CHAPTER 4
FINANCIAL RATIO ANALYSIS AND THEIR IMPLICATIONS TO MANAGEMENT
Ratios present relationships between two variables:
Financial ratios, refer to the relationships between financial statement items or accounts expressed in mathematical fashion.
In using these ratios, your task is to interpret them as favorable or unfavorable. Some of the standards ratios used are based on:
1.
2.
3.
4.
5.
Company budget for the same period
Those used by the industry to which the firm belongs
Those used by the firm’s successful competitors
Those used by the firms using prior periods
Those used by the analyst in the past
Industry ratios are averages developed by a group of experts involved in research. These empirically-based ratios are used as
standards in financial statement analysis. Industries have their own peculiarities; hence experts developed ratios that are suitable
for that industry.
Results derived from the computation of ratios could be presented as a percentage (%), a fraction (1/4), a peso amount (25.50), or
s relative ratio (2:1).
ILLUSTRATIVE EXAMPLES:
Let us use the figures of Riel Corporation in chapter 3 as example. Assume further that Riel Corporation is a leading department
store of fashionable clothes and apparels with five strategic branches located in metro. In this example, provided is the computation
of the ratios for the current year. Compute the ratio for the previous year.
Riel Corporation
Comparative statements of financial position
December 31, 2025 and 2024
Assets
Current assets
Cash & cash equivalent
Trade and other receivables
Inventory
Prepaid expenses
Total current assets
Noncurrent assets
Property, plant & equipment
Intangibles
Total noncurrent assets
Total Assets
Liabilities and shareholders equity
Current liabilities
Trade & other payables
Unearned revenues
Notes payables-current
Total current liabilities
Noncurrent liabilities
Notes payable-noncurrent
Total liabilities
Shareholders equity
Preference shares
₱ 100 par
Ordinary shares ₱ 1 par
Premium on ordinary shares
Total paid-in-capital
Retained earnings
Total shareholders equity
TOTAL LIABILITIES & SHAREHOLDERS
EQUITY
Total shareholders equity
TOTAL LIABILITIES & SHAREHOLDERS
EQUITY
2025
2024
106,789
327,611
334,863
101,565
870,828
102,375
277,467
297,654
114,813
792,309
135,754
7,500
143,254
1,014,082
166,481
7,500
173,981
966,280
238,000
107,508
45,000
390,508
208,703
82,456
45,000
336,159
208,422
598,930
253,500
589,659
105,000
15,000
135,000
255,000
105,000
15,000
135,000
255,000
160,152
121,631
415,152
1,014,082
376,631
966,290
Riel Corporation
Comparative Income Statements
For the period ending December 31, 2025 and 2024
Sales
Less: Cost of good sold
Gross profit
Less: Selling expenses
Administrative Expenses
Total Operating Expenses
Operating income
Less: Interest expense
Net income before taxes
Less: Income tax
Net income after taxes
2025
₱3,007,887
2,208,520
799,367
372,000
207,000
579,000
220,367
41,860
178,507
62,477
₱116,030
2024
₱2,732,712
1,964,865
767,847
345,000
213,000
558,000
209,847
43,905
165,942
58,080
₱107,862
In doing the analysis we shall cover the company status in terms of:
I.
II.
III.
IV.
Liquidity/short-term solvency- pertains to the firm’s ability to pay any immediate and incoming cash disbursements
(payment of payables and operating costs and expenses).
Asset utilization liquidity analysis- measures how often is the turnover of accounts receivable, inventory, and long-term
assets. Stated differently, we measure the liquidity of assets, namely: accounts receivable, inventory, and long-term
assets. Along with this, we also measure how efficient management uses these assets.
Debt-utilization (leverage) ratios- estimates the overall debt status of the firm in light of its asset base and earning
power. We measure the degree of company financing in terms of borrowings and investment or equity. We also
measure the company’s ability to pay interest and other fixed charges such us rent and payment of investment funds
like sinking funds, redemptions, pensions, etc.
Profitability ratios- measures the firm’s capacity to earn sufficient return on sales, total assets, and owner’s investment.
Solution:
Liquidity/short-term solvency
1.
Current ratio
(2025) = current assets of ₱870,828 = 2.23:1 or 223%
Current liabilities of ₱390,508
(2024) =
Current ratio of 2.23:1 can be interpreted to mean that for every ₱1 of current liability, the company has
₱2.23 current assets to pay it. This result may at times be considered as favorable and satisfactory. It
indicates that riel is able to pay their current maturing debts, with ₱1.23 to spare for every ₱1 of liability
they have.
Inventory is considered as a slow-moving asset in terms of its convertibility into cash.
Another asset that some analyst do not use in the computation of current ratio is prepaid expense. The
reason is because they are not sources of cash. It represents the consumption or use of future benefits
like prepaid rent or prepaid advertisement. Consumption of these does not entail cash inflow but
recognition of expense for the company.
On the other hand, a company with a low current ratio may be able to pay current maturing debts because
the composition of its current asset is easily convertible to cash like having collectible receivables and
highly salable trading securities.
It is recommended to see whether the said ratio is favorable or not by comparing it with the firm’s
competitors or with the firm’s trend of liquidity over a period of 5 years.
2. Upward and Downward Movement of Current Ratio
Movements in current ratio components give rise to changes in the current ratio. Ponder on the
following statements and experiment using the figures of Riel Corporation:
a. Increase in current assets or decrease in current liabilities increases the current ratio.
Components
Total current assets
Total current liabilities
Current ratio:
Components
Total current assets
Total current liabilities
Current ratio:
Previous current
ratio
₱50,000
₱25,000
2:1
Previous current
ratio
₱50,000
₱25,000
2:1
Increase(decrease)
₱10,000
Increase(decrease)
₱10,000
New current ratio
₱60,000
₱25,000
2.4:1 increase
New current ratio
₱50,000
₱15,000
3.3:1 increase
b. If the previous current ratio is 1:1 and there is an increase or decrease of the same amount on
both the total current assets and total current liabilities, it shall have no effect on the new current
ratio or the new current ratio will be the same as the previous. To prove this, here is an example.
Components
Total current assets
Total current liabilities
Current ratio:
Previous current ratio
₱50,000
₱50,000
1:1
Increase(decrease)
₱10,000
₱10,000
New current ratio
₱60,000
₱60,000
1:1 no effect/same
ratio
c. If the previous current ratio is positive (current assets>current liabilities), and there is an
increase by the same amount in both total current assets and total current liabilities, the ratio
shall decrease and vice-versa. The opposite will occur if the previous current ratio is negative
(current liabilities >current assets).
Components
Total current assets
Total current liabilities
Current ratio:
Components
Total current assets
Total current liabilities
Current ratio:
Previous current
ratio
₱50,000
₱25,000
2:1 positive
Previous current ratio
₱25,000
₱50,000
0.5:1 negative
Increase(decrease)
New current ratio
₱10,000
₱10,000
₱60,000
₱35,000
1.71:1 decrease
Increase(decrease)
₱10,000
₱10,000
New current ratio
₱35,000
₱60,000
0.58:1 decrease
3. Acid test ratio/Quick ratio/Liquidity ratio
(2025) =
quick assets (cash +trading securities=receivables)
Of ₱106,789+327,611
=2.23:1 or 223%
Current liabilities Of ₱ 390,508
=1.11:1 or 1.11%(2024)
(2024) =
The quick ratio is a stricter test of liquidity. This could be interpreted that for every ₱1.11 of current assets
to pay it. As you can see, Riel is not as liquid as we pictured it to be done when the current ratio was used.
As a general rule, the higher the quick ratio, the more liquid the firm is and thus, can pay its current
maturing debts.
Note that the inventories are ignored because of its nature being uncertain as to their salability. Another
reason for their exclusion from the formula is its uncertainty as to when the item will be converted into
cash. This is more so if the company is a manufacturing entity where the inventory will be raw materials
the work in process to finished goods, converted to receivables, and eventually collected and converted
into cash.
Asset Utilization Liquidity Analysis
1. For Accounts Receivable
Accounts Receivable Turnover
Net Sales of ₱3,007,887
(2025) =
= 9.94 times
Average Accounts Receivable of ₱227,467 + ₱327,611
2
(2024)
Note for the 2024 receivable turnover you may use the ending inventory of 2014 as the average
inventory.
Days’ Sales in Average Collection Period
365 days
(2025) =
=36.7 days
Receivable turnover of 9.94 times
(2024)
This ratio is used to measure the liquidity of the firm’s accounts receivable. The result of 9.94 times could
be interpreted to mean the firm is able to collect all their receivables 9.94 times in a year. A high turnover
rate means that receivable is collected in a short period of time. In Riel corporation’s case, it is able to
collect the average receivables every 37 days or approximately every month. This has great bearing on
management since a high receivable turnover speed up its conversion to cash, management can use it
further to enhance company operations and increase company profits.
High receivable turnover rate does not automatically mean good of efficient collection of the company.
The high turnover rate could be caused by any of the following.
a.
b.
c.
d.
e.
f.
Price level changes
Changes in sales terms
Special sales promotion
Strikes and plant shutdown during the previous period
Higher cash sales
(turnover was) computed when most receivables are collected
2. For Inventory
Inventory Turnover Ratio
The inventory turnover rate pertains to the number of times the average inventory is sold (finishing goods
and merchandise) used (raw materials), or processed (work-in-process). The following formulas are
adapted depending on the nature of the inventory being assessed:
raw materials used
Raw materials
=
Inventory turnover
Average raw materials inventory
cost of goods manufactured
Work-in-process
Inventory process
=
Average work in process inventory
cost of goods sold
Finished goods
=
Inventory turnover
Average finished goods inventory
cost of goods sold
Merchandise
=
Inventory turnover
average merchandise inventory
beginning inventory + Ending inventory
Average inventory =
2
In our example, we used Merchandise Inventory; hence, the turnover rate is computed as:
cost of goods sold of ₱2,208,520
(2025) =
= 6.98 times
₱297,654+ ₱334,863
Average inventory of
2
(2024) =
The inventory turnover indicates the company’s efficiency in managing and disposing inventory. As a
general rule, the higher the turnover rate, the better. However, this is not always the case because a high
turnover rate may also indicate that the firm is underinvesting in their inventory or suffering lost orders.
It may also mean inventory shortages.
For purposes of providing an interpretation for Riel Corporation, the result has a relatively slight
unfavorable inventory turnover. A dress store like Riel should be able to dispose of their inventory quicker,
since fashion is highly dynamic and the turnover of new clothes are high; a higher turnover for Riel would
be more appropriate. The management should recommend and come up with strategies on improving
the inventory turnover ratio.
Number of days in Inventory or Average Sale Period
365 days
(2025) =
= 52.30 days
Inventory turnover of 6.98 times
(2024) =
The number of days in inventory indicates the number of days the entire inventory is sold. As a general
rule, the higher the result, the better. This indicates that since inventories are sold out quickly, funds use
for the inventories are quickly converted to cash, and ultimately translated to more earnings. Riel’s days
inventory of 52.30 days can still be improved. It would be better if management can dispose of their
inventory in shorter number of days.
3. Property, Plant, and Equipment (PPE) or Fixed Asset Turnover
Net sales of ₱3,007,887
(2025) =
= 19.90:1
Average net PPE of ₱135,754 + ₱166,481
(2024) =
This turnover indicated the firm’s efficiency in using their PPE in generating revenue. The computed ratio
of 19.90:1 can be interpreted that for every ₱1 PPE acquired and used by the company, ₱19.90 sales
revenue is generated. We could infer that Riel Corporation is efficient in using their PPE.
4. Total Asset Turnover
Net sales of ₱3,007,887
(2025) =
=
3.04:1 or 304 %
Average total assets of ₱1,014,082 + 966,290
(2024) =
This ratio presents the company’s efficiency in utilizing their total assets to generate revenue. Low
turnover rate means that there is slow or low sales generation or that there is too high investment in
assets. Looking at Riel’s asset turnover rate (3.04:1), we can interpret that for every ₱1 asset of the
company, ₱3.04 of sales revenue is generated. Based on this, we can infer that management utilizes its
asset efficiently. It can, however, be recommended that the company instills more asset utilization policies
that would further enhance asset usage efficiency.
Debt-Utilization (Leverage)Ratios
The leverage ratios allow the analyst to ascertain how efficient the company manages its financial
obligations. Under this, you need to compare the liabilities and owner’s equity vis-à-vis total assets or
total liabilities and owners’ equity.
As previously mentioned in chapter 3, the owner’s equity is considered as the margin of safety by the
creditors. This is because the owner’s equity is the amount that can absorb any decline in asset. In other
words, in case the assets of the company decline, the owner’s equity is the amount that can be used to
pay the creditors. In Riel corporation, the total assets may decline by ₱415,152 (amount of stockholder’s
equity) or ₱598,930 and the company will still be able to pay its credits.
The following ratios may be used in the analyses:
1. Debt to Equity Ratio
total liabilities of ₱598,930
(2025) =
= 1.44:1 0r 144%
Total stockholder’s equity of
₱415, 152
(2024) =
The use of borrowed funds in carrying out the firm’s operation is called trade on equity. This means that
the firm is willing to borrow money and pay fixed interest charges from the loan. The borrowed money
will be used to increase volume of operation and ultimately earn more profit. This is an example of
financial leverage.
When a firm borrows fund to be used in the business, the total assets (cash) and total liabilities (bank
loan) of the company increase, however, the owner’s equity remains the same. If profits increase, the
trading on equity (use of borrowed money) would increase the debt/ equity.
The debt /equity ratio presents the firm’s capital structure and its inherent risk. The liabilities of the
company present a risk, and blessings or benefit on the part of the owners. It is a risk because if the
company fails to use the borrowed money wisely to improve operations the interest expense from their
borrowings will be higher than their operating income (operating loss). It will be a blessing, if the company
is able to use the money wisely to improve operations leading to higher income, and the higher income
ultimately increases owner’s equity. The high income exceeds the interest expense from the borrowing,
thus making liabilities a blessing for the company. This structure indicates the tradeoff between risk and
return.
Riel’s debt /equity (144%) presents a high risk in the firm’s capital structure. Management should be
mindful of the efficient use of the company’s borrowings in improving operations to ensure higher yields.
2. Debt Ratio
total liabilities of ₱598,930
(2025) =
= 0.59.1 or 59%
Total assets of ₱1,014,082
(2024) =
The ratio could be interpreted to mean that for every ₱1 asset of the company, ₱0.59 was borrowed or
was provided by the creditors. It basically presents the proportion of borrowings to total assets. Generally,
as explained earlier, the higher the debt proportion, the higher is the risk. In addition, the risk is higher be
cause of the firm gets bankrupt, the creditors must be paid first, if the assets are not sufficient to pay all
the debts, the owners will end up with nothing.
Riel’s debt ratio (59%) presents a relatively high risk on the part of the company. Management should be
mindful of the risk from borrowings. In addition, the ratio may bring about some difficulty on the part of
management to borrow when they need it. Low owner’s equity structure decreases the margin of the
safety for creditors.
3. Number of Times Interest Earned
Net Income before interest and Income tax or operating income of ₱220,367
(2025) =
= 5.26 times
Annual Interest Expense of ₱41,860
(2024) =
This ratio indicates the ability of the firm o pay fixed interest charges. It gauges the company’s ability to
protect long-term creditors. Riel’s times interest earned of 5.26 times indicate that the firm is very much
capable of paying its fixed interest charges from its operating income.
Profitability Ratios
1. Gross Profit Ratio
gross profit of ₱799,367
(2025) =
=₱0.26 or 0.26:1 or 26%
Net sales of ₱3,007,887
(2024) =
This presents the gross margin per peso of sales. This is used to ascertain if the gross margin or profit is
sufficient to cover the operating expenses and the firm’s desired net income. It also gauges the firm’s
ability to control production/ acquisition costs and inventories, including mark-ups in the selling of their
products. The said mark-ups must be more than adequate to cover not only the inventory related costs
but also operating expenses and achieve a desired profit for a period.
Riel’s gross profit ratio (₱0.26) indicates their ability to earn more than adequate sales revenue to cover
their cost of selling the goods. However, a 26% gross profit ratio means a 74% cost ratio. This is relatively
too high. Management must come up with more stringent cost control measures to decrease cost of sales
thereby increasing the gross margin ratio in the succeeding years.
2. Net Profit or Profit Margin
net profit of ₱116,030
(2025) =
= ₱0.039: ₱1 or 3.9
Net sales of ₱3,007,887
(2024) =
The ratio could mean that for every ₱1 sales revenue, the firm has ₱0.39 net income. These gauges the
profitability of the firm after including all revenues and deducting all costs and expenses, and taxes. Riel’s
net profit ratio of 39% is positive. however, management should look closely to come up with measures
that would increase revenue and decrease costs in order to ensure and achieve profit maximization.
3. Return on Assets (ROA)
net income of ₱116,030
(2025) =
= 0.12:1 or 12%
Average total assets of ₱1,014,082 + ₱966,290
2
(Du pont Method) = Net profit ratio of 3.9% × total asset turnover of 3.04= 12%
(2024)
=
This could mean that for every ₱1 asset used by the company to generate revenue, it yielded ₱0.12 of net
income. It gauges the profitability of the firm in the use of the total assets or total liabilities and total
owner’s equity.
4. Return on Equity
net income of ₱116,030
(2025) =
= 0.29:1 or 29%
Ave. stockholder’s equity of ₱415,142 + ₱376,631
(2024) =
This could be interpreted to mean that for every ₱1 of invested capital by the owner’s and used to
generate revenue, it yielded ₱0.29 of net income. This ratio, just like ROA, is used to gauge the company’s
efficiency in managing its total assets invested and in coming up with return to shareholders.
5. Du Pont System of Analysis
After seeing and analyzing the ratios, you might think that they are too many. A man by the name of
Donald Brown, who happened to be Du Pont’s chief financial officer, thought of the same thing. He came
up with the Du Pont Equation or the Du Pont System Analysis. The Du Pont company emphasized that
satisfactory return on assets may be achieved by having high profit margins/net profit ratio or by having
a faster asset turnover, or a good combination of both.
A favorable net profit ratio would indicate that the company has good cost control measures, and a high
asset turnover rate would mean efficient use of assets. Various industries have various operating and
financial structures. Companies belonging to industries with heavy/ high capital produce emphasizes high
net profit ratio with a relatively low asset turnover. On the other hand, the food processing industries
emphasize low net profit margin and high turnover of assets indicating a satisfactory return on assets.
The model includes the following formula to compute return on equity:
Return on assets = Profit Margin or Net Profit Ratio × asset turnover
Debt ratio
= total liabilities/total assets
Equity ratio
= 1- debt ratio
Return on equity = return on assets
(Du Pont Method)
Equity Ratio
Using the analysis for Riel Corporation:
Return on Asset
Debt ratio
= 12% (Du Pont)
= 59%
Return 0n Equity
= 12% = 29%
1-59%
RATIOS USED TO GUAGE COMPANY LIQUIDITY OR SHORT-TERM SOLVENCY
The following rate are the most common ratios to gauge a firm’s liquidity or short-term solvency:
Ratio
Formula
Significance
Current assets
Current liabilities
Signifies the firm’s capacity to
1. Current ratio
Note: some analysts do not
pay or meet current financial
include prepaid expenses in the
obligation
computation of the current
assets
Current assets
Current liabilities
2. Quick ratio
Quick asses current
A stricter test of liquidity;
Liabilities QA=cash + trading
suggest the firm’s ability to pay
securities + trade and other
current financial obligations by
receivables
considering more liquid current
assets
Current assets
Suggests the relative liquidity of
3. Currents assets to total
Total assets
the total assets and shows the
assets or Working
proportion of current asset to
capital to Total assets
total asset
4. Each current asset item
to total current assets
Each current asset items
Total current asset
5. Cash flow liquidity ratio
Cash & cash equivalents +
trading services + cash flow
from operating
Activities
Current liabilities
6. Defensive interval ratio
Current liabilities
Cash and cash equivalents
Signifies the proportion of each
current asset item to total
assets, also indicates the
liquidity of the current assets
and the breakdown of each
component
Gauges the firm’s ability to pay
current financial obligations by
considering cash and other cash
equivalents
Indicates the coverage of
current liabilities
RATIOS USED TO GUAGE ASSET MANAGEMENT EFFICIENCY AND LIQUIDTY
The following are the most common ratios to gauge a firm’s ability to efficiently manage their assets and
measure liquidity or short-term solvency:
Ratio
1. Receivable turnover
2. Average collection
period or number of
days in receivables
3. Merchandise Turnover
Formula
Net sales or Net Credit sales
Average Receivables
365 Days or 360 days
Receivable Turnover
Costs of goods sold
Average merchandise inventory
4. Finished Goods
Turnover
Costs of goods sold
Average finished goods
inventory
5. Wok-in-process
Turnover
Cost of goods manufactured
Average work in process
inventory
6. Raw materials Turnover
7. Number of days in
inventory
8. Working capital
turnover
Raw materials used
Average raw materials
inventory
365 days or 360 days
Inventory turnover
Costs of goods sold + operating
Expenses (excluding charges not
requiring working capital)
Or
Net sales
Average Working capital
Significance
Signifies the number of times
the average receivables are
collected during the year, also
measures the firm’s efficiency in
collecting their receivables
This ratio is very much related to
accounts receivable turnover,
indicates the number of days the
firm collects its average
receivables. It implies the
efficiency of the firm in
collecting their receivables
Suggests the number of times
the average inventory was
disposed
of
during
the
accounting period, also signifies
the over or under investment of
the firm in inventory
Suggests the number of times
the average inventory was
disposed
of
during
the
accounting period, also signifies
the over or under investment of
the firm in inventory
Signifies the number of times
average inventory was produced
during the accounting period,
also indicates the time taken to
produce the products
Measures the number of times
average raw materials inventory
was used during the period, also
indicates the sufficiency of the
raw materials available
Indicates the number of days by
which inventories are used or
sold, implies the firm’s efficiency
in
consuming
or
selling
inventories.
Signifies the pace by which
working capital is used; also
indicates the adequacy of
working capital in the firm’s
operations
9. Current Asset turnover
10. Payable turnover
11. Operating Cycle (trading
Concern)
12. Operating cycle
(manufacturing
concern)
Cost of goods sold + operating
expenses + income taxes +
other expenses (excluding
charges not requiring current
assets like depreciation and
amortization expenses)
Average Current assets
Net credit purchases or net
purchases
Average trade and other
payables or accounts payables
Signifies the firm’s ability to pay
trade payables; also measures
the number of times the
amount of average payables is
paid during the accounting
period
Day’s sales in merchandise
Measures the length of time in
inventory + no. of days to
order to convert cash to
collect receivables
inventory to receivables and
back to cash
No. of days usage in raw
Measures the length of time in
materials inventory + no. of
order to convert cash to rawdays in production process + no. materials inventory to work-inof days sales in finished goods process to finished good
inventory + no. of days to
inventory to receivables and
collect receivables
back to cash
Average cash balance
13. Days Cash
Cash operating costs
365 days or 360 days
14. Asset Turnover
Net sales
Average Total Asset
15. Property, plant, &
equipment turnover or
fixed asset Turnover
Signifies the pace by which
current assets are used; also
indicates the adequacy of
current Assets in the firm’s
operations
Net sales
Average PPE Assets
Indicates the ability of the firm’s
cash to pay the average daily
cash obligations
Indicates the firm’s ability to
efficiently manage their assets
to generate revenue
Indicates the firm’s ability to
efficiently manage their PPE’s to
generate revenue
RATIOS USED TO GAUGE FIRM’S UTILIZATION OF DEBT AND COMPANY STABILITY
The following are the most common ratios used to gauge a firm’s stability or long-term solvency:
Ratio
1. Debt to Equity Ratio
2. Equity to Debt Ratio
3. Proprietary or Equity Ratio
4. Debt Ratio
5. Fixed Assets to Total Owner’s
Equity
6. Fixed Assets to Total Asset
7. Fixed Assets to Total longterm Liabilities
8. Plant Turnover
9. Book Value per Share
10. Number of times interest
earned
11. Number of times preference
shares dividend requirement
is earned
12. Number of times Fixed
charges are earned
Formula
Total Liabilities
Owner’s Equity
Owner’s Equity
Total Liabilities
Owner’s Equity
Total Asset
Total Liabilities
Total assets
PPE or Fixed Assets (net)
Owner’s Equity
PPE or Fixed Assets (net)
Total Asset
PPE or Fixed Assets (net)
Total Long-term liabilities
Net sales
Average PPE or Fixed Assets (net)
Ordinary Shareholder’s Equity
Number of ordinary sales outstanding
net income before interest and income taxes
annual interest charges
Net income after tax
Preference shares dividend requirment
Net income before taxes & fixed charges
Fixed expenses (rent, interest, sinking fund
payments before taxes)
Significance
Measures the relationship or
proportion of the capital
provided by creditors to the
capital provided by owner’s
Measures the margin of safety
creditors
Measures the proportion of the
firm’s assets coming from its
owner’s,
signifies
financial
stability of the firm and caution
the creditors
Measures the proportion of the
firm’s assets coming from its
creditors, also signifies the
extent of trading on equity
Measures the portion of the
owner’s equity used to acquire
fixed assets
Signifies whether the firm over
or under invested in PPE
Measures the extent covered by
the carrying value of PPE to longterm obligations
Signifies the firm’s efficiency in
using their PPE
Measures the carrying value of
net assets for every ordinary
share outstanding, also indicates
the amount, which the
shareholders can recover if the
firm sells its assets upon
liquidation or converts them
into cash at their bock values
Signifies the firm’s capacity in
paying fixed interest charges,
measures the number of times
interest charges is covered by
the firm’s operating income
Measures the firm’s ability to pay
the preference shareholder’s
dividend requirement
Indicates the firm’s ability to pay
annual fixed charges
RATIOS USED TO GAUGE FIRM’S PREOFITABILTY AND RETURN TO OWNER’S
The following are the most common ratios used to gauge a firm’s profitability and returns to
owner’s.
Ratio
1. Rate of return on
sales or net profit
ratio or net profit
margin
Formula
Net income
Net sales
Return on sales × asset turnover
2. Rate of return to
total assets (ROA)
3. Asset turnover
4. Gross Profit ratio
5. Operating Ratio
6. Cash flow margin
7. Rates of return on
Current assets or
working capital
8. Rate of return on
current assets or
Working Capital
(current assetscurrent liabilities)
Or
Net income
Average total assets
net sales
Average total assets
gross profit
net sales
operating income
net sales
cash flow from operating activities
net sales
Net income
Average current assets
net income
average net working capital
Significance
Measures the amount of net
income per peso of sales,
also shows the proportion of
net income to the firm’s
sales revenue
Measures the company’s
profitability in using their
total assets; indicates the net
income generated by using
the firm’s total asset’s;
signifies management
efficiency in using their
assets to earn income
Signifies management
efficiency in using their
assets to generate sales
revenue
Measures the gross profit
per peso of sales revenue;
important in ascertaining the
adequacy of gross profit to
meet operating expenses
plus their desired profit
Measures the portion of
sales revenue used to cover
operating costs.
Indicates the firm’s ability to
translate sales into cash
Gauges management
efficiency in using current
assets to generate net
income
Measures management
efficiency in using net
working capital to generate
revenue
9. Rate return on
owner’s equity
10. Earnings per share
11. Price-earnings Ratio
12. Earning-price ratio
or capitalization
rate
13. Dividends per share
14. Payout ratio or
dividends payout
15. Retained Earnings
to share capital
16. Market price to
book value per
share
net income
average owner’s equity
Net income- preference share dividend
requirement
No. of ordinary shares outstanding
market price per share
earnings per share
earnings per share
market price per share
Dividends paid or declared
Ordinary shares outstanding
Dividends per share
Earnings per share
Retained Earnings
Share capital
market price per share
book value per share
Indicates the amount of
return per peso of owner’s
equity; gauges management
efficiency in using its
invested capital to generate
revenue
Measures the peso return on
each ordinary share issued;
signifies the firm’s ability to
pay dividends
Indicates the relationship
between the market price of
ordinary shares and the
earnings of each ordinary
share
Measures the rate at which
the share market is
capitalizing the value of
current earnings
Indicates the earnings
distributed to the owner’s on
a per share basis
Measures the percentage of
the company’s earnings paid
to owners
Measures the probability of
declaration of dividends by
the firm
Signifies the under or overvaluation