ANALYSIS OF

FINANCIAL STATEMENTS

As mentioned in chapter 9 “the objective of financial statements is to provide

information about the financial position, performance, and changes in financial position
of an entity that is useful to a wide range of users in making economic decisions.”
Merely reading and understanding the financial statement per se is not enough. A
thorough analysis and interpretation of such statements is necessary if management
and other users are expected to make informed judgments and decisions. The
information derived from financial statement analysis can be used in assessing and evaluating the firm’s past
performance, its present condition and future business potentials.

Financial statement analysis is the process of identifying financial strengths and

weaknesses of the firm by properly establishing relationship between the items in
the financial statements and other related information to arrive at an
evaluation and conclusion as to the soundness of the financial position and the results of operations of an
enterprise.

Analysis of a business is a broader evaluating activity focusing on the strengths and weaknesses of an enterprise
based on internal factors and relating such to the problems and opportunities as perceived based on external
factors. Analysis of financial statements, on the other hand, limits the evaluation to the data in the financial
statements and other related information.

THREE TYPES OF COMPARISONS

Items from financial statements are usually not particularly informative when viewed in isolation. In assessing the
financial performance of a company, managers are interested in making comparison with the results of other
periods, items with significant items, the different units and, most often, with the results of other companies.
There are three (3) types of comparisons to improve the decision usefulness of financial information.

A. Intra-company basis. Comparisons within a company are often useful to detect changes in financial
relationships and significant trends. For example, a comparison of the company’s current year’s cash amount
with the prior year’s cash amount shows either an increase or decrease. Likewise, a comparison of the
company’s year-end cash amount with the amount of its total assets at year-end shows the proportion of
total assets in the form of cash.

B. Inter-company basis. Comparisons with other companies provide insight into a company’s competitive
position. For example, Jollibee’s total sales for the year can be compared with the total sales of its
competitors in the fastfood area, such as McDonalds and Jollibee.

C. Industry averages. Comparisons with industry averages provide information about a company’s relative
position within the industry. The ratios of a firm are compared with those of similar firms or with industry
averages or norms to determine how the company is faring relative to its competitors. For example, Levi’s
Straus’ financial data can be compared with the averages for its industry compiled by financial ratings

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 organizations such as Reuters, Dun (Dun’s Review) & Bradstreet (Key Business Ratios), Robert Morris
Associates (Annual Statement Studies), Moody’s, Yahoo!, and Standard & Poor’s.

METHODS AND TECHNIQUES IN ANALYSIS

Three (3) basic approaches are often used to compare financial statements between companies, between
different years, different items, or performances by units for the same company: horizontal (trend) analysis,
vertical (common-size) analysis, and ratio analysis. These basic tools are used in comparative analysis to highlight
the significance of financial statement data. Following are the most important tools and techniques of financial
statement analysis:

I. HORIZONTAL OR TREND ANALYSIS. This is an analytical method by which comparative statements are
presented to show changes in each item as of different dates or for different period as a means of
determining improvement or deterioration of the financial condition or results of operations of a business
enterprise.

A. Increase/Decrease Method. It highlights the peso as well as the percentage increase or decrease of
each item in the comparative statements. The percentage change in comparative statements is
computed by doing these steps:

1. Compute the difference between the amount for a comparison year and the amount of a base
(earlier) year.

PESO CHANGE = Amount in Comparison year - Amount in Base year

2. Divide the peso amount of change computed in (1) by the amount of the base year. However,
this is not done if the base year figure is negative or zero.

% CHANGE = PESO CHANGE

x 100
AMOUNT IN BASE YEAR

This method only enables the analyst to compare financial statements for two accounting
periods.

B. Trend Percentages or Index Numbers. The changes in financial statement items from a base year
to following years are often expressed as trend percentages to show the extent and direction of
change. It emphasizes changes that have occurred from period to period and are useful in
comparing data covering several years. To compute for trend percentages, these steps are followed:

1. A base year is selected and each item in the financial statements for the base year is
given a weight of 100%.

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 2. Express each item in the financial statements for following years as percentage of its
base year amount. This is done by dividing an item in the years after the base year by the
amount of such item in the base year.

TREND % = AMOUNT IN COMPARISON YR

x 100
AMOUNT IN BASE YEAR

This method is used in comparing data from financial statements of more than two years.

To illustrate, the comparative statement of financial position and statement of comprehensive income of PRUTAZ
Corporation for two years taken from Chapter 9 are shown below and on the next pages

A. HORIZONTAL ANALYSIS: INCREASE (DECREASE) METHOD

PRUTAZ Corporation
Comparative Statement of Financial Position
As of December 31, 2013 and 2014

INCREASE(DECREASE)
Assets 2014 2013 Amount %
Current Assets
Cash and cash equivalents P 202,600 P 160,000 42,600 26.63
Trade receivables, net 300,000 180,000 120,000 66.67
Merchandise inventory 320,000 400,000 (80,000) (20.00)
Total P 822,600 P 740,000 82,600 11.16
Non-current Assets
Property, plant and equipment, net P 355,000 P 550,000 (195,000) (35.45)
Investment in equity securities 325,000 300,000 25,000 8.33
Goodwill 250,000 250,000 - -
Total P 930,000 P1,100,000 (170,000) (15.45)
Total Assets P1,752,600 P1,840,000 (87,400) (4.75)

Liabilities and Shareholders’ Equity

Current Liabilities
Accounts payable P 150,000 P 80,000 70,000 87.5
Income tax payable 290,000 330,000 (40,000) (12.12)
Total P 440,000 P 410,000 30,000 7.32
Non-current liabilities
Bonds payable 300,000 500,000 (200,000) (40.00)
Total Liabilities P 740,000 P 910,000 (170,000) (18.68)
Shareholders’ equity
Ordinary share capital,P10 par P 500,000 P 500,000 - -
Reserves 255,000 230,000 25,000 10.87
Accumulated profits 257,600 200,000 57,600 28.80
Total shareholders’ equity P1,012,600 P 930,000 82,600 8.89
Total liabilities and shareholders’ equity P1,752,600 P1,840,000 (87,400) (4.75)

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 PRUTAZ Corporation
Comparative Statement of Comprehensive Income
For the Years Ended, December 31, 2013 and 2014
INCREASE(DECREASE)
2014 2013 AMOUNT %
Net sales P7,000,000 P5,950,000 1,050,000 17.65
Less: Cost of sales 5,920,000 4,960,000 960,000 19.35
Gross Profit P1,080,000 P 990,000 90,000 9.09
Less: Operating Expenses
Selling expenses P 540,000 P 490,000 50,000 10.20
Administrative expenses 160,000 147,000 13,000 8.84
Total P 700,000 P 637,000 63,000 9.89
Net operating income P 380,000 P 353,000 27,000 7.65
Less: Interest expense 60,000 60,000 - -
Net income before taxes P 320,000 P 293,000 27,000 9.22
Less: Income taxes (30%) 96,000 87,900 8,100 9.22
Net income after tax P 224,000 P 205,100 18,900 9.22
Add: Other comprehensive income
Unrealized gain on investment on
equity securities 25,000 - 25,000 -
Comprehensive income P 249,000 P 205,100 43,900 21.40

B. HORIZONTAL ANALYSIS: TREND PERCENTAGES

PRUTAZ Corporation
Comparative Statement of Financial Position
As of December 31, 2013 and 2014
( in %)

Assets 2014 2013

Current Assets
Cash and cash equivalents 126.63 100
Trade receivables, net 166.67 100
Merchandise inventory 80.00 100
Total 111.16 100
Non-current Assets
Property, plant and equipment, net 64.55 100
Investment in equity securities 108.33 100
Goodwill 100.00 100
Total 84.55 100
Total Assets 95.25 100

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 2014 2013
Liabilities and Shareholders’ Equity
Current Liabilities
Accounts payable 187.50 100
Income tax payable 87.88 100
Total 107.32 100
Non-current liabilities
Bonds payable 60.00 100
Total Liabilities 81.32 100
Shareholders’ equity
Ordinary share capital,P10 par 100.00 100
Reserves 110.87 100
Accumulated profits 128.80 100
Total shareholders’ equity 108.89 100
Total liabilities and shareholders’ equity 95.25 100

PRUTAZ Corporation
Statement of Comprehensive Income
For the Years Ended, December 31, 2013 and 2014
( in %)

2014 2013
Net sales 117.65 100.00
Less: Cost of sales 119.35 100.00
Gross Profit 109.09 100.00
Less: Operating Expenses
Selling expenses 110.20 100.00
Administrative expenses 108.84 100.00
Total 109.89 100.00
Net operating income 107.65 100.00
Less: Interest expense 100.00 100.00
Net income before taxes 109.22 100.00
Less: Income taxes (30%) 109.22 100.00
Net income after tax 109.22 100.00
Add: Other comprehensive income
Unrealized gain on investment on equity securities
Comprehensive income 121.40 100.00

II. VERTICAL ANALYSIS. This is a technique, also known as common-size analysis, for evaluating financial
statement data that expresses each item in a financial statement within a year as percent of a base amount.
It is an analysis in which a statistic is calculated for the relationship between two items on a single financial
statement. The formula is:

% = AMOUNT OF LINE ITEM

x 100
BASE ITEM AMOUNT

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 Vertical analysis is the procedure of preparing and presenting common size statements. Common-
size financial statement or 100% statement is one that shows the items appearing on it in percentage form
as well as in peso form. Each item is stated as a percentage of some total of which that item is a part.
Key financial changes and trends can be highlighted by the use of common size statements.

a. Common-size statement of financial position - TOTAL ASSETS represent 100%. Other items in the
statement of financial position are expressed as percentages of total assets by dividing each item
by the total assets.

b. Common-size statement of comprehensive income - NET SALES or NET OPERATING REVENUE is

set at 100%. Each item in the statement of comprehensive income is divided by net sales/net
operating revenue to express these items as percentage of net sales.

To illustrate, the common-size statement of financial position and statement of comprehensive income of
PRUTAZ Corporation are shown below and the next page.

PRUTAZ Corporation
Common-size Statement of Financial Position
As of December 31, 2013 and 2014

Assets 2014 % 2013 %

Current Assets
Cash and cash equivalents P 202,600 11.56 P 160,000 8.70
Trade receivables, net 300,000 17.12 180,000 9.78
Merchandise inventory 320,000 18.26 400,000 21.74
Total P 822,600 46.94 P 740,000 40.22
Non-current Assets
Property, plant and equipment, net P 355,000 20.26 P 550,000 29.89
Investment in equity securities 325,000 18.54 300,000 16.30
Goodwill 250,000 14.26 250,000 13.59
Total P 930,000 53.06 P1,100,000 59.78
Total Assets P1,752,600 100.00 P1,840,000 100.00

Liabilities and Shareholders’ Equity

Current Liabilities
Accounts payable P 150,000 8.56 P 80,000 4.35
Income tax payable 290,000 16.55 330,000 17.93
Total P 440,000 25.11 P 410,000 22.28
Non-current liabilities
Bonds payable 300,000 17.12 500,000 27.17
Total Liabilities P 740,000 42.22 P 910,000 49.46
Shareholders’ equity
Ordinary share capital,P10 par P 500,000 28.53 P 500,000 27.17
Reserves 255,000 14.55 230,000 12.50
Accumulated profits 257,600 14.70 200,000 10.87
Total shareholders’ equity P1,012,600 57.78 P 930,000 50.54
Total liabilities and shareholders’ equity P1,752,600 100.00 P1,840,000 100.00

PRUTAZ Corporation

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 Common-size Statement of Comprehensive Income
For the Years Ended, December 31, 2013 and 2014

2014 % 2013 %
Net sales P7,000,000 100.00 P5,950,000 100.00
Less: Cost of sales 5,920,000 85.57 4,960,000 83.36
Gross Profit P1,080,000 15.43 P 990,000 16.64
Less: Operating Expenses
Selling expenses P 540,000 7.71 P 490,000 8.24
Administrative expenses 160,000 2.29 147,000 2.47
Total P 700,000 10.00 P 637,000 10.71
Net operating income P 380,000 5.43 P 353,000 5.93
Less: Interest expense 60,000 0.86 60,000 1.01
Net income before taxes P 320,000 4.57 P 293,000 4.92
Less: Income taxes (30%) 96,000 1.37 87,900 1.48
Net income after tax P 224,000 3.20 P 205,100 3.45
Add: Other comprehensive income
Unrealized gain on investment on equity
securities 25,000 0.36 - -
Comprehensive income P 249,000 3.56 P 205,100 3.45

III. RATIO ANALYSIS. These are percentages, turnovers, or ratios expressing the relationship between
selected items derived from the statement of financial position or from the statement of comprehensive
income or from both. Since the financial statements are fundamentally related, we also have to relate
information contained in one statement with the related information found in another. This is called inter-
financial statements analysis or simply financial mix ratio analysis. As indicators of profitability, liquidity,
growth and leverage, they are used to determine the possible areas of weaknesses and strengths of an
organization in comparison with a standard. All examples are taken from the data of PRUTAZ CORPORATION.

A. LIQUIDITY /SHORT-TERM SOLVENCY RATIOS

Liquidity ratios measure the ability of a company to meet its current obligation. Following are the most important
liquidity ratios:

1. Current Ratio. The current ratio is another way to express the relation between current assets and current
liabilities. This ratio is also known as "working capital ratio". It is computed as follows:

Current Ratio = Current Assets

Current Liabilities

DEFINE WORKING CAPITAL (CA-CL)

Significance: A ratio equal to or near 2 : 1 is considered as a standard or normal or satisfactory. The idea of
having double the current assets as compared to current liabilities is to provide for the delays and losses in
the realization of current assets. However, the rule of 2 :1 should not be blindly used while making
interpretation of the ratio. This is because of the reason that current ratio measures the quantity of the
current assets and not the quality of the current assets. A current ratio of less than 1 may be considered

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 unacceptable since in that case current liabilities would exceed current assets—a warning that there may
soon be a cash flow problem.
Example:
2014 2013
Current Assets 822,600 740,000
Divided by: Current Liabilities 440,000 410,000
Current Ratio 1.87 1.80

2. Liquid / Acid Test / Quick Ratio. It is used as a complementary ratio to the current ratio. The acid-test ratio
is a more rigorous test of a company’s ability to meet its short-term debts than the current ratio since it
excludes less liquid current assets such as inventories and prepaid expenses. It measures the firm’s ability to
pay off short-term obligations without relying on the sale of inventories. The acid-test ratio is computed as
follows:

Acid Test Ratio = Current Assets – Inventories - Prepayments

Current Liabilities

Significance: Usually a high liquid ratio is an indication that the firm is liquid and has the ability to meet its
current or liquid liabilities in time and on the other hand a low liquidity ratio represents that the firm's
liquidity position is not good. As a convention, generally, a quick ratio of "one to one" (1:1) is considered to
be satisfactory.
Example:
2014 2013
Quick Assets 502,600 340,000
Divided by: Current Liabilities 440,000 410,000
Quick Ratio 1.14 0.83

B. ACTIVITY / EFFICIENCY RATIOS

Activity ratios are calculated to measure the efficiency with which the resources of a firm have been employed.
These ratios are also called turnover ratios because they indicate the speed with which assets are being turned
over into sales. Following are the most important activity ratios:

1. Accounts Receivable Turnover. Accounts receivable turnover is a measure of how quickly accounts
receivables are turned into cash or how quickly receivables are collected. Accounts receivable turnover in
days provides information about the number of days the average balance of accounts receivable is
outstanding before cash is collected. Note that current receivables include any notes receivable as well as
accounts receivable.

Accounts Receivable TO = Sales on Account

Average Accounts Receivable**
1.
2.
3.
4.

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 **Average Accounts receivable = (Accts Receivable, beg + Accts Receivable, end)/2

Significance: Accounts receivable turnover ratio or debtors’ turnover ratio indicates the number of times the
receivables are turned over a year. The higher the value of receivables turnover the more efficient is the
management of debtors or more liquid the debtors are.
Example:
2014
Net Sales 7,000,000
Divided by: Ave. Accounts Receivable
(180,000 + 300,000)/2 240,000
A/R Turnover 29.17

2. Average Collection Period. This ratio is used to evaluate credit management and account collection
practices.

Ave Collection Period = 360 days

Accounts Receivable Turnover

Significance: This ratio measures the quality of debtors. A short collection period implies prompt payment
by debtors. It reduces the chances of bad debts. Similarly, a longer collection period implies too liberal and
inefficient credit collection performance. An increase in the accounts receivable turnover (and a decrease in
the average collection period) would usually be considered favorable.
Example:
2014
No. of days in a year 360
Divided by: A/R turnover 29.17
Ave. Collection period in Days 12.34

3. Inventory Turnover. The inventory turnover ratio measures how quickly inventory is converted into sales.
Inventory turnover in days provides information about the number of days inventory is held before being
sold. It gives us an indication of how long it takes the firm to convert its inventory into cash.

Inventory TO = Cost of Goods Sold

Average Inventory**

**Average Inventory = (Inventory, beg + Inventory, end)/2

The inventory turnover and current ratio are related. The combination of a high current ratio and a low
inventory turnover ratio, relative to industry norms, suggests that the firm has an above-average inventory
level and/or that part of the inventory is obsolete or damaged.

Significance: Usually a high inventory turnover/stock velocity indicates efficient management of inventory
because more frequently the stocks are sold. A low inventory turnover implies over-investment in

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 inventories, dull business, poor quality of goods, stock accumulation, accumulation of obsolete and slow
moving goods and low profits as compared to total investment. The inventory turnover ratio is also an index
of profitability.
Example:
2014
Cost of goods sold/cost of sales 5,920,000
Divided by: Ave. inventory
(400,000 + 320,000)/2 360,000
Inventory Turnover 16.44
Work in Process Inventory Turnover. The inventory turnover ratio measures how quickly inventory is
manufactured. It gives us an indication of over or under investment in work in process.

WIP Inventory TO = Cost of Goods Manufactured

Average WIP Inventory

Raw materials Inventory Turnover. The inventory turnover ratio measures how quickly raw materials is
used. It gives us an indication of the sufficiency of raw materials in stock.

RM Inventory TO = Raw Materials used

Average RM Inventory

4. Average Sales Period / Average Age of Inventory / Inventory Holding Period. It calculates the number
of days, on average, that elapsed between finished goods production and sale of product

Ave Age of Inventory = 360 days

Inventory Turnover

Significance: An increase in the inventory turnover (and a decrease in the average sale period) would
usually be considered favorable.
Example:
2014
No. of days in a year 360
Divided by: Inventory turnover 16.44
Ave. Age of Inventory in Days 21.90

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 C. LEVERAGE / LONG-TERM SOLVENCY

Long term solvency or leverage ratios convey a firm's ability to meet the interest costs and payment schedules of
its long term obligations. Leverage ratios look at the extent that a company has depended upon borrowing to
finance its operations. As a result, these ratios are reviewed closely by bankers and investors. Most leverage
ratios compare assets or net worth with liabilities. A high leverage ratio may increase a company's exposure to
risk and business downturns, but along with this higher risk also comes the potential for higher returns. Some of
the major measurements of leverage include:

1. Times-Interest-Earned Ratio. The times-interest-earned ratio is a measure of a firm’s ability to meet

interest payments. It indicates the relation between interest payments and the earnings that are available to
make those interest payments. Earnings before interest expense and income taxes is also referred to as “net
operating income”. This ratio is computed as follows:

Times interest Earned = Earnings before interest exp and income taxes
Interest expense

Significance: The times-interest-earned ratio, also known as, interest coverage ratio is very important from
the lender’s point of view. It is an index of the financial strength of an enterprise. In general, a higher interest
coverage ratio means that the small business is able to take on additional debt.
Example:
2014 2013
Earnings before interest & income taxes 380,000 353,000
Divided by: Interest expense 60,000 60,000
Times interest earned 6.33 5.88

2. Debt to Asset Ratio. This is referred to also as financial leverage. It measures the portion of a company's
assets that is provided by borrowing. It involves financing assets with funds that have been provided by
creditors or preferred shareholders at a fixed rate of return. A debt ratio greater than 1.0 means the
company has negative net worth, and is technically bankrupt. The debt ratio is calculated as:

Debt to Asset ratio = Total Liabilities

Average Total Assets

Significance: If assets in which the funds are invested earn a rate of return greater than the fixed rate of
return required by the suppliers of the funds, then financial leverage is positive and the ordinary
shareholders benefit. As the percentage of assets financed by creditors increases, the riskiness of the
company increases.
Example:
2014
Total Liabilities 740,000
Divided by: Ave. Total assets
(1,840,000 + 1,752,600)/2 1,796,300

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 Debt to Asset Ratio .41 or 41.20%

3. Debt to Equity Ratio. Long-term creditors would like a reasonable balance between the capital provided by
creditors and the capital provided by shareholders. Creditors would like the debt-to-equity ratio to be
relatively low. This balance is measured by the debt-to-equity ratio:

Debt to Equity ratio = Total Liabilities

Average Shareholders’ Equity

Significance: A company is generally considered safer if it has a low debt to equity ratio—that is, a higher
proportion of owner-supplied capital—though a very low ratio can indicate excessive caution. In general,
debt should be between 50 and 80 percent of equity.
Example:
2014
Total Liabilities 740,000
Divided by: Ave. Shareholders’ equity
(930,000 + 1,012,600)/2 971,300
Debt to Equity Ratio .76 or 76.19%

D. PROFITABILITY

Profitability ratios show the combined effects of liquidity, asset management, and debt management on a firm's
operating results. Profitability ratios measure the earning ability of a company and the extent to which invested
funds are being used efficiently. However, it is important to note that many factors can influence profitability
ratios, including changes in price, volume, or expenses, as well the purchase of assets or the borrowing of money.
Some of the most popular profitability ratios are:

1. Gross Margin Ratio/ Gross Profit Ratio. It measures the margin on sales the company is achieving. It can be
an indication of manufacturing efficiency or marketing effectiveness. It reflects efficiency with which a firm
produces its products. As the gross profit is found by deducting cost of goods sold from net sales, higher
the gross profit better it is.

Gross profit (margin) ratio = Gross Profit

Net Sales

Significance: There is no standard GP ratio for evaluation. It may vary from business to business. However,
the gross profit earned should be sufficient to recover all operating expenses and to build up reserves after
paying all fixed interest, charges and dividends.

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 Example:
2014 2013
Gross Profit 1,080,000 990,000
Divided by: Net sales 7,000,000 5,950,000
Gross profit ratio (in %) 15.43 16.64

2. Return on Sales (Profit Margin). It is the percentage of net profit to net sales. It measures the overall
profitability of the company, or how much is being brought to the bottom line. It is an income statement
ratio and a high profit margin indicates good cost control.

Return on Sales = Net Income

Net Sales

Significance: In general terms, net profitability shows the effectiveness of management or the firm’s capacity
to face adverse economic conditions such as price competition, low demand, etc. Obviously, the higher the
ratio, the better is the profitability.

Example:
2014 2013
Net Income 224,000 205,100
Divided by: Net sales 7,000,000 5,950,000
Return on Sales (in %) 3.20 3.45

3. Total Assets Turnover. It measures a company's ability to use assets to generate sales.

Total assets turnover = Net Sales

Average total assets

Significance: Although the ideal level for this ratio varies greatly, a very low figure may mean that the
company maintains too many assets or has not deployed its assets well, whereas a high figure means that the
assets have been used to produce good sales numbers.
Example:
2014
Net sales 7,000,000
Divided by: Ave. Total assets
(1,840,000 + 1,752,600)/2 1,796,300
Total Assets Turnover 3.90

4. Return on Assets. The return on total assets is a measure of how profitably assets have been employed. The
return on total assets attempts to measure what the return on total assets would be if the company had no

13
 long-term debt in its capital structure. The after-tax interest expense is added back to net income to
eliminate the interest expense associated with debt. Return on assets (ROA) considers the return to
investors on all assets invested in the company.

Return on Total Assets = Net income + [Interest Expense x (1- tax rate)]
Average total assets

Significance: A very low ROA usually indicates inefficient management, whereas a high ROA means efficient
management. However, this ratio can be distorted by depreciation or any unusual expenses.
Example:
2014
Net Income(224,000 + 42,000) 266,000
Divided by: Ave. Total assets
(1,840,000 + 1,752,600)/2 1,796,300
Return on Total Assets .15 or 14.8%

5. Return on Equity. Return on common equity (or return on equity, ROE) is the most important measure of
profitability for investors. It represents the amount of income generated per peso of book value of equity or
common equity. It is a financial ratio which is monitored by financial analysts, business managers and
investors because it is an important metric showing how successful is the management of the company in
creating value for the business and its stakeholders

Return on Equity = Net income

Average total equity

Return on Ordinary Equity = Net income – Preferred dividends

Average ordinary shareholders’ equity

Example:
2014
Net Income 224,000
Divided by: Ave. Total equity
(930,000 + 1,012,600)/2 971,300
Return on Equity .23 or 23.06%

6. Earnings per Share. The earnings per share is a good measure of profitability and when compared with EPS
of similar companies, it gives a view of the comparative earnings or earnings power of the firm. Earnings per
share is computed as follows:

Earnings per share = Net income – Preferred dividends

Average No. of ordinary share outstanding

Significance: EPS ratio calculated for a number of years indicates whether or not the earning power of the
company has increased.
Example:
2014

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 Net Income 224,000
Divided by: Ave. No of ordinary shares 50,000
Earnings per share 4.48

7. Price-Earnings Ratio. The relation between the market price of a share of stock and the stock’s current
earnings per share is often stated in terms of a price-earnings ratio. This ratio tells us how much investors are
willing to pay for a peso of current earnings. The price-earnings ratio is computed as follows:

Price earnings ratio = Market price per share

Earnings per share (EPS)

Significance: The price-earnings ratio is widely used by investors as a general guideline in gauging stock
values. If the ratio is unusually high or low for a company in relation to its industry, an analyst may suspect
that the stock is overvalued or undervalued. In general, investors regard companies with higher price-
earnings ratios as being less risky and/or more likely to enjoy higher growth in the future.

8. Dividend Payout Ratio. The dividend payout ratio gauges the portion of current earnings being paid out in
dividends. This ratio is computed as follows:

Dividend payout ratio = Dividend per share

Earnings per share (EPS)

Significance: A high or low dividend payout ratio is neither good nor bad taken by itself. A low payout ratio
may be an indication that the company has excellent internal investment opportunities and therefore
foregoes paying dividends.
Example:
2014
Dividend per share (P166,400/50,000sh)* 3.328
Divided by: Earnings per share 4.480
Dividend payout ratio .74

*taken from the additional data under the cash flow statement of chapter 9

9. Dividend Yield Ratio. The dividend yield ratio is primarily of interest to retirees and other shareholders who
need a steady stream of cash income from their investments. Such shareholders “buy dividends” and
compare dividend yields to the returns they could earn on bonds and other fixed income securities.
Historically some shares’ dividends have been so reliable that investing in the stock is believed to be almost
as safe as putting money in the bank. The dividend yield ratio is computed as follows:

Dividend yield ratio = Dividend per share

Market price per share

10. Book Value Per Share. The book value per share measures the amount that would be distributed to holders
of each share of ordinary share if all assets were sold at their balance sheet carrying amounts and if all
creditors were paid off. The book value per share is computed as follows:

Book value per share = Ordinary shareholders’ equity

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 No. of ordinary shares outstanding , end

Significance: Because book values of assets can be quite out of date, this ratio is of limited use. The
denominator in this ratio is the number of common shares outstanding at the end of the year rather than the
average number of common shares outstanding.
Example:
2014
Ordinary shareholders’ equity 1,012,600
Divided by: No of ordinary shares 50,000
Book value per share 20.25

LIMITATIONS OF FINANCIAL STATEMENTS ANALYSIS

Financial statement analysis by means of horizontal, vertical and ratio analysis has several inherent limitations.
The analysts/users should bear them in mind in evaluating the performance and status of a single enterprise or of
several enterprises compared to each other. Some of these limitations are:
1. The results of analytical procedures applied emphasize only certain trends and changes in individual
items and relationships. The reason behind the trend or change is not provided. The analyst should
investigate further to answer the question - “Why”?

2. Ratios and percentages are affected by any change in accounting procedures the company may have
adopted in the current period in relation to prior periods. Erroneous conclusions may be drawn from the
results of analysis unless the user of the information is aware of such changes.

3. Conventional financial statements do not reflect the effects of changing price levels. Misperceptions can
result for the failure to account for the effects of inflation or deflation.

4. Use of different accounting procedures by two or more companies will result in ratios and percentages
that are not comparable. Adjustments will have to be made if an intelligent comparison is to be made
regarding the performance and status of two or more companies. Comparability assumes the use of the
same accounting principles and procedures.

5. Information reflected on financial statements is not exact and not final. Estimates and judgment are
applied by the accountant in measuring operating results and financial position. Thus, the financial
report is basically a mixture of facts and opinions. It follows that analytical data are intrinsically tentative
in character and single measurements should not be given too much weight and importance.

6. Financial statements, which are the basis of financial analysis, are historical reports. They merely provide
a basis for predicting future events. Moreover, they only include matters that are capable of
quantification. Other vital information such as industry changes, management changes, competitors’
actions, technological developments, government actions and union activities are not provided by the
traditional financial statements.

16
INTERPRETATION
Financial statement analysis is just one tool or means of interpreting intelligently financial data. It is a
guide so that users of the financial data can arrive at better decisions whether they are to invest, to lend, to keep
the investment or dispose of it, etc. To arrive at some informed conclusions however, the statement user must
be able to interpret the results of financial analysis. In other words, there should be a standard against which the
result of analysis could be compared. This standard may be summarized as follows:

1. Personal standards which are based on the analyst’s own experience and observation;
2. Budgeted standards which come from the company’s goals and plans as reflected on the budget;
3. Historical standards which refer to the company’s performance in the past; and
4. Rule of thumb standards which are general and obtained from other companies’ financial standards,
trade publication and published references.
As a summary, the following steps make up the steps in financial statement analysis.

1. Identify the economic characteristics and competitive dynamics of the industry in which a particular
firm participates.

2. Identify the strategies the firm pursues to gain and sustain a competitive advantage.

3. Assess the quality of the firm’s financial statements and, if necessary, adjust them for such desirable
characteristics as sustainability or comparability

4. Analyze the current profitability and risk of the firm using information in the financial statements.

5. Prepare forecasted financial statements.

6. Value the firm.

17
DISCUSSION QUESTIONS
1. In financial statement analysis, what is the basic objective of observing trends in data and ratios?

2. Distinguish between trend percentages and component percentages. Which would be better suited for
analyzing the change in sales over a term of several years?

3. What is the quick ratio? Under what circumstances are short-term creditors most likely to regard a
company’s quick ratio as more meaningful than its current ratio?

4. Identify the ratios or other analytical tools used to evaluate profitability. Explain briefly how each is
computed.

5. Net sales of Major General Store have been increasing at a reasonable rate, but net income has been
declining steadily as a percentage of these sales. What appears to be the problem?

6. Why might earnings per share be more significant to a shareholder in a large corporation than the total
amount of net income?

7. ABC Co. has a current ratio of 3 to 1. Ono Corp. has a current ratio of 2 to 1. Does this mean that ABC’s
operating cycle is longer than Ono’s? Why?

8. Assume that Congress announces its intention to limit the prices and profits of pharmaceutical companies as
part of an effort to control health care costs. What effect would expect this announcement to have on the
price-earnings ratios and stock prices of pharmaceutical companies such as GlaxoSmithKline? Explain.

9. Spencer Company earned a 16 percent return on its total assets. Current liabilities are 10 percent of total
assets. Long-term bonds carrying an 11 percent coupon rate are equal to 30 percent of total assets. There are

18
 no preferential shares. Is this application of leverage favorable or unfavorable from the viewpoint of
Spencer’s shareholders?

10. An investor states, “I bought this share for P50 several years ago and it now sells for P100. It paid P5 per
share in dividends last year so I’m earning 10 percent on my investment. Evaluate this statement.

Name: Date: Score:

Professor: Schedule:

T10-1A: MATCHING TYPE

Match the items below by entering the appropriate letter code in the space provided.
A. Receivable turnover K. Current ratio
B. Leverage ratios L. Inter-comparability
C. Intra-comparability M. Acid-test ratio
D. Price earnings ratio N. Vertical analysis
E. Solvency O. Asset Turnover
F. Return on Equity P. Debt to Equity ratio
G. Horizontal analysis Q. Dividend yield ratio
H. Inventory Turnover R. Liquidity
I. Book value per share S. Return on sales
J. Gross profit ratio T. Efficiency ratios

_______1. A technique to evaluate each item in a financial statement as a percent of a base amount
or item.
_______2. It is the ability of a business to meet long term obligations.
_______3. It measures the amount of sales generated by each peso of asset.
_______4. A ratio that shows how much an investor is willing to pay for each peso of earnings given the
actual market price.
_______5. The proportion of assets provided by creditors compared to that provided by owners.
_______6. It is the ability of a company to convert receivables to cash measured by the number of
collection cycles.
_______7. It is a measure of the average number of times a company’s inventory has been sold during
a year.

19
 _______8. It is the percentage of net profit to net sales.
_______9. Comparisons with other companies.
_______10. It is also known as working capital ratio.
_______11. A measure of long-term solvency.
_______12. The most important measure of profitability for investors
_______13. It is primarily of interest to retirees and other shareholders who need a steady stream of
cash income from their investments
_______14. It is an analytical method by which comparative statements are presented to show changes
in each item for different periods.
_______15. It is a more rigorous test of a company’s ability to meet its short-term debts

Name: Date: Score:

Professor: Schedule:

T10-2A: COMPLETION STATEMENTS

Identify the appropriate term/s that will best complete the individual statements.

1. Statements that express all items in a particular financial statement as a percentage of some common
base are called_________________________ statements.

2. Basic EPS is calculated as net income minus ____________________________divided by the weighted

average number of shares outstanding.

3. The book value per share measures the amount that would be distributed to holders of each
______________________share.

4. The three basic approaches often used to compare financial statements are:_____________________,
______________________ and ______________________.

5. The quick ratio is computed as current assets less _______________________ and

_________________________ divided by current liabilities.

6. Return on assets is defined as _______________________ divided by total average assets.

7. The times-interest-earned ratio is computed as earnings before ___________________ and

_______________________ divided interest expense.

8. Debt to asset ratio is _______________________ liabilities over total assets.

9. Ratio analysis is an indicator of ___________________________, ____________________,

__________________________________ and ______________________.

20
 10. As a limitation of financial statement analysis, financial statements are ___________________ reports.

Name: Date: Score:

Professor: Schedule:

T10-3A: TRUE OR FALSE

On the space provided, write TRUE if the statement is correct, if incorrect, write FALSE.

___________1. Financial statements that reflect financial data for two or more periods are often referred
to as comparative statements.
___________2. Development of data that measure changes occurring from one accounting period to
another is a form of horizontal analysis
___________3. A common-size income statement usually shows each revenue or expense item as a
percentage of net sales.
___________4. Comparability between enterprises is more difficult to obtain than comparability within a
single enterprise.
___________5. Generally, the first concern of a financial analyst is a firm’s liquidity.
___________6. The acid test ratio is regarded primarily as a measure of a company’s long term liquidity
situation
___________7. The accounts receivable turnover is both a measure of liquidity and a measure of activity.
___________8. Normally a relatively low inventory turnover is desirable.
___________9. The price earnings ratio is a measure of the relative attractiveness of ordinary shares as an
investment.
___________10. Horizontal analysis is a technique to compare company’s financial condition over a period
of time.
___________11. When calculating the return on assets, you should use average total assets.
___________12. If a company has no liabilities, its return on equity will equal its return on assets.
___________13. Inventory turnover is generally a more important ratio for a manufacturing firm than a
service firm.
___________14. Common-size statements are useful for intercompany comparisons.

21
 ___________15. Profitability ratios show the combined effects of liquidity, asset management, and debt
management on operations.
___________16. If a firm has high current and quick ratios, this is always a good indication that a firm is
managing its liquidity position well.

Name: Date: Score:

Professor: Schedule:

T10-4A: MULTIPLE CHOICE - CONCEPTUAL

Select the letter of the best possible answer to each of the following items.
_____1. Which of the following statements concerning financial ratios is incorrect?
A. Accounting principles and methods used by a company will not affect financial ratios.
B. The informational value of a ratio in isolation is limited.
C. A ratio is one number expressed as a percentage or fraction of another number.
D. Calculation of financial ratios is not sufficient for a complete financial analysis of a company.

_____2. Which of the following statements is correct?

A. All other things being equal, the more efficiently a company utilizes its assets, the greater
will be its return on investment.
B. All other things being equal, if return on equity increases, the return on assets must have
also increased.
C. All other things being equal, if the number of days inventory held increases, the return on
assets will increase.
D. All other things being equal, if the gross margin decreases, the inventory turnover must
have increased.

_____3. Liquidity of a company is generally defined as a measure of:

A. the ability of a company to pay its employees in a timely manner
B. the ability to pay interest and principal on all debt
C. the ability to pay dividends
D. the ability to pay current liabilities

_____4. Which of the following ratios is not generally considered to be helpful in assessing short-term liquidity?
A. Acid-test ratio
B. Current ratio
C. Days' to collect receivable
D. Total asset turnover

22
_____5. While determining the most profitable company from the given number of companies, which of the
following would be the best indicator of relative profitability?
A. Highest net income
B. Highest retained earnings
C. Highest return on equity
D. Highest operating margin
_____6. Other things held constant, which of the following will not affect the current ratio, assuming an initial
current ratio greater than 1.0?
A. Fixed assets are sold for cash.
B. Long-term debt is issued to pay off current liabilities.
C. Accounts receivable are collected.
D. Cash is used to pay off accounts payable.
E. A bank loan is obtained, and the proceeds are credited to the firm's checking account.

_____7. Which of the following actions can a firm take to increase its current ratio?
A. Issue short-term debt and use the proceeds to buy back long-term debt with a maturity of
more than one year.
B. Reduce the company’s days sales outstanding to the industry average and use the resulting
cash savings to purchase plant and equipment.
C. Use cash to purchase additional inventory.
D. Statements A and B are correct.
E. None of the statements above is correct.

_____8. Earnings per share is affected by

A. net income
B. number of shares
C. dividends
D. A & B only
E. A, B & C

_____9. A firm is considering actions which will raise its debt ratio. It is anticipated that these actions will have
no effect on sales, operating income, or on the firm’s total assets. If the firm does increase its debt
ratio, which of the following will occur?
A. Return on assets will increase.
B. Basic earning power will decrease.
C. Times interest earned will increase.
D. Profit margin will decrease.
E. Total assets turnover will increase.

_____10. Five areas that financial ratios concentrate on are:

A. liquidity, profitability, debt, efficiency, market related;
B. profitability, strategy, liquidity, auditing, share prices;
C. liquidity, current ratio, quick ratio, interest cover, dividend cover;
D. market related, share prices, dividend policy, debt policy, strategy
E. none of the above

23
Name: Date: Score:

Professor: Schedule:

E10-1B: (Horizontal analysis – Increase /Decrease Method)

Following is the comparative statement of financial position of SPINACH Company:

SPINACH COMPANY
Comparative Statement of Financial Position
December 31, 2014 and 2013
(in thousands of pesos)

Assets 2013 2012

Current Assets P 440 P 280
Plant Assets 675 520
Total Assets P1,115 P 800

Liabilities and Shareholders' Equity

Current Liabilities P 280 P 120
Long-term Debt 250 160
Ordinary Share 325 320
Accumulated Profits 260 200
Total liabilities and Shareholders' Equity P1,115 P 800

Instruction: Perform a horizontal analysis of SPINACH Company’s financial statement. Show the increases and
decreases in each account in absolute peso values and percentages. Use the format provided.

SPINACH COMPANY
Comparative Statement of Financial Position
December 31, 2014 and 2013
(in thousands of pesos)

Year Increase (Decrease)

Assets 2013 2012 Amount %
Current Assets P 440 P 280
Plant Assets 675 520
Total Assets P1,115 P 800
Liabilities and Shareholders' Equity
Current Liabilities P 280 P 120
Long-term Debt 250 160

24
 Ordinary Share 325 320
Accumulated Profits 260 200
Total liabilities and Shareholders' Equity P1,115 P 800

Name: Date: Score:

Schedule
Professor: :

E10-2B: (Horizontal analysis – Trend Percentages)

RADDISH Company's sales and current assets have been reported as follows over the last four years:

Year 4 Year 3 Year 2 Year 1

Sales P800,000 P700,000 P600,000 P570,000
Net Income 94,880 92,050 74,400 68,400
Cash 35,000 30,000 24,000 18,000
Accounts Receivable 75,000 50,000 58,000 45,000
Inventory 78,000 75,000 80,000 75,000
Prepaid Expenses 47,000 39,000 11,000 25,000
Total Current Assets 235,000 194,000 173,000 163,000

Instruction:
A. Compute for the trend percentages of the selected data for RADDISH Company.

YEAR 4 YEAR 3 YEAR 2 YEAR 1

Sales
Net income
Cash
Accounts Receivable
Inventory
Prepaid expenses
Total current assets

B. Compare the years’ results and make an evaluation on which is the best year. Explain your answer.

25
Name: Date: Score:

Professor: Schedule:

E10-3B: (Vertical Analysis)

Following is the comparative income statement of CABBAGE Company:

Cabbage Company
Income Statement
For the years ended December 31, 2014 and 2013

2014 2013
Net sales P 800,000 P 700,000
Cost of goods sold (350,000) (320,000)
Gross profit P 450,000 P 380,000
Selling expenses (P150,000) (P110,000)
Administrative expenses (37,000) (20,000)
Total operating expenses (P187,000) (P130,000)
Income before income tax P 263,000 P 250,000
Income tax (40,000) (32,000)
Net income P 223,000 P 218,000

Instruction: Perform a vertical analysis on the financial statements of Cabbage Company. Convert all income
statement accounts to common units, using net sales as the base. Use the format provided.

Cabbage Company
Income Statement
For the years ended December 31, 2014 and 2013

2014 2013
Amount Percent Amount Percent
Net sales P 800,000 P 700,000
Cost of goods sold (350,000) (320,000)
Gross profit P 450,000 P 380,000
Selling expenses (P150,000) (P110,000)
Administrative expenses (37,000) (20,000)
Total operating expenses (P187,000) (P130,000)
Income before income tax P 263,000 P 250,000
Income tax (40,000) (32,000)
Net income P 223,000 P 218,000

26
Name: Date: Score:

Professor: Schedule:

E10-4B: (Indicators of Profitability)

Selected data from the STRINGBEANS Company at year end are presented below:

Total assets P2,000,000

Average total assets 2,200,000
Net income 250,000
Net sales 1,300,000
Average ordinary share capital 1,000,000
Net cash provided by operating activities 275,000
Ordinary Shares of outstanding 10,000

Instruction: Determine the following:

A. Return on Sales
B. Return on Assets
C. Return on Ordinary Equity

A. RETURN ON SALES
1 1

2 2

3 3

4 4

B. RETURN ON ASSETS
1 1

2 2

3 3

4 4

C. RETURN ON ORDINARY EQUITY

1 1

2 2

3 3

4 4

Name: Date: Score:

Professor: Schedule:

27
E10-5B: (Indicators of Liquidity and Leverage)
Financial statements of CARROTS Corporation are reproduced below. The market price of Carrot’s ordinary share
was P20 per share on November 30, Year 2.

Carrots Corporation
Statement of Financial Position
As of November 30
(in thousands of pesos)
Year 2 Year 1
Cash P 3,000 P 2,000
Trading securities 1,000 1,000
Accounts receivable (net) 14,000 11,000
Merchandise inventory 24,000 16,000
P P
Total current assets 42,000 30,000
Property, plant, and equipment (net) 68,000 60,000
Long-term investments 10,000 10,000
P120,00 P100,00
Total assets 0 0

Accounts payable P 5,000 P 4,000

Wages payable 1,000 1,000
Total current liabilities P 6,000 P 5,000
Bonds payable, 10% 20,000 20,000
P P
Total liabilities 26,000 25,000
Ordinary share capital, no par, 10,000,000 P P
shares 25,000 25,000
Accumulated profits 69,000 50,000
P P
Total shareholders’ equity 94,000 75,000
P120,00 P100,00
Total liabilities and shareholders’ equity 0 0

Carrots Corporation
Statement of Income
For the Year Ended November 30, Year 2
(in thousands of pesos)

Sales (all on credit) P200,000

Cost of goods sold (120,000)
Gross margin 80,000
Operating expenses (38,000)
Net operating income 42,000
Interest expense (2,000)

28
 Net income before income tax 40,000
Income tax expense (15,000)
Net income P 25,000

Name: Date: Score:

Professor: Schedule:

Instruction: Determine the following for Carrots Corporation

A. Current Ratio F. Average collection period

B. Acid-test ratio G. Times interest earned
C. Inventory turnover H. Debt to asset ratio
D. Days’ supply in inventory I. Debt-to-equity
E. Receivable turnover

A. CURRENT RATIO
1 1

2 2

3 3

4 4

B. ACID-TEST RATIO
1 1

2 2

3 3

4 4

C. INVENTORY TURNOVER
1 1

2 2

3 3

4 4

D. DAYS SUPPLY IN INVENTORY

1 1

2 2

3 3

4 4

E. RECEIVABLE TURNOVER
1 1

2 2

3 3

4 4

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Name: Date: Score:

Professor: Schedule:

F. AVERAGE COLLECTION PERIOD

1 1

2 2

3 3

4 4

G. TIMES-INTEREST-EARNED RATIO
1 1

2 2

3 3

4 4

H. DEBT TO ASSET RATIIO

1 1

2 2

3 3

4 4

I. DEBT TO EQUITY
1 1

2 2

3 3

4 4

E10-6B: (Indicators of Profitability/Growth)

Selected data for LETTUCE Company follow:
Year 2 Year 1
Preference share, par value P50, 10% P100,000 P100,000
Ordinary share, par value P20 400,000 400,000
Share premium – ordinary share 100,000 100,000
Retained earnings 140,000 120,000
Net income 80,000 60,000
Dividends on preference share 10,000 10,000
Dividends on ordinary share 50,000 40,000
Market price per share, Dec 31 28.00 21.00

Instruction: Determine the following

A. Price-earnings ratio D. Return of Equity
B. Dividend yield ratio E. Book value per share

30
 C. Payout ratio

Name: Date: Score:

Professor: Schedule:

A. PRICE EARNINGS RATIO

1 1

2 2

3 3

4 4

B. DIVIDEND YIELD RATIO

1 1

2 2

3 3

4 4

C. DIVIDEND PAY-OUT RATIIO

1 1

2 2

3 3

4 4

D. RETURN ON EQUITY
1 1

2 2

3 3

4 4

E. BOOK VALUE PER SHARE

1 1

2 2

3 3

4 4

31
P10-1C: MULTIPLE CHOICE - PROBLEMS

1. During the year ELLE Company purchased P400,000 of inventory. The inventory balance at the beginning of
the year was P150,000 and the cost of goods sold for the year was P425,000. The inventory turnover for the
year was:
A. 2.83
B. 2.91
C. 3.09
D. 3.40

2. EM Co.'s budgeted sales and budgeted cost of sales for the coming year are P212,000,000 and P132,500,000
respectively. Short-term interest rates are expected to be 5%. Assume that all inventories must be financed
with short-term debt. If EM could increase inventory turnover from its current 8 times per year to 10 times
per year, its expected interest cost savings in the current year would be:
A. P0
B. P81,812
C. P165,625
D. P331,250

3. ENN Corporation has interest expense of P16,000, sales of P600,000, a tax rate of 30%, and after-tax net
income of P56,000. What is the firm's times-interest-earned ratio?
A. 6.0
B. 5.0
C. 4.5
D. 3.5

4. OHW Company's debt to equity ratio is 0.6. Current liabilities are P120,000, long term liabilities are P360,000,
and working capital is P140,000. Total assets of the company must be:
A. P 600,000
B. P 800,000
C. P1,200,000
D. P1,280,000

5. The accounts receivable for PEA Company was P140,000 at the beginning of the year and P180,000 at the
end of the year. The accounts receivable turnover for the year was 8.5 and 15% of total sales were cash sales.
The total sales for the year were:
A. P1,400,000
B. P1,360,000
C. P1,600,000
D. P1,800,000

6. The QYU, Inc. has sales of P5 million per year (all credit) and an average collection period of 35 days. What is
its average amount of accounts receivable outstanding?
A. P479,452 C. P150,000
B. P142,857 D. P500,000

32
7. AHR Company has provided the following data: Inventory and prepaid expenses, P35,000; Current ratio, 2.2;
Acid-test ratio 1.5. AHR Company's current liabilities were:
A. P40,000
B. P50,000
C. P63,000
D. P44,100

8. ESS Company's current liabilities are P50,000, its long-term liabilities are P150,000, and its working capital is
P80,000. If ESS Company's debt-to-equity ratio is 0.32, its total long-term assets must equal:
A. P625,000
B. P745,000
C. P825,000
D. P695,000

9. The market price per share of TEE Co. stock at the beginning of the year was P60.00 and at the end of the
year was P72.00. Net income for the year was P48,000. Dividends to the preferred stockholders for the year
totaled P12,000, and dividends of P2.50 per share were paid on the 6,000 shares of common stock
outstanding during the year. The price-earnings ratio at year end was:
A. 6
B. 10
C. 11
D. 12

10. YOU Company has 40,000 shares of common stock outstanding that it originally issued for P30 per share. The
following data pertains to these shares for the most recent year: Book value, December 31 – P60 per share;
Market value, January 1 – P75 per share; Market value, December 31 – P80 per share. The total dividend
on common stock was P360,000. The dividend yield ratio for the year was:
A. 11.25%
B. 12.00%
C. 15.00%
D. 30.00%

11. As a short-term creditor concerned with a company's ability to meet its financial obligation to you, which one
of the following combinations of ratios would you most likely prefer?
Current ratio TIE Debt Ratio
A. 0.5 0.5 0.33
B. 1.0 1.0 0.50
C. 1.5 1.5 0.50
D. 2.0 1.0 0.67
E. 2.5 0.5 0.71

P10-2C: (Effects of Management Decisions on Ratios)

33
Most decisions made by management impact the ratios analysts use to evaluate performance. Instruction:
Indicate(by letter) whether each of the actions listed below will immediately increase (I), decrease(D), or have no
effect (N) on the ratios shown. Assume each ratio is less than 1.0 before the action is taken.

CURRENT ACID-TEST DEBT TO

ACTION
RATIO RATIO EQUITY
Issuance of long-term bonds

Issuance of short-term notes

Payment of accounts payable

Purchase of inventory on account

Purchase of inventory for cash

Purchase of equipment with a four-year note

Retirement of bonds

Sale of common shares

Write-off of obsolete inventory

Purchase of short-term investment for cash

Decision to refinance on a long-term basis

some currently maturing debt

Issuance of treasury shares

Collection of accounts receivables

Paid in advance rent

Rendered services for cash

P10-3C: (Horizontal analysis – Increase /Decrease Method)

Financial statements for SUGARBEETS Corporation are presented below. The market price of Sugarbeets' ordinary

34
share was P25 per share on December 31, 2014. During 2014, dividends of P2 million were paid to preference
shareholders and P10 million to ordinary shareholders.
SUGARBEETS Corporation
Comparative Statement of Financial Position
December 31, 2014 and 2013
(in thousands of pesos)

Assets 2014 2013

Current assets:
Cash P 4,000 P 3,600
Trading securities 2,000 1,200
Accounts receivable (net) 20,000 16,800
Inventory 28,000 28,800
P
Total current assets P 54,000 50,400
Non-Current assets:
Property, plant, and equipment (net) 75,000 81,600
Long-term investments 12,000 12,000
P144,00
Total assets P141,000 0
Liabilities and Shareholders’ Equity
Current liabilities:
Accounts payable P 7,000 P 6,000
Wages payable 1,000 1,200
Total current liabilities P 8,000 P 7,200
Non-current liabilities:
Bonds payable, 10% 24,000 24,000
P
Total liabilities P 32,000 31,200
Shareholders’ equity:
P
Preference shares, 10%, 1,000,000 shares P 20,000 20,000
Ordinary shares, 5,000,000 shares, no par 30,000 30,000
Accumulated profits 59,000 62,800
P109,00 P112,80
Total shareholders’ equity 0 0
P144,00
Total liabilities and shareholders’ equity P141,000 0

SUGARBEETS Corporation
Comparative Income Statement
For the years ended December 31, 2014 and 2013
(in thousands of pesos)
2013 2012
Sales (all on credit) P280,000 P280,000
(200,000 (168,000
Cost of goods sold ) )
Gross margin P 80,000 P112,000
Operating expenses (40,000 (38,000
) )

35
 Net operating income P 40,000 P 74,000
Interest expense (5,000) (4,000)
Net income before income tax P 35,000 P 70,000
(14,000 (28,000
Income tax expense ) )
Net income P 21,000 P 42,000
Instruction: Perform a horizontal analysis on SUGARBEETS Corporation’s financial statements. Show the
increases and decreases in each account in absolute peso values and percentages.

P10-4C: (Vertical analysis / Decision making)

Instruction:
A. Perform a vertical analysis on the financial statements of SUGARBEETS Corporation. Convert all income
statement and statement of financial position accounts to common units, using net sales and total
assets as the base.

B. Based on the horizontal and vertical analysis made, evaluate which year Sugarbeets performed better.

P10-5C: (Financial Ratios)

Financial statements for BITTERGOURD Company appear below:

BITTERGOURD Company
Income Statement
For the Year Ended December 31, 2014
(in thousands of pesos)

Sales (all on account) P 2,000

Cost of goods sold (1,400)
Gross margin P 600
Operating expenses (240)
Net operating income P 360
Interest expense (50)
Net income before taxes P 310
Income taxes (30%) (93)
Net income P 217

BITTERGOURD Company
Statement of Financial Position
December 31, 2014 and 2013
(in thousands of pesos)

Assets 2014 2013

Current assets:
Cash and Cash equivalents P 140 P 130
Accounts receivable, net 120 110
Inventory 100 110
Prepaid expenses 50 40

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 Total current assets P 410 P 390
Noncurrent assets:
Plant & equipment, net 1,840 1,830
Total assets P2,250 P2,220

Liabilities and Shareholders’ Equity

Current liabilities:
Accounts payable P 100 P 100
Accrued liabilities 80 80
Notes payable, short term 210 230
Total current liabilities P 390 P 410
Noncurrent liabilities:
Bonds payable 460 500
Total liabilities P 850 P 910
Shareholders’ equity:
Preference share capital,P5 par, 5% P 100 P 100
Ordinary share capital, P10 par 200 200
Share premium - ordinary 260 260
Accumulated profits 840 750
Total shareholders’ equity P1,400 P1,310
Total liabilities & shareholders’ equity P2,250 P2,220

Dividends during 2014 totaled P127,000, of which P5,000 were preference dividends. The market price of an
ordinary share on December 31, 2014 was P140.

Instruction: Compute the following for 2014:

1. Earnings per share of common stock ordinary share 9. Current ratio
2. Price-earnings ratio 10. Acid-test ratio
3. Dividend payout ratio 11. Accounts receivable turnover
4. Dividend yield ratio 12. Average collection period
5. Return on total assets 13. Inventory turnover
6. Return on shareholders’ equity 14. Average sales period
7. Book value per share 15. Times interest earned
8. Working capitalratio? 16. Debt-to-equity ratio

P10-6C: (Liquidity Ratios)

The following data are taken from the balance sheet at the end of the current year.

Accounts payable P245,000

Accounts receivable 210,000
Accrued liabilities 4,000
Cash 90,000
Income tax payable 10,000
Inventory 240,000
Marketable securities 350,000
Notes payable, short-term 85,000
Prepaid expenses 15,000

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Instruction:
Determine the (A) working capital, (B) current ratio, and (C) quick ratio. Present figures used in your
computations. Round ratios to the nearest tenth

P10-7C: (Interpretation of Ratios)

Instructions: Compute for the missing information. Underline the best choice within the statements.

For each company listed below, compute the debt ratio, which reveals the proportion of assets financed with
debt. Debt ratio = Total liabilities / Total assets
($ in millions) Date Total Assets Total Liabilities Debt Ratio
Microsoft (MSFT) 6/30/2008 $ 72,793 $ 36,507 50.15%
Wal-Mart Stores (WMT) 1/31/2009 $ 163,429 $ 98,144 ?
Ford Motor Company (F) 12/31/2008 $ 218,328 $ 235,639 ?

● Wal-Mart is primarily financed with (debt / equity), resulting in a debt ratio that is (less / more) than
50.00%, while a company primarily financed with equity will have a debt ratio that is (less / more)
than 50.00%. Ford has a debt ratio greater than (50% / 100%), indicating its liabilities are (greater /
less) than its assets.

For each company listed below, compute Return on Sales (ROS), which reveals the portion of each revenue dollar
that results in profit. ROS = Net income / Sales revenue
($ in millions) Year Ended Revenue Net Income ROS
Microsoft (MSFT) 6/30/2008 $ 60,420 $ 17,681 29.26%
Wal-Mart Stores (WMT) 1/31/2009 $ 405,607 $ 13,400 ?
Ford Motor Company (F) 12/31/2008 $ 146,277 $ (14,672) ?

● Wal-Mart Stores has (greater / less) revenue than Microsoft, but Microsoft has a (higher / lower) ROS
ratio than Wal-Mart. The ROS ratio for Microsoft indicates ________of every revenue dollar resulted
in profit (net income), but for Wal-Mart Stores only _________ of every revenue dollar resulted in
profit. Ford Motor Company reports a (positive / negative) ROS, indicating (revenue / net income) is
negative.

● The corporation with the strongest ROS ratio is (MSFT / WMT / F).

For each company listed below, compute Asset Turnover, which reveals how efficiently assets are used to
generate revenue. Asset Turnover = Sales Revenue / Total Assets
($ in millions) Year Ended Revenue Total Assets Asset Turnover
Microsoft (MSFT) 6/30/2008 $ 60,420 $ 72,793 0.8300
Wal-Mart Stores (WMT) 1/31/2009 $ 405,607 $ 163,429 ?
Ford Motor Company (F) 12/31/2008 $ 146,277 $ 218,328 ?
● The asset turnover ratios computed above are in the range (less than 3 / 3 or more).

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● (MSFT / WMT / F) has the strongest asset turnover, indicating the company makes profits by
generating a large volume of revenue using relatively few assets. Wal-Mart generates
_________ in revenue for every $1 invested in assets.

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