UNIVERSITY OF GONDER

INISTITUTE OF TECHNOLOGY
DEPARTMENT OF CoTM
Financial Management In Construction
(COTM 3162)
Target Group:- CoTM 5th Year Students
Year-2024.
 CHAPTER-3

FIRM’S FINANCIAL OPERATION

 Accounting System

Financial Accounting System Managerial Accounting System

Periodic financial statements and Detailed plans and continuous
related disclosures performance reports

External Decision Makers Internal Decision Makers

Investors, creditors, Managers throughout the
suppliers, customers, etc. organization
 3.1.Financial Statement
• is a collection of monetary data and information organized according to
logical and consistent accounting procedures.
• The main purpose is to convey an understanding of some financial aspects
of a business firm.
Uses of Financial Statement
• To present a historical record of the firm’s financial development when
fulfilled over a number of years.
• Used to forecast a course of action for the firm.
• To known present their financial situations to stockholders, creditors and
the general public.
• Financial statements summarize the financial activities of the business.
Purpose of Financial Statements
To inform the following parties of the financial
performance and position of the entity:
1) Manager– for reviewing their performance during the
reporting period
2) Shareholders – for assessing the worth of their investments
and reviewing the effectiveness of the Management
3) Investors – for judging the worth of the entity before
deciding to invest
4) Suppliers and Lenders – for judging the creditworthiness of
the entity before deciding to extend credit
5) Government – for calculating the amount of tax to be
collected
Major Forms of Financial Statements
1. The Balance Sheet
2. The Income Statement ( Profit and loss statement)
3. A Flow of Funds Statement
4. The statement of owner’s equity
1. The Balance Sheet
A balance sheet shows a company’s financial position as at a point of time
(usually the last date of the company’s fiscal year).
There are three major items in a balance sheet:
(1) Assets,
(2) Liabilities,
(3) Equity (or called Net Worth).
1.Balance sheet
 It shows the financial position of the firm at a moment of reporting,
which is the fiscal year.
 It declares the assets, liabilities and equity for the firm at the last day
of the accounting period
 It matches resources (assets) with sources (liabilities and equity).

Assets = Liabilities + Owner’s equity

 1.Assets

Assets: any physical thing (tangible) or right (intangible) that has a monetary value is an asset.

Assets are classified into two categories:

1) Current Assets and

2) Fixed Assets.

1). Current Assets

Current Assets : Contains all assets to be converted into cash within the current accounting
period
 Cash and Cash equivalents
 Marketable Securities:
 Costs & estimated earnings in excess of billings on uncompleted contracts (Work in
Progress)
 Receivables:
 Inventories: goods held by the firm for eventual resale.
2. Fixed Assets :
 are tangible assets used in the businesses.

 These are permanent properties, which can not be easily converted to cash

within a year,
 The assets used by the firm to generate revenues.

 Fixed Assets of a construction company are usually property and equipment,

construction plant, machinery, building, vehicles and land. and soon which cannot
be readily turned into cash in a short time.
 Fixed Assets are also called Long-term Assets.
 Total Assets is the sum Current Assets and Fixed Assets
 As time passes, some of the fixed assets depreciate and their contribution as a
fixed asset reduces through time.
 This means part of the assets, which is equal to the depreciation is converted into
expenses.
 LIABILITIES
• These are debts of the firm. They represent sources of assets since
 the firm either borrows the money or
make use of certain assets that have not yet been paid for.
• There exist two forms of liabilities:
1) Current Liabilities and
2) Long-term Liabilities.
1) Current Liabilities
 debts of the firm that must be paid during the current accounting
period (usually one year or less) .
 Current Liabilities of a construction company include bank,
accounts payable to subcontractors, suppliers and employers,
rents, utilities and so on.
 This includes:
• Accounts payable: when a firm makes purchase on credit,
• Short term notes payable: promissory notes that mature in one year,
• Other payables: accruals (wages payable), tax liabilities or taxes payable.
• Line of Credit
• Customer Deposits
• Billings in excess of costs and estimated earnings on uncompleted contracts

2). Long-term Liabilities

Long-term Liabilities:- are liabilities that will be due for a comparatively long time
(usually more than one year).
 They often refer to long term bank loans or loans for mortgages of Fixed assets.
 This includes the long term secured and unsecured financing which covers
mortgage and notes where a building or other
 Total Liabilities is the sum Current Liabilities and Long- term Liabilities
 OWNERS EQUITY
Owner equity: is the residual claim against the assets of the business after the total
liabilities are deducted.
 Equity is the capital invested by the owner(s) of a company. Because some
construction companies are owned by stockholders.
 Equity is what remains after deducting total liabilities from total assets
 This is the book value of the company to the owners
 Equity represents the Net Worth of the business,
 the Net Worth can be calculated by summing up the
 capital the owners have invested
 profits that have been accumulated (after deducting all the dividends paid so
far to the owners) and
 retained up to the present moment since the business began.
  Revenue: is the amount charged to customers for goods or services sold to

them. It is an increase in capital that resulted from the normal operation of the
business.
Example: Professional fees, commissions revenue, interest income, etc.
 Expense: costs that have been consumed in the process of producing revenue.

Example: Wages expense, rent expense, supplies expense, utilities expense, etc.
Balance Sheet
Owns Owes

Assets
Liabilities and Equity
Current assets:
Current liabilities:
Cash & securities
Payables
Receivables
Short-term debt
Inventories
Long-term liabilities
Fixed assets:
Shareholders' equity
Tangible assets
Intangible assets
 The Balance Sheet

Basic Accounting Equation

Assets
Assets == Liabilities
Liabilities ++ Stockholders’
Stockholders’Equity
Equity
1. Name of entity Addis-Matador CORP.
2. Title of statement Balance Sheet
At December 31, 2006
3. Specific date
(in thousands of dollars)
4. Unit of measure
Assets
Cash $ 4,895
Accounts receivable 5,714
The Balance Inventories 8,517
Plant and equipment 7,154
Sheet reports Land 981
the financial Total assets $ 27,261
position of an Liabilities and Stockholders' Equity
entity at a Liabilities
Accounts payable $ 7,156
particular point Notes payable 9,000
in time. Total liabilities $ 16,156
Stockholders' Equity
Contributed capital $ 2,000
Retained earnings 9,105
Total stockholders' equity 11,105
Total liabilities and stockholders' equity $ 27,261
 Addis-Matador CORP.
Balance Sheet
At December 31, 2006
(in thousands of dollars)
Assets are Assets
Cash $ 4,895
economic
Accounts receivable 5,714
resources Inventories 8,517
owned by the Plant and equipment 7,154
business as a Land 981
Total assets $ 27,261
result of past
Liabilities and Stockholders' Equity
transactions. Amount of cash in the company’s bank
Liabilities
Cash
accounts.
Accounts payable $ 7,156
Accounts
Notes payable Amounts owed by customers from prior
9,000
Assets are receivable sales.
Total liabilities $ 16,156
listed by their Parts andEquity
Stockholders' completed but unsold
Inventories
ease of products.
Contributed capital $ 2,000
Retained earnings
Plant and 9,105
conversion into Factories and production machinery.
Total stockholders' equity 11,105
cash. equipment
Total liabilities and stockholders' equity $ 27,261
Land Land on which factories are built.
 Addis-Matador CORP.
Balance Sheet
At December 31, 2006
(in thousands of dollars)
Assets
Cash $ 4,895
Liabilities are Accounts receivable 5,714
debts or Inventories 8,517
obligations of Plant and equipment 7,154
Land 981
the business
Total assets $ 27,261
that result from Liabilities and Stockholders' Equity
past Liabilities
transactions. Accounts payable $ 7,156
Notes payable 9,000
Total liabilities $ 16,156
Stockholders' Equity
Accounts Amounts owed to suppliers for prior
Contributed capital $ 2,000
payable purchases.
Retained earnings 9,105
Notes Amounts owed Totalon written debt
stockholders' equity 11,105
payable contracts.Total liabilities and stockholders' equity $ 27,261
 Addis-Matador CORP.
Balance Sheet
At December 31, 2006
Equity is the (in thousands of dollars)
Assets
amount of Cash $ 4,895
financing Accounts receivable 5,714
provided by Inventories 8,517
owners of the Plant and equipment 7,154
Land 981
business and Total assets $ 27,261
earnings. Liabilities and Stockholders' Equity
Liabilities
Contributed Amounts invested in the business by
Accounts payable $ 7,156
capital stockholders.
Notes payable 9,000
Retained Past earnings not distributed to
earnings stockholders.Total liabilities $ 16,156
Stockholders' Equity
Contributed capital $ 2,000
Retained earnings 9,105
Total stockholders' equity 11,105
Total liabilities and stockholders' equity $ 27,261
 Addis-Matador CORP.
Balance Sheet
At December 31, 2006
(in thousands of dollars)
Assets
Cash $ 4,895
Use $ on the Accounts receivable 5,714
first item in a Inventories 8,517
group Plant and equipment 7,154
Land 981
and on the
Total assets $ 27,261
group total. Liabilities and Stockholders' Equity
Liabilities
Accounts payable $ 7,156
Notes payable 9,000
Assets = LiabilitiesTotal
+ Stockholders’
liabilities Equity $ 16,156
Stockholders' Equity
Contributed capital $ 2,000
Retained earnings 9,105
Total stockholders' equity 11,105
Total liabilities and stockholders' equity $ 27,261
Balance Sheet
31/12/2012 31/12/2011
Assets
Current Assets
Cash……………………………………………………………………….. 2,589,000 1,967,890
Accounts receivable…………………………………………………. 5,767,000 5,403,670
Retention money……………………………………………………… 1,641,750 1,350,918
Material Inventory…………………………………………………… 850,000 520,000
Costs and estimated earnings in excess
of billings on work in progress………………………………….. 450,306
547,250 983,944
Prepaid expenses and others……………………………............ 894,500
Total Current Assets………………………………………………….. 12,289,500 10,676,728
Fixed assets
Property and equipment…………………………………………… 15,536,900 13,800,000
Construction plant……………………………………………………. 2,680,040 2,039,480
Vehicles/Trucks……………………………………………………...... 2,070,000 1,812,000
Furniture and fixtures………………………………………………... 345,000 379,000
Total fixed assets…………………………………………….. 18,030,480
20,631,940 11,158,000
Less accumulated depreciation…………………………….......... 12,529,373
Net Fixed Assets……………………………………………………………8,102,567 6,872,480
Total Assets…………………………………………………………………. 20,392,067 17,549,208
Liabilities
Current Liabilities
Accounts payable……………………………………………….. 4,773,240
4,325,250 1,475,918
Accrued expenses………………………………………………........ 1,586,037
Notes payable………………………………………………………… 491,973
647,250 756,514
Retention money payable….……………………………………... 919,380
Billings in excess of costs and estimated 678,922
earnings on work in progress……………………………………... 617,205
Other current liabilities……………………………………………… 355,713 …. 292,699
Total Current Liabilities…………………………………………… 8,450,835 8,469,266
Long-term Liabilities………………………………………………… 3,528,557 3,695,267
Total Liabilities…………………………………………………… 12,164,533
11,979,392
Equity (i.e. NetWorth)
Capital stock…………………………………
Additional paid-in capital………………
Retained earnings………………………….
Total Equity…………………………………..
Equity +Total Liabilities………………….
 2. The Income Statement
 The income statement is a report of a firm’s activities during a given
accounting period.
 It shows the revenues and expenses of the firm, the effect of interest and
taxes and the net income for the period.
 It may be called as the profit-and-loss statement or the statement of
earnings.
 It is an accounting device designated to show stockholders and creditors
whether the firm is making money.
 It can also be used as a tool to identify the factors that affect the degree of
profitability.
The Income Statement
It includes cost accounting of:
• Revenue
• Cost of Revenue
• Gross Profit
• Selling, General & Administrative Expenses
• Operating Income
• Net sales or construction income or work execution in monetary terms.
• Construction costs/ production costs/ that include the direct costs.
• Other Income/expenses
– Interest Income & Interest Expense
• Income before taxes
• Taxes
• Net Income
 Addis- Matador Corp.
Income Statement
For the year ended December 31,2006
(In thousands of dollars)

Revenues
Sales revenues $ 37,436.00
Expenses
Cost of goods sold $26,980.00
Selling, general &
administrative expenses $ 3,624.00
Research & Development
expenses $1,982.00
interest expense $450.00

Total expense $33,036.00

Pre- tax income $ 4,400.00
Income tax expense $1,100.00
Net income $3,300.00
 Addis-Matador CORP.
Income Statement
For the Year Ended December 31, 2006
(in thousands of dollars)

Revenues
Sales
1. Namerevenue
of entity $ 37,436
Expenses
2. Title of statement
Cost of goods
3. Specific sold(Unlike the balance$ sheet,
date 26,980 this
Selling, general
statement and administrative
covers a specified period3,624
of time.)
Research
4. Unit of and development
measure 1,982
Interest expense 450
Total expenses 33,036
Pretax income $ 4,400
Income tax expense 1,100
Net income $ 3,300
 Addis-Matador CORP.
Income Statement
For the Year Ended December 31, 2006
(in thousands of dollars)

Revenues
Sales revenue $ 37,436
Expenses
Revenues aresold
Cost of goods earnings from the$ 26,980
sale of goods
Selling, general and administrative
or services to customers. 3,624
Research and development 1,982
Revenue
Interest is recognized in the period450
expense in which
goods and services are sold, not necessarily
Total expenses 33,036
the period in which cash is received. $ 4,400
Pretax income
Income tax expense 1,100
Net income $ 3,300
 Addis-Matador CORP.
Income Statement
Expenses
Forare
the the
Yeardollar
Endedamount of resources
December 31, 2006 used
up by the entity
(in to earn revenues
thousands during a period.
of dollars)

An expense is recognized in the period in which

Revenues
goods
Sales and services are used, not necessarily
revenue $ 37,436
Expenses the period in which cash is paid.
Cost of goods sold $ 26,980
Selling, general and administrative 3,624
Research and development 1,982
Interest expense 450
Total expenses 33,036
Pretax income $ 4,400
Income tax expense 1,100
Net income $ 3,300
 Addis-Matador CORP.
Income Statement
For the Year Ended December 31, 2006
(in thousands of dollars)

Revenues
Cost of The cost to produce products sold this
Sales revenue $ 37,436
goods sold period. Production costs: direct costs
Expenses
CostSelling,
of goods sold $ 26,980
Operating expenses not directly related
generalgeneral
Selling, and
toand administrative
production. 3,624
administrative
Research and development 1,982
Interest
Research expense 450 new
and Expenses incurred to develop
Total expenses
development products. 33,036
Pretax income
Interest $ 4,400
Income tax The cost of using borrowed funds.1,100
expense
expense
Net income
Income tax Income taxes on current period’s $ pretax
3,300
expense income.
 Addis-Matador CORP.
Income Statement
For the Year Ended December 31, 2006
(in thousands of dollars)

Revenues
Sales revenue $ 37,436
Expenses
Cost of goods sold $ 26,980
Selling, general and administrative 3,624
Research and development 1,982
Interest expense 450
Total expenses 33,036
Pretax income $ 4,400
Income tax expense 1,100
If expenses
Net income exceed revenues, $ 3,300
we report net loss.
 Income Statement
31/12/2012 31/12/2011
Revenue 38,483,000
40,185,000
Cost of Revenue
Materials 13,000,000 12,500,000
Building 5,500,000 5,400,000
Equipment 12,500,000 12,000,000
Other direct costs 1,087,000 1,085,000
Total Cost of Revenue 32,087,000 30,985,000
Gross Profit 8,098,000 7,498,000
Operating Expenses
Variable overhead 2,036,500 1,943,500
Fixed overhead 3,358,500 2,979,500
Total Operating Expenses 5,395,000 4,923,000
Operating Profit 2,703,000 2,575,000
Other Income/Expense
30,000 (38,000)
Gain/loss on sale of assets
(5,500) 4,000
Miscellaneous income/expense
19,000 12,900
Interest income (41,000)
(42,500)
Interest expense (62,100)
1,000
Total Other Income/Expense 2,704,000 2,512,900
Net Profit beforeTax 676,000 628,225
Tax Expense (25% tax rate) 2,028,000 1,884,675
Net Profit afterTax
 3. Flow-of-Funds Statement
 This statement shows the movement of funds into the firm’s current asset
accounts from external sources such as stockholders, creditors and
customers.
 It also shows the movement of funds to meet the firm’s obligation, or pay
dividends.
 The difference between sources and uses is shown as an increase or
decrease in net working capital.
 If the firm has more funds coming in than going out, net working capital
increases.
Cash Flow Statement

The income statement shows how much the company has lost or gained,
but does not indicate financing and investment activities during the period.
Therefore, an additional financial statement is required which can show
how the company generated the cash and how it has spent or utilized it.
This statement is known as the cash flow statement
 Addis-Matador CORP.
Statement of Cash Flows
For the Year Ended December 31, 2006
1. Name of entity (in thousands of dollars)

2. Title of statement
Cash flows from operating activities:
3. Specific
Cash collecteddate (Like the income $statement
from customers 33,563 and
statement
Cash of retained
paid to suppliers earnings, this
and employees (30,854)
Cash paid for interest (450)
statement
Cash paid for taxes
covers a specified period of time.)
(1,190)
4.
NetUnit
cash of measure
flow from operating activities $ 1,069
Cash flow from investing activities:
Cash paid to purchase equipment $ (1,625)
Net cash flow from investing activities (1,625)
Cash flow from financing activities:
Cash received from bank loan $ 1,400
Cash paid for dividends (1,000)
Net cash flow from financing activities 400
Net decrease in cash during the year $ (156)
Cash at beginning of the year 5,051
Cash at end of the year $ 4,895
 The Statement ofAddis-Matador
Cash Flows CORP.
reports the inflows
Statement of Cash Flows
and outflows of cash during the period in the
For the Year Ended December 31, 2006
categories of operating, investing,
(in thousands of dollars) and financing.

Cash flows from operating activities:

Cash collected from customers $ 33,563
Cash paid to suppliers and employees (30,854)
Cash paid for interest (450)
Cash paid for taxes (1,190)
Net cash flow from operating activities $ 1,069
Cash flow from investing activities:
Cash paid to purchase equipment $ (1,625)
Net cash flow from investing activities (1,625)
Cash flow from financing activities:
Cash received from bank loan $ 1,400
Cash paid for dividends (1,000)
Net cash flow from financing activities 400
Net decrease in cash during the year $ (156)
Cash at beginning of the year 5,051
Cash at end of the year $ 4,895
4. Statement of owner’s equity
Statement of owner’s equity is a summary of the changes in the
owner’s equity of a business entity that have occurred during a
specific period of time such as a month or a year.
Provide the change between the beginning and ending balance of
each of the stockholders equity accounts, include retained earning,
investments by owners and distribution to owners.
 Addis-Matador CORP.
Statement of Retained Earnings
For the Year Ended December 31, 2006
(in thousands of dollars)

Retained earnings, January 1, 2006 $ 6,805

Net income for 2006 3,300
Dividends for 2006 (1,000)
Retained earnings, December 31, 2006 $ 9,105

The Statement of Retained Earnings reports the way

that net income and the distribution of dividends affect
the financial position of the company during a period.
Relationship Among the Financial Statements

Addis-Matador CORP.
Income Statement
For the Year Ended December 31, 2006
Net income from the
(in thousands of dollars)
income statement
increases ending
Revenues
Sales revenue $ 37,436
Expenses
Cost of goods sold
Selling, general and administrative
$ 26,980
3,624
retained earnings on the
Research and development
Interest expense
1,982
450 statement of retained
Total expenses 33,036
Pretax income $ 4,400 earnings.
Income tax expense 1,100
Net income $ 3,300
Addis-Matador CORP.
Statement of Retained Earnings
For the Year Ended December 31, 2006
(in thousands of dollars)

Retained earnings, January 1, 2006 $ 6,805

Net income for 2006 3,300
Dividends for 2006 (1,000)
Retained earnings, December 31, 2006 $ 9,105
 Relationship Among the Financial Statem
Addis-Matador CORP.
Balance Sheet
At December 31, 2006 Ending retained earnings
(in thousands of dollars)
Assets from the statement of
Cash $ 4,895
Accounts receivable 5,714 retained earnings is one
Inventories 8,517
Plant and equipment 7,154 of the components of
Land 981
Total assets $ 27,261 stockholders’ equity on
Liabilities and Stockholders' Equity
Liabilities the balance sheet.
Accounts payable $ 7,156
Notes payable 9,000
Addis-Matador CORP.
Total liabilities $ 16,156
Stockholders' Equity
Statement of Retained Earnings
Contributed capital $ 2,000 For the Year Ended December 31, 2006
Retained earnings 9,105
(in thousands of dollars)
Total stockholders' equity 11,105
Total liabilities and stockholders' equity $ 27,261
Retained earnings, January 1, 2003 $ 6,805
Net income for 2003 3,300
Dividends for 2003 (1,000)
Retained earnings, December 31, 2003 $ 9,105
 Relationship Among the Financial Statem
Addis-Matador CORP. Addis-Matador CORP.
Balance Sheet Statement of Cash Flows
At December 31, 2006
For the Year Ended December 31, 2006
(in thousands of dollars)
(in thousands of dollars)
Assets
Cash $ 4,895
Accounts receivable 5,714 Cash flows from operating activities:
Inventories 8,517 Cash collected from customers $ 33,563
Plant and equipment 7,154 Cash paid to suppliers and employees (30,854)
Land 981 Cash paid for interest (450)
Cash paid for taxes (1,190)
Total assets $ 27,261
Net cash flow from operating activities $ 1,069
Liabilities and Stockholders' Equity
Cash flow from investing activities:
Liabilities Cash paid to purchase equipment $ (1,625)
Accounts payable $ 7,156 Net cash flow from investing activities (1,625)
Notes payable 9,000 Cash flow from financing activities:
Total liabilities $ 16,156 Cash received from bank loan $ 1,400
Stockholders' Equity Cash paid for dividends (1,000)
Contributed capital $ 2,000 Net cash flow from financing activities 400
Retained earnings 9,105 Net decrease in cash during the year $ (156)
Total stockholders' equity 11,105 Cash at beginning of the year 5,051
Total liabilities and stockholders' equity $ 27,261 Cash at end of the year $ 4,895

The change in cash on the statement of cash flows added to

the beginning of the year balance in cash equals the ending
balance in cash on the balance sheet.
 3.2. Financial Analysis
•If properly analyzed and interpreted, financial statements can provide valuable
insights into a firm’s performance. Analysis of financial statements is of interest to:
 Lenders (short-term as well as long-term)
 Investors,
 Security analysts,
 Managers, public and others.
• Process of evaluating business/project to determine their performance and
suitability.
•Financial statements analysis is helpful in assessing:
 Corporate excellence,
 Judging creditworthiness,
 Forecasting bond ratings,
 Predicting bankruptcy and assessing market risks.
•Financial Ratios help a lot in indicating the financial health of a
construction company.
•are quantitative measures that are used to assess businesses performance

The financial ratios relevant to the construction industry can be classified into
five categories. They are :-
(1) Profitability Ratios
(2) Liquidity Ratios
(3) Working Capital Ratios
(4) Capital Structure Ratios
(5) Activity Ratios.
1. Profitability Ratios
 Profitability ratios measure the construction company’s ability to earn
profit from its operation. or
 measure the ability of a company to generate profits.
The three most commonly used profitability ratios are:
A) Gross Profit Margin Ratio
 It shows how much profit a company makes after paying off its cost of
goods sold (COGS).
 The ratio indicates the percentage of each dollar of revenue that the
company retains as gross profit,
 so naturally a high gross margin ratio is desired.
 It measures the efficiency of production and pricing.
It depends on the r/ship price/sale, volume and costs.
Gross Profit Margin Ratio= (Gross profit (total revenue- COGS)/
Revenue)*100

= 8,098,000 / 40,185,000
= 20.15%
(The goal for gross profit margin ratio is 25% minimum.)
 B) Net Profit Margin Ratio
• is a financial ratio used to calculate the percentage of profit a
company produces from its total revenue.
• It measures the amount of net profit a company obtains per dollar of
revenue gained.

• Net Profit Margin Ratio= Net profit before tax / Revenue

= 2,704,000 / 40,185,000 = 6.73%

• Net Profit Margin Ratio= Net profit after tax / Revenue

= 2,028,000 / 40,185,000 = 5.05%

• (The goal for net profit margin ratio is 5% minimum)
 C) Return on Equity Ratio
 Measures the efficiency with which a company is using its shareholder
equity to generate revenue.
 a measure of a company’s annual return (net income) divided by the
value of its total shareholders’ equity,
 expressed as a percentage (e.g. 10%).

Return on Equity Ratio= Net profit before tax / Owners’ equity

= 2,704,000 / 8,412,675
= 32.14%
(The return on equity ratio should be between 15% and 40%)
2. Liquidity Ratios
• These ratios measure a company’s ability to repay both short-
term and long-term debt obligations.
• are often used to determine the riskiness of a firm to decide
whether to extend credit to the firm
• Liquidity ratios indicate the construction company’s ability to
pay its obligations as they come due.
• The three most common liquidity ratios used are shown below.
 A) Current Ratio
 Current Ratio used to ability of a firm to meet its obligation in
short-run.
 measures the ability of a business to meet its short-term
obligations that are due within a year.
 The ratio compares total current assets to total current liabilities.
 Current assets get converted into cash in the operating cycle of
the firm and provide the funds needed to pay current liabilities.
Current Ratio = Current assets / Current liabilities
= 12,289,500 / 8,450,835 = 1.45
(The current ratio should be higher than 1.3 for a financially healthy
construction company)
 B) Acid Test Ratio
 A more strict measure of liquidity than the current ratio.
 Inventories are least liquid of current assets. It requires a two-
step process in order to be converted into cash.
 it shows the ability of a firm to pay its obligation without relying
on the sale and collection of its inventories.
 measures the ability of a business to pay its short term liabilities
by having assets that are readily convertible into cash.
 A 1/1 quick ratio has traditionally been deemed adequate for most
firms.
 A quick ratio greater than 1 strongly implies financial well-being
for the company as it shows that the company can repay its short-
term debt obligations with only its liquid assets
Acid Test Ratio (or Quick Ratio)
= (Cash + Accounts receivables) / Current liabilities
= (2,589,000 + 5,767,000) / 8,450,835
= 0.99
(The acid test ratio or quick ratio should be higher than 1 for a
construction company)
 C) Current Assets to Total Assets Ratio
 Total assets accounts for all current asset and long term fixed assets,
 This current asset is any asset that that will provide an economical value for or
within one year.
 This ratio indicates the extent of total funds invested for the purpose of working
capital and throws light on the importance of current assets of a firm.
 It should be worthwhile to observe that how much of that portion of total assets is
occupied the current assets
Current Assets to Total Assets Ratio
= Current assets / Total Assets
= 12,289,500 / 20,392,067
= 60.27%
(The current assets to total assets ratio should be between 60% and 80%)
3. Working Capital Ratios
 These ratios measure how well the construction company is utilizing its
working capital.
 The three most commonly used working capital ratios are shown below.

A) Working Capital Turnover

 working capital turnover (WCT) measures how your ** Working Capital** is
being used to generate revenue/sales for the company over time.
 Measure how effective a business is at generating sales for every dollar of
working capital put use.
 A higher ratio is better,
 Indicates that a company is able to generate a larger amount of sales.
 Indicates that management is being extremely efficient in using a firm short
term assets and liabilities to support sales
 net working capital (NWC), is the difference between a company's current assets
and its current liabilities
Working Capital Turnover = Revenue / Working capital
= 40,185,000 / (12,289,500 – 8,450,835)
= 10.47
(The working capital turnover should be between 8 and 12 per year)
B) Net Profit to Working Capital Ratio
 Measure how effective a business is at generating net income for every dollar of
working capital put use.
Net Profit to Working Capital Ratio =
Net profit before/after tax /Working capital
= 2,704,000 / (12,289,500 – 8,4ነ50,835) = 70.44%
(The net profit to working capital ratio should be recommend between 40% and

60%)
 C) Degree of Fixed Asset Newness
 Measure current book value of fixed assets against their original purchase price
 Gives information relative to age and efficiency of fixed assets

Degree of Fixed Asset Newness

= Net fixed assets / Total fixed assets
= 8,102,567 / 20,631,940 = 39.27%
(The degree of fixed asset newness should be between 40% and 60%)
4. Capital Structure Ratios
 Capital structure ratios indicate the ability of the construction company to manage
liabilities.
 These ratios also indicate the approach that the company prefers to finance its
operation.
 The two major capital structure ratios are:
 A) Debt to Equity Ratio
 Indicates how much debt a company is using to finance its assets relative to the
value of shareholder equity.
 A high Debt to Equity Ratio means that a company is being supported by creditors
rather than equity.
 For this reason, this ratio is particularly important to potential investors or further
lenders
 A higher debt-equity ratio indicates a levered firm – a firm that is financed with
debt.
Debt to Equity Ratio = Total liabilities / Owners’ equity
= 11,979,392 / 8,412,675 = 1.42
 (The debt to equity ratio should be lower than 2.5)
 If the total debt of a business is worth $50 million and the total equity is worth
$120 million, as per
debt-to-equity would be 0.42. In other words, the firm has 42 cents in debt for every
dollar of equity.
 B) Asset to equity ratio
 Indicates the r/ship of the total assets of the firm to the part of owned by
shareholders.
 A relatively high ratio indicating lots assets and very little equity or may
indicate the company has taken on substantial debt merely to remain its
business.
Asset to equity ratio
= Total assets / Owners’ equity
= 20,392,067 / 8,412,675 = 2.42
OR = Total assets / Owners’ equity
= (Total liabilities + Owners’ equity) / Owners’ equity
= (Total liabilities / Owners equity) + 1
= Debt to Equity Ratio + 1
= 1.42 + 1
= 2.42
(this ratio should be lower than 3.5.)
 5. Activity Ratios
 Are financial metrics used to measure how efficient a company operation are.

 Activity ratios indicate whether or not the construction company is using its assets
effectively, and if yes, how effective they are.
 There are quite a number of activity ratios, and the seven commonly used ones are shown
below.

A) Average Age of Material Inventory

 To gives insight into how fast a company is turning over its inventory.

 A low average age of inventory indicates faster inventory turnover means that a company
efficiently selling inventory.
 If a company reports a low inventory turnover is high average age of inventory, it can
indicates that a company is not optimally managing its inventory or that its inventory is
difficult to turnover.

Average Age of Material Inventory = (Material inventory / Materials cost) × 365 days

= (850,000 / 13,000,000) × 365 = 23.87 days

Assume that you are an investor that is deciding on whether to invest in two cement
retail companies. Company A reports an average inventory of $200,000 and COGS of
$1,000,000. Company B reports an average inventory of $100,000 and COGS of
$1,500,000
Average age of inventory (company A) = (200,000/$1,000,000)*365 = 73 days
Average age of inventory (company B) = (100,000/$1,500,000)*365 = 24.3 days
Company B appears to be a more attractive investment and profitable company.
B) Average Age of Under Billings
If contractor is 50% complete with the cost on contract, but they have billed only
40%of the total contract price, the result would be an under billing (a current assets)in
the amount of 10% of the contract price.
Average Age of Under Billings = (Under billings / Revenue) × 365 d
= (547,250 / 40,185,000) × 365 = 4.97 days
(The average age of under billings should be the shorter the better)
 C) Average Age of Accounts Receivable
 Shows the average number of days that it takes a customer to pay the company for
sales on credit.
Average Age of Accounts Receivable = (Accounts receivable / Revenue) × 365 day
= (5,767,000 / 40,185,000) × 365 = 52.38 days
(The average age of accounts receivable should be shorter than 45 days)
D) Cash Conversion Period
 CCP is a working capital metric which expressed how many days it takes a
company to convert cash into inventory, and other back into cash.
 The shorter a company CCP , the less time a company has cash tied up in its
inventory and account receivable. It indication operational efficiency and financial
healthy.
Cash Conversion Period = Average age of material inventory + Average age of under
billings + Average age of accounts receivable
= 23.87 + 4.97 + 52.38 = 81.22 days
(The cash conversion period should be shorter than 75 days)
 E) Average Age of Accounts Payable
 This ratio measures the average number of days it takes for a company to
pay its suppliers.
Average Age of Accounts Payable = [Accounts payable / (Materials +
Subcontracts/equipment)] × 365 day
= [4,325,250 / (13,000,000 + 12,500,000)] × 365
= 61.91 days
(The average age of accounts payable should be shorter than 45 days)
 Short average day payable ratio is indicates the company are able to meet
their financial obligations toward their suppliers.
 High ratio or days indicating that the company is slow to pay its bills or
having difficulty paying its bills.
 F) Average Age of Over Billings
If contractor is 50% complete with the cost on contract, but they have billed only
60%of the total contract price, the result would be an over billing (current liability)
the amount of 10% of the contract price.
Average Age of Over Billings = (Over billings / Revenue) × 365 day
= (617,205 / 40,185,0 2 gl00) × 365 = 5.61 days
(Usually there is no guideline on average age of over billings)
G) Cash Demand Period
 Provide Cash demand shall not include any such disbursement for payments or
expenses that are not contemplated by budget.
Cash Demand Period = Cash conversion period – Average age of accounts
payable– Average age of over-billings
= 81.22 – 61.91 – 5.61 = 13.70 days
(The cash demand period should be shorter than 30 days)
We will see how we can use these ratios to analyze the financial health of a
construction company by reviewing its income statement and balance sheet.