COURSE FINANCIAL MANAGEMENT

DEVELOPER This module is prepared by Mr. Henry D. Rufino. Mr. Rufino is currently the
AND THEIR Chairperson of Tarlac State University College of Business and Accountancy -
BACKGROUND Accountancy Department. He is a Certified Public Accountant with Master’s
degree in Business Administration. He teaches financial management and financial
accounting courses. Mr. Rufino is currently a Member of Philippine Institute of
Certified Public Accountants (PICPA) National Committee on Students
Participation for FY 2020-2021 and Chairperson of the Publication Committee of
PICPA Tarlac Chapter FY 2020-2021. Mr. Rufino is an Outstanding Chapter
President of PICPA Tarlac Chapter for FY 2018-2019.
COURSE This course exposes the students to the accounting aspects of finance in order to
DESCRIPTION develop appropriate financial strategies in realizing the goals of the business. It
includes various ways on how to analyze and interpret the figures presented in the
financial statements using financial ratios. This course also covers cash flows,
financial planning, and budgeting. It discusses different ways on how to manage
the current assets and current liabilities of the business. Different capital structures
with their corresponding costs of capital are also dealt within the course. Likewise,
this course will also discuss the relationship between cost, volume and profit.
Ultimately, this course provides business students with knowledge and
understanding of the wide variety of uses of accounting, particularly for planning,
controlling, and decision-making in business not only to generate profit but
primarily to maximize the owners’ wealth.
COURSE 1. Financial Statement Analysis
OUTLINE 2. Cash flows, Financial Planning and Budgeting
3. Working Capital Management (Current Assets)
4. Working Capital Management (Current Liabilities)
5. Cost of Capital, Leverage and Capital Structure
6. Cost-Volume Profit Analysis.
CHAPTER NO. 1
TITLE Financial Statement Analysis
I. RATIONALE

This module covers the topics on financial statement analysis. This module covers the financial
analysis, and interpreting financial statements for indications of business performances, status and
value of the company. It includes various ways on how to analyze and interpret the figures presented
in the financial statements using financial ratios. This module provides business students with
knowledge and understanding of the wide variety of uses of accounting, particularly for planning,
controlling, and decision-making in business not only to generate profit but primarily to maximize
the owners’ wealth.
.
INSTRUCTION TO THE USERS

This module covers financial statement analysis, the first topic of Financial Management Course. In
its developmental activities section, it provides substantial discussions of the topics. It discusses the
concepts, nature, scope and principles of the topics. Ample examples, illustrations and word problems
with suggested solutions are provided for the application of concepts and practical exercises. To
evaluate what the students have learned, this module provides work exercises at the closure activities
section. To ensure that learning objectives are attained at the end of the semester, the learner / students
are evaluated based on attendance, portfolio journal, formative assessment and summative
assessment. See evaluation section for the details. For further readings, see assignment / agreement
section.

II. LEARNING OBJECTIVES

1. Define and explain financial statement analysis, its objectives and limitations
2. Define and differentiate the types and categories of financial ratios
3. Solve, compute, and analyze the firm’s liquidity, activity, financial leverage, performance,
and market value with the use of financial ratios.
4. Prepare, analyze and interpret financial ratios and financial data derived from financial
statement analysis in making business decisions.
5. Discuss and explain the DuPont system in analyzing the liquidity, activity, financial
leverage, market value and performance of the firm
 III. CONTENT
A. PREPARATORY ACTIVITIES

This module covers the financial analysis and interpreting financial statements for indications of
business performances, status and value of the company using financial ratios. With this, learners
/ students must:
1. Review the types of financial statements and understand the recognition, measurement
and presentation of accounting elements learned from FAR 0, FAR 1, FAR 2 and FAR
3
2. Review functions of financial management and the concept of risk and return learned in
MAS 2

B. DEVELOPMENTAL ACTIVITIES

Please refer to the discussion below

FINANCIAL STATEMENTS ANALYSIS

1. What is Financial Statement Analysis (FS Analysis)?

FS Analysis involves methods of calculating, analyzing and interpreting the firm’s financial status, financial
performances and financial activities through the use of financial ratios. It involves careful and thorough
selection of data, primarily financial in nature, from the financial statements for the purpose of forecasting
the financial health and soundness and capabilities of the firm. It also involves the comparisons and
evaluation of financial data across companies from the same industries and other relevant companies.

2. What is financial ratio?

Financial ratio is the relative value of an account or financial data that compare, relate and interact with
other account or financial data for the purposes of analyzing the financial statements of the firm.
Financial ratio can be expressed in proportion, decimal, percentages, fraction or times.

3. Who are the interested parties on the analysis of financial statements?

a. Shareholders / Owners - Both current and prospective shareholders are interested in the firm’s
current and future level of risk and return, particularly the distribution of dividends, and the changes
in the value or price of their ownership or shares.

b. Creditors - Creditors are interested primarily in the short-term liquidity and long-term solvency of
the firm and its ability to make interest and principal payments when they become due.

c. Management – Management shall monitor the firm’s financial status, financial performances and
financial activities favorable both to the shareholders / owners and creditors.

4. Limitations and cautions on using financial statement analysis

a. Ratios that reveal large deviations from the norm merely indicate the possibility of a problem.
Comparing the ratios of a firm in one industry with those of a firm in another industry is difficult
because industry peculiarities will cause the ratios to differ.
b. A single ratio does not generally provide sufficient information from which to judge the overall
performance of the firm. However, if an analysis is concerned only with certain specific aspects of
a firm’s financial position, one or two ratios may suffice.
c. The ratios being compared should be calculated using financial statements dated at the same point
in time during the year. If they are not, the effects of seasonality may produce erroneous conclusions
and decisions.
d. It is preferable to use audited financial statements for ratio analysis. If they have not been audited,
the data in them may not reflect the firm’s true financial condition.
 e. The financial data being compared should have been developed in the same way. The use of
differing accounting treatments, such as accounting standards, can distort the results of ratio
comparisons, regardless of whether cross-sectional or time-series analysis is used.
f. Results can be distorted by inflation. Without adjustment, inflation tends to cause older firms (older
assets) to appear more efficient and profitable than newer firms (newer assets).
g. Data from the financial statements are year-end numbers and are based on historical costs.
Predictions for the future may not be realized.

5. Types of Ratio Comparisons (PUT EXAMPLES)

a. Cross sectional Analysis - Comparison of different firms’ financial ratios at the same point in time;
involves comparing the firm’s ratios to those of other firms in its industry or to industry averages.

Benchmarking - A type of cross-sectional analysis in which the firm’s ratio values are compared to
those of a key competitor or group of competitors that it wishes to emulate.

Example of Cross-Sectional Analysis

b. Time Series Analysis - Evaluation of the firm’s financial performance over time using financial
ratio analysis. Interchangeably known as horizontal analysis, is a comparison of financial data for
two or more years of the same firm to determine the increase or decrease from the previous years
or vice versa. It is also considered a trend analysis that analyze trends or changes of performances
from one period to another.

Example ------

c. Vertical Analysis – Evaluation of the proportionality of each line item or account on a financial
statement as a percentage of another item in a single reporting period. This analysis is also useful
in comparing relative changes in accounts over time in a time series analysis.

For Statement of Financial Position, the Total Assets is primarily the base 100% for asset accounts,
and the Total Liabilities and Shareholder’s Equity for liabilities and equity accounts. Simply stated,
it is each asset line item as a percentage of total assets. In Statement of Comprehensive Income, the
Gross Sales is primarily the base 100%. Simply stated, it is each income statement line item as a
percentage of gross sales. This is also known as Common-Sized Balanced Sheet or Common-Sized
Income Statement.

Example -----
6. Categories of financial ratios
a. Liquidity Ratios
b. Activity Ratios
c. Debt Ratios (Leverage ratios)
d. Profitability Ratios
e. Market Ratios

Liquidity, activity, and debt ratios primarily measure risk. Profitability ratios measure return.
Market ratios capture both risk and return.

7. Liquidity Ratios (Liquidity or short-term solvency)

Liquidity Ratios are ratios that measure the liquidity or the ability of the firm to meet cash needs in short
period of time for its day to day operations depending on its ordinary course of operations, usually within
one year. It is the firm’s ability to satisfy its short-term obligations as they come due.

Name Formula Significance / Interpretation

Current Ratio Total Current Assets Measures the firm’s ability to meet its short-term
Total Current Liabilities obligations.

A higher current ratio indicates a greater degree of

liquidity. How much liquidity a firm needs depends on a
variety of factors, including the firm’s size, ordinary
course of business, its access to short-term financing
sources like bank credit lines, and the volatility of its
business.

Acid Test Ratio Total Quick Assets A more severe test of liquidity that excludes inventory,
or Quick Ratio Total Current Liabilities which is generally the least liquid current asset and
typically sold on credit, and prepayments which is a non-
financial resource.
 Quick Assets = Cash and Cash Equivalents + Trade and
other Receivables + Short Term Investments

8. Activity Ratios (Management Efficiency)

Activity ratios measure the speed with which various accounts are converted into sales or cash—inflows
or outflows. In a sense, activity ratios measure how efficiently a firm operates along a variety of
dimensions such as inventory management, disbursements, and collections.

Name Formula Significance / Interpretation

Trade Receivable Net Credit Sales Measures the efficiency of the firm’s collection of
Turnover Average Trade Receivable trade receivables. It indicates the number of times
the firm collects its receivable in a given period.

Ave. Trade Receivable = The higher the trade receivable turnover indicates a
(Trade Receivable Beg + more efficient or faster collection of trade
Trade Receivable End ) / 2 receivables.
Average 365 Known as the average age of accounts receivable, is
collection period Receivable Turnover useful in evaluating credit and collection policies. It
indicates the number of days the firm collects its
Or trade receivables.

Ave. Trade Receivable The average collection period is meaningful only in

Net Credit Sales / 365 relation to the firm’s credit terms. The actual
average collection period must be shorter or faster
than its credit term or average collection period.
Inventory Cost of Goods Sold It measures the efficiency of the firm in managing
turnover Average Inventory and selling its inventories. It indicates the number of
times the firm converts its inventory into sales

The higher the inventory turnover, the more

efficient the firm converts its inventory into sales.
Goods in Process Cost of Goods Manufactured It indicates the number of times goods in process
Turnover Average Goods in Process inventory are completed or finished and readily
Inventory available for sale.
Raw Materials Raw Materials Used It indicates the number of times the raw materials
Turnover Average Raw Materials inventory was used and replenished during the
Inventory period.
Average age of 365 Measures how many days of inventory the firm has
inventory Inventory Turnover on hand. It indicates the number of days to sell or
consume the average inventory.
Or
The higher the average age of inventory, means the
Ave. Inventory longer the inventory stays on hand. The shorter, the
COGS / 365 better specially for perishable items or products that
must be sold quickly.
Trade Payable Net Credit Purchases Measures the efficiency of the firm’s payment of
Turnover Average Trade Payables trade payables. It indicates the number of times the
firm pays its trade payables in a given period.

The higher the trade payable turnover indicates a

frequent payment of the firm’s trade payables.
Average payment 365 Known as the average age of accounts payable, or
period Trade Payable Turnover the average number of days the firm pays its trade
payables.
Or
This figure is meaningful only in relation to the
Ave. Trade Payables average credit terms extended to the firm. The
Net Credit Purchases/ 365 average age payment must not go beyond the credit
term which means the firm takes too long to pay its
trade payables. The payment days must not also too
 early of the credit term to maximize the time value
of money and payment of interest if there is any.

Total Asset Net Sales Measures the efficiency with which the firm uses its
Turnover Average Total Assets assets to generate sales. It indicates the number of
times the firm generates sales from its assets.
Or
The higher the total assets turnover, the more
Net Sales efficient the assets or its total resources have been
Average Investments used in generating sales.

Capital Intensity Average Total Assets Measures the efficiency of the firm to generate sales
Ratio Net Sales through employment of its resources.

9. Debt Ratios (Leverage Ratios)

Debt ratios indicate the firm’s debt position which shows how the amount of money from creditors or
lenders are used to generate profits. It determines the degree of indebtedness measures the amount of
debt relative to other significant balance sheet amounts. It also reflects the ability to service debts,
reflects a firm’s ability to make the payments required on a scheduled basis over the life of a debt.

In general, the more debt a firm uses in relation to its total assets, the greater its financial leverage.
Financial leverage is the magnification of risk and return through the use of fixed-cost financing, such
as long-term debt and preferred stock. The more fixed-cost debt a firm uses, the greater will be its
expected risk and return. Details on leverage, financial and operating leverage will be discussed in the
succeeding modules.

Name Formula Significance / Interpretation

Debt Ratio Total liabilities Measures the proportion of total assets financed by the
Total assets firm’s creditors.

The higher this ratio, the greater the amount of other

people’s money being used to generate profits. It also
means the greater the firm’s degree of indebtedness and
the more financial leverage it has.

Equity Ratio Total Equity Indicates the proportion of assets provided by owners.
Total Assets Reflects financial strength and caution to creditors. Its
relevance depends on the risk preferences of the firm.

Debt to Equity Total Liabilities Measures debt relative to amounts of resources provided
Ratio Total Equity by the owners.

Times interest Earnings before Sometimes called the interest coverage ratio, measures
earned ratio interest and taxes the firm’s ability to make contractual interest payments.
Annual Interest Charges It indicates how many times interest expense is covered
by operating profit.
Or
The higher its value, the better able the firm is to fulfill
EBIT / Interest Expense its interest obligations.
Fixed-payment Measures the firm’s ability to meet all fixed payment
coverage ratio Earnings before interest obligations, such as loan interest and principal, lease
and taxes + Lease payments, and preferred stock dividends. The higher this
Payments value the better.
_________________
The lower the ratio, the greater the risk to both lenders
Interest + Lease and owners, and the greater the ratio, the lower the risk.
payments + [(Principal
payments + Preferred This ratio allows interested parties to assess the firm’s
stock dividends) x (1 / ability to meet additional fixed-payment obligations
(1- T)*] without being driven into bankruptcy.
 *The term 1/(1 T) is included to adjust the after-tax
principal and preferred stock dividend payments back to
a before-tax equivalent that is consistent with the before-
tax values of all other terms.

10. Profitability ratios

Profitability Ratios is the way in which the firm generates income from its resources. It measures the
performance of the firm. Owners, creditors, and management pay close attention to boosting income or
profits because of the great importance the market places on earnings. Income means the revenue
generated by the firm, whereas profit means the net revenue or net income earned by the firm after
considering the firm’s expenses.

Name Formula Significance / Interpretation

Gross profit Gross profits Measures the profit generated after consideration of costs
margin Net Sales of product sold. It indicates the percentages of peso sales
after the cost of goods sold.
Gross Profits = Sales -
Cost of goods sold The higher the gross profit margin, the better which may
Sales mean the lower the relative cost of merchandise sold.

Operating profit Operating profits Measures the profit generated after consideration of
margin Net Sales operating costs – administrative and selling expenses.
Operating costs exclude interest, taxes, and preference
share dividends, and other finance costs. It indicates the
percentages of peso sales after the cost production and
operation.

The higher the operating profit margin, the better which

may mean the lower the relative cost of operations.
Net profit Net Profit Measures the profit generated after consideration of all
margin Net Sales expenses including interest, taxes, and preference share
dividends. It indicates the percentages of peso sales after
the cost production, operation expenses and other
expenses such as finance costs, taxes and preference share
dividends.

Net profit for FS Analysis purposes is equal to earnings

available for ordinary shareholders. Note that preference
dividends deducted are those declared. Further, consider
the classification of preference share whether a
cumulative, non-cumulative, participating and non-
participating.

The higher the net profit margin, the better which may
mean the lower the relative cost of production, operations
and other expenses.

Earnings per Earnings available for Number of dollars earned during the period on behalf of
share (EPS) ordinary shareholders each outstanding share of ordinary share. It is an
Number of ordinary indicative to pay dividends.
shares outstanding
The higher the EPS, the better. It is generally of interest to
present or prospective shareholders and management as it
is considered an indicator of a corporate success. It tells
the earning capability of each share of investment.
Return on total Earnings available for Often called the return on investment (ROI), measures the
assets (ROA) ordinary shareholders overall effectiveness and efficiency of management in
Average Total Assets generating profits with its available assets.
 Average = (Beginning The higher the ROA, the better. It means, the higher return
Balance + Ending earned on the use of the assets of the firm.
Balance)/2
Return on Earnings available for Measures the return earned on the common stockholders’
common equity ordinary shareholders investment in the firm.
(ROE) Average Ordinary Share
Capital Ordinary share capital is Total Shareholders Equity less
Preference Share Capital.

The higher the ROE, the better. It means, the higher return
earned on every ordinary share investment in the firm

11. Market Ratios

Market ratios relate the firm’s market value, as measured by its current share price, to certain accounting
values. These ratios give insight into how investors in the marketplace feel the firm is doing in terms
of risk and return.

Name Formula Significance / Interpretation

Price/earnings Market price per Commonly used to assess the owners’ appraisal of share
(P/E) ratio of ordinary shares value. It measures the relationship between the price of
Earnings per share the ordinary shares in the open market and the profit
earned on a per share basis. The P/E ratio also measures
Or the amount that investors are willing to pay for each dollar
of a firm’s earnings.
Market value of
ordinary shares The higher the P/E ratio, the greater the investor
Earnings per share confidence in the firm’s future performance. The P/E ratio
is most informative when applied in cross-sectional
analysis using an industry average P/E ratio or the P/E
ratio of a benchmark firm.

Market/book Market price per Provides an assessment of how investors view the firm’s
(M/B) ratio ordinary shares performance. It relates the market value of the firm’s
Book value per ordinary shares to their book— strict accounting—value.
share
The higher the M/B ratio, the better. Firms expected to
earn high returns relative to their risk typically sell at
higher M/B multiples.

Book value per share of common stock = (Ordinary Share

Equity / Number of ordinary shares outstanding)
Dividend Payout Dividends per share* Shows the percentage of earnings paid to ordinary
Earnings per share shareholders. Take note that this is applicable for ordinary
shareholders only.

The higher the dividend payout ratio, the better. It means

Use dividends declared that the firm was able to pay or distribute dividends from
for ordinary shares a portion or for every earning peso of ordinary share. This
makes the firm attractive for the investors.
Dividends Yield Dividends per share Shows the rate earned by shareholders from dividends
Market value per relative to current price of shares. Take note that this is
ordinary share applicable for ordinary shareholders only.

The higher the dividends yield ratio, the better. It shows

the earning capability of the investment given market
price of each share.

12. DUPONT System Analysis

The DuPont system of analysis is used to dissect the firm’s financial statements and to assess its
financial condition. It merges the income statement and balance sheet into two summary measures of
profitability, return on total assets (ROA) and return on common equity (ROE).

DuPont Formula

ROA = Net profit margin x Total asset turnover

ROA = Earnings available for ordinary shareholders x Sales = Earnings available for ordinary shareholders
Sales Ave. Total Assets Ave. Total Assets

Modified DuPont Formula

ROE = ROA x Financial Leverage Multiplier (FLM)

ROE = Earnings available for ordinary shareholders x Ave. Total Assets = Earnings available for ordinary shareholders
Ave. Total Assets Ordinary Share Equity Ordinary Share Equity

FLM is also known as equity multiplier. It is computed as 1 .

Equity Ratio

where Equity Ratio is Ordinary Share Equity divide by average Total Assets.

The advantage of the DuPont system is that it allows the firm to break its return on equity into a profit-
on-sales component (net profit margin), an efficiency-of-asset-use component (total asset turnover),
and a use-of-financial-leverage component (financial leverage multiplier).

SAMPLE PROBLEM 1 (Adopted from Gitman, L.J and Zutter, C.J. Principles of Managerial
Finance 13th Edition. Prentice Hall)

Prepare a complete financial statement analysis for Bartlett Company for year 2012.

Presented below are the Income Statement, Balance Sheet (Statement of Financial Position) and
Statement of Retained Earnings.
…
 COMPLETE RATIO ANALYSIS FOR BARTLETT COMPANY

Analysts frequently wish to take an overall look at the firm’s financial performance and status. Here
we consider two popular approaches to a complete ratio analysis: (1) summarizing all ratios and (2) the
DuPont system of analysis. The summary analysis approach tends to view all aspects of the firm’s
financial activities to isolate key areas of responsibility. The DuPont system acts as a search technique
aimed at finding the key areas responsible for the firm’s financial condition.

SUMMARIZING ALL RATIOS

We can use Bartlett Company’s ratios to perform a complete ratio analysis using both cross-sectional
and time-series analysis approaches. The 2012 ratio values calculated earlier and the ratio values
calculated for 2010 and 2011 for Bartlett Company, along with the industry average ratios for 2012,
are summarized in Table 3.8 (see pages 86 and 87), which also shows the formula used to calculate
each ratio. Using these data, we can discuss the five key aspects of Bartlett’s performance—liquidity,
activity, debt, profitability, and market.

Liquidity

The overall liquidity of the firm seems to exhibit a reasonably stable trend, having been maintained at
a level that is relatively consistent with the industry average in 2012. The firm’s liquidity seems to be
good.

Activity

Bartlett Company’s inventory appears to be in good shape. Its inventory management seems to have
improved, and in 2012 it performed at a level above that of the industry. The firm may be experiencing
some problems with accounts receivable. The average collection period seems to have crept up above
that of the industry. Bartlett also appears to be slow in paying its bills; it pays nearly 30 days slower
than the industry average. This could adversely affect the firm’s credit standing. Although overall
liquidity appears to be good, the management of receivables and payables should be examined.
Bartlett’s total asset turnover reflects a decline in the efficiency of total asset utilization between 2010
and 2011. Although in 2012 it rose to a level considerably above the industry average, it appears that
the pre-2011 level of efficiency has not yet been achieved.

Debt

Bartlett Company’s indebtedness increased over the 2010–2012 period and is currently above the
industry average. Although this increase in the debt ratio could be cause for alarm, the firm’s ability to
meet interest and fixed-payment obligations improved, from 2011 to 2012, to a level that outperforms
the industry. The firm’s increased indebtedness in 2011 apparently caused deterioration in its ability to
pay debt adequately. However, Bartlett has evidently improved its income in 2012 so that it is able to
meet its interest and fixed-payment obligations at a level consistent with the average in the industry. In
summary, it appears that although 2011 was an off year, the company’s improved ability to pay debts
in 2012 compensates for its increased degree of indebtedness

Profitability

Bartlett’s profitability relative to sales in 2012 was better than the average company in the industry,
although it did not match the firm’s 2010 performance. Although the gross profit margin was better in
2011 and 2012 than in 2010, higher levels of operating and interest expenses in 2011 and 2012 appear
to have caused the 2012 net profit margin to fall below that of 2010. However, Bartlett Company’s
2012 net profit margin is quite favorable when compared to the industry average. The firm’s earnings
per share, return on total assets, and return on common equity behaved much as its net profit margin
did over the 2010–2012 period. Bartlett appears to have experienced either a sizable drop in sales
between 2010 and 2011 or a rapid expansion in assets during that period. The exceptionally high 2012
level of return on common equity suggests that the firm is performing quite well. The firm’s above-
average returns—net profit margin, EPS, ROA, and ROE—may be attributable to the fact that it is more
risky than average. A look at market ratios is helpful in assessing risk.
Market

Investors have greater confidence in the firm in 2012 than in the prior 2 years, as reflected in the
price/earnings (P/E) ratio of 11.1. However, this ratio is below the industry average. The P/E ratio
suggests that the firm’s risk has declined but remains above that of the average firm in its industry. The
firm’s market/book (M/B) ratio has increased over the 2010–2012 period, and in 2012 it exceeds the
industry average. This implies that investors are optimistic about the firm’s future performance. The
P/E and M/B ratios reflect the firm’s increased profitability over the 2010–2012 period: Investors
expect to earn high future returns as compensation for the firm’s above-average risk.

In summary, the firm appears to be growing and has recently undergone an expansion in assets, financed
primarily through the use of debt. The 2011–2012 period seems to reflect a phase of adjustment and
recovery from the rapid growth in assets. Bartlett’s sales, profits, and other performance factors seem
to be growing with the increase in the size of the operation. In addition, the market response to these
accomplishments appears to have been positive. In short, the firm seems to have done well in 2012.

SAMPLE PROBLEM 2

Given the data below, reconstruct the statement of financial position and income statement of MAS3
Company for the year 2019

MAS3 COMPANY
Statement of Financial Position
December 31, 2019

Assets

Current Assets
Cash Php ?
Marketable Securities 50,000
Accounts Receivable, net ?
Inventories ? Php ?

Property, plant and equipment, net ? .

Total Assets Php ? .

Liabilities and Shareholders’ Equity

Current liabilities Php ?

Long term Liabilities

Bonds Payable, 12.5% ? .

Total Liabilities Php ?

Shareholders Equity
Ordinary Share Capital Php 500,000
Retained Earnings 300,000 800,000

Total Liabilities and Shareholders’ Equity Php ? .

Additional data:
1. Gross margin on sales is Php525,000
 2. Operating expenses were 15% of net sales
3. Acid-test ratio was 1.3 : 1
4. Time interest earned was 6 times
5. Tax rate is 35%
6. Gross Margin was 35% of net sales
7. The age of receivables was 36 days
8. The beginning accounts receivable was P160,000. Use 360 day year
9. Inventory turnover was 4 times. The beginning inventory amounted to Php250,000
10. Total debt to shareholders’ equity was 0.80 : 1

Suggested Solutions

1. Net Sales = Gross Margin / Gross Margin Ratio = 525,000 / 35% = 1,500,000
2. Cost of sales = Net Sales x Cost of Sales Ratio = 1,500,000 x (1 -0.35) = 975,000
3. Operating Expenses = Net Sales x % to net Sales = 1,500,000 x 15% = 225,000
4. Operating Income = Net Sales – COS – Operating Expenses = 1,500,000 – 975,000-225,000
= 300,000
5. Interest Expense = Operating Income / Times Interest Earned = 300,000 / 6 times = 50,000.
Operating Income is also known as Earnings before interest and tax (EBIT).
6. Bonds Payable = Interest Expense / Interest Rate = 50,0000 / 12.5 % = 400,000
7. Receivable turnover = 360 days / age in receivables = 360 /36 = 10 times
8. Average receivables = Net credit sales / Receivable turnover = 1,500,000/10 times = 150,000
9. Ending Accounts Receivable = (Average Receivable x 2) – Beg. Receivables = (150,000 x
2) – 160,000 = 140,000
10. Average Inventory = Cost of Goods Sold / Inventory Turnover = 975,000 / 4 times = 243,750
11. Ending Inventory = (Ave Inventory x 2) – Beginning Inventory = (243,750 x 2) – 250,000
= 237,500
12. Total debt = Ratio to debt x shareholders’ equity = 0.80 x 800,000 = 640,000
13. Current liabilities = Total debts – Bonds payable = 640,000 - 400,000 = 240,000
14. Quick Assets = Acid Test Ratio x Current Liabilities = 1.3 x 240,000 = 312,000
15. Cash = Quick Assets – Marketable Securities – Acct Receivables = 312,000 – 50,000 –
140,000 = 122,000
16. Total Assets = Total Liabilities + Total Shareholders Equity = 240,000 + 400,000 + 800,000
= 1,440,000
17. PPE = Total Assets – Total Current Assets = 1,440,000 – 549,500 = 890,500

MAS3 COMPANY
Statement of Financial Position
December 31, 2019

Assets

Current Assets
Cash Php 122,000
Marketable Securities 50,000
Accounts Receivable, net 140,000
Inventories 237,500 Php 549,500

Property, plant and equipment, net 890,500

Total Assets Php 1,440,000

Liabilities and Shareholders’ Equity

Current liabilities Php 240,000

Long term Liabilities

Bonds Payable, 12.5% 400,000 .
Total Liabilities Php 640,000

Shareholders’ Equity
Ordinary Share Capital Php 500,000
Retained Earnings 300,000 800,000

Total Liabilities and Shareholders’ Equity Php 1,440,000

MAS3 COMPANY
Income Statement
For the year ended December 31, 2019

Net Sales Php 1,500,000

Cost of Goods Sold 975,000
Gross Margin Php 525,000
Operating Expenses 225,000
Net Operating Income (EBIT) Php 300,000
Other Expenses
Interest Expense 50,000
Net Income Before Tax Php 250,000
Income Tax (35%) 87,500
Net Income Php 162,500

SAMPLE PROBLEM 3

COVID Company
December 31, 2019

Income Statement
Sales 8,000,000.00
Cost of goods sols 5,260,000.00
gross profit 2,740,000.00
Selling and Admin Expenses 1,500,000.00
Operating Profit 1,240,000.00
Interest Expense 140,000.00
Income Before Tax 1,100,000.00
Tax Expense 440,000.00
Net Income 660,000.00

Statement of Financial Position 2019 2018

Cash 200,000.00 50,000.00
Accounts Receivable 1,200,000.00 950,000.00
Inventory 1,840,000.00 1,500,000.00
Total Current Assets 3,240,000.00 2,500,000.00
Fixed Assets 3,200,000.00 3,000,000.00
Total Assets 6,440,000.00 5,500,000.00

Accounts Payable 800,000.00 720,000.00

Bank Loan 600,000.00 100,000.00
Total Current Liabilities 1,400,000.00 820,000.00
Bonds Payable 900,000.00 1,000,000.00
Total Liabilities 2,300,000.00 1,820,000.00
Preference Share Capital, 2% 100,000.00 100,000.00
 Ordinary Share Capital (130,000 shares) 300,000.00 300,000.00
Retained Earnings 3,740,000.00 3,280,000.00
Total Liabilities and Shareholders’ Equity 6,440,000.00 5,500,000.00

The ordinary shares are trading in the stock market for 40php each.
Preferred dividends is 100,000 x .02 = 2,000.

1. The firm's current ratio for 2019 is _____.

2. The firm's quick ratio for 2019 is _____.
3. The firm's leverage ratio for 2019 is _____.
4. The firm's times interest earned ratio for 2019 is _____.
5. The firm's average collection period for 2019 is _____.
6. The firm's inventory turnover ratio for 2019 is _____.
7. The firm's fixed asset turnover ratio for 2019 is _____.
8. The firm's asset turnover ratio for 2019 is _____.
9. The firm's return on equity ratio for 2019 is _____.
10. The firm's P/E ratio for 2019 is _____.
11. The firm's market to bo
12. ok value for 2019 is _____.

Suggested Solutions:

1. 3,240,000/1,400,000 = 2.31.
2. (3,240,000 - 1,840,000)/1,400,000 = 1.00.
3. 6,440,000/4,140,000 = 1.56.
4. 1,240,000/140,000 = 8.86.
5. AR Turnover = 8,000,000 / [(1,200,000 + 950,000) / 2] = 7.44; ACP = 365 / 7.44 = 49.05 days
6. 5,260,000/[(1,840,000 + 1,500,000) / 2] = 3.15.
7. 8,000,000/[(3,200,000 + 3,000,000) / 2] = 2.58.
8. 8,000,000/[(6,440,000 + 5,500,000) / 2] = 1.34.
9. (660,000-2000)/[(4,040,000 + 3,580,000) / 2] = .1727.
10. EPS = (660,000-2000)/130,000 = 5.06; P/E = 40/5.06 = 7.90
11. BV/S = 4,040,000 / 130,000 = 31.08 ; M/B = 40/31.08 = 1.29

SAMPLE 4

A firm has a (net profit / pretax profit ratio) of 0.625, a leverage ratio of 1.2, a (pretax profit /
EBIT) of 0.9, an ROE of 17.82%, a current ratio of 8, and a return on sales ratio of 8%. Return on
Sales ratio is computed as Operating Profit or EBIT divide by Net Sales. The firm's asset turnover
is _________.

ROE = NET PROFIT = NET PROFIT x PRE TAX PROFIT x EBIT x NET SALES x T ASSETS
SHE PRE TAX PROFIT EBIT NS T. ASETS SHE

ROE = 17.82% = 0.625 x 0.9 x 8% x AT x

1.2

Therefore, Asset Turnover (AT) = 3.30

Net profit is assumed to be the earnings available for ordinary shareholders, that is after finance
cost, tax and preferred dividends. This is true since there were no finance cost, tax and preferred
dividends given.
 C. CLOSURE ACTIVITIES

The following work exercises intend to evaluate what the learners have learned in this topic.
Write your answers in your portfolio journal.

IV. SYNTHESIS / GENERALIZATION

Financial Statement Analysis involves methods of calculating, analyzing and interpreting the firm’s
financial status, financial performances and financial activities through the use of financial ratios.
Shareholders or owners, creditors and the management are the major parties interested on the
financial statement analysis. Use of financial ratios is not conclusive and perfect, and has limitations
thus careful and thorough selection of data and interpretation are necessary. Cross sectional analysis,
time series analysis and vertical analysis are useful in analyzing financial ratios. The five major
categories of financial ratios are Liquidity Ratios, Activity Ratios, Debt Ratios (Leverage ratios),
Profitability Ratios and Market Ratios. Liquidity, activity, and debt ratios primarily measure risk.
Profitability ratios measure return. Market ratios capture both risk and return. Financial statement
analysis provides wide variety of uses of accounting information, particularly for planning,
controlling, and decision-making in business not only to generate profit but primarily to maximize
the owners’ wealth.

V. EVALUATION

The student / learner’s performance in this module is evaluated as follows:

20% Attendance, Poll Questioning and Oral Exercises

20% Portfolio Journal for work exercises
20 % Formative Examination (One online/ offline written quiz covering Topic 1)
40% Summative Examination (This topic is included in the Online / Offline Written Midterm
Examination)

VI. ASSIGNMENT / AGREEMENT

For further reading: Roque, R.S. Management Advisory Services. 16 th Edition.

The next topic is Cash Flows, Financial Planning and Budgeting. Learner / student is advised to
read in advance the topic in the book of Gitman, L.J and Zutter, C.J. Principles of Managerial
Finance 13th Edition. Prentice Hall. Review also the Cash Flow Statements discussed in FAR 3.
You may use the discussion of cash flows in financial accounting.

REFERENCES

Cabrera, MEB. C. Management Advisory Services 2009 Edition. GIC Enterprises & Co., Inc.
Gitman, L.J and Zutter, C.J. Principles of Managerial Finance 13 th Edition. Prentice Hall