FINANCIAL MANAGEMENT

CHAPTER 4
BUSINESS ORGANIZATION AND TRENDS
THE ORGANIZATION OF THE BUSINESS FIRM LEGAL POINT OF ACCOUNTING
VIEW POINT OF VIEW
BUSINESS FIRM
The owner of a The business is an
➢ An entity designed to organize raw
proprietorship is nor entity separate
materials, labor, and machines with the
goal of producing goods and/or separable from the from the owner.
services. business and is Therefore, the
➢ It can be organized in one of three personally liable for financial
ways: all debts of the statements of the
• Proprietorship business. business present
• Partnership only those assets
• Corporation and liabilities
pertaining to the
FIRMS business.
➢ Purchase productive resources from The owner cannot
households and other firms. be paid salary or
➢ Transform them into a different wages from the
commodity, and business, but the
➢ Sell the transformed product or service owner may
to consumers. withdraw funds or
other property from
Note: the business.
➢ Business firms engage in retail or trading
activities, transforming purchased goods WITHDRAWALS
into a different commodity does not ➢ Treated as reduction of owner’s equity
necessarily take place. or financial interest of the owner in the
business.
LEGAL FORMS OF BUSINESS ORGANIZATION
TAX
There are three types of business
➢ The business itself does not pay any
organizations.
income taxes.
PROPRIETORSHIP ➢ The income or loss of the business is
reported on the owner’s personal
➢ Owned by a single person who has
income tax return.
complete control over business
decisions. ADVANTAGES OF SOLE PROPRIERTORSHIP
➢ The individual owns all the firm’s assets
EASY OF ENTRY AND EXIT
and is responsible for all its liabilities.
➢ The proprietorship may be an ideal form ➢ Requires no formal charter and is
of business organization when the inexpensive to form and dissolve.
following conditions exist:
• The anticipated risk is minimum and FULL OWNERSHIP AND CONTROL
adequately covered by insurance. ➢ The owner has full control, reaps all
• The owner is either unable or profits and bears all losses.
unwilling to maintain the necessary
organizational documents and tax TAX SAVINGS
returns of more complicated ➢ The entire income generated by the
business entities. proprietorship passes directly to the
• The business does not require owner.
extensive borrowing. • This may result in a tax advantage if
the owner’s tax rate is less than the
tax rate of a corporation.
FEW GOVERNMENT REGEULATIONS
➢ It has the greatest freedom as
compared with any form of business
organization.
DISADVANTAGES
UNLIMITED LIABILITY
➢ The owner is personally liable or
responsible for all business debts.
➢ The owner’s personal assets can be
claimed by the creditors if the firm
defaults on its obligations.
LIMITATIONS IN RAISING CAPITAL
➢ Fund-raising ability is limited.
➢ Resources may be limited to the assets
of the owner.
➢ The growth may depend on his or her
ability to borrow money.
LACK OF CONTRINUTIY
➢ Upon death or retirement of the owner,
the proprietorship ceases to exist.
PARTNERSHIP
➢ Legal arrange in which two or more
persons agree to contribute capital or
services to the business and divide the
profits or losses that may be derived
therefrom.
➢ May operate under varying degrees of
formality.
➢ May be either general or limited.
ADVANTAGES OF PARTNERSHIP
EASE OF FORMATION
➢ Require relatively little effort and low
start-up costs.
ADDITIONAL SOURCES OF CAPITAL
➢ It has the financial resources of several
individuals.
MANAGEMENT BASE
➢ It has broader management base or
expertise than a sole proprietorship.
TAX IMPLICATION
➢ Does not pay any income taxes.
➢ The income or loss of the business is
distributed among the partner in
accordance with the partnership and
each partner reports his or her portion
whether distributed or not on personal
income tax return.
DISADVANTAGES
UNLIMITED LIABILITY
➢ General partners have unlimited liability
for the debts and litigations of the
business.
LACK OF CONTINUTY
➢ May be dissolve upon the withdrawal or
death of a general partners, depending
on the provisions of the partnership.

GENERAL LIMITED DIFFICULT OF TRANSFERRING OWNERSHIP

PARTNERSHIP PARTNERSHIP ➢ It is difficult for a partner to liquidate or
One in which each Containing one or transfer ownership.
partner has more general • It varies with condition set forth in
unlimited liability for partners and one or the partnership agreement.
the debts incurred more limited
by the business partners. LIMITATIONS IN RAISING CPAITAL
General partners Personal liability: ➢ It may have problems raising large
usually manage the General partners: amounts of capital because many
firm and may enter unlimited sources of funds are available only to
into contractual Limited partners: corporations.
obligations on the limited to their
firm’s behalf. investment. CORPORATIONS
Profits and assets Limited partners ➢ Artificial being created by law.
ownership may be cannot be active in ➢ Legal entity separate and distinct from
divided in any way management. its owners.
agreed upon by ➢ It may own assets, borrow money, and
members. engage in other business entities without
directly involving the owners.

SHAREHOLDERS
➢ Also known as the owners
➢ They do not directly manage the firm,
instead select managers designated as
board of directors.
BOARD OF DIRECTORS
➢ The managers selected by the
shareholders to run the firm for them.
➢ Authorized to act in the corporation’s
behalf.
INCORPORATION PROCESS
➢ Initiated by filing the articles of
incorporation (AOI) and other
requirements with the Securities and
Exchange Commission (SEC).
➢ The AOI includes among other the
following:
• Incorporators
• Name of the corporation
• Purpose of the corporation
• Capital stock
• Authorized shares
CAPITAL STOCK
➢ After the corporation is legally form it will
then issue its capital stock.
STOCK CERTIFICATE
➢ Evidence of stock ownership.
BYLAWS
➢ Rules that govern the internal
management of the company.
➢ Established by the board of directors
and approved by the shareholders.
➢ May be amended or extended from
time to time by shareholder.
ADVANTAGES
LIMITED LIABILITY
➢ Shareholders are liable only to the
extent of their investment in the firm’s
shares and not any other personal
assets.
EXCEPTION
➢ Government may pass through the
corporate shield to collect unpaid taxes.
➢ Piercing the Corporate Veil.
UNLIMTED LIFE
➢ Continue to exist even after death of
the owners.
➢ Maximum legal life: 50 years
• May be renewed for desire
additional life not to exceed 50
years.
EASE IN TRANSFERRING OWNERSHIP
➢ Shareholders can easily sell their
ownership interest by selling their stocks
without affecting the legal form of
business organization.
ABILTIY TO SELL STOCKS
➢ It provides corporations with a stronger
financial base and the capital needed
for expansion.
ABILITY TO RAISE CAPITAL
➢ Can raise capital through the sale of
securities such as bonds to investors who
are lending money to the corporations
and equity securities such as common
stock to investors who are the owners.
DISADVANTAGES
TIME AND COST OF FORMATION
➢ Registration of public companies with
the SEC may be time consuming and
costly.
REGULATION
➢ Subject to greater government
regulations
➢ Shareholders cannot just withdraw
assets.
• They can only receive corporate
assets when dividends are declared
and these amounts may be subject
to limits imposed by law.
TAXES
➢ Corporations pay taxes on income they
have earned.
➢ The subject of taxation demands the
advice of a qualified tax accountant.
IMPORTANT BUSINESS TRENDS
1. Increased globalization of business
2. Ever improving information technology
3. Corporate governance
4. Outsourcing
FINANCIAL MANAGEMENT
CHAPTER 5
UNDERSTANDING FINANCIAL STATEMENTS
FINANCIAL STATEMENTS
➢ How the business activities are reported.
➢ Report on company’s performance and
financial condition.
➢ It also reveals executive management’s
privilege and information insights.
➢ Serve the needs of different users.
➢ Provide crucial input for strategic
planning as well as information about
relative success of those plans which
can be used as corrective action and
make new operating, investing, and
financing decisions.
ACCOUNTING INFORMATION
➢ Should be used in the business context.
GENERAL OBJECTIVES OF FINANCIAL
STATEMENTS
The importance objectives of financial
statements are:
PROVIDING INFORMATION FOR ECONOMIC
DECISIONS
➢ Evaluation of the ability of an enterprise
to generate cash and cash equivalents
and the timing and certainty of their
generation.
➢ Determines the capacity of an
enterprise to pay its employees and
suppliers, meet interest payments, repay
loans and make distributions to its
owners.
PROVIDING INFOMRATION ABOUT FINANCIAL
POSITION
The financial position of an enterprise is
affected by economic resources such as:
Information about economic resources
➢ useful in predicting the ability of the
enterprise to generate cash and cash
equivalents in the future.
Information about financial structure
➢ Predicting borrowing needs and how
future profits and cash flows will be
distributed among those with an interest
in the enterprise.
Information is useful
➢ How successful the enterprise is likely to
be raising further in finance.
Information about liquidity and solvency
➢ To mee the financial commitments as
fall due.
LIQUIDITY
➢ The availability of cash in the near future
after taking account of financial
commitments
SOLVENCY
➢ Availability of cash over the longer term
to meet financial commitments as they
fall due.
PROVIDING INFORMATION ABOUT
PERFORMANCE OF AN ENTERPRISE
➢ Provides information about the
performance and in particular its
profitability.
• Requires assessing potential
changes in the economic resources.
➢ Information about variability of
performance
➢ Predicting the capacity of the enterprise
to generate cash flows from its existing
resource base.
PROVIDIG INFORMATION ABOUT CHANGES
IN FINANCIAL POSITION
➢ To assess its investing, financing, and
operating activities.
➢ Provides the user with a basis to assess
the ability of the enterprise to generate
cash and cash equivalents and the
needs of the enterprise to utilize those
cash flows.
DEMAND FOR FINANCIAL ACCOUNTING
INFORMATION
➢ Decision makers and other stakeholders
demand information on the company’s
past and prospective returns and risks to
facilitate efficient contracting and risk-
sharing.
 CLASSES OF USERS CUSTOMERS AND POTENTIAL STRAGEGIC
PARTNERS
MANAGERS AND EMPLOYEES
POTENTIAL
➢ They need accounting information on
CUSTOMERS STRATEGIC
the financial condition, profitability, and
PARTNERS
prospects of their companies as well as
To evaluate a
comparative financial information on
company’s ability
competing companies and business To estimate the
opportunities. to provide products
firm’s profitability to
➢ To raise financing for company, to mee and services as
assess the fairness
disclosure requirement, and to serve as agreed.
of returns on mutual
a basis for executive remuneration and To assess the
transactions and
bonuses for wage negotiations and to company’s
strategic alliances
meet disclosure requirements. reliability and
staying power.
INVESTORS AND ANALYSTS
OTHER DECISION MAKES
➢ To decided whether to buy or sell equity
shares. ➢ Varied from assessing damages for
➢ Future profitability and the ability to environmental abuses to making policy
generate cash influence the price of decisions involving economic, social,
securities. taxation and other initiatives.
➢ Company’s ability to borrow money at
favorable terms. SOURCES OF INFORMATION ABOUT
ENTERPRISE
CREDITORS AND SUPPLIERS
➢ Determined by manager’s assessment
➢ To monitor and adjust their contractual
of the benefits and cost disclosure.
requirements and environment with a
business firm.
FINANCIAL ACCOUTING INFORMATION
AUDITED ANNUAL REPORT
CREDITORS
➢ To help determine loan terms, loan ➢ Four financial statements:
amounts, interest rates and required 1. Statement of financial position
collateral. (balance sheet statement)
SUPPLIERS 2. Statement of comprehensive
➢ To establish credit terms and to income
determine their long-term commitment 3. Statement of stockholders’ equity
to supply chain relations. 4. Statement of cash flow
• This includes explanatory notes and
SHAREHOLDERS AND DIRECTORS management’s discussion and
analysis of financial results.
➢ To assess its profitability and risks.
➢ To evaluate managerial performance.
UNAUDITED QUARTERLY OR INTERIM REPORTS
➢ To help make leadership decisions.
➢ Summary version of the four financial
REGULATORY AND TAX AGENCIES statements and limited additional
disclosure.
➢ To monitor the business firms’
compliance with laws, for public
PUBLICY LISTER COMPANIES
protection, price setting and for setting
➢ They must file financial accounting
tax and other regulatory practices.
information with the SEC.

ALL OTHER REGISTERED CORPORATION AND

PARTNERSHIPS
➢ Require filing annually audited financial
statements with accompanying
explanatory notes with SEC.
 BENEFITS OF DISCLOSURE
➢ The company’s ability to disclose
reliable (audited) accounting
information enable them to better
compete in capital, labor, input and
output market.
• The better a company’s prospects,
the lower will be its cost of capital as
reflected in higher stock prices or
lower interest rate.
COST OF DISCLOSURE
➢ Can be substantial.
➢ The possibility for information to produce
competitive disadvantages is high.
➢ Can also face possible lawsuits when
disclosure create expectations that
eventually are not met.
DISCLOSURE COSTS
➢ Includes political cost.
➢ Its costs are high for highly visible
companies because they are favorite
target of public scrutiny.
BALANCE BETWEEN QUALITATIVE
CHARACTERISTICS
➢ The aim is to achieve an appropriate
balance among the characteristics in
order to meet the objective of financial
statements.
➢ Matter of professional judgement
TRUE FAIR VIEW OR FAIR PRESENTATION
➢ Financial statements are frequently
described as showing a true and fair
view of the financial position,
performance and changes in financial
position of an enterprise.
FINANCIAL STATEMENTS
➢ Reported periodically.
➢ Four financial statements:
• Statement of financial position
(balance sheet statement)
• Statement of comprehensive
income
• statement of stockholders’ equity
• statement of cash flow

CONSTRATINTS ON RELEVANT AND RELIABLE

INFORMATION
TIMELINESS
➢ undue delay=lose relevance
➢ may need to balance the relative merits
of timely reporting and the provision of
reliable information.
➢ to provide information on timely basis, it
may often be necessary to report before
all aspects of a transaction or other
events are known thus impairing
reliability. LINKAGE OF FINANCIAL STATEMENTS
➢ Conversely, reporting delayed until all ➢ Also known as articulation
aspects are known=the information ➢ Statement of financial position +
maybe highly reliable but of little use to statement of comprehensive income =
users who have had to make decisions linked by retained earnings
in the interim
➢ A balance between relevance and
reliability is able to best satisfy the
economic decision-making needs of the
users.

BLANACE BETWEEN BENEFIT AND COST

➢ Pervasive constraint rather than a
qualitative characteristic.
➢ The benefits derived from information
should exceed the cost of providing it.
➢ The evaluation of benefits and cost is
however, substantially a judgmental
process.
RETAINED EARNINGS
Updated each period and reflect
cumulative income that has not yet been
distributed to shareholders.

LONG-TERM PERSPECTIVE
The income statement does measure
INVESTING ACTIVITIES
change in company value.
➢ Company assets.
➢ Finance by a combination of nonowner
STATEMENT OF FINANCIAL POSITION financing (liabilities) and owner
➢ Reports a company’s financial position financing (equity).
at a point in time, the company’s
resources (assets) namely, what the FINANCING ACTIVITEIS
company owns and also the source of ➢ Combination of owner and nonowner
asset financing. financing.
➢ Financial statement title sometimes
begins with the word consolidated. NONOWNER
OWNER FINANCING
• Means it includes a parent FINANCING
company and one or more Resource
subsidiaries, companies that the contributed to the
parent company owns. company by its Borrowed money.
➢ There are two ways a company can owners along with
finance its assets: any profit retained
• Owner financing by the company.
• Nonowner financing Entails no such Legal obligation to
obligation for repay amounts
NONOWNER repayment. owned.
OWNER FINANCING
FINANCING Failure to do so can
Can raise money Raise money from result in severe
from shareholder banks or other consequences for
creditors and the borrower.
suppliers
Both owners and nonowners hold clams WORKING CAPITAL
on company assets ➢ Current assets
Owner claims on Nonowner claims: ➢ These assets turnover as they are used
asset: equity liabilities (or debt) and the placed throughout the year.

ACCOUNTING EQUATION NET WORKING CAPITAL

Asset = liability + owner’s equity ➢ Difference between current assets minus
current liabilities
NET OPERATING WOKRING CAPITAL NET LOSS
➢ Difference between current assets and Occurs when expenses exceed revenue.
non-interest-bearing current liabilities.
STATEMET OF STOCKHOLDERS’ EQUITY
STATEMENT OF COMPREHENSIVE INCOME
➢ Report on changers in key types of
➢ Company’s performance over a period equity over a period of time.
of time.
➢ Lists amount for revenues (sales),
expenses and other comprehensive
income
➢ Revenue less expense yield the bottom-
line net income amount.

COST OF GOODS SOLD (COST OF SALES)
➢ Additional expense account
• Added in the statement of
comprehensive income by
manufacturing and merchandising
companies
GROSS PROFIT (GROSS MARGIN)
➢ The subtotal
➢ Revenue less cost of goods solve
➢ The remaining expenses are the
reported below gross profit.
CONTRIBUTED CAPITAL
Cash that the company received from the
sale of stock to stockholders/sharholders less
any funds expended for repurchase of stock
(treasury shares)
RETAINED EARNINGS
➢ Earned capital or reinvested capital.
➢ Cumulative total amount of income that
the company has earned and that has
been retained in the business and not
distributed to shareholders in the form of
dividends.
➢ Change in retained earnings links
consecutive statement of financial
position via the income statement.

ENDING RETAINED EARNINGS

Beginning retained earnings + net income –
dividends.

OPERATING ACTIVITIES
➢ To produce, promote and sell its
products and services.
these activities extend from input
markets to output markets.

INPUT MARKETS OUTPUT MARKETS

Generate revenues
It generates the
(sales)
most expenses
Can also generate
(cost)
some expenses.

NET INCOME
➢ Arises when revenue exceed expenses.
 STATEMENT OF CASHFLOWS
➢ The change (increase or decrease) in a
company’s cash balance over a period
of time.
➢ Cash inflows and outflows from
operating, investing, and financing
activities over a period of time.
FINANCIAL MANAGEMENT
CHAPTER 6
ASSESSMENT OF THE FIRMS OPERATING EFFICIENCY AND FINANCIAL POSITION THROUGH FINANCIAL
STATEMENT ANALYSIS
FINANCIAL STATEMENT ANALYSIS
➢ The process of extracting information
from financial statements to better
understand a company’s current and
future performance and financial
condition.
➢ Designed to determine the relative
strengths and weaknesses of a
company.
➢ Concentrates on financial statement
analysis, which highlights the key
aspects of a firm’s operations.
➢ s involves a study of the relationships
between income statement and
balance sheet accounts, how these
relationships change over time (trend
analysis or horizontal analysis), and how
a particular firm compares with other
firms in its industry (bench-marking or
vertical analysis).
BASIC TOOLS IN FINANCIAL ANALYSIS
Horizontal Analysis or Trend Analysis
➢ A technique for evaluating a series of
financial statement data over a period
of time.
➢ Its purpose is to determine the increase
or decrease that has taken place,
expressed either an amount or a
percentage.
Vertical Analysis or Common Size Analysis
➢ It is a technique for evaluating financial
statement data that expresses each
item in a financial statement as a
percent of a base amount.
Ratio Analysis
➢ This technique establishes relationships
among financial statement accounts at
given date or period of time.
➢ These ratios analyze firm’s liquidity, the
use of leverage, asset management,
cost control, profitability, growth, and
valuation.
BASIC RULES IN
COMPUTING FINANCIAL RATIOS
➢ When calculating a ratio using balance
sheet amounts only, the numerator and
denominator should be based on
amounts as of the same balance sheet
date.
• The same is true for ratios using only
income statement numbers.
• Exception: calculation of growth
ratios.
➢ If an income statement amount and a
balance sheet amount are sued at the
same time to calculate a ratio, the
balance sheet amount should be
expressed as an average for the time
period represented by the income
statement amount.
➢ If the beginning balance of a balance
sheet account is not available and
cannot be computed from the given
data, the ending balance of the
account is sued 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 CASH FLOW RATIOS
Sales and Sales and
purchases are purchases are
made on credit. made in cash.
➢ As a rule, an operating year is assumed
to have 360 days, unless specified
otherwise.
 FINANCIAL RATIOS
Tests of Liquidity
It is a measure of adequacy of working capital. It
Current Ratio is the primary test of liquidity to meet current
obligations from current assets
It measures the number of times that the current
liabilities could be paid with the available cash
Quick Ratio
and nearcash assets (i.e., cash, current
receivables and marketable securities)

Working Capital Activity Ratios

Receivables It measures the number of times receivables are
Turnover recorded and collected during the period.
It indicates the average number of days during
Average Age
which the company must wait before
of Receivables
receivables are collected.
Inventory It measures the number of times that the
Turnover inventory is replaced during the period.
It indicates the average number of days during
Average Age
which the company must wait before the
of inventory
inventories are sold.

𝐶𝑜𝑠𝑡 𝑜𝑓 𝑚𝑎𝑡𝑒𝑟𝑖𝑎𝑙𝑠 𝑢𝑠𝑒𝑑

Raw Materials Turnover
𝐴𝑣𝑒. 𝑅𝑀 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦
𝐶𝑜𝑠𝑡 𝑜𝑓 𝑔𝑜𝑜𝑑𝑠 𝑚𝑎𝑛𝑢𝑓𝑎𝑐𝑡𝑢𝑟𝑒𝑑
Work In Process Turnover
𝐴𝑣𝑒. 𝑊𝐼𝑃 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦
𝐶𝑜𝑠𝑡 𝑜𝑓 𝑔𝑜𝑜𝑑𝑠 𝑠𝑜𝑙𝑑
Finished Goods Turnover
𝐴𝑣𝑒. 𝐹𝐺 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦
Normal Operating Cycle 𝐴𝑣𝑒. 𝐴𝑔𝑒 𝑜𝑓 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 + 𝐴𝑣𝑒. 𝐴𝑔𝑒 𝑜𝑓 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠
𝑁𝑒𝑡 𝐶𝑟𝑒𝑑𝑖𝑡 𝑃𝑢𝑟𝑐ℎ𝑎𝑠𝑒𝑠
Trade Payables Turnover
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑇𝑟𝑎𝑑𝑒 𝑃𝑎𝑦𝑎𝑏𝑙𝑒𝑠
360 𝑑𝑎𝑦𝑠
Average Age of Trade Payables
𝑃𝑎𝑦𝑎𝑏𝑙𝑒𝑠 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟
𝐶𝑜𝑠𝑡 𝑜𝑓 𝐺𝑜𝑜𝑑𝑠 𝑆𝑜𝑙𝑑 + 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐸𝑥𝑝𝑒𝑛𝑠𝑒
Current Assets Turnover
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠

Test of Solvency
Times Interest 𝐸𝐵𝐼𝑇 It determines the extent to which
Earned 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝐸𝑥𝑝𝑒𝑛𝑠𝑒 operations cover interest expense.
𝑇𝑜𝑡𝑎𝑙 𝐿𝑖𝑎𝑏𝑖𝑙𝑡𝑖𝑖𝑒𝑠 Proportion of assets provided by
Debt-Equity Ratio creditors compared that provided by
𝑇𝑜𝑡𝑎𝑙 𝐸𝑞𝑢𝑖𝑡𝑦
owners
𝑇𝑜𝑡𝑎𝑙 𝐿𝑖𝑎𝑏𝑖𝑙𝑡𝑖𝑒𝑠 Proportion of total assets provided by
Debt Ratio
𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 creditors
𝑇𝑜𝑡𝑎𝑙 𝐸𝑞𝑢𝑖𝑡𝑦 Proportion of total assets provided by
Equity Ratio
𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 owners.

Test of Profitability
𝐼𝑛𝑐𝑜𝑚𝑒 Determines the proportion of sales
Return on Sales
𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠 that went into company’s earnings.
𝐼𝑛𝑐𝑜𝑚𝑒 Efficiency with which assets are used
Return on Assets
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐴𝑠𝑠𝑒𝑡𝑠 to operate the business
 𝐼𝑛𝑐𝑜𝑚𝑒 Measures the amount earned on
Return on Equity the owners’ or stockholders’
𝐴𝑣𝑒𝑟𝑎𝑡𝑒 𝐸𝑞𝑢𝑖𝑡𝑦
investment.
Earnings Per 𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒 − 𝑃𝑟𝑒𝑓𝑒𝑟𝑟𝑒𝑑 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑡𝑠 Measures the amount of net income
Share 𝑊𝑡𝑑. 𝐴𝑣𝑒. 𝐶𝑜𝑚𝑚𝑜𝑛 𝑆ℎ𝑎𝑟𝑒𝑠 𝑂𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔 earned by each common share.

Market Tests
Price-Earnings 𝑃𝑟𝑖𝑐𝑒 𝑃𝑒𝑟 𝑆ℎ𝑎𝑟𝑒 It indicates the number of pesos
Ratio 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑃𝑒𝑟 𝑆ℎ𝑎𝑟𝑒 required to buy P1 of earnings.
𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑡 𝑃𝑒𝑟 𝑆ℎ𝑎𝑟𝑒 Measures the rate of return in the
Dividend Yield
𝑃𝑟𝑖𝑐𝑒 𝑃𝑒𝑟 𝑆ℎ𝑎𝑟𝑒 investor’s common stock investments.
𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑡 𝑃𝑒𝑟 𝑆ℎ𝑎𝑟𝑒 It indicates the proportion of earnings
Dividend Pay-Out
𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑃𝑒𝑟 𝑆ℎ𝑎𝑟𝑒 distributed as dividends

Stability Ratios
Measures the proportion of
owners’ equity to fixed
Fixed Assets to Total 𝐹𝑖𝑥𝑒𝑑 𝐴𝑠𝑠𝑒𝑡𝑠 assets. Indicative of over or
Equity 𝑇𝑜𝑡𝑎𝑙 𝐸𝑞𝑢𝑖𝑡𝑦 under investment by
owners and weakness in
trading the equity.
Indicates the possible
Fixed Assets to Total 𝑁𝑒𝑡 𝐹𝑖𝑥𝑒𝑑 𝐴𝑠𝑠𝑒𝑡𝑠
overexpansion of plant
Assets 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 and equipment
Tests roughly the efficiency
Sales to Fixed
𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠 of management in
Assets (Plant
𝑁𝑒𝑡 𝐹𝑖𝑥𝑒𝑑 𝐴𝑠𝑠𝑒𝑡𝑠 keeping plant properties
Turnover)
employed.
Measures recoverable
𝐶𝑜𝑚𝑚𝑜𝑛 𝑆ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟𝑠 ′ 𝐸𝑞𝑢𝑖𝑡𝑦 amount by stockholders in
Book Value per
the event of liquidation if
share – CS 𝐶𝑜𝑚𝑚𝑜𝑛 𝑆ℎ𝑎𝑟𝑒𝑠 𝑂𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔
assets are realized at their
book values.
It indicates ability to
Times Preferred 𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒 𝐴𝑓𝑡𝑒𝑟 𝑇𝑎𝑥𝑒𝑠
provide dividends to
Dividend Earned 𝑃𝑟𝑒𝑓𝑒𝑟𝑟𝑒𝑑 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑡𝑠
preferred stockholders.
Measures efficiency of the
Capital intensity 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 firm to generate sales
ratio 𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠 through employment of its
resources.
Times fixed charges 𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒 𝑏𝑒𝑓𝑜𝑟𝑒 𝑡𝑎𝑥𝑒𝑠 𝑎𝑛𝑑 𝑓𝑖𝑥𝑒𝑑 𝑐ℎ𝑎𝑟𝑔𝑒𝑠 Measures ability to meet
earned 𝐹𝑖𝑥𝑒𝑑 𝑐ℎ𝑎𝑟𝑔𝑒𝑠 + 𝑠𝑖𝑛𝑘𝑖𝑛𝑔 𝑓𝑢𝑛 𝑝𝑎𝑦𝑚𝑒𝑛𝑡 fixed charges

Tests of Over-all Short-Term Solvency or Short-Term Financial Position

𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠 Indicates adequacy of working
Working Capital Turnover
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑊𝑜𝑟𝑘𝑖𝑛𝑔 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 capital to support operation (sales)
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑡𝑖𝑖𝑒𝑠 Measures coverage of current
Defensive Interval Ratio
𝐶𝑎𝑠ℎ 𝑎𝑛𝑑 𝐶𝑎𝑠ℎ 𝐸𝑞𝑢𝑖𝑣𝑎𝑙𝑒𝑛𝑡 liabilities
𝑁𝑒𝑡 𝑃𝑢𝑟𝑐ℎ𝑎𝑠𝑒𝑠 Measures efficiency of the
Payable Turnover company in meeting the accounts
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑃𝑎𝑦𝑎𝑏𝑙𝑒
payable.
Reflects extent of the utilization of
Fixed assets to long-term 𝐹𝑖𝑥𝑒𝑑 𝐴𝑠𝑠𝑒𝑡𝑠 resources from long-term debt.
liabilities 𝐿𝑜𝑛𝑔𝑡𝑒𝑟𝑚 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 Indicative of sources of additional
funds.
Tests of Over-all Short-Term Solvency or Short-Term Financial Position
Rate of return on average 𝐼𝑛𝑐𝑜𝑚𝑒 Measures the profitability of current
current assets 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠 assets invested
𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑝𝑟𝑜𝑓𝑖𝑡 Measures profit generated after
Operating Profit Margin
𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠 consideration of operating costs.
𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑐𝑎𝑠ℎ 𝑓𝑙𝑜𝑤 Measures the ability of the firm to
Cash flow margin
𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠 translate sales to cash.