Fundamentals of Accountancy, Business and Management 2
Accounting cycle is a sequence of operations used to account business transactions during a specified period.
Eleven steps in the accounting cycle:
1. Analysis of the transaction
2.
3.
4.
5.
6.
Recording of the transactions in the journal
Posting of journal entries to the ledger.
Preparation of the trial balance.
Compilation of data needed to adjust the accounts.
Journalizing and posting of adjusting entries.
7. Preparation of the worksheet.
8. Preparation of the financial statements.
9. Journalizing and posting of closing entries.
10.Preparation of post-closing trial balance.
11.Journalizing and posting of reversing entries.
Worksheet
An accounting worksheet is a tool used to help bookkeepers and accountants complete the accounting cycle
and prepare year-end reports like unadjusted trial balance, adjusting entries, adjusted trial balances, and financial
statements. (See page 3 – Worksheet)
Review Problem 1:
Sure Freight Forwarders
Trial Balance
As of February 28, 2017
Cash
Accounts Receivable
Prepaid Insurance
Prepaid Rent
Office Equipment
Mechanical Tools
Delivery Truck
Furnitures and Fixtures
Accounts Payable
Juan D. Masipag, Capital
Freight Service Income
Wages expense
Rent expense
Utilities expense
Total
A
B
C
D
E
F
720,250
50,000
16,250
30,000
58,000
50,000
750,000
25,000
260,000
1,300,000
220,500
65,000
10,000
6,000
1,780,500
Adjusting entries made:
Doubtful accounts expense
Allowance for doubtful accounts
1,780,500
500
500
Insurance expense
Prepaid insurance
1,250
Rent expense
Prepaid rent
5,000
Depreciation expense-Office Equipment
Accumulated depreciation- Office Equipment
1,000
Depreciation expense-Delivery Truck
Accumulated depreciation- Delivery Truck
6,250
Depreciation expense-Furniture & Fixtures
Accumulated depreciation- Furniture & Fixtures
1,050
1,250
5,000
1,000
6,250
1,050
Required: Prepare the worksheet of Sure Freight Forwarders
1
Review Problem 2:
KALAYAAN COMPANY
Trial Balance
As of December 31, 20X1
Cash
Accounts receivable
Allowance for doubtful accounts
Merchandise Inventory, January 1,
20X1
Prepaid Rent
Prepaid Insurance
Equipment
Accumulated depreciation
Land
Accounts payable
Unearned Subscription revenue
Notes payable
R. Cruz, Capital
Sales Revenue
Purchases
Interest expense
Selling expense
Wages expense
General and administrative expense
Total
A
B
C
D
E
F
G
H
400,000
600,000
60,000
900,000
600,000
300,000
7,800,000
1,000,000
1,500,000
220,000
240,000
2,000,000
4,500,000
9,000,000
2,500,000
120,000
400,000
1,100,000
800,000
17,020,000
Adjusting entries made
Merchandise Inventory, December 31, 20x1
Cost of Goods sold
Purchases
Merchandise Inventory, January 1, 20x1
17,020,000
700,000
2,000,000
2,500,000
900,000
Depreciation expense
Accumulated depreciation
500,000
500,000
Bad debts expense
Allowance for doubtful accounts
90,000
Interest expense
Interest payable
40,000
Wages expense
Wages payable
50,000
90,000
40,000
50,000
Rent expense
Prepaid rent
300,000
Insurance expense
Prepaid Insurance
150,000
300,000
150,000
Unearned subscription revenue
Subscription revenue
80,000
80,000
Required: Prepare the worksheet of Kalayaan Company
2
3
FINANCIAL STATEMENTS
1. Statement of Financial Position ( Balance Sheet)
2. Statement of Comprehensive Income / Income Statement
3. Statement of Changes in Equity
4. Statement of Cash Flows
Statement of Comprehensive Income / Income Statement
The Statement of Comprehensive Income or Income Statement is a is a financial statement providing information
about an entity’s past performance. Its purpose is to measure the results of the entity’s operations for some specific time
period.
The information presented in the Income Statement is a major concern of the investor because it shows whether
the business is profitable or not. It shows whether the business is earning, losing or breakeven.
Elements:
1. Revenues – inflows of assets to an entity from delivering or producing goods, rendering services, or carrying out
other activities. Revenues represent what a company’s customer pay for its goods or services and the rewards of
doing business.
2. Expenses – outflows of assets arising from delivering or producing goods, rendering services, or carrying out
other activities. Expenses are the sacrifices required to attain revenues.
3. Gains and losses – arise from sale or loss in value of assets other than merchandise. These assets may include
equipment, machinery, investments in marketable securities.
Sample questions:
1. Learning is Fun Company generated revenues amounting to Php 100,000. Expenses for the year totaled Php 76,000.
How much is the company’s net income for the year?
2. Happy Selling’s beginning inventory amounted to 250,000. Net purchases amounted to 70,000. Freight In totaled
15,000. Compute for the company’s cost of goods available for sale.
3. Happy Selling’s Sales amounted to Php 500,000. Sales returns and sales discounts amounted to Php 30,000 and Php
10,000 respectively. Purchases of the company totaled Php 100,000 while purchase returns and purchase discounts
amounted to Php 20,000 and Php 10,000 respectively. How much is the company’s Net Sales? Net Purchases?
4. Company’s Cost of Goods Sold amounted to Php 285,000. Net cost of purchases totaled Php 85,000. Beginning
inventory amounted to Php 250,000. Sales amounted to Php 500,000. Compute for the company’s Ending Inventory.
5. Gross profit of Happy Selling amounted to Php 175,000. Beginning Inventory totaled Php 250,000. Ending Inventory
amounted to Php 50,000 while Net Cost of Purchases totaled Php 85,000. Compute for Happy’s Net Sales.
Example 1: Statement of Comprehensive Income for Service Concern
POLO COMPANY
STATEMENT OF COMPREHENSIVE INCOME
For the month ended March 31, 2016
Revenue
Service Fee
Operating Expenses
Salaries expense
Advertising expense
Office Supplies expense
Rent expense
Depreciation expense
Total operating expense
Net income
P
4
P
50,000
P
33,400
16,600
11,000
7,000
3,400
10,000
2,000
Example 2: Statement of Comprehensive Income for Merchandising Concern
Teen Store
Statement of Comprehensive Income
For the Year Ended December 31, 2016
Gross sales
P
Sales return and allowances
1,070,000
(5,000)
Sales discounts
(15,000)
Net sales
P
1,050,000
Cost of Goods Sold
Merchandise Inventory, Jan. 1
200,000
P
Purchases
610,000
Purchase return
(40,000)
Purchase discount
(70,000)
Total goods available for sale
700,000
Merchandise Inventory, Dec. 31
(100,000)
Cost of Goods Sold
(600,000)
Gross income / Gross margin
P
450,000
Total operating expense
P
(420,000)
Net income
P
30,000
Operating Expenses
Salaries expense
P
218,000
Advertising expense
80,000
Store supplies expense
50,000
Office supplies expense
12,000
Bad debts
10,000
Depreciation expense-Equipment
10,000
Depreciation expense-Building
40,000
STATEMENT OF CHANGES IN EQUITY
The Statement of Changes in Equity summarizes the changes in equity for a given period of time. For a sole
proprietorship, the beginning equity of the owner is increased by additional investment and net income or profit for the
period and is decreased by withdrawal and loss.
Example 1: Statement of Changes in Owner's equity Single Proprietorship
POLO COMPANY
STATEMENT OF CHANGES IN OWNER'S EQUITY
For the month ended March 31, 2016
P. Cruz, Capital, March 1, 20x1
Add: Net income
Sub total
Less: Withdrawals
P. Cruz, Capital, March 31, 20x1
P
130,000
16,600
146,600
(2,000)
144,600
Sample questions:
1. Beginning owner’s equity amounted to P 300,000. Net loss for the year totaled P 45,000. No additional investments
and withdrawals for the period. Compute for total increase in equity for the year.
2. Ending owner’s equity amounted to P70,000. Additional investments during the year amounted to P30,000.
Withdrawals totaled P50,000. Compute for the company’s net income for the year assuming beginning equity is
P10,000.
5
3. Owner, Juan invested an initial capital amounting P50,000 in order to put up his janitorial services company. During
the first year of operations (2016), the company had a loss of P25,000. Because of this, Juan invested additional
capital amounting to P50,000 in 2017. In the second year (2017), the company had a net income of P100,000 and
Juan withdrew P10,000 for personal use. Compute for the ending capital balance of Juan for the year 2017
STATEMENT OF FINANCIAL POSITION
The Statement of Financial Position is a financial statement providing information about the entity’s resources
(assets), claims against those resources (liabilities), and the remaining claim accruing to the owner ( owner’s equity) as of
the end of a period. It may be used to evaluate such factors as liquidity, solvency, financial structure and the need of the
entity for additional financing.
Liquidity - ability of the company to meet currently maturing obligations
Solvency - the availability of cash over the longer term to meet maturing obligations
Financial structure – indicates how much is the equity of the creditors and how much is the
equity of the owners
Elements:
1. Assets – resources controlled by the entity as a result of past events and from which future economic benefits are
expected to flow to the entity
2. Liabilities – obligations of the entity arising from past events, the settlement of which is expected to result in an
outflow from the resources embodying economic benefits.
3. Equity – represents residual interest in the assets of the entity after deducting all its liabilities.
Sample questions:
1. Learning is Fun Company had current assets amounting to Php 100,000. Noncurrent assets for the year totaled
Php 76,000. How much is the company’s total assets?
2. Happy Selling Company’s total liabilities amounted Php 10,000. Total equity had an ending balance of Php 20,000. How
much is total assets?
3. Happy Selling’s had the following accounts at year end: Cash-250,000, Accounts Payable-70,000, Prepaid Expense15,000. Compute for the company’s current assets.
4. Happy Selling’s Accounts Receivable amounted to Php 500,000. Prepaid Expense and Unearned Income totaled
Php 30,000 and Php 10,000 respectively. Cash balance amounted to Php 100,000 while Accounts Payable and
Inventory totaled to Php 20,000 and Php 10,000 respectively. How much is the company’s current assets? Current
liabilities?
5. Company’s Total Liabilities and Equity amounted to Php 285,000. Total noncurrent assets ended at Php 85,000.
Cash totaled Php50,000. Inventory amounted to Php100,000. Assuming the company had no other assets, how much is
Accounts Receivable?
6. Total assets amounted to Php575,000. Total equity amounted to Php 250,000. Accounts Payable amounted to
Php 50,000 while Unearned Income totaled Php 85,000. Assuming there are no other current liabilities, compute for
the company’s noncurrent liabilities.
6
POLO COMPANY
STATEMENT OF FINANCIAL POSITION
March 31, 2016
ASSETS
Current Assets
Cash
Accounts Receivable
P
Less: Allowance for bad
debts
Prepaid Rent
Office Supplies
Total current assets
P
118,000
P
10,000
20,000
600
148,600
P
13,000
161,600
LIABILITIES AND OWNER'S EQUITY
Current Liabilities
Accounts payable
P
Salaries payable
Total liabilities
12,000
5,000
17,000
Noncurrent Assets
Office Equipment
Less: Accumulated
depreciation
Total noncurrent Assets
Total Assets
10,200
(200)
P
15,000
(2,000)
Owner's Equity
P. K Cruz, Capital
Total liabilities & Owner's
Equity
144,600
P
161,600
Exercise 1 : Classification of Accounts
Classify the accounts given below and the financial statement:
CA
NCA
CL
NCL
EQ
IN
EX
-
Current asset
Non-current asset
Current Liability
Non-current liability
Equity
Revenue / Income
Expenses
SCI - Statement of Comprehensive Income
SFP - Statement of Financial Position
SCE - Statement of Changes In Equity
Account
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
Juan dela Cruz, Capital
Depreciation expense
Delivery Equipment
Utilities expense
Service revenue
Prepaid insurance
Accounts payable
Kho Juan, Drawing
Office supplies
Furnitures & Fixture
Merchandise Inventory
Prepaid rent
Mortgage payable
Prepaid rent
Cash
FS
Account
16 Accumulated depreciation
17 Allowance for bad debts
18 Salaries payable
19 Copyright
20 Note payable
21 Advertising expense
22 Bad debts expense
23 Accounts receivable
24 Delivery trucks
25 Accrued expenses
26 Notes receivable
27 Note payable, due in 3 yrs
28 Marketable securities
29 Income tax payable
30 Land
7
FS
Review Problem 1:
MEGALINK INFORMATION CENTER
Trial Balance
For the year ended December 31, 2016
Accounts Payable
Accounts Receivable
Accrued Expenses Payable
Accumulated Depreciation-Furnitures & Fixtures
Accumulated Depreciation-Office Equipment
Cash
Chattel Mortgage Payable
Depreciation expense-Office Equipment
Depreciation expense-Office Furniture & Fixtures
Insurance Expense
Kho Juan Co., Capital
Kho Juan Co., Personal Drawing
Miscellaneous Expense
Office Equipment
Office Furnitures & Fixtures
Office Supplies
Office Supplies Expense
Prepaid Insurance
Prepaid Rent
Rent Expense
Salaries & Wages
Salaries Payable
Trucking Service Income
Unearned Trucking Income
Utilities expense
VAT Payable
Total
145,215
711,634
50,000
15,290
21,853
145,270
150,000
10,926
17,675
16,000
300,000
38,500
2,270
109,265
75,154
27,019
10,807
48,000
36,000
12,000
148,170
12,347
649,185
41,176
59,310
1,468,000
82,934
1,468,000
Required: Prepare the Statement Comprehensive Income, Statement of Changes in Equity and
Statement of Financial Position
Review Problem 2:
The following data was taken from the books of Hanson Retail Food Store for the year ended
December 31, 2014
Total sales
Interest Expense
Delivery expense
Cash
Prepaid rent
Machinery & Equipment
Interest Payable
Wages Payable
Merchandise Inventory, December 31
Mortgage Payable
Land
Accounts Payable
Telephone expense
License Expense
Advertising expense
Salaries and wages
Hanson, Capital, January 1
Cost of Goods Sold
Notes Payable
Rent Expense
Accounts Receivable
Office supplies on hand
Building
Php
8
262,000.00
350.00
9,000.00
9,000.00
2,000.00
31,000.00
1,000.00
800.00
10,000.00
80,000.00
45,000.00
4,200.00
2,250.00
3,000.00
12,400.00
45,000.00
55,000.00
159,000.00
15,000.00
6,300.00
5,000.00
1,000.00
86,000.00
Additional Data:
a. Merchandise inventory as of January 1, P 25,000
b. Total purchases for the year, P 144,000
Required: Prepare the Statement Comprehensive Income, Statement of Changes in Equity and
Statement of Financial Position
STATEMENT OF CASH FLOWS
The Statement of Cash flows shows the sources and uses of cash of an entity for a given period of time. This
statement shows the net increase or decrease of cash during the period and the cash balance at the end of the period.
The sources and uses of cash are classified into the following activities:
a. Operating activities
These are the sources or inflows, and the uses or outflows of cash and cash equivalents from the normal
operating activities of the enterprise. These are the cash flow derives primarily from the principal revenue producing
activities of the enterprise.
Examples of these are:
1. cash received ( inflow) from the sale of goods and services
2. cash received (inflow) from collections from customers and rentals
3. cash paid (outflow) for payments of purchases and expenses of operating the company.
b. Investing activities
Investing activities are those centered in support of the operations. These are the cash flows derived from the
acquisition and disposal of long term assets and other investments not included in cash equivalents. These cash receipts
and disbursements arise from activities involving non-operating assets.
Examples of these are:
1. cash paid ( outflow) for purchase of property, plant and equipment
2. cash paid ( outflow) for purchase of equity investments in other companies
3. cash received ( inflow) from the sale of delivery equipment.
The transactions usually involve items in the non-current section of the balance sheet.
c. Financing activities
These are cash flows derived from the equity capital and borrowings of the enterprise. Cash inflow can be
derived from additional investment from the owner, and obtaining loans from banks or other lenders.
While repayment of loans as well as withdrawals by owners are financing transactions that are reported as cash
outflow under the financing activity category. The financing activity usually involves items that are reported in the longterm liability or owner’s equity section of the balance sheet.
Exercise 1: Statement of Cash Flows
Classify the given transactions below into either (A) Operating, (B)Investing or (C) Financing activity.
_____1.Opening an account under the business’ name and depositing cash for initial capital
contribution of the owner
_____2.Paying barangay, municipal, and other related taxes for the creation of the business entity.
_____3.Contributing land to the business.
_____4.Puchase of a building for business use
_____5.Borrowing cash from a bank for additional working capital
_____6.Purchase of computers and printer for office use
_____7.Purchase of office tables and chairs
_____8.Selling and distributing merchandise sold by the company
_____9.Conducting advertising for public exposure of goods for sale
_____10.Paid electricity and water consumption during the month
_____11.Rendered services to customers
_____12.Paid internet subscription for office use
9
_____13.Mortgaged business property to acquire bank loan
_____14.Withdrawal of owner for personal use
_____15.Paid salaries of employees
ROSE BOUTIQUE
STATEMENT OF CASH FLOWS
For the year ended December 31, 20XX
Cash Flows from Operating Activities
Cash Inflows
From sale of goods and services
xx
From interest earned on loans/
accounts receivable
xx
Cash Outflows
Payments to suppliers
xx
Payment of expenses
xx
Payment for interest on loans
xx
Net cash provided ( used) by operating
activities
Cash Flows from Investing Activities
Cash Inflows
From sale of property, plant &
equipment
From sale investments
Cash Outflows
Purchase of property, plant &
equipment
Purchase of investment to other
companies
Net cash provided ( used) by investing activities
Cash Flows from Financing Activities
Cash Inflows
From additional investment
From bank loan
Cash Outflows
Withdrawal of capital
Payment of loans
Net cash provided ( used) by financing
activities
xx
xx
xx
(xx)
xx
xx
xx
xx
(xx)
xx
xx
xx
xx
xx
xx
(xx)
xx
Net increase ( decrease) in cash
Add: Cash balance, January 1, 20xx
Cash balance, December 31, 20xx
xx
xx
xx
Sample questions:
1. Identify which of the following transactions fall under operating, investing and financing activities:
a. Cash received from customers
b. Cash paid to suppliers
c. Cash paid to employees
d. Cash paid to purchase equipment (company does not sell equipment)
e. Cash received from sale of furniture (company’s main line of business is not related to furniture)
f. Sale of goods on credit
g. Purchase of goods on credit
h. Cash received from getting a loan from a bank
10
i. Cash paid to owners
2. Juana’s sari-sari store had the following transactions during the year:
a. Purchase of goods. Paid cash. 100,000
b. Sale of goods. Received cash. 150,000
c. Paid utilities 30,000
d. Paid rent 10,000
e. Sold equipment for cash 100,000
f. Owner withdraws investment 10,000
10
Compute for the net cash flow generated by/used in operating activities
3. Using the given above, compute for the net cash flow generated by/used in investing activities.
4. Using the given above, compute for the net cash flow generated by/used in financing activities.
5. Using the given above, prepare a Cash Flow Statement.
ANALYSIS AND INTERPRETATION OF FINANCIAL STATEMENTS
Financial statement analysis involves careful selection of data from statements for the primary purpose of
forecasting the financial health of the company. This is accomplished by examining trends in key financial data,
comparing financial data across companies, and analyzing key financial ratios. Another important aspect of financial
analysis is the comparison of actual financial conditions with expected financial conditions. Expected conditions may be
represented by :
1. predetermined standards
2. past performance
3. competitor’s performance or industry average
Objectives of financial statement analysis
Managers, investors, and lenders analyze financial statements to identify an organization’s financial strengths and
weaknesses. Although financial statements are essentially historical documents and tell what has happened during a
particular period of time, most users are concerned about what will happen in the future.
The following major economic decision makers perform financial statement analysis:
1. Creditors (short-term and long-term)
2. Equity investors or owners (present and potential)
3. Company management
Objectives of creditors
Short-term creditors are those who provide funds, goods and services to a business and expect payment within
one year or whatever time period is a customary in the industry. Their primary objective in the analysis of a company’s
financial statement is to determine whether the company pays its bills on time and will be able to pay current obligations
as they mature.
Long-term creditors include banks and other institutions who lend money to companies for extended periods of
time. Their principal objective is to determine whether the company will be able to make its periodic interest payments
and to maintain the company’s ability to maintain successful earnings and cash flows to meet continuing financial
commitments.
Objectives of equity investors
Equity investors are those who purchase an ownership interest in a company. When analyzing a company’s
financial statement, equity investors want to determine if the business firm will be able to distribute earnings in the future
and will bring out an appreciation in the company’s ability to generate income in the future.
Objectives of the company management
Managers of the enterprise analyze the financial statements to guide them in making future plans, in directing
and controlling operations, and in making decisions to effect further improvement in the company’s financial position and
performance.
General Approach to Financial Statement Analysis
A general approach to financial statement analysis will cover the broad areas given below. In addition, each
analytical situation should be tailored to meet specific user objectives.
1. Background study and evaluation of firm industry, economy and outlook
11
Since economic developments and the actions of competitors affect the ability of any business enterprise to
perform successfully, it is necessary to start the analysis of a firm’s financial statement with an evaluation of the
environment in which the firm conducts business.
2. Short term solvency analysis
This refers to the analysis of the company’s ability to meet near-term demand for cash and normal operating
requirements. Some of the indications that a company enjoys satisfactory short term solvency position are:
a. Favorable credit position
b. Ability to pay current debts in the regular course of business
c. Ability to extend more credit to customers
d. Ability to replenish inventory promptly
3. Capital structure and long-term solvency analysis
This pertains to the evaluation of the amount and proportion of debt in a firm’s capital structure to assess its
ability to service debt. This will also cover the analysis of the of the use of financial leverage to maximize the returns to
the owners.
4. Operating efficiency and profitability analysis
This involves the evaluation of how well assets have been employed by management in terms of generating
revenues and maximizing returns on such resources. Some indicators of managerial efficiency is the use of such
resources are:
a. Ability to earn satisfactory return on investment of borrowed funds and owner’s equity
b. Ability to control operating costs within reasonable limits
c. Optimum level of investment in assets
How to analyze financial statements
1. Comparative Statements – the presentation of financial information for current and prior periods which
allows the statement user to compare changes in the individual items.
2. Horizontal analysis – the presentation of financial data on a percentage basis over time. The result is the presentation
of the relative growth or decline of each item in terms of the base year.
3. Vertical analysis – the presentation of each item on a financial statement as a percentage of an appropriate base
amount.
Comparative Statements
FINANCIAL RATIO ANALYSIS
Financial ratio is a comparison in fraction, proportion, decimal or percentage form of two significant figures taken from
the financial statements. It expresses the direct relationship between two or more quantities in the balance sheet and
income statement of a business firm.
Purpose:
Through ratio analysis, the financial statements user comes into possession of measures which provide insight into the
profitability of operations, the soundness of the firm’s short-term and long-term financial condition and the efficiency with
which management has utilized the resources entrusted into it.
12
Uses:
1. It provides an indication of the firm’s financial strengths and weaknesses and should generally be used in
conjunction with other evaluation techniques.
2. Ratios are useful tools of financial statement analysis because they summarize data in a form easy to understand,
interpret and compare.
Limitations:
1. Attempting to predict the future using past results can be problematic. Changes in the general economy, in the
economy of the particular industry, being studied, and in management are just some of the uncertainties that can cause
past results to be an unreliable predictor of the future.
2. The financial statements used as the basis of the ratios are based on historical cost. In a time of changing prices, this
makes comparison between years difficult.
3. Figures from the balance sheet ( assets, liabilities) used in the calculation of the ratios are year-round numbers. Since
most businesses have their fiscal year-end when the business is slow, the balances in such accounts as receivable,
payables and inventory at year-end may not be the representative of the rest of the year.
4. Comparing the ratios of a company in one industry with those of a company in another industry is difficult because
industry peculiarities will cause the ratios to differ. Even comparison of companies within an industry may not be
reasonable at times because different companies use different accounting methods ( example – depreciation method).
Measuring of Profitability
Profitability is the ease with which a company generates income. Profitability ratios are used to measure a firm’s
past performance and to help predict its future profitability level. Present and potential owners and creditors use these
profitability ratios to evaluate investments wile managers use them to monitor and evaluate their company’s performance.
Measuring Liquidity and Activity
Liquidity describes the ease with which an item, such as an asset can be converted into cash. It also refers to
the company’s ability to generate sufficient cash to meet its short-term obligations. Liquidity ratios are ratios that
measure the firm’s ability to meet cash needs as they arise ( example: payment of accounts payable, bank loans and
operating costs). Activity ratios are ratios that measure the liquidity of specific assets and efficiency in managing assets
such as accounts receivable, inventory and fixed assets.
Measuring Solvency and Stability
Solvency is the company’s ability to meet obligations created by its long-term debt. Obligations resulting from
the debt include paying back the amount borrowed and paying interest on the debt.
Solvency ratios have been developed to measure a company’s overall level of debt it carries as well
as its ability to make interest payments. They are of most interest to owners, long-term creditors
and company management.
Stability on the other hand measures the ability of the company to continue operations for a relatively
long period of time. Satisfactory capital structure as well as the fund sourcing strategy of the company
may be assessed through the use of these ratios.
LIQUIDITY AND ACTIVITY RATIOS
Ratio
1
2
Current Ratio
Formula
Significance
Current assets
Measures ability to meet maturing
Current liabilities
obligations from existing current assets
Acid-test or
Quick assets
Provides a more sever test of immediate
Quick Ratio
Current liabilities
solvency. Measures ability to discharge currently
maturing obligations based on most liquid (quick)
assets
13
Quick assets = Cash + marketable securities+
accounts receivable (net)
3
4
Receivable Turnover
Inventory turnover
Credit Sales
Average Receivable
Confirms fairness of receivable balance. Provides
an indication of the efficiency of credit policies
and collection
Cost of goods sold
Measures relative control over inventory
Average inventory
5
Net sales to working
capital
investment
Net sales
Measures the level of sales generated from a
Working capital
given level of working capital
Working capital = currents assets - current liabilities
SOLVECY AND STABILITY RATIOS
1
Debt ratio or
Debt to Asset ratio
2
Debt to Equity ratio
or
Total liabilities to
Total liabilities
Measures the proportion of assets financed by
Total assets
the debt
13
Total liabilities
Directly compares the amount of debt financing
Net worth
to the amount of equity financing
Net Worth
3
Times interest earned
or Coverage ratio
Income before interest
expense and income
taxes
Measures the ability of the firm to meet
interest payment
Interest expense
PROFITABILITY
RATIOS
1
2
Gross margin ratio
Profit margin ratio
Gross margin
Indicates the average mark-up available to
Net sales
cover selling and administrative expenses
Net income
Measures efficiency of earning net income
Sales
3
Profit margin ratio
before tax
4
Return on Total
Asset
generated by a peso of sales
Net income before tax
Measures pretax earnings produced from a
Sales
given level of revenues
Net income after tax +
interest expense
Average total assets
5
Return on equity
Net income
Measures the after-tax income generated from
Equity
6
Asset turnover ratio
a given level of equity
Net sales
Measures how effectively assets are used to
Total assets
produce sales
14
Illustrative problem 1
Presented below are the Statement of Comprehensive Income for the year ended December 31. 2016 and
Statement of Financial Position for the year December 31, 2016 and December 31, 2015.
1
2
3
4
5
6
7
Required: Calculate the following ratios for 2016:
Return on assets
8
Profit margin before tax
9
Asset turnover
10
Profit margin
11
Return on equity
12
Return on total asset
13
Current ratio
14
Quick ratio
Net sales to working capital
Receivable turnover
Inventory turnover
Debt ratio
Debt to equity ratio
Coverage ratio
BALLA COMPANY
Statement of Comprehensive Income
For the Year ended December 31, 2016
( in thousands)
Sales
Less: Cost of goods sold
Gross profit
Less: Operating expenses
Depreciation-Buildng and eqpt.
Other selling and administrative exp
Total operating expenses
Income before interest and taxes
Less: Interest expense
Income before tax
Less: Income tax
Net income
P
P
102
2,667
P
P
BALLA COMPANY
Statement of Financial Position
December 31, 2016 and December 31, 2015
( in thousands)
2016
ASSETS
Current assets
Cash
Accounts receivable
Merchandise Inventory
Prepaid expenses
Total current assets
Non-current assets
Plant and equipment
Buildings, net of accumulated depreciation
Equipment , net of accumulated depreciation
Total plant and equipment
Total Assets
LIABILITIES
Current liabilities
Accounts payable
Notes payable
Total current liabilities
Long term liabilities
Total liabilities
OWNER'S EQUITY
Bert Balla, Capital
Total liabilities and owner's equity
11,228
7,751
3,477
P
2,769
708
168
540
114
426
2015
1,618
1,925
1,070
188
4,801
P
4,457
1,293
5,750
10,551
P
P
P
1,818
900
2,718
2,500
5,218
P
1,686
1,100
2,786
2,000
4,786
P
P
5,333
10,551
P
P
3,698
8,484
P
P
P
P
15
P
P
1,220
2,112
966
149
4,447
2,992
1,045
4,037
8,484
Sample Problems:
1.
Information from G Co.'s balance sheet is as follows:
Current assets
Current liabilities
Cash
P 2,400,000
Notes payable
Marketable securities
7,500,000
Accounts payable
Accounts receivable
57,600,000
Accrued payable
Inentories
66,300,000
Income tax payable
Prepaid expenses
1,200,000
Current portion of
135,000,000
long-term debt
P
1,500,000
19,500,000
12,500,000
500,000
3,500,000
37,500,000
What is the acid-test ratio?
2
During 2008, R Inc. purchased P2,000,000 of inventory. For 2008, cost of goods sold is P 2,200,000,
and the ending inventory as of December 31,2008 was P 400,000. What was the inventory
turnover for 2008?
3
R Co.'s net accounts receivable were P 500,000 at December 31,2007 and P 600,000 at
December 31,2008. Net cash sales for 2008 were P200,000. The accounts receivable turnover for
2008 was 5.0. What was R's net sales for 2008?
4
B Corp's books showed the following information for 2008:
Mdse.
Net credit sales
2,000,000
Inventory,end
Net cash sales
500,000
Accounts receivable,beg.
Merchandise purchases
1,000,000
Accounts receivble,end
Mdse. Inventory beg.
600,000
Net income
a. B's accounts receivable turnover is?
b. B's percent of net income on sales is?
16
200,000
300,000
700,000
100,000