Fundamentals of

Accountancy, Business
and Management 2
ASSIGNMENT:

A. Prepare a common-size Statement of Comprehensive Income for 2014 and 2013 for Abakada
Trading Company

B. Prepare a horizontal analysis for Abakada Trading Company

Checking of Assignment:

✔️20pts.
Jhasli Anne
Andrei Micah ✔️20pts.
Daniela ✔️20pts.
Jamaica ✔️19 pts.
Review Activity

2013

Requirements:
a. Prepare a common-size Statement of Financial Position for 2014 and 2013 for Ilang-Ilang Trading Company.
b. Prepare a horizontal analysis for Ilang-Ilang Trading Company.
Solution:
Chapter 6
Analysis and Interpretation of
Financial Statement 2
 Expresses the relationship among selected items of
financial statement data. The relationship is expressed in
terms of a percentage, a rate, or a simple proportion
(Weygandtet.al. 2013). A financial ratio is composed of a
Financial numerator and a denominator. For example, a ratio that
divides sales by assets will find the peso amount of sales
Ratio generated by every peso of asset invested. This is an
important ratio because it tells us the efficiency of invested
asset to create revenue. This ratio is called asset turnover.
There are many ratios used in business. These ratios are
generally grouped into three categories:
(a) profitability, (b) efficiency, and (c) financial health.
 Take for example a company with sales of P1,000,000 and net
income of P100,000. If we take the ratio of net income divide by
sales, the results is 10% . We can understand this as “net income is
10% of sales”. We can look at it as a rate or proportion. For every
P1.oo of sales that the company generate, it earns P.10 of net
income.

To organize our study of financial ratios, we will divide this

chapter based on the performance indicator being measured
namely profitability, operational efficiency, financial health.
Profitability measure the ability of the company to generate income from
the use of its assets and invested capital. The company's
Ratios ability to control its cost is also inferred from profitability
ratios.
Refer to
Table 1 for
a list of
ratios
classified as
profitability
measures.
Gross profit margin reports the peso value of the gross profit earned for
every peso of sales. We can infer the average pricing policy from the
gross profit margin. For example, if the gross profit margin is 60% then
cost of goods sold is 40% of sales. This means that the company
establishes its selling price by adding a mark-up of 150% (60%/40%) of
cost. If the company bought the inventory at P100 per unit, the mark-up
is P150 (P100 X 150%) and the selling price is P250. Check the gross profit
rate in this example. Gross profit is P150 (P250 - P100) and the rate is
P150/P250 = 60%.
Gross profit
Formula: Gross profit margin= Net sales
Operating profit margin expresses operating income as a percentage of sales. It is the
peso value of the operating income earned for every peso of sales. Operating income is
computed as gross profit less operating expenses. Therefore, between two companies
with the same gross profit margin, the company with the better operating income margin
has leaner operations. In business, leaner operations imply lower operating expenses as a
percentage of sales.
Operating income
Formula: Operating profit margin= Net sales
Net profit margin expresses net income as a percentage of sales. It can be interpreted as
the peso value of the net income earned for every peso of sales. A company with a higher
net profit margin is considered more profitable. Recall from Chapter 2 that the difference
between operating and net income are other income and other expenses. Therefore,
between two companies with the same level of operating profit margin, the company with
higher net profit margin may have lower interest expense (other expenses) or higher other
income (as a percentage of sales)
Net income
Formula: Net profit margin=
Net sales
Return on Assets

Also known as ROA, return on asset is computed as net income divided by average
total assets. ROA can also be computed using the ending balance of total assets instead of
average total assets. It is a popular measure of the profitability of the company's assets. It
also measures the company's efficiency to generate income by employing its assets. In
comparing companies, the company with a higher ROA is judged to be more profitable.
(Average assets is computed as beginning balance + ending balance divided by 2.)

Net income
Formula: Return on assets = Average assets
Return on Equity

ROE or return on equity is computed as net income divided by average total equity.
Like return on assets, ROE can also be computed using the ending balance of equity. It
measures the return (net income) generated by the capital invested by the owner in the
business. Like ROA, the company with a higher ROE is judged to be more profitable.

Formula: Return on equity = Net income

Average equity
Compute for the company’s Profitability Ratio:
Solutions:
Operational measures the ability of the company to utilize its assets.
Operational efficiency is measured based on the company’s
Efficiency ability to generate sales from the utilization of its assets, as a
whole or individually. The turnover ratios are primarily used
Ratio to measure operational efficiency.
Refer to Table
2 for a list of
ratios for
measuring
operational
efficiency.
Asset turnover measures the peso value of sales generated for every peso of the
company’s assets. The higher the turnover rate, the more efficient the company is in
using its assets.
Net sales
Formula: Asset turnover = Average assets

Fixed asset turnover is indicator of the efficiency of fixed assets in generating sales.
Net sales
Formula: Fixed asset turnover =
Average fixed Asset

Inventory turnover is measured based on cost of goods sold and not sales. As such both
the numerator and denominator of this ratio are measured at cost. It is an indicator of
how fast the company can sell inventory. An alternative to inventory turnover is “days in
inventory”. This measures the number of days from acquisition to sale.
Formula: Inventory turnover = Cost of Goods Sold
Average Inventory
Accounts receivable turnover measures the number of times the company was able to
collect on its average accounts receivable during the year. An alternative to accounts
receivable turnover is “days in accounts receivable”. This measures the company’s
collection period which is the number of days from sale to collection.

Formula: Accounts Receivable turnover = Net Sales

Average Accounts Receivable
Compute for the company’s Operational Efficiency Ratio
Solutions:

1,400,000

228.13
1.60
Assignment: Compute for the company’s profitability and operating efficiency ratios for 2014.

3,100,000
Financial To evaluate the financial health of a business, we will look into
the company’s solvency and liquidity ratios. Solvency refers to
Health the company’s capacity to pay their long term liabilities. On the
other hand, liquidity ratio intends to measure the company’s
Ratios ability to pay debts that are coming due (current liabilities).
 Solvency Ratios

Refer to Table 3
for a list of
ratios for
measuring
Financial Liquidity Ratios
Health ratios.
 SOLVENCY RATIOS

Debt to equity ratio indicates the company’s reliance to debt or liability as a source
of financing relative to equity. A high ratio suggests a high level of debt that may
result in high interest expense.

Total Debt
Debt to equity ratio =
Equity

Debt ratio indicates the percentage of the company’s assets that are financed by
debt. A high debt to asset ratio implies a high level of debt.
Total Debt
Debt ratio =
Total Assets
Equity ratio indicates the percentage of the company’s assets that are financed by
capital. A high equity to asset ratio implies a high level of capital.

Equity ratio = Total Equity

Total Assets

Interest coverage ratio measures the company’s ability to cover the interest expense
on its liability with its operating income. Creditors prefer a high coverage ratio to give
them protection that interest due to them can be paid.
Operating Income
Interest coverage ratio =
Interest Expense
 LIQUIDITY RATIOS

Current ratio is used to evaluate the company’s liquidity. It seeks to measure whether
there are sufficient current assets to pay for current liabilities. Creditors normally
prefer a current ratio of 2.
Current Assets
Current ratio =
Current Liabilities

Quick ratio is a stricter measure of liquidity. It does not consider all the current assets,
only those that are easier to liquidate such as cash and accounts receivable that are
referred to as quick assets. A quick ratio of 1 is acceptable.

Quick Assets
Quick ratio =
Current Liabilities
Compute for the company’s Financial Health Ratio
Solution:

%
Activity: Compute for the company’s financial health ratios for 2014.

3,100,000