Review of Financial

Statement Preparation,
Analysis, and Interpretation
Parts 2, 3 & 4
Week 7
Business case:

Zapatoes, Inc
Anthony Cruz owns Zapatoes, Inc., a home-grown
Filipino shoe company. His company has
experienced tremendous growth since it started its
operations in 2009. With a growing demand for his
products, Anthony Cruz is considering expanding his
operations by opening his first production facility.
• Currently, he pays another company to
manufacture the shoes he designs. He
is contemplating producing the shoes
Zapatoes, Inc. facility, with the hope of
lowering the cost of production.
• The company needs PHP10 million to
finance this expansion and is in a tight cash
position. Anthony Cruz is now wondering
where to get the funds needed – invite an
investor or personally borrow from a bank?
Here are the comparative
financial statements of
Zapatoes, Inc.:
 Financial Financial
Position: Performance:
• is a snapshot of the • a subjective
finances of an measure of how well
organization as of a
particular date. It
a firm can use assets
provides an overview of from its primary
how well the company mode of business
manages its assets and and generate
liabilities. revenues.
 EQUITY
2013
22%
2015
2014
2015 2013
48%

2014
30%
• Zapatoes, Inc. sold 3,300 pairs in
2013, 4,500 pairs in 2014, and 6,200
pairs in 2015. With the brand’s target
market – young professionals and
college students, it can only sell it at
the PHP1,000 to PHP2,000 price range
per pair.
• Anthony is wondering whether owning
his own manufacturing facility can
really improve its profitability.
Currently, he is producing his shoes at
PHP475 pesos per pair. He expects that
he can lower production costs to as
much as PHP300 per pair if he will
manufacture it himself.
• However, opening a new production
facility will increase operating
expenses (including depreciation)
by 30%. Currently, most of his
operating expenses are marketing
and distribution costs.
• To finance the PHP10 million facility, he has three
options:
• •Accept a PHP10 million equity investment from
his friend, Alex. Alex will hold 45% percent
ownership of the business afterwards. Alex does
not demand any specific return.
• •Short-term loan for 1 year for PHP10 million at
6% per annum from Shor time Bank.
• •Long-term loan for 5 years for PHP10 million at
10% per annum from Longly Bank
• Anthony is very confident that his
sales volume will still grow for the
next 5 years. However, his
confidence is tainted by his
uncertainties over the impact of
opening a new production facility.
What must he do?
Part 3
(Liquidity)
 Four Main Categories Of
Financial Ratios
• LIQUIDITY
• refers to the company’s ability to
satisfy its short-term obligations as
they come due. Refer back to the
household example to emphasize the
meaning of liquidity.
Types of liquidity ratios:
Exercises:
• •Current assets is PHP2,000, current liabilities is PHP3,500. What is
the current ratio?
• •Inventory is PHP150. Accounts payable is PHP450. Cash and accounts
receivable total PHP800. What is the current ratio? Quick ratio?
• •If the current ratio is 1.7, what is the total accounts receivable if cash
is PHP20,000, inventory is PHP7,500 and accounts payable is
PHP30,000?
• •Cash is 30% of total current assets. If the current ratio is 2.3, what is
the new current ratio if total non-cash current assets grow by 50%?
 Answer Key:

• •Current ratio: 2,000/3,500 = 0.57

• •Current ratio: (800 + 150)/450 = 2.11
• Quick ratio: 800/450 = 1.78
• •Total receivables: 1.7= (X+20,000+7500)/30,000 = 23,500
• •Current ratio: 2.3 = (6,900 + 16,100)/10,000 Assuming an
increase in noncurrent assets of 50% New current ratio:(6,900
+ 24,150)/10,000 = 3.105 Use hypothetical numbers to
compute.
 Here are the condensed
financial statements of the
three companies as of
December 31, 2014
Exercises:
• 1. Compute the ratios of the sample companies
and compare the three companies using the ratios
computed.
JFC PETRON GLOBE
Current Ratio
Quick Ratio
• 2. What are the possible reasons why
the sample companies have different
ratios? What could have possibly
caused these differences? What are the
implications?
 Part 4
(Profitability)
• Profitability
• refers to the company’s ability
to generate earnings. It is one
of the most important goals of
businesses.
• These are the return on equity,
return on assets, gross profit
margin, operating profit
margin, and net profit margin.
• •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 costs from its sales. Remember that gross
profit is just sales less the 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 ÷ Sale
 sample financial statement:
compute for the financial ratios.
Here is an extract of the statements of
the financial position of the three
companies as of December 31, 2014.
 Here is the condensed statement of financial
performance of the three companies for the year
ended December 31, 2014
Exercises: (during class)

• 1. Compute the ratios of the sample companies

and compare the three companies using the ratios
computed.
• 2. What are the possible reasons why the sample
companies have different ratios? What could have
possibly caused these differences? What are the
implications?
 Activity 7 (30 pts.)
• 1. Why it is important to use profitability ratios?
• 2. What other factors would a bank or supplier
look into in deciding whether to lend short-term
credit?
• 3. Which ratio is more relevant - quick ratio or
current ratio?