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Financial

Analysis
Cris John Dequiña
Grace Famarangco
Jolyn Mae Ramos
FINANCIAL ANALYSIS
• To diagnose the current and past
financial condition of the firm to
give some clues about its future
condition.
• Is a way by which various groups
would know the financial condition
of the firm.
• This is determined through single-
period analysis and/or comparative
or trend analysis.
SINGLE-PERIOD ANALYSIS

• Ratios, percentages, and other


• Refers to comparison and
analytical techniques disclose
measurements based upon
the financial positions and
the financial data of a single
result of operations of the
period. firm at the end of the current
• It reveals financial position period.
and relationship as of a given
• Example: current and equity
point or period of time. ratios.
COMPARATIVE OR TREND ANALYSIS

• Compares and measures items


on the financial statements of
two or more fiscal periods.
• The improvement or lack of
improvement in financial
position and in the results of
operations is determined.
FINANCIAL RATIOS

•A very useful method in


financial analysis.
• It is used to expressed relation
of one part of the financial
statement to another.
Functions of Financial Ratios: Classes of Financial Ratios:
As a starting point for detailed Liquidity
financial analysis;
Activity
To help diagnose a situation;
Profitability
To monitor performance;
Solvency
To help plan forward; and
To reduce the amount of date to
workable form and to make data
more meaningful.
LIQUIDITY RATIOS
• Refers to the ability of the firm to pay
its bills on time or to meet its current
obligations. Ratios which are used to
measure this ability of the firm.
Classified as Liquidity Ratios:
 Current ratio

 Acid test ratio

 Sales to receivable ratio

 Sales to inventory ratio

 Inventory to net working capital ratio


Exhibit A
Exhibit B
Substituting data from the illustrative
balance sheet (Exhibit A), the current
Current Ratio: ratio for 2006 is computed as follows:
This ratio indicates the 𝐂𝐮𝐫𝐫𝐞𝐧𝐭 𝐀𝐬𝐬𝐞𝐭𝐬
𝐂𝐮𝐫𝐫𝐞𝐧𝐭 𝐑𝐚𝐭𝐢𝐨 =
margin of safety by which a 𝐂𝐮𝐫𝐫𝐞𝐧𝐭 𝐋𝐢𝐚𝐛𝐢𝐥𝐢𝐭𝐢𝐭𝐞𝐬
firm can Type equation here.
𝐏𝟑𝟗𝟓, 𝟔𝟎𝟎, 𝟎𝟎𝟎
meet its obligations falling 𝐂𝐮𝐫𝐫𝐞𝐧𝐭 𝐑𝐚𝐭𝐢𝐨 =
due within the year from such 𝐏𝟏𝟕𝟔, 𝟓𝟎𝟎, 𝟎𝟎𝟎
assets easily convertible into 𝐂𝐮𝐫𝐫𝐞𝐧𝐭 𝐑𝐚𝐭𝐢𝐨 = 𝟐. 𝟏𝟒
cash within the year.
𝐂𝐮𝐫𝐫𝐞𝐧𝐭 𝐀𝐬𝐬𝐞𝐭𝐬
It is widely believed that the current
𝐂𝐮𝐫𝐫𝐞𝐧𝐭 𝐑𝐚𝐭𝐢𝐨 = ratio of the firm is satisfactory when it
𝐂𝐮𝐫𝐫𝐞𝐧𝐭 𝐋𝐢𝐚𝐛𝐢𝐥𝐢𝐭𝐢𝐭𝐞𝐬
is 2 or better. This means that a
minimum 100 percent margin is
provided.
Substituting data from Exhibit A, the
acid test ratio will then appear as
Acid Test Ratio: follows:
Also called quick ratio, is the 𝐂𝐮𝐫𝐫𝐞𝐧𝐭 𝐀𝐬𝐬𝐞𝐭𝐬 − 𝐈𝐧𝐯𝐞𝐧𝐭𝐨𝐫𝐲
𝐀𝐜𝐢𝐝 𝐓𝐞𝐬𝐭 𝐑𝐚𝐭𝐢𝐨 =
ratio of cash assets to current 𝐂𝐮𝐫𝐫𝐞𝐧𝐭 𝐋𝐢𝐚𝐛𝐢𝐥𝐢𝐭𝐢𝐭𝐞𝐬
liabilities. It is calculated by 𝐀𝐜𝐢𝐝 𝐓𝐞𝐬𝐭 𝐑𝐚𝐭𝐢𝐨 =
𝐏𝟑𝟗𝟓, 𝟔𝟎𝟎, 𝟎𝟎𝟎 − 𝟏𝟐𝟗, 𝟓𝟎𝟎, 𝟎𝟎𝟎
deducting inventories from 𝐏𝟏𝟕𝟔, 𝟓𝟎𝟎, 𝟎𝟎𝟎
current assets and dividing 𝐀𝐜𝐢𝐝 𝐓𝐞𝐬𝐭 𝐑𝐚𝐭𝐢𝐨 = 𝟏. 𝟓
the remainder by current
liabilities. The answer 1.5 indicates that the mere
liquid assets of the firm is more
𝐂𝐮𝐫𝐫𝐞𝐧𝐭 𝐀𝐬𝐬𝐞𝐭𝐬 − 𝐈𝐧𝐯𝐞𝐧𝐭𝐨𝐫𝐲 enough to cover its current liabilities.
𝐀𝐜𝐢𝐝 𝐓𝐞𝐬𝐭 𝐑𝐚𝐭𝐢𝐨 =
𝐂𝐮𝐫𝐫𝐞𝐧𝐭 𝐋𝐢𝐚𝐛𝐢𝐥𝐢𝐭𝐢𝐭𝐞𝐬 The acid test is a more stringent test of
shorter, debt-paying capacity than the
current ratio because it excludes
inventory.
Sales to Receivable Ratio : Computing for Annual Turnover:
This ratio may be computed in
two ways: 𝐀𝐧𝐧𝐮𝐚𝐥 𝐍𝐞𝐭 𝐒𝐚𝐥𝐞𝐬
𝐀𝐧𝐧𝐮𝐚𝐥 𝐭𝐮𝐫𝐧𝐨𝐯𝐞𝐫 =
𝐀𝐜𝐜𝐨𝐮𝐧𝐭𝐬 𝐑𝐞𝐜𝐞𝐢𝐯𝐚𝐛𝐥𝐞
1. In terms of annual
turnover; and 𝐏𝟖𝟕𝟐, 𝟕𝟎𝟎, 𝟎𝟎𝟎
𝐀𝐧𝐧𝐮𝐚𝐥 𝐭𝐮𝐫𝐧𝐨𝐯𝐞𝐫 =
𝐏𝟏𝟒𝟔, 𝟐𝟎𝟎, 𝟎𝟎𝟎
2. In terms of collection
period 𝐀𝐧𝐧𝐮𝐚𝐥 𝐭𝐮𝐫𝐧𝐨𝐯𝐞𝐫 = 𝟔 𝒕𝒊𝒎𝒆𝒔

𝐀𝐧𝐧𝐮𝐚𝐥 𝐍𝐞𝐭 𝐒𝐚𝐥𝐞𝐬


𝐀𝐧𝐧𝐮𝐚𝐥 𝐭𝐮𝐫𝐧𝐨𝐯𝐞𝐫 =
𝐀𝐜𝐜𝐨𝐮𝐧𝐭𝐬 𝐑𝐞𝐜𝐞𝐢𝐯𝐚𝐛𝐥𝐞
When sales to receivables ratio Substituting data from the Exhibit A &
is computed in terms of B, above, the collection period is:
collection period, what is
determined is the average
length of time for which credit 𝐂𝐨𝐥𝐥𝐞𝐜𝐭𝐢𝐨𝐧 𝐏𝐞𝐫𝐢𝐨𝐝 =
𝟑𝟔𝟎 𝐝𝐚𝐲𝐬
is being extended by the 𝑺𝒂𝒍𝒆𝒔
𝑨𝒄𝒄𝒐𝒖𝒏𝒕𝒔 𝑹𝒆𝒄𝒆𝒊𝒗𝒂𝒃𝒍𝒆
business to its customers.
𝟑𝟔𝟎 𝐝𝐚𝐲𝐬
𝐂𝐨𝐥𝐥𝐞𝐜𝐭𝐢𝐨𝐧 𝐏𝐞𝐫𝐢𝐨𝐝 =
𝟑𝟔𝟎 𝐝𝐚𝐲𝐬 𝑷𝟖𝟕𝟐, 𝟕𝟎𝟎, 𝟎𝟎𝟎
𝐂𝐨𝐥𝐥𝐞𝐜𝐭𝐢𝐨𝐧 𝐏𝐞𝐫𝐢𝐨𝐝 = 𝑷𝟏𝟒𝟔, 𝟐𝟎𝟎, 𝟎𝟎𝟎
𝑺𝒂𝒍𝒆𝒔
𝑨𝒄𝒄𝒐𝒖𝒏𝒕𝒔 𝑹𝒆𝒄𝒆𝒊𝒗𝒂𝒃𝒍𝒆
𝐂𝐨𝐥𝐥𝐞𝐜𝐭𝐢𝐨𝐧 𝐏𝐞𝐫𝐢𝐨𝐝 = 60 days
Substituting data from Exhibit A & B
Sales Inventory Ratio: above, sales to inventory ratio is
This ratio is a measure of derived as follows:
inventory turnover. Firms
with excessive inventories will Sales Inventory 𝐑𝐚𝐭𝐢𝐨 =
𝐀𝐧𝐧𝐮𝐚𝐥 𝐑𝐞𝐜𝐞𝐢𝐩𝐭𝐬 𝐟𝐫𝐨𝐦 𝐒𝐚𝐥𝐞𝐬
𝐈𝐧𝐯𝐞𝐧𝐭𝐨𝐫𝐲 𝐚𝐭 𝐞𝐧𝐝 𝐨𝐟 𝐘𝐞𝐚𝐫
show a low ratio.
𝐏𝟖𝟕𝟐,𝟕𝟎𝟎,𝟎𝟎𝟎
Sales Inventory 𝐑𝐚𝐭𝐢𝐨 =
𝐏𝟏𝟐𝟗,𝟓𝟎𝟎,𝟎𝟎𝟎

Sales Inventory 𝐑𝐚𝐭𝐢𝐨 = 6.73 times


𝐀𝐧𝐧𝐮𝐚𝐥 𝐑𝐞𝐜𝐞𝐢𝐩𝐭𝐬 𝐟𝐫𝐨𝐦 𝐒𝐚𝐥𝐞𝐬
Sales Inventory 𝐑𝐚𝐭𝐢𝐨 =
𝐈𝐧𝐯𝐞𝐧𝐭𝐨𝐫𝐲 𝐚𝐭 𝐞𝐧𝐝 𝐨𝐟 𝐘𝐞𝐚𝐫
Inventory to Net Working Capital
Ratio:
Substituting data the Exhibit A, ratio is
 This ratio shows the proportion of derived as follows:
net current assets tied up in
inventory, including the potential Inventory to net working capital 𝐑𝐚𝐭𝐢𝐨 =
𝐈𝐧𝐯𝐞𝐧𝐭𝐨𝐫𝐲
𝐂𝐮𝐫𝐫𝐞𝐧𝐭 𝐀𝐬𝐬𝐞𝐭𝐬 − 𝐂𝐮𝐫𝐫𝐞𝐧𝐭 𝐋𝐢𝐚𝐛𝐢𝐥𝐢𝐭𝐢𝐞𝐬
loss to the company in the event of 𝐏𝟏𝟐𝟗,𝟓𝟎𝟎,𝟎𝟎𝟎
a decline in inventory values. It is Inventory to net working capital 𝐑𝐚𝐭𝐢𝐨 =
𝐏𝟑𝟗𝟓,𝟔𝟎𝟎,𝟎𝟎𝟎 −𝐏𝟏𝟕𝟔,𝟓𝟎𝟎,𝟎𝟎𝟎
calculated by dividing net working
capital into the inventory figure. Inventory to net working capital 𝐑𝐚𝐭𝐢𝐨 = 𝟎. 𝟓𝟗

Since the net working capital is


defined as current assets minus
current liabilities.

𝐈𝐧𝐯𝐞𝐧𝐭𝐨𝐫𝐲
Inventory to net working capital 𝐑𝐚𝐭𝐢𝐨 =
𝐂𝐮𝐫𝐫𝐞𝐧𝐭 𝐀𝐬𝐬𝐞𝐭𝐬 − 𝐂𝐮𝐫𝐫𝐞𝐧𝐭 𝐋𝐢𝐚𝐛𝐢𝐥𝐢𝐭𝐢𝐞𝐬
Activity Ratio: Sales to Net Worth Ratio:
 Ratios that are used to measure  Ratio of net sales to owner’s
how effectively the firm employs equity represents the turnover of
the resources at its command. owner’s equity.
Four classifications of Activity N𝐞𝐭 𝐬𝐚𝐥𝐞𝐬 𝐩𝐞𝐫 𝐩𝐞𝐬𝐨 𝐨𝐟 𝐎𝐄 =
𝐍𝐞𝐭 𝐒𝐚𝐥𝐞𝐬
𝐓𝐚𝐧𝐠𝐢𝐥𝐞 𝐎𝐰𝐧𝐞𝐫𝐬′ 𝐄𝐪𝐮𝐢𝐭𝐲
Ratios:
𝐏𝟖𝟕𝟐,𝟕𝟎𝟎,𝟎𝟎𝟎
1. Sales to receivable ratio N𝐞𝐭 𝐬𝐚𝐥𝐞𝐬 𝐩𝐞𝐫 𝐩𝐞𝐬𝐨 𝐨𝐟 𝐎𝐄 = 𝐏𝟐𝟖𝟏,𝟒𝟎𝟎,𝟎𝟎𝟎

2. Sales to inventory ratio N𝐞𝐭 𝐬𝐚𝐥𝐞𝐬 𝐩𝐞𝐫 𝐩𝐞𝐬𝐨 𝐨𝐟 𝐎𝐄 = 𝟑. 𝟏𝟎 𝐭𝐢𝐦𝐞𝐬

3. Inventory to net working capital


ratio
4. Sales to net worth ratio
Profitability Ratio: Profit to Net Sales:
 Are those which measure  Also called Profit Margin on Sales,
management’s effectiveness as is computed by dividing net
shown by the returns generated income after taxes by sales. The
on sales and investment. result is the profit margin
expressed in percentage. Using the
Ratios indicating profitability data from Exhibit B, the profit
consist of the following: margin for 2006 is computed as
1. Sales to inventory ratio follows:
𝐍𝐞𝐭 𝐈𝐧𝐜𝐨𝐦𝐞
2. Profit to net sales Profit Margin =
𝐒𝐚𝐥𝐞𝐬

3. Profit to net worth Profit Margin =


𝐏𝟒𝟕,𝟎𝟎𝟎,𝟎𝟎𝟎
𝐏𝟓𝟕𝟐,𝟕𝟎𝟎,𝟎𝟎𝟎
4. Profit to assets
Profit Margin = 𝟓%
Profit to Net Worth: Profit to Assets:
 Also referred to as return on net  Also called Return on Total Assets
worth ratio, measures the rate of Ratio. It measures on total
return on the owner’s investment. investment in the firm. It is
Using figures provided under computed as follows:
Exhibit A & B, the formula and
computation are provided as 𝐍𝐞𝐭 𝐈𝐧𝐜𝐨𝐦𝐞
R𝐞𝐭𝐮𝐫𝐧 𝐨𝐧 𝐧𝐞𝐭 𝐰𝐨𝐫𝐭𝐡 (𝟐𝟎𝟎𝟔) =
follows: 𝐓𝐨𝐭𝐚𝐥 𝐀𝐬𝐬𝐞𝐭𝐬
𝐏𝟒𝟕,𝟎𝟎𝟎,𝟎𝟎𝟎
𝐍𝐞𝐭 𝐈𝐧𝐜𝐨𝐦𝐞 R𝐞𝐭𝐮𝐫𝐧 𝐨𝐧 𝐧𝐞𝐭 𝐰𝐨𝐫𝐭𝐡 (𝟐𝟎𝟎𝟔) =
𝐏𝟓𝟔𝟑,𝟔𝟎𝟎,𝟎𝟎𝟎
R𝐞𝐭𝐮𝐫𝐧 𝐨𝐧 𝐧𝐞𝐭 𝐰𝐨𝐫𝐭𝐡 (𝟐𝟎𝟎𝟔) =
𝐍𝐞𝐭 𝐖𝐨𝐫𝐭𝐡

R𝐞𝐭𝐮𝐫𝐧 𝐨𝐧 𝐧𝐞𝐭 𝐰𝐨𝐫𝐭𝐡 (𝟐𝟎𝟎𝟔) =


𝐏𝟒𝟕,𝟎𝟎𝟎,𝟎𝟎𝟎 R𝐞𝐭𝐮𝐫𝐧 𝐨𝐧 𝐧𝐞𝐭 𝐰𝐨𝐫𝐭𝐡 𝟐𝟎𝟎𝟔 = 𝟖%
𝐏𝟐𝟖𝟏,𝟒𝟎𝟎,𝟎𝟎𝟎

R𝐞𝐭𝐮𝐫𝐧 𝐨𝐧 𝐧𝐞𝐭 𝐰𝐨𝐫𝐭𝐡 𝟐𝟎𝟎𝟔 = 𝟏𝟔%


SOLVENCY RATIOS Solvency ratio includes the
following:
1. Current ratio
• Refers to those which 2. Sales to inventory ratio
measure the ability of the firm
to pay its debt eventually, if it 3. Inventory to net working
is not paid on time.. capital ratio
4. Net worth to fixed assets
ratio
5. Sales to net worth ratio
Debt to Net Worth Ratio: Net Worth to Fixed Assets:
 This ratio shows the relative  This ratio indicates to what extent
proportion of debt to equity. In fixed assets have been financed by
effect, it measure the debt the contribution of the
exposure of the firm. stockholders. Using Exhibit 8 as a
𝐓𝐨𝐭𝐚𝐥 𝐃𝐞𝐛𝐭 basis, the ratio is calculated with
D𝐞𝐛𝐭 𝐭𝐨 𝐧𝐞𝐭 𝐰𝐨𝐫𝐭𝐡 (𝟐𝟎𝟎𝟔) = the use of a formula as follows:
𝐍𝐞𝐭 𝐖𝐨𝐫𝐭𝐡
𝐏𝟐𝟖𝟐,𝟐𝟎𝟎,𝟎𝟎𝟎
D𝐞𝐛𝐭 𝐭𝐨 𝐧𝐞𝐭 𝐰𝐨𝐫𝐭𝐡 (𝟐𝟎𝟎𝟔) = 𝐍𝐞𝐭 𝐖𝐨𝐫𝐭𝐡
𝐏𝟐𝟖𝟏,𝟒𝟎𝟎,𝟎𝟎𝟎 𝐍𝐞𝐭 𝐰𝐨𝐫𝐭𝐡 𝐭𝐨 𝐟𝐢𝐱𝐞𝐝 𝐚𝐬𝐬𝐞𝐭𝐬 =
𝐅𝐢𝐱𝐞𝐝 𝐀𝐬𝐬𝐞𝐭𝐬
D𝐞𝐛𝐭 𝐭𝐨 𝐧𝐞𝐭 𝐰𝐨𝐫𝐭𝐡 𝟐𝟎𝟎𝟔 = 𝟏𝟎𝟎% 𝐏𝟐𝟖𝟏, 𝟒𝟎𝟎, 𝟎𝟎𝟎
𝐍𝐞𝐭 𝐰𝐨𝐫𝐭𝐡 𝐭𝐨 𝐟𝐢𝐱𝐞𝐝 𝐚𝐬𝐬𝐞𝐭𝐬 =
𝐏𝟏𝟔𝟑, 𝟖𝟎𝟎, 𝟎𝟎𝟎

𝐍𝐞𝐭 𝐰𝐨𝐫𝐭𝐡 𝐭𝐨 𝐟𝐢𝐱𝐞𝐝 𝐚𝐬𝐬𝐞𝐭𝐬 = 𝟏𝟕𝟏%


COMPARATIVE RATIO ANALYSIS
• Financial ratios may be made more useful by comparing the to the
financial ratios of the other firms in the industry.
• If the firm’s ratio is different from that of the industry, the cause of the
deviation should be investigated.
• Comparisons may be made either with those of selected firms or with
averages for the industry.
• The publication requirements imposed on financial intermediaries
also provide the analyst with ready materials.