Measurement levels

LIQUIDITY
refers to the company’s ability to
satisfy its short-term obligations as
they come due.
Two Types of Liquidity Ratios
Company Current ratio Quick ratio

JFC 1.26 .95

PETRON 1.08 .82

GLOBE .77 .72
PROFITABILITY
refers to the company’s ability to
generate earnings.
It is one of the most important
goals of businesses.
Return on equity measures the amount of net income earned in relation to
stockholders’ equity. • ROE (return on equity) = Net income ÷ Stockholders’
equity
• Return on assets measures the ability of a company to generate income out of
its resources/assets. • ROA (return on asset) = Operating income ÷ Total assets
• Gross profit margin shows how many pesos of gross profit is earned for every
peso of sale. It provides information regarding the ability of a company to cover
its manufacturing cost from its sales. Remember that gross profit is just sales
less cost of goods or cost of services. • Gross profit margin = Gross profit ÷ Sales
• Operating profit margin shows how many pesos of operating profit is earned
for every peso of sale. It measures the amount of income generated from the
core business of a company. • Operating profit margin =Operating income ÷
Sales
• Net profit margin measures how much net profit a company generates for
every peso of sales or revenues that it generates. • Net profit margin = Net
income ÷ Sales
 EFFICIENCY

• refers to a company’s ability to be efficient

in its operations.
• Specifically, it refers to the speed with which
various current accounts are converted into
sales, and ultimately, cash.
Inventory turn over
= Cost of goods sold/ inventory
Average age of inventory
= 356/inventory turn over
Accounts payable turn over
= purchases/accounts payable
Average payment turn over
= 365/accounts payable turn over
operating cycle
= average collection payment + Average Age of Inventory
(Easy)
• Total asset is PHP750,000. Sales is PHP1,500,000. What
is the total asset turnover?
• Accounts receivable turnover is 4. What is the average
collection period assuming annual data are used? What is
the average collection period assuming quarterly data are
used?
• Sales for the year amount to PHP100,000. Accounts
receivable amount to PHP12,000. What is the average
collection period assuming annual data are used? What is
the average collection period assuming quarterly data are
(Average/Difficult)
A. The quick ratio is 1.7 while the current ratio is 2.5. The current liabilities
amount to PHP5,000. Cost of goods sold is PHP52,500. What is the inventory
turnover? Average age of inventory?
B. Beginning inventory is PHP2,000 while ending inventory is PHP5,000. Cost of
goods sold is double the ending inventory and accounts payable is PHP4,000.
What is accounts payable turnover? Average payment period?
C. Ending inventory is PHP13,000 while accounts payable is PHP2,500. Purchases
were half the ending inventory. What is accounts payable turnover? Average
age of payables?
D. Current assets amount to PHP30,000 while noncurrent assets are PHP50,000.
Sales amount to PHP200,000. What is the total asset turnover?
E. Based on your answers from letters c, d, and e, what is the operating cycle of
the company? Cash conversion cycle?
Answer Key:
• Total asset turnover = 1.5M/750K = 2
• Average collection period: 365/4 = 91.25
• Average collection period = 43.8 days, Accounts receivable turnover =
8.3x
• Inventory turnover = 13.1x, Average age of inventory = 27.8 days
• Accounts payable turnover = 3.25x, Average payment period = 112.3 days
• Accounts payable turnover = 2.6x, Average age of payables = 140.4 days
• Total asset turnover = 2.5x
• Operating cycle = 71.6 days, Cash conversion cycle = (40.7) days
financial leverage
• refers to the company’s use of debt.
•It defines the company’s capital
structure which indicates how much of
the total assets are financed by debt and
equity.
TYPES OF LEVERAGE RATIOS
• Debt ratio – This ratio measures the proportion of total assets finance
by total liabilities or money provided by creditors (not by the business
owners).
• Debt-to-equity ratio – A variation of debt ratio, shows the proportion
of debt to equity.
• Interest coverage ratio – This ratio shows the company’s ability to pay
its fixed interest charges in relation to its operating income or
earnings before interest and taxes
Factors that can influence management’s
decision in setting its capital structure.
• Nature of Business
• Stage of Business Development
• Macroeconomic conditions
• Prospects of the industry
• Taxes
• Management style
Nature of Business – If the business is risk then it has to be financed conservatively
hence, lower debt ratio.
State of Business Development – A newly formed business may have difficulty
borrowing from banks. Banks usually look for the historical financial performance
of borrowers.
Macroeconomic conditions – If the overall economy is good then management can
be more aggressive on taking in risk through increased debt financing.
Prospects of the industry – A growing industry makes business more confident to
take on more financial risk.
Taxes - Interest expenses are tax deductible while cash dividends are not. By having
more debt than equity, businesses save on taxes as interest expense (multiplied by
the tax rate) decreases income tax due.
Management style –Management and the board of directors can be aggressive o
1. Total assets is 100,000. Total debt is 50,000. What is the debt-to-equity ratio?
 Vertical Analysis or common size analysis
 This is a technique for evaluating the data of financial statements that express each
item within a financial statement in terms of a percent of a base amount.
For the Statement of Financial Position or Balance Sheet, all accounts are presented
as a percentage of total assets.
For the statement of Profit or Loss or Income Statement, all accounts are presented
as a percentage of net sales.
In using this type of analysis, attention must be focused on items with significant
changes from one period to another. Depending on the nature of the business, it is
possible that even a slight change in the percentage may warrant the attention of
top management.
For example, a reduction of 0.5% in the gross profit margin of a consumer based
company with annual sales of PHP 200 billion translate to a PHP 1 billion in gross
profit.
 HORIZONTAL ANALYSIS
This is also known as trend analysis.
To establish the trend, percentage changes of
accounts from one period to another have to be
made.
To compute:
Amount of change = Current year amount – Base (earlier) year amount
Percent of change = Amount of change/Base (earlier) year amount
Some of the more important accounts to
monitor when doing trend analysis are the
following:
• Sales
• Operating profits
• Total assets
• Interest bearing liabilities
• Interest expense