Financial Statement Analysis PDF

BM1915 FINANCIAL STATEMENT ANALYSIS Overview of Financial Statements Financial statements provide the basic source of information to managers and other in...

BM1915 FINANCIAL STATEMENT ANALYSIS Overview of Financial Statements Financial statements provide the basic source of information to managers and other interested parties outside the organization. A financial statement is referred to as the means in which financial information is accumulated and processed. It is a structured representation of the entity’s financial position and operating performance and is periodically communicated to different users (Robles & Empleo, 2016). Financial statements are primarily prepared for external users, but managers find it equally useful for decision-making. Objective of Financial Statements (IAS 1) The objective of a financial statement is to provide information about the financial position, financial performance, and cash flows of an entity that are useful to a wide range of users in making economic decisions. Financial statements also show the results of the management’s stewardship of the resources entrusted to it. Elements of Financial Statements (IAS 1) 1. Assets – These are resources controlled by the enterprise as a result of past transactions and events and from which future economic benefits are expected to flow from the enterprise. 2. Liabilities – These are present obligations of an enterprise arising from past transactions or events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits. 3. Capital – It represents the equity or claim of the owner on the assets of the business. 4. Revenue – It is the gross inflow of economic benefits during the period in the form of inflows or enhancements on assets or decrease in liabilities that increase in equity. 5. Expenses – It represents the gross outflow of economic benefits during the period in the ordinary course of business when these outflows result in a decrease in equity other than those relating to distribution to owners. Components of Financial Statements (Robles & Empleo, 2016) A complete set of financial statement comprises the following: Statement of financial position at the end of the period; Statement of profit or loss and other comprehensive income for the period; Statement of changes in owner’s equity for the period; Statement of cash flows for the period; and Notes comprising significant accounting policies and other explanatory information. Note: Since the financial statement analysis is intended for managerial decisions, the heading or caption of the financial statements may not necessarily be in accordance with the generally accepted accounting principles (GAAP). For example, for the financial reporting of income statement, the heading is: ABC Company (Company name) Statement of Comprehensive Income (Name of financial statement) For Year Ended December 31, 201A (Period covered) For management purposes, it can be presented without complying with the prescribed heading as long as the financial statement presented can be identified and the year/s it covers is indicated. 02 Handout 1 *Property of STI  [email protected] Page 1 of 16  BM1915 1. Statement of Financial Position (Balance Sheet) Current assets – An entity shall classify an asset as current when: It expects to realize the asset, or intends to sell or consume it, in its normal operating cycle; It holds the asset primarily for trading; It expects to realize the asset within 12 months after the reporting period; or The asset is cash or cash equivalent unless the asset is restricted from being exchanged or used to settle a liability for at least 12 months after the reporting period (International Accounting Standards [IAS] 1). Non-current assets – These are assets that do not meet the definition of current assets. Examples of this type of assets are machinery, land, equipment, and building. Current liabilities – An entity shall classify a liability as current when: It expects to settle the liability in its normal operating cycle; It holds the liability primarily for trading; The liability is due to be settled within 12 months after the reporting period; or It does not have an unconditional right to defer settlement of the liability for at least 12 months after the reporting period (IAS 1). Non-current liabilities – These are assets that do not meet the definition of current liabilities. Examples of this type of liabilities are bonds payable and mortgage payable. Assets Liabilities Current Assets Current Liabilities Cash xxx Accounts Payable xxx Accounts Receivable xxx Accrued Expense xxx Prepaid Rent xxx Unearned Revenue xxx Inventory xxx Total Current Liabilities xxx Long-Term Liabilities xxx Total Current Assets xxx Total Liabilities xxx Stockholders’ Equity Long-Term Assets Ordinary Share Capital Machinery xxx Preference Share Capital xxx Accumulated Depreciation (xxx) xxx Retained Earnings xxx Total Long-Term Assets xxx Total Stockholders’ Equity xxx Total Assets xxx Total Liabilities and Stockholders’ Equity xxx Table 1. Statement of financial position 2. Statement of Comprehensive Income (Income Statement) It reports the results of the operation of the business and shows the revenues and expenses of a particular period. Table 2 is an example of an income statement. Sales xxx Less: Sales Returns and Allowances xxx Net Sales xxx Less: Cost of goods sold xxx Gross Profit xxx Less: Operating Expenses xxx Income from operations xxx Less: Interest expense xxx Income before income tax xxx Less: Income Tax (30%) xxx Net Income/Net Loss xxx Table 2. Income statement 02 Handout 1 *Property of STI  [email protected] Page 2 of 16  BM1915 Manufacturing companies must consider inventory in various stages of production in order to compute for the cost of goods sold, which will be charged against the sales revenue to get the net income for the period. Raw Materials Inventory Work-in-process Inventory Finished Goods Inventory Raw materials, beginning xxx Raw materials used xxx Finished goods, beginning xxx Add: Raw materials purchased xxx Direct labor xxx Add: Cost of goods manufactured xxx Less: Raw materials, end xxx Manufacturing overhead xxx Total cost of goods available for sale xxx Raw materials used xxx Total manufacturing cost xxx Less: Finished goods, end xxx Add: WIP, beginning xxx Cost of goods sold xxx Less: WIP, end xxx Cost of goods manufactured xxx Table 3. Cost of goods sold by a manufacturing company 3. Statement of Changes in Equity This financial statement shows the link between the income statement and the statement of financial position. It portrays changes in the capital balance of a business over a reporting period due to additional investment or contributions, withdrawals, and net income/net loss. 4. Statement of Cash Flows This provides users with a basis to assess the ability of the entity to generate cash and cash equivalents and the needs of the entity to utilize those cash flows. This type of financial statement is presented using the cash basis of accounting. 5. Notes to the Financial Statements This is a document accompanying the numerical data listed on the financial statements. The notes shall provide information that is not presented elsewhere in the financial statements but is relevant to an understanding of any of them. Working Capital Management Surveys indicate that the largest portion of most financial managers’ time is devoted to day-to-day operations. A company requires financing, whether from creditors (debt) or owners (equity), to acquire assets and generate revenues. Working capital management refers to the administration and control of current assets and current liabilities to minimize the firm’s value by achieving a balance between profitability and risk (Payongayong, 2016). For financial analysts, working capital equals current assets, while for accountants, it equals current assets minus current liabilities. Example (Payongayong, 2016): Mr. Tan, President of EDGE, Inc., was shocked to learn that one of the company’s financial suppliers had just informed the company that it would no longer supply the firm with parts needed in their products. The reason is the company’s inability to pay its obligation in due time for quite some time now, including other suppliers. It was also found out that the reason for slow payments was the shortage of cash. Mr. Tan cannot believe and understand how that happened, when, in fact, the company’s sales were great and the profits break its records in the past. “How can that happen? How can the company possibly not have enough cash to pay our bills on time?” The financial officer’s response was short and simple: “There’s a big difference between profits and cash. We’re making profits, yes, but because of the amazing growth we are experiencing, we had to acquire more 02 Handout 1 *Property of STI  [email protected] Page 3 of 16  BM1915 new assets than we could finance with retained earnings. We have lots of inventory, receivables, and fixed assets, but no cash. We really have to change our operating policies, or else we will go bankrupt.” The above situation is typical among firms and happens all the time. With this, two (2) questions can be asked from the situation above: 1. How much should be invested in current assets (cash, accounts receivable, inventory, or temporary investments)? 2. How should the investment be financed? An effective working capital will improve the overall return on investment performance of the firm. In this regard, the goal of the company is not to maximize, but to minimize the net working capital. Here are some of the ways to minimize the working capital requirement: Manage cash and raw materials effectively. Be efficient in making collections and in the manufacturing operations. Implement effective credit and collection policies. Reduce the time lag between completion and delivery of finished goods. Seek favorable terms from suppliers and other creditors. Comparative Analysis Financial statement (FS) analysis involves careful selection of data from financial statements in order to assess and evaluate the firm’s past performance, present condition, and future business potentials. Objectives of Financial Statement Analysis (Garrison, Noreen, & Brewer, 2018) The primary purpose of FS analysis is to evaluate and forecast the company’s financial condition. Interested parties, such as managers, investors, and creditors, can identify the company’s financial strengths and weaknesses and know about the following: Profitability of the firm Solvency of the firm Safety of the investment in the business Effectiveness of management in running the firm. Limitations of Financial Statement Analysis (Garrison, Noreen, & Brewer, 2018) This topic discusses two (2) limitations of FS analysis that managers should always keep in mind: 1. Comparison of financial data across companies Comparisons of one company with another can provide information about the financial health of an organization. However, the following factors make it difficult to compare their financial data: Differences in accounting methods and estimates Valuation problem – Financial statements are based on historical costs and, therefore, do not reflect the current market value of the firm’s assets. Moreover, the effects of price level changes must be considered. The timing of transactions and the use of averages in applying the various techniques in FS analysis affect the results obtained. 2. The need to look beyond ratios These refer to the financial ratios. The ratios are designed to show relationships between financial statement accounts. For example, Company A might have a debt of P2 million and interest charges of P150,000, while Company B might have a debt of P20 million and interest charges of P1.5 million. Which company is stronger? It depends. The burden of these debts and the company’s ability to repay 02 Handout 1 *Property of STI  [email protected] Page 4 of 16  BM1915 them can be ascertained by comparing each firm’s debt to its assets or by comparing the interest to the income available for the payment of interest. However, financial ratios should not be viewed as an end, but rather as a starting point. Ratios are not sufficient in themselves as a basis for judgment about the future. Other factors must be considered, such as the following: Internal factors Employee learning and growth Business process performance Customer satisfaction External factors Industry trends Technological changes Changes in consumer tastes Changes in broad economic indicators An item on a balance sheet or income statement has a little meaning by itself. Suppose a company’s sales for a year were P2,500,000. In isolation, that is not particularly useful information. How is that item compared to last year’s sales? How do the sales relate to the cost of goods sold? In making these comparisons, three (3) analytical techniques are widely used: 1. Horizontal analysis 2. Vertical analysis 3. Ratio analysis. Horizontal analysis Also known as trend analysis, this involves analyzing data over time, such as computing year-to-year peso and percentage changes within a set of financial statements. Each item on the most recent statement is compared with the same item on one (1) or more earlier statements, in which the earlier statement is normally used as the base year for computing increases and decreases (Garrison, Noreen, & Brewer, 2018). 𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀 𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟 𝑣𝑣𝑣𝑣𝑣𝑣𝑣𝑣𝑣𝑣 − 𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵 𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝 𝑣𝑣𝑣𝑣𝑣𝑣𝑣𝑣𝑣𝑣 𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 𝑐𝑐ℎ𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 = 𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵 𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝 𝑣𝑣𝑣𝑣𝑣𝑣𝑣𝑣𝑣𝑣 𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 𝑐𝑐ℎ𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 = 𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀 𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟 𝑣𝑣𝑣𝑣𝑣𝑣𝑣𝑣𝑣𝑣 − 𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵 𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝 𝑣𝑣𝑣𝑣𝑣𝑣𝑣𝑣𝑣𝑣 A comprehensive illustration of the horizontal and vertical analyses in the comparative financial statements of Mighty Warrior Corporation is shown on the next page. Note that the amounts are in pesos. 02 Handout 1 *Property of STI  [email protected] Page 5 of 16  BM1915 Mighty Warrior Corporation Comparative Statement of Financial Position December 31, 201B and 201A Increase (Decrease) 201B 201A Peso change % change Assets Current Assets Cash 100,000 127,000 (27,000) (21.3%) Marketable Securities 40,000 40,000 0 0.0% Accounts Receivable, Net 80,000 100,000 (20,000) (20.0%) Inventory 200,000 140,000 60,000 42.9% Prepaid Expenses 30,000 20,000 10,000 50.0% Total Current Assets 450,000 427,000 23,000 5.4% Long-Term Investments 180,000 162,500 17,500 10.8% Property, Plant, and Equipment 510,400 603,000 (92,600) (15.4%) Intangible Assets 90,000 120,000 (30,000) (25.0%) Total Assets 1,230,400 1,312,500 (82,100) (6.3%) Liabilities Current Liabilities 140,000 162,000 (22,000) (13.6%) Long-Term Liabilities 130,000 220,000 (90,000) (40.9%) Total Liabilities 270,000 382,000 (112,000) (29.3%) Stockholders' Equity Preferred Stock, 6%, P100 par 150,000 150,000 0 0.00% Common Stock, P30 par 480,000 480,000 0 0.00% Retained Earnings 330,400 300,500 29,900 10.0% Total Stockholders' Equity 960,400 930,500 52,900 5.7% Total Liabilities and Stockholders' Equity 1,253,400 1,312,500 (82,100) (6.3%) Table 4. Horizontal analysis – Comparative statement of financial position Mighty Warrior Corporation Comparative Income Statement December 31, 201B and 201A Increase (Decrease) 201B 201A Peso change % change Sales 455,000 390,000 65,000 16.7% Less: Sales Returns and Allowances 5,000 3,000 2,000 66.7% Net Sales 450,000 387,000 63,000 16.3% Less: Cost of goods sold 297,000 288,750 8,250 2.9% Gross Profit 153,000 98,250 54,750 55.7% Less: Operating Expenses 52,000 22,000 30,000 136.4% Income from operations 101,000 76,250 24,750 32.5% Less: Interest expense 18,250 21,000 (2,750) (13.1%) Income before income tax 82,750 55,250 27,500 49.8% Less: Income Tax (30%) 24,825 16,575 8,250 49.8% Net Income 57,925 38,675 19,250 49.8% Table 5. Horizontal analysis – Comparative income statement 02 Handout 1 *Property of STI  [email protected] Page 6 of 16  BM1915 An extended horizontal analysis can be developed, and it is called trend analysis. For example, assume the sales and net income items for the past seven (7) years are as follows: 201A 201B 201C 201D 201E 201F 201G Sales 313,425 341,805 352,830 341,175 361,125 421,590 411,615 100% 109% 113% 109% 115% 135% 131% Net Income 53,160 35,925 64,695 68,265 74,190 83,790 71,370 100% 68% 122% 128% 140% 158% 134% Table 6. Trend analysis In the data above, it can be seen that sales increased every year except for years 201D and 201G and the net income increased every year except 201B and 201G. In the table, both the sales and net income have been restated as percentages of the 201A sales and net income. Note that the earliest year should be the base period unless otherwise stated. For example, the sales during 201E of P361,125 is 115% of the sales during 201A of P313,425. This trend analysis is plotted in Figure 1. TREND ANALYSIS Sales Net income 200% 158% 140% 134% 150% 122% 128% 100% 109% 135% 131% 100% 115% 113% 109% 50% 68% 0% 201A 201B 201C 201D 201E 201F 201G Figure 1. Trend analysis Vertical Analysis Vertical analysis focuses on the relations among financial statements at a given point in time (Garrison, Noreen, & Brewer, 2018). A common-size financial statement is a vertical analysis in which each account is expressed as percentage. In the statement of financial position, all items are expressed as a percentage of total assets and total liabilities and equity, while in income statements, all items are expressed as a percentage of net sales. A common size balance sheet and income statement are shown on the next page. 02 Handout 1 *Property of STI  [email protected] Page 7 of 16  BM1915 Mighty Warrior Corporation Common-Size Statement of Financial Position December 31, 201B and 201A 201B 201A Assets Current Assets Cash 100,000 8.13% 127,000 9.68% Marketable Securities 40,000 3.25% 40,000 3.05% Accounts Receivable, net 80,000 6.50% 100,000 7.62% Inventory 200,000 16.25% 140,000 10.67% Prepaid Expenses 30,000 2.44% 20,000 1.52% Total Current Assets 450,000 36.57% 427,000 32.53% Long-Term Investments 180,000 14.63% 162,500 12.38% Property, Plant, and Equipment 510,400 41.48% 603,000 45.94% Intangible Assets 90,000 7.31% 120,000 9.14% Total Assets 1,230,400 100% 1,312,500 100% Liabilities Current Liabilities 140,000 11.38% 162,000 12.34% Long-Term Liabilities 130,000 10.57% 220,000 16.76% Total Liabilities 270,000 21.94% 382,000 29.10% Stockholders' Equity Preferred Stock, 6%, P100 par 150,000 12.19% 150,000 11.43% Common Stock, P30 par 480,000 39.01% 480,000 36.57% Retained Earnings 330,400 26.85% 300,500 22.90% Total Stockholders' Equity 960,400 78.06% 930,500 70.90% Total Liabilities and Stockholders' Equity 1,230,400 100% 1,312,500 100% Table 7. Vertical analysis – Common-size statement of financial position Mighty Warrior Corporation Common-Size Income Statement December 31, 201B and 201A (in pesos) 201B 201A Sales 455,000 101.11% 390,000 100.8% Less: Sales Returns and Allowances 5,000 1.11% 3,000 0.8% Net Sales 450,000 100.00% 387,000 100.0% Less: Cost of goods sold 297,000 66.00% 288,750 74.6% Gross Profit 153,000 34.00% 98,250 25.4% Less: Operating Expenses 52,000 11.56% 22,000 5.7% Income from operations 101,000 22.44% 76,250 19.7% Less: Interest expense 18,250 4.06% 21,000 5.4% Income before income tax 82,750 18.39% 55,250 14.3% Less: Income Tax (30%) 24,825 5.52% 16,575 4.3% Net Income 57,925 12.87% 38,675 10.0% Table 8. Vertical analysis – Common-size income statement 02 Handout 1 *Property of STI  [email protected] Page 8 of 16  BM1915 Ratio Analysis Financial statements are fundamentally related. Data contained in one statement is also related to that information found in another. In the financial ratio analysis, the account used from the financial statements shall be as follows: Financial Statements Basis Examples Income Statement Net amount Net sales, net income, net purchases (Beginning balance + Ending Balance) Balance Sheet Average 2 The following are the most common ratios used by financial analysts (Garrison, Noreen, & Brewer, 2018): I. STATEMENT OF FINANCIAL POSITION Liquidity Ratios Liquidity refers to how quickly an asset can be converted into cash. Companies need to continuously monitor the amount of liquid assets (current assets) relative to the amount that they owe to short-term creditors (current liabilities), such as suppliers. If a company’s liquid assets are not enough to support timely payments to creditors, this presents an important management problem that, if not remedied, can lead to bankruptcy. RATIO FORMULA SIGNIFICANCE 1 Net working 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶 𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 − 𝐶𝐶𝑢𝑢𝑢𝑢𝑢𝑢𝑢𝑢𝑢𝑢𝑢𝑢 𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙 If a company has enough working capital capital, it assures that the company can pay its creditors in full and on time. However, it must be financed with long-term debt and equity—both of which are expensive. Furthermore, a large and growing working capital may indicate troubles, such as excessive growth in inventories. 2 Current ratio 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶 𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 It is the basic test of liquidity of the 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶 𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙 firm. This will determine the adequacy of working capital to meet current obligations. It measures a rough estimate in the ability of the business to meet its currently maturing obligations; this ratio varies in great disparity from one industry to another. The higher the current ratio, the better, as it would mean more current assets are available for paying its current obligations. 3 Quick ratio 𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄𝑄 𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 It is a more severe test of immediate (Acid-test ratio) 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶 𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙 liquidity to meet currently maturing obligations. OR 02 Handout 1 *Property of STI  [email protected] Page 9 of 16  BM1915 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶 𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 − 𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼 − 𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 Quick assets include cash, marketable 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶 𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙 securities, and receivables. The higher the quick ratio, the better liquidity position of the firm. Asset Management Ratios It measures how the firm uses its assets to generate revenue and income. It is a set of ratios that measures how effectively a firm is managing its assets. These ratios are called utilization ratios, and these measure how effectively the firm utilized its assets to earn profits. Normally, companies borrow or obtain capital from other sources to acquire assets. If a company has too many assets acquired through borrowings, the interest expenses will be too high, hence a lower profit. On the other hand, if assets are too low, profitable sales may be lost. Managing assets, most especially current assets, will help the firm avoid borrowing funds to finance operations. RATIO FORMULA SIGNIFICANCE 1 Accounts receivable 𝑁𝑁𝑁𝑁𝑁𝑁 𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐 𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠 It measures the efficiency of turnover 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟 collections. The higher the turnover, the better, as it would mean a greater number of times receivable is reinvested for more profit. 2 Number of days in 365 𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑 It measures the average number of accounts receivable 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟 𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡 days to collect a receivable. The shorter, the better. 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟 Average collection period 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑 𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠 3 Inventory turnover 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶 𝑜𝑜𝑜𝑜 𝑔𝑔𝑔𝑔𝑔𝑔𝑔𝑔𝑔𝑔 𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠 It determines how fast the inventories 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖 are converted to sales. It indicates if a firm holds excessive inventories that are unproductive, which lessens the company’s productivity. For a manufacturing company, the number of days and turnover is determined for each item in the inventory. Raw materials turnover Work in process turnover Finished goods turnover 4 Number of days in 365 𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑 It measures the average number of inventory 𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼 𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡 days that inventory is held before sale. 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑 𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐 𝑜𝑜𝑜𝑜 𝑔𝑔𝑔𝑔𝑔𝑔𝑔𝑔𝑔𝑔 𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠 02 Handout 1 *Property of STI  [email protected] Page 10 of 16  BM1915 5 Fixed assets turnover 𝑁𝑁𝑁𝑁𝑁𝑁 𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆 It measures the level of use of fixed 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 𝑛𝑛𝑛𝑛𝑛𝑛 𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓𝑓 𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 assets such as property, plant, and equipment. 6 Total assets turnover 𝑁𝑁𝑁𝑁𝑁𝑁 𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆 It measures the effectiveness of asset 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡 𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 utilization and determines the number of times investments in assets are used to generate sales. The more the number of times it turns over, the higher profit the company utilized its assets. Solvency Ratios or Financial Leverage It measures the ability of the business to use debt in maximizing the shareholder’s value. These measure the extent to which the firm uses its debt financing or financial leverage. Some important implications can be raised: 1. By raising funds through debt, owners can maintain control of the firm with limited investment. 2. Creditors look to the equity, or owner-supplied funds, to provide a margin of safety, that is, if the owners have provided only a small proportion of the total financing, the risks of the enterprise are borne mainly by its creditors. However, financial leverage raises the expected rate of return to stockholders for two (2) reasons: 1. Since interest is deductible, the use of debt financing lowers the tax and leaves more of the firm’s operating income available to its shareholders. 2. If the rate of return on assets (net income/total assets) exceeds the interest rate on debt, as it generally does, then the company can use debts to finance assets, pay the interest on the debt, and have something left over for its stockholders. Normally, firms with high debt ratios are exposed to more risks of losses but also have higher expected returns. Conversely, firms with low debt ratios are less risky, but they also forego the opportunity to leverage up on their return on equity. Ratio Formula Significance 1 Debt-to-equity It measures the use of debt to 𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙 ratio finance operations and provides a 𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠ℎ𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑠𝑠 ′ 𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒 measure of relative amount of resources contributed by the creditors and owners. 2 Debt ratio or 𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙 It measures the relative share of Debt-to-assets 𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 creditors over the total resources of ratio the firm. 1 − 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟 3 Equity ratio 𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠ℎ𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑠𝑠 ′ 𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒 It measures the amount of resources 𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 provided by the owners of the firm. 1 − 𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷 𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟 4 Times-interest- 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏 𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖 𝑎𝑎𝑎𝑎𝑎𝑎 𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡 (𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸) EBIT is the income from operations earned 𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼 𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒 before deducting interest and taxes. 02 Handout 1 *Property of STI  [email protected] Page 11 of 16  BM1915 This is the ability of the firm to meet its annual interest payments. II. INCOME STATEMENT Profitability Ratios Profitability is a measure of operating effectiveness. It measures the ability of the business to recover long- term investments from money generated by its normal operating activities. It also measures earnings in relation to some base such as assets, sales, or capital. Ratio Formula Significance 1 Profit margin on sales / 𝑁𝑁𝑁𝑁𝑁𝑁 𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖 It measures profit percentage Return on sales (ROS) 𝑁𝑁𝑁𝑁𝑁𝑁 𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠 per peso sales. 2 Gross Profit ratio It measures the gross profit 𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺 𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝 percentage on sales to recover 𝑁𝑁𝑁𝑁𝑁𝑁 𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠 operating expenses. 3 Cost ratio 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶 𝑜𝑜𝑜𝑜 𝑔𝑔𝑔𝑔𝑔𝑔𝑔𝑔𝑔𝑔 𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠 It measures the proportion of 𝑁𝑁𝑁𝑁𝑁𝑁 𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠 the cost of goods sold to sales. 4 Return on investment It measures the overall asset (ROI) / Return on 𝑁𝑁𝑁𝑁𝑁𝑁 𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖 profitability and indicates how assets (ROA) 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡 𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 the management has employed effective assets. 5 Return on equity 𝑁𝑁𝑁𝑁𝑁𝑁 𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖 It measures the percentage of income derived for every peso 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠ℎ𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑠𝑠 ′ 𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒 of the owner’s equity. 6 Earnings per share It measures the amount of net income earned per outstanding 𝑁𝑁𝑁𝑁𝑁𝑁 𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖 𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 𝑡𝑡𝑡𝑡 𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐 𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠 share. 𝑊𝑊𝑊𝑊𝑊𝑊𝑊𝑊ℎ𝑡𝑡𝑡𝑡𝑡𝑡 𝑎𝑎𝑎𝑎𝑎𝑎. 𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛𝑛 𝑜𝑜𝑜𝑜 𝑠𝑠ℎ𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 The higher a company’s EPS, the more profitable it is considered. 7 Dividend per share It is the amount of dividends 𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷 𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝 𝑡𝑡𝑡𝑡 𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐 𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠 attributed to each share 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶 𝑠𝑠ℎ𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜 outstanding. 8 Dividend payout ratio 𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷 𝑝𝑝𝑝𝑝𝑝𝑝 𝑠𝑠ℎ𝑎𝑎𝑎𝑎𝑎𝑎 It is the percentage of net income paid to shareholders in 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 𝑝𝑝𝑝𝑝𝑝𝑝 𝑠𝑠ℎ𝑎𝑎𝑎𝑎𝑎𝑎 the form of dividends. III. RETAINED EARNINGS Market value ratios This is a set of ratios that relate the firm’s stock price to its earnings and book value per share. Ratio Formula Significance 1 Book value per share It indicates the peso remaining 𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠ℎ𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑠𝑠 ′ 𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒 − 𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝 𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠 for common shareholders 𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂 𝑠𝑠ℎ𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 after all assets are liquidated and all debtors are paid. 02 Handout 1 *Property of STI  [email protected] Page 12 of 16  BM1915 2 Market–book ratio It indicates the relationship 𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀 𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝 𝑝𝑝𝑝𝑝𝑝𝑝 𝑠𝑠ℎ𝑎𝑎𝑎𝑎𝑎𝑎 between the market price to 𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵 𝑣𝑣𝑣𝑣𝑣𝑣𝑣𝑣𝑣𝑣 𝑝𝑝𝑝𝑝𝑝𝑝 𝑠𝑠ℎ𝑎𝑎𝑎𝑎𝑎𝑎 book value. 3 Price–earnings ratio It shows the peso amount 𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀 𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝 𝑝𝑝𝑝𝑝𝑝𝑝 𝑠𝑠ℎ𝑎𝑎𝑎𝑎𝑎𝑎 investors will pay for every P1 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 𝑝𝑝𝑝𝑝𝑝𝑝 𝑠𝑠ℎ𝑎𝑎𝑎𝑎𝑎𝑎 of current earnings. 4 Dividend yield ratio It measures the rate of return 𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷 𝑝𝑝𝑝𝑝𝑝𝑝 𝑠𝑠ℎ𝑎𝑎𝑎𝑎𝑎𝑎 on actual dividend distribution 𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀 𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝 𝑝𝑝𝑝𝑝𝑝𝑝 𝑠𝑠ℎ𝑎𝑎𝑎𝑎𝑎𝑎 to common stockholders. Note: All ratios could be more meaningful if they are compared to the industry standards so that the financial analyst could assess the performance of the company in relation to its competitors. ILLUSTRATIVE PROBLEM: Financial statement analysis of Mighty Warrior Corporation Year 1 Year 2 1. Net working capital Current assets P427,000 P450,000 Current liabilities 162,000 140,000 Net working capital P265,000 P310,000 2. Current ratio Current assets P427,000 P450,000 Current liabilities 162,000 140,000 2.64 3.21 3. Quick Ratio Quick assets P267,000 P220,000 Current liabilities 162,000 140,000 1.65 1.57 4. Accounts receivable (A/R) turnover (assuming all sales are on credit) 𝑁𝑁𝑁𝑁𝑁𝑁 𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆 𝑃𝑃450,000 = = 5.0 𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡 𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵 𝐴𝐴/𝑅𝑅 + 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 𝐴𝐴/𝑅𝑅 𝑃𝑃100,000 + 𝑃𝑃80,000 ( ) ( 2 ) 2 5. Number of days in accounts receivable / Average collection period 365 𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑 365 𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑 = = 73 𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟 𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡 5 OR 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 𝐴𝐴/𝑅𝑅 𝑃𝑃90,000 = = 73 𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑 𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠 (𝑃𝑃450,000) 365 𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑 6. Inventory turnover 02 Handout 1 *Property of STI  [email protected] Page 13 of 16  BM1915 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶 𝑜𝑜𝑜𝑜 𝑔𝑔𝑔𝑔𝑔𝑔𝑔𝑔𝑔𝑔 𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠 𝑃𝑃297,000 = = 1.75 𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡 𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵 𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖 + 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖 𝑃𝑃140,000 + 𝑃𝑃200,000 ( ) ( 2 ) 2 7. Number of days in inventory 365 𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑 365 𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑 = = 208.57 𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑 𝑜𝑜𝑜𝑜 209 𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑 𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼 𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡 1.75 OR 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖 𝑃𝑃170,000 = = 208.92 𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑 𝑜𝑜𝑜𝑜 209 𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑 𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐 𝑜𝑜𝑜𝑜 𝑔𝑔𝑔𝑔𝑔𝑔𝑔𝑔𝑔𝑔 𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠 (𝑃𝑃297,000) 365 𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑 8. Fixed assets turnover 𝑁𝑁𝑁𝑁𝑁𝑁 𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆 450,000 = = 0.81 𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡 (𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵 + 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸) (𝑃𝑃603,000 + 𝑃𝑃510,400) 2 2 9. Total assets turnover 𝑁𝑁𝑁𝑁𝑁𝑁 𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆 𝑃𝑃450,000 = = 0.35 𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡 (𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡 𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎) (𝑃𝑃1,312,500 + 𝑃𝑃1,230,400) 2 2 10. Debt-to-equity ratio Year 201A Year 201B 𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙 𝑃𝑃382,000 𝑃𝑃270,000 = = 𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠ℎ𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑠𝑠 ′ 𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒 𝑃𝑃930,500 𝑃𝑃960,400 = 0.41 = 0.28 11. Debt ratio / Debt-to-assets ratio Year 201A Year 201B 𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙𝑙 𝑃𝑃382,000 𝑃𝑃270,000 = = 𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 𝑃𝑃1,312,500 𝑃𝑃1,230,400 = 0.29 = 0.22 12. Equity ratio Year 201A Year 201B 𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠ℎ𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑠𝑠 ′ 𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒 𝑃𝑃930,500 𝑃𝑃960,400 = = 𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 𝑃𝑃1,312,500 𝑃𝑃1,230,400 = 0.71 = 0.78 13. Times-interest-earned Year 201A Year 201B 02 Handout 1 *Property of STI  [email protected] Page 14 of 16  BM1915 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏 𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖 𝑎𝑎𝑎𝑎𝑎𝑎 𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡 𝑃𝑃76,250 𝑃𝑃101,000 = = 𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼𝐼 𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒 𝑃𝑃21,000 𝑃𝑃18,250 = 3.63 𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡 = 5.53 𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡 14. Profit margin on sales / Return on sales (ROS) 𝑁𝑁𝑁𝑁𝑁𝑁 𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖 𝑃𝑃57,925 = = 12.87% 𝑁𝑁𝑁𝑁𝑁𝑁 𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆 𝑃𝑃450,000 15. Gross profit ratio 𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺 𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 𝑃𝑃153,000 = = 34% 𝑁𝑁𝑁𝑁𝑁𝑁 𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆 𝑃𝑃450,000 16. Cost ratio 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶 𝑜𝑜𝑜𝑜 𝑔𝑔𝑔𝑔𝑔𝑔𝑔𝑔𝑔𝑔 𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠 𝑃𝑃450,000 = = 66% 𝑁𝑁𝑁𝑁𝑁𝑁 𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠 𝑃𝑃297,000 17. Return on investment (ROI) / Return on assets (ROA) 𝑁𝑁𝑁𝑁𝑁𝑁 𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖 𝑃𝑃57,925 = = 4.56% (𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝑖𝑖𝑖𝑖𝑖𝑖 + 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸) (𝑃𝑃1,312,500 + 𝑃𝑃1,230,400) 2 2 18. Return on common equity 𝑁𝑁𝑁𝑁𝑁𝑁 𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖 − 𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝 𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑 𝑃𝑃57,925 − 𝑃𝑃9,000 = = 6.15% ′ 𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴𝐴 𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐 𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠ℎ𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑠𝑠 𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒 (𝑃𝑃780,500 + 810,400) 2 In computing for the common stockholders’ equity, subtract the preferred stock from the total. 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶 𝑆𝑆𝑆𝑆𝑆𝑆 (𝑦𝑦𝑦𝑦𝑦𝑦𝑦𝑦 201𝐴𝐴) = 𝑃𝑃930,500 − 𝑃𝑃150,000 = 𝑷𝑷𝑷𝑷𝑷𝑷𝑷𝑷, 𝟓𝟓𝟓𝟓𝟓𝟓 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶 𝑆𝑆𝑆𝑆𝑆𝑆 (𝑦𝑦𝑦𝑦𝑦𝑦𝑦𝑦 (201𝐵𝐵) = 𝑃𝑃960,400 − 𝑃𝑃150,000 = 𝑷𝑷𝑷𝑷𝑷𝑷𝑷𝑷, 𝟒𝟒𝟒𝟒𝟒𝟒 𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟 𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑 = 𝑃𝑃150,000 𝑥𝑥 6% = 𝑷𝑷𝑷𝑷, 𝟎𝟎𝟎𝟎𝟎𝟎 19. Earnings per share 𝑁𝑁𝑁𝑁𝑁𝑁 𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖 𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 𝑡𝑡𝑡𝑡 𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐 𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠ℎ𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜 𝑃𝑃57925 − 𝑃𝑃9,000 = = 𝑃𝑃3.06 𝑁𝑁𝑁𝑁𝑁𝑁𝑁𝑁𝑁𝑁𝑁𝑁 𝑜𝑜𝑜𝑜 𝑠𝑠ℎ𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜 16,000 𝑁𝑁𝑁𝑁𝑁𝑁𝑁𝑁𝑁𝑁𝑁𝑁 𝑜𝑜𝑜𝑜 𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐𝑐 𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠 𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜 = 𝑃𝑃480,000/𝑃𝑃20 = 24,000 𝑠𝑠ℎ𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 20. Dividend per share Retained earnings, beginning (201A) P300,500 Add: Net income (201B) 57,925 Less: Retained earnings, ending (201B) 330,400 Dividends paid to stockholders P28,025 Dividends paid to preferred stockholders 9,000 Dividends paid to common stockholders P19025 Divided by: Number of common stock outstanding 16,000 Dividend per share P1.19 02 Handout 1 *Property of STI  [email protected] Page 15 of 16  BM1915 21. Dividend payout ratio 𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷 𝑝𝑝𝑝𝑝𝑝𝑝 𝑠𝑠ℎ𝑎𝑎𝑎𝑎𝑎𝑎 𝑃𝑃1.19 = = 38.88% 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 𝑝𝑝𝑝𝑝𝑝𝑝 𝑠𝑠ℎ𝑎𝑎𝑎𝑎𝑎𝑎 𝑃𝑃3.06 22. Book value per share 𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇𝑇 𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠ℎ𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑠𝑠 ′ 𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒 − 𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝 𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠 𝑃𝑃810,400 = = 𝑃𝑃50.65 𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂𝑂 𝑠𝑠ℎ𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 16,000 23. Market–book ratio Market price per share is the peso amount that investors are willing to pay for one share of stock. It is the price that a stock can be readily bought or sold in the current market. Assume the market price per share is at P80. The market-book ratio is: 𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀 𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝 𝑝𝑝𝑝𝑝𝑝𝑝 𝑠𝑠ℎ𝑎𝑎𝑎𝑎𝑎𝑎 80 = = 1.58 𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡𝑡 𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵 𝑣𝑣𝑣𝑣𝑣𝑣𝑣𝑣𝑣𝑣 𝑝𝑝𝑝𝑝𝑝𝑝 𝑠𝑠ℎ𝑎𝑎𝑎𝑎𝑎𝑎 50.65 24. Price–earnings ratio 𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀 𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝 𝑝𝑝𝑝𝑝𝑝𝑝 𝑠𝑠ℎ𝑎𝑎𝑎𝑎𝑎𝑎 𝑃𝑃80 = = 26.14 𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 𝑝𝑝𝑝𝑝𝑝𝑝 𝑠𝑠ℎ𝑎𝑎𝑎𝑎𝑎𝑎 3.06 25. Dividend yield ratio 𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷 𝑝𝑝𝑝𝑝𝑝𝑝 𝑠𝑠ℎ𝑎𝑎𝑎𝑎𝑎𝑎 𝑃𝑃1.19 = = 1.48% 𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀 𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝 𝑝𝑝𝑝𝑝𝑝𝑝 𝑠𝑠ℎ𝑎𝑎𝑎𝑎𝑎𝑎 𝑃𝑃80 References: International Accounting Standards Board. (n.d.). IAS 1 — Presentation of financial statements. Retrieved from IASPlus: https://www.iasplus.com/en/standards/ias/ias1 Payongayong, L. S. (2016). Management services. Manila: Polytechnic University of the Philippines. Robles, N. S., & Empleo, P. M. (2016). The intermediate accounting series volume 3. Mandaluyong City: Millenium Books, Inc. Weygandt, Ph.D., CPA, J. J., Kimmel, Ph.D., CPA, P. D., Kieso, Ph.D., CPA, D. E., & Aly, Ph.D., I. M. (2018). Managerial accounting: Tools for business decision-making. Canada: John Wiley & Sons, Inc. 02 Handout 1 *Property of STI  [email protected] Page 16 of 16