Financial Statement Analysis 2 PDF

Lesson 4 Financial Statement Analysis 2 Learning Objectives At the end of the lesson, the students are expected to be able to: 1. Discuss financial ratio analysis and its objectives 2. Explain and distinguish the limitations of financial ratio analysis 3. Perform the steps in doing Finan...

Lesson 4 Financial Statement Analysis 2 Learning Objectives At the end of the lesson, the students are expected to be able to: 1. Discuss financial ratio analysis and its objectives 2. Explain and distinguish the limitations of financial ratio analysis 3. Perform the steps in doing Financial ratio analysis interpretations, conclusions, and draw implications based on the result of the applied ratios.  RATIO This presents the relationship between two variables.  FINANCIAL RATIO It refers to the relationship between financial statement items or account expressed in mathematical fashion.  BASIS OF STANDARD RATIOS 1. Company budget for the same period 2. Those used by the industry to which the firm belongs. 3. Those used by the firm’s successful competitors 4. Those used by the firm using the prior period. 5. Those used by the analyst in the past.  LIQUIDITY RATIOS The liquidity ratios determine whether a company can meet its current debt obligations with its current assets.  LIQUIDITY RATIOS 1. Working capital ratio or the current ratio 2. Quick ratio or acid test ratio 1. WORKING CAPITAL RATIO OR THE CURRENT RATIO It measures the business’ capacity to pay its short-term debt obligations with its current assets. WCR or Current Ratio = current assets current liabilities  RIEL CORPORATION COMMON-SIZE COMPARATIVE STATEMENT OF FINANCIAL POSITION RIEL CORPORATION December 31, 2022 and 2023 2023 2022 COMPARATIVE INCOME STATEMENT Assets Current Assets For the year ended December 31, 2022 and 2023 Cash and cash equivalents 106,789 102,375 Trade and other receivables 327,611 277,467 2023 2022 Inventory 334,863 297,654 Prepaid expenses 101,565 114,813 Total current assets 870,828 792,309 Sales 3,007,887 2,732,712 Non-current assets Property Plant and Equipment 135,754 166,481 Less Cost of Sales 2,208,520 1,964,865 Intangibles 7500 7500 Total non-current Assets 143,254 173,981 Gross profit 799,367 767,847 TOTAL ASSETS 1,014,082 966,290 Liabilitites and Owner's Equity Less Distribution cost 372,000 345,000 Current liabilities Trade and other payables 238,000 208703 Administrative expenses 207,000 213,000 Unearned revenues 107,508 82,456 Notes payable - current 45,000 45,000 Total operating expenses 579,000 558,000 Total current liabilities 390,508 336159 Non-current liabilities Notes payable-non current 208,422 253,500 Operating Income 220,367 209,847 Total liabilities 598,930 589,659 Shareholders' Equity Less interest expense 41,860 43,905 Preferred share P100, par 105,000 105,000 Common shares P1, par 15,000 15,000 Net income before taxes 178,507 165,942 Premium on ordinary shares 135,000 135,000 Total Paid-in capital 255,000 255,000 Retained Earnigs 160,152 121,631 Less: income tax 62,477 58,080 Total shareholders equity 415,152 376,631 Total liabilities and shareholders equity 1,014,082 966,290 Net income after taxex 116,030 107,862  1.97:1 Current ratio = Current Assets current lliabilities = 769,263 390,508 = 1.969903305 Ratio 1.96:1 1. WORKING CAPITAL RATIO OR THE CURRENT RATIO A high current ratio does not necessarily mean the company is able to meet its current obligation inventory slow moving asset. Prepaids consumption or use of future benefit  2. QUICK RATIO OR ACID TEST RATIO The quick ratio measures the company’s ability to meet its short-term obligations without selling any inventory Quick ratio or acid test ratio = current assets – inventory current liabilities  1.11:1 Quick ratio or current assets-inv acid test ratio current liabilities = 769,263 - 334,863 390,508 434,400 390,508 = 1.112397185 Ratio 1.11:1  EFFICIENCY RATIOS This is used to find out the effectiveness of the company in using its assets to produce revenue and maximize profit or shareholder’s wealth. They measure the internal and short-term efficiency operation of the business.  EFFICIENCY RATIOS 1. Accounts receivable turnover 1a.Average collection period or days sales in average receivables 2. Inventory turnover ratio 2a. Average sale period or number of sale in inventory 3. Fixed assets turnover 4. Total asset turnover  1. ACCOUNTS RECEIVABLE TURNOVER Net sales = Average accounts receivable (Beg AR+EndAR/2) Accts Receivable Net sales Turnover Average Accounts Receivable 3,007,887 327,611+277,467/2 3,007,887 302539 9.942146302 x receivable turnover  1. ACCOUNTS RECEIVABLE TURNOVER a. Average collection period or days sales in average receivables 365 = Receivable turnover  Average collection period = 365 9.94 = 36.72  2. INVENTORY TURNOVER RATIO Raw material inventory = Raw Materials Used Average RM Inventory Work-in-process = Cost of goods manufactured inventory turnover Ave WIP inventory  2. INVENTORY TURNOVER RATIO Finished goods inventory = Cost of goods sold Average FG Inventory Merchandise = Cost of goods sold inventory turnover Ave merchandise inventory  2. INVENTORY TURNOVER RATIO Average inventory = Inventory beg + inventory End 2 Merchandise = Cost of goods sold inventory turnover Ave merchandise inventory = P2,208,520 297,654+334,863/2 = 6.98 times  2. INVENTORY TURNOVER RATIO Average sale period or number of sale in inventory 365 = Inventory turnover ratio this ratio is used by the financial managers to assess the efficiency of the firm in collecting its receivables.  2. INVENTORY TURNOVER RATIO Average sale period or number of sales in inventory 365 = Inventory turnover ratio = 365 6.98 = 52.30 days  3. FIXED ASSETS TURNOVER evaluates its effectiveness in using those assets. net sales = average net fixed assets (PPE)  3. FIXED ASSETS TURNOVER net sales = average net fixed assets (PPE) = P3,007,887  (P135,754+166,481)/2 = 19.90 times  4. TOTAL ASSET TURNOVER RATIO shows evidence of how efficiently the company is using its asset base into one ratio. Net Sales = Average Total Assets  4. TOTAL ASSET TURNOVER Net Sales = Average Total Assets = P3,007,887 (1,014,082+966,290)/2 = 3.04  DEBT UTILIZATION (LEVERAGE RATIO) This allow the analyst to ascertain how efficient the company manages financial obligations. The use of borrowed funds in carrying out the firm’s operation is called trade on equity RATIOS USED DEBT UTILIZATION (LEVERAGE RATIO) 1. Debt-to-equity ratio 2. Debt ratio 3. Number of times interest earned  1. DEBT-TO-EQUITY RATIO = Total liabilities Total Stockholders’ equity =This ratio gauges the amount of risk involving the firm’s capital structure in so far as the relationship of funds provided by the creditors and owners are concerned.  1. DEBT-TO-EQUITY RATIO = Total liabilities Total Stockholders’ equity = 598,930 415,152 = 1.44:1 or 144%  2. DEBT RATIO = Total Liabilities Total Assets = 598,930 1,014,082 =0.59:1 or 59%  2. DEBT RATIO The ratio means that for every P1 asset of the company, P0.59 was borrowed or provided by the creditors.  3. NUMBER OF TIMES INTEREST EARNED = Net income before interest and income tax or operating income Annual interest expense  3. NUMBER OF TIMES INTEREST EARNED = Net income before interest and income tax or operating income Annual interest expense = P220, 367 41,860 = 5.26 times  3. NUMBER OF TIMES INTEREST EARNED This ratio indicates the ability of the firm to pay fixed-interest charges. It gauges to the company’s ability to protect long-term creditors.  PROFITABILITY RATIOS Profitability ratios are financial metrics used to measure and evaluate business performance in terms of income (profit), whether relative to revenue, assets, operating costs or shareholder equity, over a given period of time.  PROFITABILITY RATIOS 1. Gross profit ratio 2. Net profit ratio or profit margin 3. Return on Assets (ROA) 4. Return on Equity (ROE) 5. Du Pont system of analysis  1. GROSS PROFIT RATIO = Gross profit Net Sales  1. GROSS PROFIT RATIO = Gross profit a. This ascertains if the Net Sales gross margin is sufficient to cover the operating expenses and the Company’s desired income  1. GROSS PROFIT RATIO = Gross profit a. This ascertains if the Net Sales gross margin is sufficient to cover the operating expenses and the forms desired income It also gauges the firm’s ability to control production/ acquisition costs and inventories including selling mark-ups.  1. GROSS PROFIT RATIO = Gross profit Net Sales = P799, 367 3,007,887 = P0.26 or 26:1 or 26%  1. GROSS PROFIT RATIO = Gross profit This indicates their Net Sales ability to earn more = P799, 367 than adequate sales 3,007,887 revenue to cover their = P0.26 or 26:1 or cost of selling the 20% goods.  2. NET PROFIT RATIO OR PROFIT MARGIN = Net profit Net sales  2. NET PROFIT RATIO OR PROFIT MARGIN = Net profit Net sales = P116,030 P3,007,887 = 0.039:1 or 3.9%  2. NET PROFIT RATIO OR PROFIT MARGIN = Net profit This ratio means for Net sales every P1 sales = P116,030 revenue the firm has P0.39 net income. P3,007,887 This gauge the = 0.039:1 or 3.9% profitability of the firm after including all revenues and deducting all costs,  3. RETURN ON ASSETS (ROA) = Net income Average total assets  3. RETURN ON ASSETS (ROA) = Net income Average total assets = P116,030 (1,014,082+966,290)/ 2 = 0.12:1 or 12%  3. RETURN ON ASSETS (ROA) = Net income This means that for Average total assets every P1 asset used by = P116,030 the company to generate a revenue, it (1,014,082+966,290)/ yielded P0.12 of net 2 income. It gauge the = 0.12:1 or 12% probability of the firm in the used of the total assets or total liabilities and owner’s equity.  4. RETURN ON EQUITY (ROE) = Net income Ave. stockholders equity = P116,030 (415,142+376,631)/2 = 0.29:1 or 29%  4. RETURN ON EQUITY (ROE) = Net income This mean that for Ave. stockholders every P1 of equity invested capital by = P116,030 the owners and used to generate (415,142+376,631)/2 revenue, it yielded = 0.29:1 or 29% P0.29 of net income.  5. DU PONT SYSTEM OF ANALYSIS DuPont analysis is a multistep financial equation that offers insight into a business's fundamental performance. The DuPont model, also known as the DuPont equation or the DuPont framework, provides a thorough analysis of the key metrics affecting a company's return on equity.  5. DU PONT SYSTEM OF ANALYSIS The DuPont analysis decomposes the ROE formula to provide a clearer picture of a company’s performance The DuPont model was established by Donald Brown the Chief Financial Officer of DuPont company in 1920’s DuPont Model can better identify a business’ strengths and areas of opportunity  5. DU PONT SYSTEM OF ANALYSIS Three major financial metrics that drive ROE 1. Operating efficiency, which is represented by net profit margin or net income divided by total sales or revenue 2. Asset use efficiency, which is measured by the asset turnover ratio 3. Financial leverage a metric that is measured by the equity multiplier. Equity multiplier = average assets average equity  5. DU PONT SYSTEM OF ANALYSIS 1. Dupont analysis = Net profit margin x AT x EM Where: Net profit margin = Net income Revenue AT (Asset turnover) = sales Ave total assets EM (Equity multiplier) = Ave total assets Ave shareholders’ equity Reference: Fundamentals of Financial Management (revised edition)