Chapter 3: Financial Statement Analysis

Purpose of the Chapter:

 How analysts use historical financial statements in financial statement analysis.

 Calculate and interpret operating, credit, and investment ratios.
 Prepare a trend analysis of a company’s financial ratios.
 How analysts use financial statement analysis to help prepare a valuation forecast.
 The cautions analysts must consider when using financial statement analysis.

Financial statement analysis are used to weigh and evaluate the operating performance of a
firm. It access the profitability of the business firm, the firm’s ability to meet its obligations,
safety of the investment in the business and effectiveness of management in running the firm.

Tools and techniques in analysing financial statement.

1. Horizontal Analysis – involves comparing figures in two or more consecutive period. The
difference between the figures of the two periods is calculated and the percentage of
change from one period to the next, with the earliest period as the base.
Example: 2017 2018 %change

Sales 10,000 15,000 50%

Increases are usually reflected with a positive % of change and decreases are usually
reflected with a negative () % of change.
a. Trend Analysis – a more advance form of Horizontal Analysis. Trend Analysis needs
at least 5 – 10 years of experience in order to determine the trend for a particular
account, unusual changes are not reflected in the trend. The firm will then compare
the financial statement for a given year, based on the trend with that of the actual
financial statement of the firm.

Analysis: Net Income Decreases by 42.29% as a result of decrease in sales of 5%, though
Cost of Goods Sold decreases by 1.49% it didn’t equal the decrease of 5% in sales
(possible scenarios are: The volume of sale decreases and cost to produce one unit
increases or Selling Price decreases as a result of decreasing the cost of goods sold) and
Total operating expenses decreases by 3.49%.
 2. Vertical Analysis – involves comparing figures in financial statements of a single period.
The base for income statement is the revenue/sales and the base for balance sheet is
the total assets/ total liabilities and equity. Vertical Analysis are effective when
comparing two or more companies.
Example: A firm’s salaries expense is 60% of revenue while another firm’s salaries
expense is 70% of revenue.

At the bottom of the analysis, note that net income, as a percentage of sales, declined
by 2.62 percentage points (6.67 percent to 4.05 percent). As a dollar amount, net
income declined by 14,096 (33,333 to 19,237). Management should consider both the
percentage change and the dollar amount change.
3. Ratio Analysis – different ratios are computed to access the performance of the firm.

Financial statement ratios are categorized into four (3).

a. Liquidity ratios – allows the firm to measure its ability to pay its current obligations.
b. Solvency ratios – allows the firm to measure its ability to pay long-term obligations. It
access the firm’s ability to exist in the long run (going concern).
c. Profitability ratios – allows the firm to measure its ability to earn an adequate return on
sales, total assets and invested capital. It allows the firm to access if its capital is earning
effectively through operations. Usually the firm’s rate of return is compared to a highest
risk-free rate of return of an investment that is available in the market

Liquidity Ratios:
1. Current ratio – also called the working capital ratio, measures the number of times that
the current liabilities can be paid with the available current liabilities. Working Capital =
Current Assets – Current Liabilities
Formula is:
Current Assets
Current Ratio =
Current Liabilities
Example: If Current Assets is 1,000,000 and Current Liabilities is 200,000. Then:
Current Ratio = 1,000,000= 5
200,000
Which means that the current liabilities can be paid 5 times until the current assets are
exhausted. Current Ratio roughly defines the short term debt-paying ability of the firm
2. Acid test ratio – also called the quick asset ratio, because not all asset can pay current
liabilities, like prepaid expenses, quick asset considers only the part of current liabilities
that are nearly converted into cash. The quick assets are: Cash and cash equivalent,
trading securities and receivables.
Formula is:
Cash & Cash Equivalent + Trading Securities + Receivables
Acid test ratio =
Current Liabilities
Example: If Cash is 150,000, Short term Investment is 200,000 and Accounts Receivable
is 400,000 and Current Liabilities is 200,000. Then:
Acid test ratio = 150,000 + 200,000 + 400,000 = 3.75
200,000
Acid test ratio is stricter than current ratio. Acid test ratio does not include inventory
and prepaid expense, because inventory needs to be sold then collected first before it
can be used to pay debts and prepaid expenses will never be converted to cash while
short term investments can be immediately sold through active market and accounts
receivable can be used to finance short term debt through pledging and factoring.

3. Working capital activity ratios – measures the turnover rate of working capital
a. Receivable turnover – measures how fast cash is collected from receivable, it is
presented in the unit (times), times meaning in a single year how many times does
receivable be converted to cash.
Formula is:
Net Credit Sales
Receivable Turnover =
Average Receivable
Average Receivable = Beginning Receivable + Ending Receivable
2
Example: If net credit sales is 500,000 and average receivable is 50,000. Then:
Receivable Turnover = 500,000 = 10 times
50,000
b. Average Age of Receivable – at an average how many days will it take for accounts
receivable before it is collected.
Formula is:
365 days
Average age of receivable =
Receivable Turnover
Example: In the previous example,
Average Age of Receivable = 365 = 36.5 days
10
Which means that at an average, receivables are collected after 36.5 days
c. Inventory turnover – measures how fast inventory is sold, meaning in a single year
how many times inventories are purchased and sold.
Formula is:
Cost of Goods Sold
Inventory Turnover =
Average Inventory
Average Inventory = Beginning Inventory + Ending Inventory
2
Example: if Cost of Goods sold is 300,000 and average inventory is 60,000. Then:
 Inventory Turnover = 300,000 = 5 times
60,000
d. Average Age of Inventory = at an average how many days will it take for the
inventory to be sold.
Formula is:
365 days
Average age of Inventory =
Inventory Turnover
Example: In the previous example,
Average Age of Inventory = 365 = 73 days
5
Which means that inventory are sold 73 days after purchase.
Operating Cycle – The length of time raw materials are acquired, through
production, sale of finished goods, until the time when receivables are collected or
converted into cash which may in turn be used again to acquire raw materials.
Formula is:
Ave. Age of Receivable + Ave. Age of
Operating Cycle =
Inventory
Example: If Average Age of Receivable is 36.5 days and Average Age of Inventory is
73 days then:
Operating Cycle = 36.5 + 73 = 109.5 days
Which means that if inventory are sold on credit, it takes 109.5 days for purchased
inventory to be sold and ultimately collected
e. Accounts Payable turnover – measures how fast payables are paid.
Formula is:
Net Credit Purchases
Payables Turnover =
Average Trade Payables
Average Trade Payables = Beginning Payables + Ending Payables
2
Example: If Net Credit Purchase is 500,000 and Average Trade Payables is 200,000.
Then:
Accounts Payable Turnover = 500,000 = 2.5 times
200,000
f. Average Age of Trade Payables = at an average how many days will it take for
payables to be paid.
Formula is:
365 days
Average age of Inventory =
Inventory Turnover
In the Previous Example,
Average age of Inventory = 365 = 146 days
2.5
At an average it takes 146 days for accounts payable to be paid.

Cash Conversion Cycle – The length of time for cash used to purchase inventory to be
converted back to cash.
 Cash Conversion Cycle = Ave. Age of Receivable + Ave. Age of Inventory – Ave Age of
Payable
The acceptable liquidity ratios depends on the accepted standard of the entity but in no case
should it be lower than one (1). A liquidity ratio of less than one indicates that the entity is no
longer liquid. A very high liquidity ratio may indicate that the entity might not be utilizing its
assets efficiently, To avoid underutilization of asset, the entity can either choose to expand
their business, establish a new project or purchase long-term assets.

Solvency Ratios:
1. Times Interest Earned – Determines the company’s ability to cover its interest expense
Formula is:
Times Interest Earned = Income before interest and tax
Interest Expense
Example: Income before interest and taxes is 500,000 while interest expense is 250,000.
Then:
Times Interest Earned = 500,000 = 2 times
200,000
Times Interest Earned shows if your earnings are beings used up to pay interest. If a
company has less than one (1) times interest earned, then the entities earnings are
actually not enough to cover the interest of loans. If a company has low times interest
earned (depends on the standard of the company) most operating income are used to
pay interest. High times interest earnings is desired.
2. Debt-equity ratio – Ratio of Debt to Equity
Formula is:
Total Liabilities
Debt-equity ratio =
Total Equity
Example: If Total Liabilities is 300,000 and Total Equity is 100,000. Then:
Debt-Equity Ratio = 300,000 = 3
100,000
Debt-equity ratio compares the ownership of creditors to the total asset, a very high
debt-equity ratio shows that if the entity is liquidated, most of assets are actually used
to pay liabilities, while a minimal amount goes to the owner.
3. Debt Ratio – Indicates the percentage of total assets provided by creditors.
Formula is:
Total Liabilities
Debt ratio =
Total Assets
Example: If Total Liabilities is 300,000 and Total Assets is 400,000. Then:
Debt Ratio = 300,000 = 75%
400,000
Debt Ratio shows the percentage of ownership of creditors to the total asset, in the
example in shows that 75% of the total asset belongs to the creditors
4. Equity Ratio – Indicates the percentage of total assets provided by the owners or
stockholders.
Formula is:
 Total Equity
Equity ratio =
Total Assets
Example: If Total Equity is 100,000 and Total Assets is 400,000. Then:
Equity Ratio = 100,000 = 75%
400,000
Equity Ratio shows the percentage of ownership of shareholders to the total asset, in
the example in shows that 25% of the total asset belongs to the shareholders.
Equity Ratio + Debt Ratio = 100%

Profitability Ratio:
1. Rate of Return – also known as return on investment
Formula is:
Net Income
Rate of Return =
Investment
2. Return on Sales – measures the percentage of each peso revenue that results in net
income
Formula is:
Net Income
Return on Sales =
Net Sales
3. Return on Asset – it measures how assets were efficiently used to produce the sales or
revenue
Formula is:
Net Income
Return on Asset =
Average Total Asset
4. Return on Owners’ Equity – measures the percentage of net income to capital
Formula is:
Net Income
Return on Equity =
Average Equity
5. Return on Common Equity – measures the percentage of return to common equity after
deducting the dividends for preference stock.
Formula is:
Net Income – Preferred Dividends
Rate on Common Equity =
Average Common Stockholders’ Equity
6. Basic Earnings Power Ratio - ratio is a measure that calculates the earning power of a
business before the effect of the business' income taxes and its financial leverage.
Formula is:
Net Income Before Interest and Taxes
Basic Earnings Power Ratio =
Average Common Stockholders’ Equity
7. Earnings per share
Formula is:
Earnings per share = Net Income – Preferred Dividends
Weighted Average Number of Common
 Shares

8. Market Tests – relationship of price, dividends and earnings, market test shows if shares
of stocks are worth purchasing or not.
a. Price-earnings ratio – relationship price to earnings, it shows how many years would
it take for the shareholder to recover the price paid for the shares using the earnings
received from the same shares, lower price-earnings ratio is desirable, while high
price-earnings ratio indicates that the shares are overpriced.
Formula is:
Price per share
Price-Earnings Ratio (P/E) =
Earnings Per Share
b. Dividend yield – relationship of dividends to the price per share, it shows the
percentage of the price that was recovered through dividends. High dividend yield is
desirable.
Formula is:
Dividend per share
Dividend Yield =
Price per Share
c. Dividend payout – percentage of earnings that is distributed as dividends.
Formula is:
Common Dividend Per Share
Dividend payout =
Earnings Per Share
Exercise 1: True or False
1. The purpose of financial statement analysis is not only to understand the historical results
of financial statements but also to use that information to forecast the future.
2. Operating ratios measure a firm’s ability to repay its obligations.
3. One of the common credit ratios is the return on capital ratio.
4. The revenue growth rate is a ratio that measures the expansion or contraction of the
business.
5. A ratio is most meaningful when the numerator and denominator are related to each other.
6. When an interest coverage ratio is computed, the lower the result, the better the firm’s
ability to make interest payments.
7. The MB ratio is a popular metric used to determine the relationship between the market
price of a stock and its earnings power as measured by earnings per share.
8. The only ratio that measures return on investment is the return on common equity.
9. The benchmark used in cross-sectional analysis is the prior performance of the firm
currently undergoing analysis.
10. A firm “cannibalizes” its revenue when it adds additional store locations into an area in
which the firm already has existing stores.
11. The benchmark used in trend analysis is a given firm’s performance over a period of time.
12. When analyzing revenue growth in trend analysis, often the analyst will not only look at
overall revenue growth rates but also at revenue growth by business segment.
13. Cause-of-action analysis is a special kind of evaluation in which the reasons for a change in a
specific item over some period are identified.
14. In cross-sectional analysis, we compare two or more companies using financial ratios, and
we may also compare the companies’ ratios to an industry average.
15. In doing ratio analysis, we must recognize that different firms provide different levels of
disclosure.

Exercise 2: Multiple Choice

16. In financial analysis, ratios are used to help us learn about the firm’s:
a. profitability
b. growth and potential for growth
c. resource needs
d. All of the above answers are correct.

17. A ratio that is used to evaluate a firm’s operating margin percentage is classified as:
a. a specialty ratio
b. an investment ratio
c. a credit ratio
d. an operating ratio

18. A ratio that measures income taxes to revenues is:

a. relatively meaningless since it tells us little about the income tax rate or the profitability of
the firm
b. an excellent metric since it compares the effective rate of income tax to the profitability of
the firm
c. classified as a common investment ratio
d. complimentary to the return on common equity ratio

19. The only operating ratio that uses the cost of sales in its numerator is the:
a. market-to-book ratio
b. quick ratio
c. inventory turnover ratio
d. days payables outstanding ratio

20. An operating ratio, such as the inventory turnover ratio, varies greatly by industry. An
example of a business with a high inventory turnover ratio is a:
a. watch repair shop
b. grocery store
c. jewelry retailer
d. CPA firm

21. To help determine whether a business should extend credit to various other businesses, an
analyst will look at credit ratios. The ratio that measures the speed with which the firm can
pay its obligations with cash, cash equivalents, and short-term investments is known as the:
a. days payables outstanding ratio
b. debt to capital ratio
c. current ratio
d. quick ratio

22. The denominator in the debt to capital ratio consists of:

a. debt, minority interest, and equity
b. the total obligations of the firm
c. the total equity of the firm
d. net income, common and preferred stock, and retained earnings

23. Investors and managers use the price-to-earnings and market-to-book ratios to:
a. primarily measure business performance
b. primarily screen potential investments
c. measure business performance and screen potential investments
d. track the efficiency of leverage in capital spending in both foreign and domestic markets

24. The __________ ratio uses net income in its numerator while the __________ ratio uses
diluted earnings per share in its denominator.
a. return on common equity; market-to-book
b. return on common equity; price-to earnings
c. return on capital; market-to-book
d. return on capital; price-to-earnings

25. A ratio has little meaning until it is compared to a benchmark. Financial analysts use several
common benchmarks to help them better understand and interpret financial ratios. The
benchmark in which ratios from several different companies or an industry segment are
analyzed is known as a:
a. cross-sectional analysis
b. trend analysis
c. cause-of-change analysis
d. cause-of-action analysis

26. A thorough financial analysis includes any adjustments to the financial statements that are
necessary to develop useful forecasts. Such forecasts are used in the analyst’s valuation
work. An example of an adjustment made to understand a business more completely for
purposes of valuation is to:
a. change financial statement items even though such adjustment may not be per GAAP
b. change financial statement items that may incorporate accounting policies different than
that of the firm
c. exclude a financial statement item such as joint venture income
d. All of the answers above are correct.
27. An analyst can restate each item on an income statement as a percentage of revenues. This
will afford the analyst an opportunity to factor out size differences among statements of
various firms. What is this restatement known as and with which method can it be used?
a. change of accounting principle restatement; cross-sectional analysis only
b. change of accounting principle restatement; trend or cross-sectional analysis
c. common-size income statement; trend or cross-sectional analysis
d. common-size income statement; trend analysis only

28. Identify the ratio that cannot be computed given the following information for a firm:
Current assets are P475,806; current liabilities are P257,814; cash is P89,774; earnings
before interest and taxes is P72,005; short-term investments, P145,850; equity, P192,615;
minority interest, P0; interest expense, P47,899.
a. current
b. quick
c. debt to capital
d. interest coverage

29. Identify the ratio that can be computed given the following information for a firm: Current
assets are P475,806; current liabilities are P257,814; cash is P89,774; earnings before taxes
is P72,005; short-term investments, P145,850; equity at end of period, P192,615; minority
interest, P0; income taxes, P11,211; interest expense, P47,899.
a. return on capital
b. effective income tax rate
c. gross margin percentage
d. inventory turnover

30. Identify the ratio that cannot be computed given the following information for a firm:
Diluted earnings per share, P3.57; market price of the firm’s stock, P47.75; average
common equity, P879,550; net income, P99,772; average total capital, P625,740; aftertax
interest expense, P14,885.
a. price-earnings
b. market-to-book
c. return on common equity
d. return on capital

31. A firm has the following growth rates for the last four years: 2000, 39.8%; 2001, 34.2%;
2002, 28.4%; 2003, 29.1%. From a standpoint of trend analysis, what conclusion might an
analyst reach regarding the firm’s revenue growth?
a. The trend analysis indicates the firm has had flat revenue growth over time.
b. The trend analysis indicates the firm has had diminished revenue growth over time.
c. The trend analysis indicates the firm has had moderately increasing revenue growth over
time.
d. The trend analysis indicates the firm has had significant, but slowing, revenue growth over
time.
32. A firm has the following operating income rates for the last four years: 2000, 9.0%; 2001,
8.9%; 2002, 9.1%; 2003, 8.8%. From a standpoint of trend analysis, what conclusion might
an analyst reach regarding the firm’s revenue growth?
a. The trend analysis indicates the firm’s operating income has been flat over time.
b. The trend analysis indicates the firm’s operating income has materially declined over time
and is cause for investor concern.
c. The trend analysis indicates the firm’s operating income has been increasing at a fiscally
healthy rate over time.
d. The conclusion is indeterminable from the information given.

33. There are two key ratios that measure operating profitability. The numerator for the
__________ ratio uses income while the __________ ratio uses revenues less cost of goods
sold in its computation.
a. gross margin percentage; operating margin percentage
b. operating margin percentage; gross margin percentage
c. quick; operating margin percentage
d. current; gross margin percentage

34. The analyst must exercise caution when using ratios as part of the analysis of a firm. The
fact that ratios often vary across industries is an example of what is called:
a. an accounting method discrepancy
b. an industry and business difference
c. a business environment change
d. an ambiguous ratio definition

35. Select the answer that best fits this statement, “Analysts define ratios differently.”
a. What some analysts call trend analysis others call cross-sectional analysis.
b. What some analysts call the current ratio is called the quick ratio by others.
c. The numerator used in the return on capital ratio may vary.
d. The income statement is restated in non-GAAP terms.

36. Ratios often aid analysts to project the future. Such projections require the adjustment of
certain items found on the financial statements. One such item that should be adjusted in
such a projection is:
a. removing an extraordinary item from the income statement
b. removing revenue from the income statement
c. the earnings-per-share calculation when there are no dilutive or anti-dilutive items
d. the reconciliation of cash on the balance sheet
Problems
1. Following are data about Blite Company
Average total assets P150,000
Average owner’s equity 60,000
Net income after interest but before tax 10,000
Bonds payable, 8% 50,000
Income tax rate 35%
Calculate the following ratios.
1. Times interest earned
2. Return on equity
3. Return on assets
4. Basic earnings power ratio

2. Below are data about Loi Merchandising Company:

Sales P500,000
Cost of goods sold 200,000
Average inventory 20,000
Average receivable 30,000
Compute the following:
a. Inventory turnover
b. Receivable turnover
c. Collection period of accounts receivable
d. Average age of inventory
e. Operating cycle

3. Estrada Inc. is concerned about the level of its advertising and office salaries expense.
Selected statement of comprehensive income data from 2016 – 2018 appear below:
2018 2017 2016
Sales P140,000 P60,000 P37,500
Gross Profit 89,600 37,200 22,500
Advertising Expense 7,000 3,300 2,250
Office Salaries 22,400 9,000 4,500
Profit 30,800 13,800 9,000

4. The following information was taken from the statement of financial position of Blanche
Corporation:
Cash P13,250
Accounts Receivable (net) 33,000
Merchandise Inventory 40,000
Prepaid Expenses 9,950
Accounts Payable 25,200
Accrued Payables 1,800
Notes Payable (due in 6 months) 10,000
Calculate the working capital, current ratio and quick ratio

5. The following data are available from Gumban’s annual report:

Beginning Merchandise Inventory P 245,000
 Ending Merchandise Inventory 375,000
Beginning Accounts Receivable 250,000
Ending Accounts Receivable 297,000
Cost of Goods Sold 2,480,000
Cash Sales 1,000,000
Total Sales 5,100,000
Gumban’s Credit Terms Net 30 days

Required:
1. Calculate inventory turnover and accounts receivable turnover
2. In your opinion, is Gumban doing a good job in receivables? Explain.

Horizontal analysis
6. Kline Corporation had net income of P2 million in 2016. Using the 2016 financial elements as the base
data, net income decreased by 70 percent in 2017 and increased by 175 percent in 2018. The respective
net income reported by Kline Corporation for 2017 and 2018 are:
A. P 600,000 and P5,500,000 C. P1,400,000 and P3,500,000
B. P5,500,000 and P 600,000 D. P1,400,000 and P5,500,000

7. Assume that Axle Inc. reported a net loss of P50,000 in 2016 and net income of P250,000 in 2017. The
increase in net income of P300,000:
A. can be stated as 0% C. cannot be stated as a percentage
B. can be stated as 100% increase D. can be stated as 200% increase

Liquidity ratios

8. The following financial data have been taken from the records of Ratio Company:
Accounts receivable P200,000
Accounts payable 80,000
Bonds payable, due in 10 years 500,000
Cash 100,000
Interest payable, due in three months 25,000
Inventory 440,000
Land 800,000
Notes payable, due in six months 250,000
What will happen to the ratios below if Ratio Company uses cash to pay 50 percent of its accounts
payable?
A. B. C. D.
Current ratio Increase Decrease Increase Decrease
Acid-test Increase Decrease Decrease Increase
ratio

Question Nos. 9 through 11 are based on the data taken from the balance sheet of Nomad Company at the
end of the current year:
Accounts payable P145,000
Accounts receivable 110,000
Accrued liabilities 4,000
Cash 80,000
Income tax payable 10,000
Inventory 140,000
Marketable securities 250,000
 Notes payable, short-term 85,000
Prepaid expenses 15,000

9. The amount of working capital for the company is:

A. P351,000 C. P211,000
B. P361,000 D. P336,000

10. The company’s current ratio as of the balance sheet date is:
A. 2.67:1 C. 2.02:1
B. 2.44:1 D. 1.95:1

11. The company’s acid-test ratio as of the balance sheet date is:
A. 1.80:1 C. 2.02:1
B. 2.40:1 D. 1.76:1

Activity ratios
Receivables turnover
12. Pine Hardware Store had net credit sales of P6,500,000 and cost of goods sold of P5,000,000 for the
year. The Accounts Receivable balances at the beginning and end of the year were P600,000 and
P700,000, respectively. The receivables turnover was
A. 7.7 times. C. 9.3 times.
B. 10.8 times. D. 10.0 times.

13. Milward Corporation’s books disclosed the following information for the year ended December 31,
2017:
Net credit sales P1,500,000
Net cash sales 240,000
Accounts receivable at beginning of year 200,000
Accounts receivable at end of year 400,000
Milward’s accounts receivable turnover is
A. 3.75 times C. 5.00 times
B. 4.35 times D. 5.80 times

Days receivable
14. Batik Clothing Store had a balance in the Accounts Receivable account of P390,000 at the beginning of
the year and a balance of P410,000 at the end of the year. The net credit sales during the year amounted
to P4,000,000. Using 360-day year, what is the average collection period of the receivables?
A. 30 days C. 73 days
B. 65 days D. 36 days

Cash collection
15. Deity Company had sales of P30,000, increase in accounts payable of P5,000, decrease in accounts
receivable of P1,000, increase in inventories of P4,000, and depreciation expense of P4,000. What was the
cash collected from customers?
A. P31,000 C. P34,000
B. P35,000 D. P25,000

Inventory turnover
16. During 2017, Tarlac Company purchased P960,000 of inventory. The cost of goods sold for 2017
was P900,000, and the ending inventory at December 31, 2017 was P180,000. What was the inventory
turnover for 2017?
A. 6.4 C. 5.3
B. 6.0 D. 5.0

17. Selected information from the accounting records of Petals Company is as follows:
Net sales for 2017 P900,000
Cost of goods sold for 2017 600,000
Inventory at December 31, 2016 180,000
Inventory at December 31, 2017 156,000
Petals’ inventory turnover for 2017 is
A. 5.77 times C. 3.67 times
B. 3.85 times D. 3.57 times

18. The Moss Company presents the following data for 2017.
Net Sales, 2017 P3,007,124
Net Sales, 2016 P 930,247
Cost of Goods Sold, 2017 P2,000,326
Cost of Goods Sold, 2017 P1,000,120
Inventory, beginning of 2017 P  341,169
Inventory, end of 2017 P  376,526
The merchandise inventory turnover for 2017 is:
A. 5.6 C. 7.5
B. 15.6 D. 7.7

19. Based on the following data for the current year, what is the inventory turnover?
Net sales on account during year P 500,000
Cost of merchandise sold during year 330,000
Accounts receivable, beginning of year 45,000
Accounts receivable, end of year 35,000
/16
Inventory, end of year 110,000
A. 3.3 C. 3.7
B. 8.3 D. 3.0

Days inventory
20. Selected information from the accounting records of Eternity Manufacturing Company follows:
Net sales P3,600,000
Cost of goods sold 2,400,000
Inventories at January 1 672,000
Inventories at December 31 576,000
What is the number of days’ sales in average inventories for the year?
A. 102.2 C. 87.6
B. 94.9 D. 68.1

Turnover ratios
Asset turnover
Asset
21. Net sales are P6,000,000, beginning total assets are P2,800,000, and the asset turnover is 3.0. What
is the ending total asset balance?
A. P2,000,000. C. P2,800,000.
 B. P1,200,000. D. P1,600,000.

Solvency ratios
Debt ratio
22. Jordan Manufacturing reports the following capital structure:
Current liabilities P100,000
Long-term debt 400,000
Deferred income taxes 10,000
Preferred stock 80,000
Common stock 100,000
Premium on common stock 180,000
Retained earnings 170,000
What is the debt ratio?
A. 0.48 C. 0.93
B. 0.49 D. 0.96

Times interest earned

23. House of Fashion Company had the following financial statistics for 2016:
Long-term debt (average rate of interest is 8%) P400,000
Interest expense 35,000
Net income 48,000
Income tax 46,000
Operating income 107,000
What is the times interest earned for 2016?
A. 11.4 times C. 3.1 times
B. 3.3 times D. 3.7 times

24. Brava Company reported the following on its income statement:

Income before taxes P400,000
Income tax expense 100,000
Net income P300,000
An analysis of the income statement revealed that interest expense was P100,000. Brava Company’s
times interest earned (TIE) was
A. 5 times C. 3.5 times
B. 4 times D. 3 times

25. The balance sheet and income statement data for Candle Factory indicate the following:
Bonds payable, 10% (issued 1998 due 2022) P1,000,000
Preferred 5% stock, P100 par (no change during year) 300,000
Common stock, P50 par (no change during year) 2,000,000
Income before income tax for year 350,000
Income tax for year 80,000
Common dividends paid 50,000
Preferred dividends paid 15,000
Based on the data presented above, what is the number of times bond interest charges were earned
(round to one decimal point)?
A. 3.7 C. 4.5
B. 4.4 D. 3.5
26. The following data were abstracted from the records of Johnson Corporation for the year:
Sales P1,800,000
Bond interest expense 60,000
Income taxes 300,000
Net income 400,000
How many times was bond interest earned?
A. 7.67 C. 12.67
B. 11.67 D. 13.67

Net income

27. The times interest earned ratio of Mikoto Company is 4.5 times. The interest expense for the year
was P20,000, and the company’s tax rate is 40%. The company’s net income is:
A. P22,000 C. P54,000
B. P42,000 D. P66,000

Profitability Ratios
Return on Common Equity
28. Selected information for Ivano Company as of December 31 is as follows:
2016 2017
Preferred stock, 8%, par P100, nonconvertible, P250,000 P250,000
noncumulative
Common stock 600,000 800,000
Retained earnings 150,000 370,000
Dividends paid on preferred stock for the year 20,000 20,000
Net income for the year 120,000 240,000
Ivano’s return on common stockholders’ equity, rounded to the nearest percentage point, for 2017 is
A. 17% C. 21%
B. 19% D. 23%

Dividend yield
29. The following information is available for Duncan Co.:
2016
Dividends per share of common stock P 1.40
Market price per share of common stock 17.50
Which of the following statements is correct?
A. The dividend yield is 8.0%, which is of interest to investors seeking an increase in market price of
their stocks.
B. The dividend yield is 8.0%, which is of special interest to investors seeking current returns on their
investments.
C. The dividend yield is 12.5%, which is of interest to bondholders.
D. The dividend yield is 8.0 times the market price, which is important in solvency analysis.

Market Test Ratios

Market/Book value ratio
Price per share
30. What is the market price of a share of stock for a firm with 100,000 shares outstanding, a book value of
equity of P3,000,000, and a market/book ratio of 3.5?
A. P8.57 C. P85.70
B. P30.00 D. P105.00

P/E ratio
31. Orchard Company’s capital stock at December 31 consisted of the following:
 Common stock, P2 par value; 100,000 shares authorized, issued, and outstanding.
 10% noncumulative, nonconvertible preferred stock, P100 par value; 1,000 shares authorized,
issued, and outstanding.
Orchard’s common stock, which is listed on a major stock exchange, was quoted at P4 per share on
December 31. Orchard’s net income for the year ended December 31 was P50,000. The yearly
preferred dividend was declared. No capital stock transactions occurred. What was the price earnings
ratio on Orchard’s common stock at December 31?
A. 6 to 1 C. 10 to 1
B. 8 to 1 D. 16 to 1

32. On December 31, 2016 and 2017, Renegade Corporation had 100,000 shares of common stock and
50,000 shares of noncumulative and nonconvertible preferred stock issued and outstanding.
Additional information:
Stockholders’ equity at 12/31/07 P4,500,000
Net income year ended 12/31/07 1,200,000
Dividends on preferred stock year ended 12/31/07 300,000
Market price per share of common stock at 12/31/07 144
The price-earnings ratio on common stock at December 31, 2017, was
A. 10 to 1 C. 14 to 1
B. 12 to 1 D. 16 to 1

Payout ratio
33. Selected financial data of Alexander Corporation for the year ended December 31, 2017, is presented
below:
Operating income P900,000
Interest expense (100,000)
Income before income taxes 800,000
Income tax (320,000)
Net income 480,000
Preferred stock dividend (200,000)
Net income available to common stockholders 280,000
Common stock dividends were P120,000. The payout ratio is:
A. 42.9 percent C. 25.0 percent
B. 66.7 percent D. 71.4 percent

P/E ratio & Payout ratio

Use the following information for question Nos. 33 and 34:
Terry Corporation had net income of P200,000 and paid dividends to common stockholders of P40,000 in
2017. The weighted-average number of shares outstanding in 2017 was 50,000 shares. Terry
Corporation’s common stock is selling for P60 per share in the local stock exchange.

34. Terry Corporation’s price-earnings ratio is

A. 3.8 times C. 18.8 times
B. 15 times D. 6 times
35. Terry Corporation’s payout ratio for 2017 is
A. P4 per share C. 20.0 percent
B. 12.5 percent D. 25.0 percent

Integrated ratios
Liquidity & activity ratios
Inventory
36. The current assets of Mayon Enterprise consists of cash, accounts receivable, and inventory. The
following information is available:
Credit sales 75% of total sales
Inventory turnover 5 times
Working capital P1,120,000
Current ratio 2.00 to 1
Quick ratio 1.25 to 1
Average Collection period 42 days
Working days 360
The estimated inventory amount is:
A. 840,000 C. 720,000
B. 600,000 D. 550,000

37. The following data were obtained from the records of Salacot Company:
Current ratio (at year end) 1.5 to 1
Inventory turnover based on sales and ending inventory 15 times
Inventory turnover based on cost of goods sold and ending inventory10.5 times
Gross margin for 2017 P360,000
What was Salacot Company’s December 31, 2017 balance in the Inventory account?
A. P120,000 C. P 80,000
B. P 54,000 D. P 95,000

Net sales
38. Selected data from Mildred Company’s year-end financial statements are presented below. The
difference between average and ending inventory is immaterial.
Current ratio 2.0
Quick ratio 1.5
Current liabilities P120,000
Inventory turnover (based on cost of sales) 8 times
Gross profit margin 40%
Mildred’s net sales for the year were
A. P 800,000 C. P 480,000
B. P 672,000 D. P1,200,000

Gross margin
39. Selected information from the accounting records of the Blackwood Co. is as follows:
Net A/R at December 31, 2016 P 900,000
Net A/R at December 31, 2017 P1,000,000
Accounts receivable turnover 5 to 1
Inventories at December 31, 2016 P1,100,000
Inventories at December 31, 2017 P1,200,000
Inventory turnover 4 to 1
 What was the gross margin for 2017?
A. P150,000 C. P300,000
B. P200,000 D. P400,000

Market Test Ratio

Dividend yield
40. Recto Co. has a price earnings ratio of 10, earnings per share of P2.20, and a pay out ratio of 75%.
The dividend yield is
A. 25.0% C. 7.5%
B. 22.0% D. 10.0%

41. The following were reflected from the records of Salvacion Company:
Earnings before interest and taxes P1,250,000
Interest expense 250,000
Preferred dividends 200,000
Payout ratio 40 percent
Shares outstanding throughout 2016
Preferred 20,000
Common 25,000
Income tax rate 40 percent
Price earnings ratio 5 times
The dividend yield ratio is
A. 0.50 C. 0.40
B. 0.12 D. 0.08

Comprehensive
42. The balance sheets of Magdangal Company at the end of each of the first two years of operations
indicate the following:
2017   2016  
Total current assets P600,000 P560,000
Total investments 60,000 40,000
Total property, plant, and equipment 900,000 700,000
Total current liabilities 150,000 80,000
Total long-term liabilities 350,000 250,000
Preferred 9% stock, P100 par 100,000 100,000
Common stock, P10 par 600,000 600,000
Paid-in capital in excess of par-common stock 60,000 60,000
Retained earnings 300,000 210,000
Net income is P115,000 and interest expense is P30,000 for 2017.
What is the rate earned on total assets for 2017 (round percent to one decimal point)?
A. 9.3 percent C. 8.9 percent
B. 10.1 percent D. 7.4 percent

43. What is the rate earned on stockholders' equity for 2017 (round percent to one decimal point)?
A. 10.6 percent C. 12.4 percent
B. 11.2 percent D. 15.6 percent

44. What is the earnings per share on common stock for 2017, (round to two decimal places)?
A. P1.92 C. P1.77
B. P1.89 D. P1.42
https://www.dummies.com/business/accounting/horizontal-and-vertical-analysis/
Prof. Bobadilla, Financial Management (2017)