net sales
c. Accounts receivable turnover and inventory turnover
d. Asset turnover and return on sales
28. Selected information for 2021 for Tokyo Company is as follows:
Cost of goods sold P 5,400,000
Average inventory 1,800,000
Net sales 7,200,000
Average receivables 960,000
Net income 720,000
Assuming 360 days in a year, what was the average number of days in operating cycle for 2020?
D a. 72 days c. 144 days
b. 84 days d. 168 days
SOLUTION: Age, Inventory: 360 ÷ (5.4M/1.8M) Age, Receivables: 360 ÷ (7.2M ÷ 960,000)
29. Return on investment may be calculated by multiplying total asset turnover by
B a. Average collection period c. Debt ratio
b. Profit margin d. Fixed-charge coverage
30. The following ratios were computed from Dads Company’s financial statements for 2020:
Return on asset 24%
Asset turnover 1.6 times
What was the company’s profit margin ratio?
C a. 38.4% c. 15%
b. 24% d. 6%
31. Return on investment (RoI) is a term often used to express income earned on capital invested in a business unit. A
company’s RoI is increases if
B a. Sales increase by the same peso amount as expenses and total assets
b. Sales remain the same and expenses are reduced by the same peso amount that total assets increase
c. Sales decrease by the same dollar amount that expenses increase
d. Net profit margin on sales increases by the same percentage as total assets
32. If a company is profitable by effectively using leverage, which one of the following ratios is likely to be the largest?
C a. Return on total assets c. Return on common equity
b. Return on operating assets d. Return on total equity
33. RoA and RoE are measures of ______.
C a. Solvency c. Profitability
b. Liquidity d. Current asset activity
34. National Company’s return on equity is 12% and debt ratio is 0.40. Determine the return on assets.
D a. 5.35% c. 6.60%
b. 8.4% d. 7.20%
SOLUTION: Based on DuPont technique: RoE = RoA ÷ equity ratio = 12% = RoA ÷ 0.60
35. Selected information for Saisaki Company is as follows:
2019 2020
Preferred stock * P 125,000 P 125,000
Common stock 300,000 400,000
Retained earnings 75,000 185,000
Dividends paid on preferred stock for the year ended 10,000 10,000
Net income for the year ended 60,000 120,000
* 8%, P 100 par non-cumulative, non-convertible
What is Saisaki Company’s return on common stockholders’ equity for 2020?
C a. 17% c. 23%
b. 19% d. 25%
SOLUTION: Return on Common SHE: (120,000 – 10,000) ÷ (375,000 + 585,000)/2
36. It refers to the practice of financing assets with borrowed capital. Its extensive use may impact on the return on
common stockholders’ equity to be above or below the rate of return on total asset.
C a. Discounting c. Leverage
b. Mortgage d. Arbitrage

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Week No. 18: FINANCIAL STATEMENT ANALYSIS

37. If the return on total assets is 10% and if the return on common stockholders' equity is 12% then
D a. The after-tax cost of long-term debt is probably greater than 10%.
b. The after-tax cost of long-term debt is 12%.
c. Leverage is negative.
d. The after-tax cost of long-term debt is probably less than 10%.
38. Which would be considered as the most favorable for the common stockholders?
D a. Book value per share of common stock is substantially higher than market value per share; return on
common stockholder's equity is less than the rate of interest paid to creditors.
b. Equity ratio is high; return on assets exceeds the cost of borrowing.
c. The company stops paying dividends on its cumulative preferred stock: the price earnings ratio of
common stock is low.
d. Equity ratio is low; return on assets exceeds the cost of borrowing.
39. If the ratio of total liabilities to stockholders equity increases, a ratio that must also increase is the
C a. Times interest earned c. Debt ratio
b. Current ratio d. Return on shareholders’ equity
40. The set of ratios that is most useful in evaluating solvency is
D a. Debt ratio, current ratio, and TIE c. Debt ratio, quick ratio, and TIE
b. Debt ratio, TIE, and RoA d. Debt ratio, TIE, and cash flow to debt
41. A debt equity ratio is
B a. About the same as the debt to assets ratio. c. Lower than the debt to assets ratio.
b. Higher than the debt to assets ratio. d. Not correlated with the debt to assets ratio.
42. In 2020, Kenny had total assets of P 375,000 and equity for P 206,250. For 2021, its budget for capital investments is
P 62,500. The company may borrow from a bank provided that the 2021’s debt-to-equity ratio should be the same as
the debt-to-equity ratio in 2020. How much debt should be incurred to satisfy the bank’s condition?
A a. P 28,125 c. P 51,138
b. P 34,375 d. P 62,500
SOLUTION: Equity ratio: 206,250 ÷ 375,000 = 55% Debt ratio: 45% Debt: 62,500 x 45%
43. A measure of long-term debt-paying ability is a company’s
D a. Length of the operating cycle c. Inventory turnover ratio
b. Return on assets d. Times-interest-earned ratio
44. A company has interest expense of P4 million, sales revenue of P50 million, earnings before interest and taxes of P20
million, and an income tax rate of 35%. This company has a times-interest-earned ratio of
C a. 12.5 c. 5.0
b. 7.5 d. 0.2
Items 45-47 are based on the following data
Operating income P 900,000
Interest expense 100,000
Income before 40% income tax 800,000
Net income 480,000
Preferred stock dividends 200,000
Net income available to common shareholders 280,000
Common shares outstanding 120,000
45. What is the “times interest earned” (TIE) ratio?
D a. 2.8 c. 8.0
b. 4.8 d. 9.0
46. What is the “times preferred dividend earned” (TPDE) ratio?
C a. 1.4 c. 2.4
b. 1.7 d. 4.0
47. What is the basic Earnings Per Share (EPS)?
A a. 2.3 c. 3.0
b. 2.6 d. 4.1
48. Which would likely cause a firm to increase its use of debt financing as measured by the debt to total capital ratio?
D a. Increased economic uncertainty.
b. An increase in the degree of operating leverage.
c. An increase in the price-earnings ratio.
d. An increase in the corporate income tax rate.
49. What type of ratio is Earnings Per Share (EPS)?
A a. Profitability ratio c. Liquidity ratio
b. Activity ratio d. Leverage ratio
50. The book value per share a corporation is usually different from the market value of the stocks due to the
C a. Use of accrual accounting in preparing financial statements
b. Omission of the number of preferred shares outstanding at year-end in the calculation
c. Use of historical costs in preparing financial statements
d. Omission of total assets from the numerator in the calculation
51. Book value per common share represents the amount of equity assigned to each outstanding share of common stock.
Which one of the following statements about book value per common share is correct?
B a. Market price per common share usually approximates book value per common share
b. Book value per common can be misleading because it is based on historical cost
c. A market price per common share that is greater than book value per common share is an indication
of an overvalued stock
d. Book value per common share is the amount that would be paid to shareholders if the company
were sold to another company

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Week No. 18: FINANCIAL STATEMENT ANALYSIS

52. KFC Company’s equity balances as of the end of 2021 are as follows:
6% cumulative preferred stocks, 2,000 shares outstanding
P 200 par value, with liquidation value of P 220 P 400,000
Common stocks, 20,000 shares issued and outstanding 800,000
Retained earnings 1,024,000
Preferred dividends in arrears amount to P 24,000.
What is KFC Company’s book value per share of common stock?
D a. P 111.20 c. P 89.20
b. P 91.20 d. P 88.00
SOLUTION: [800,000 + 1,024,000 – 24,000 - 2,000 (220 – 200)] ÷ 20,000
53. The issuance of new shares in a five-for-one split of common stock
A a. Decreases the book value per share of common stock
b. Increases the book value per share of common stock
c. Increases total stockholders’ equity
d. Decreases total stockholders’ equity
54. A company has net income of P 250,000 and dividends of P 50,000 on its convertible preferred stock. There were
400,000 shares of common stock outstanding and the preferred is convertible into 125,000 shares of common stock.
Basic earnings per share were (rounded):
B a. P 0.48 c. P 0.60
b. P 0.50 d. P 2.50
55. A company has net income of P 250,000 and dividends of P 50,000 on its convertible preferred stock. There were
400,000 shares of common stock outstanding and the preferred is convertible into 125,000 shares of common stock.
Diluted earnings per share were (rounded):
A a. P 0.48 c. P 0.60
b. P 0.50 d. P 2.50
56. Financial ratios, which assess the profitability of a company, include all of the following, except
A a. Dividend yield c. Earnings per share
b. Gross profit percentage d. Return on sales
57. A drop in the market price of a firm’s common stock will immediately increase its
D a. Return on equity c. Market-to-book ratio
b. Dividend payout ratio d. Dividend yield
58. Which of the following statements about the price-earnings (P-E) ratio is correct?
A a. A company with high growth opportunities ordinarily has a high P-E ratio
b. P-E ratio has more meaning when a firm has losses than when it has profits
c. P-E ratio has more meaning when a firm has abnormally low profits in relation to its assets
d. P-E ratio expresses the relationship between a firm’s market price and its net sales
59. The following information is provided about the common stock of Karate Kid Inc. at the end of the year:
Par value per share P 10.00
Dividends paid per share (last 12 months) 12.00
Market price per share 108.00
Basic earnings per share 36.00
Diluted earnings per share 24.00
What is the price earnings ratio for Karate Kid’s common stock?
B a. 3.0 times c. 9.0 times
b. 4.5 times d. 10.8 times
NOTE: Price-earnings ratio is preferably based on diluted earnings per share.
60. Aristocrat paid out half of last year’s earnings in dividends. Aristocrat’s earnings increased by 20% and the amount of
dividends increased by 15% in the current year. What was Aristocrat’s dividend payout ratio for the year?
C a. 50.0% c. 47.9%
b. 57.5% d. 78.0%
SOLUTION: Payout ratio: 1.00 (1.15) ÷ 2.00 (1.20)
61. Watson Corporation computed the following items from its financial records for the year:
Price-earnings ratio: 12 Payout ratio: 0.6 Assets turnover ratio: 0.9
What is the dividend yield on Watson’s common stock?
A a. 5.0% c. 7.2%
b. 7.5% d. 10.8%
NOTE: Yield x P/E = payout = (dividends/price) x (price/earnings) = dividends/earnings
62. Dividend yield is 10%, price-earnings ratio is 4 times, what is the plowback ratio?
C a. 2.5% c. 60%
b. 40% d. Cannot be determined from given information
NOTE: Plowback ratio = Retention ratio = 100% - payout ratio
63. ABC Corporation is a closely held corporation owned by the siblings Antoinette, Bonna & Connie. It currently earns a
profit after tax of P 6,000,000 and has 300,000 shares outstanding. Next year, ABC will go public for the first time. Its
initial public offering of 100,000 shares will be priced at P 60 per share, with a 5% underwriter’s spread on the price
offering. In addition, ABC will incur P 200,000 in out-of-pocket costs. If all the shares will be issued, how much will be
the net proceeds?
A a. P 5,500,000 c. P 5,800,000
b. P 5,700,000 d. P 6,000,000
SOLUTION: [100,000 (60) x 95%] – 200,000
64. Which of the following is not a potential source of financial leverage?
B a. Long-term debt c. Preferred stock
b. Common stock d. Current liabilities

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Week No. 18: FINANCIAL STATEMENT ANALYSIS

65. A company’s cash ratio will decrease if the company

B a. Purchases commercial paper.
b. Purchases materials on account.
c. Sells goods for cash at a selling price lower than cost.
d. Receives cash by issuing a short-term note payable.
66. A company had P 500,000 of sales for the year just ended and is projecting sales of P 600,000 for the coming year.
For every P 1 increase in sales, 38% of additional financing is required for the purchase of additional assets. The
projected profit margin is 20%, and 60% of profits will be retained for reinvestment in the company. What is the
amount of additional external financing needed by the company in the coming year?
A a. P 0 c. P 86,000
b. P 38,000 d. P 110,000
67. Given the following items that vary directly with P 2,000,000 sales for the year 2020:
Assets: 65% Liabilities: 20%
Net profit margin is expected to be 12% and while payout ratio is constant at 60%.
If sales are expected to increase by 25% in 2021, how much is the additional financing needed?
B a. P 225,000 c. P 45,000
b. P 105,000 d. Some other amount
68. Which of the following is not a limitation of ratio analysis affecting comparability among firms?
D a. Different source of information
b. Different accounting periods
c. Different accounting policies
d. Provision of useful information regarding stability of financial conditions
69. Which of the following is not a problem or limitation associated with financial statement analysis?
A a. Financial statements are based on current market value of the firm’s assets, therefore do not reflect
historical costs
b. There may be some differences in the accounting methods and estimates used by companies so that
comparison of their ratios may not be advisable
c. The timing of transactions and use averages in applying the various techniques in FS analysis affect the
results to be obtained
d. A ratio that is acceptable to one company may not be acceptable to another when some other factors
are considered
70. Financial statement analysis is least associated with
D a. Common-size income statement c. Liquidity and profitability
b. Gross profit variance d. Productivity

Solutions to Exercise No. 9 (Pages 4 & 5)

1. Current ratio (1,070/370) 11. EPS (420/1,000)
2. Acid-test ratio (660/370) 12. P/E ratio (8/0.42)
3. Accounts receivable turnover (4,700/440) 13. Dividend yield (0.1/8)
4. Inventory turnover (2,300/410) 14. Payout ratio (0.1/0.42)
5. Gross profit margin (2,400/4,700) 15. Debt ratio (2,330/4,570)
6. Operating profit margin (850/4,700) 16. Debt-equity ratio (2,330/2,240)
7. Return on sales (RoS) (420/4,700) 17. Times interest earned (850/150)
8. RoA – operational performance (850/4,570) 18. Cash flow to total debt (740/2,330)
9. RoA – total management effort (420/4,570) 19. Cash flow margin (740/4,700)
10. Return on equity (RoE) (420/2,240) 20. Cash ratio (220/370)
Cash Flow (Operations): Net Income + Depreciation = 420 + 320 = 740

Answers to Exercise No. 10 (Page 5)

Condensed Income Statement
Sales P 900
Cost of sales (A) 540
Gross profit (B) 360
Operating (C) 306
expenses (D) 54
Net income
Condensed Balance Sheet
Cash P 30 Current liabilities (H) 115
Receivables (E) 180 Long-term debt (I) 291
Inventory (F) 135 Shareholders’ equity (J) 609
Plant and equipment 670
Total (G) 1,015 Total (K) 1,015

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