FINANCIAL STATEMENT ANALYSIS
Financial statement analysis – involves careful selection of data from financial statements in order to assess and evaluate the
firm’s past performance, its present condition and future business proposals.
What is the purpose of financial statement analysis?
The objective of financial statements analysis is to determine the extent of a firm’s success in attaining its financial goals,
namely: (1) to earn maximum goals; (2) to maintain solvency and (3) to attain stability.
1)
2)
3)
The three major financial statement user groups and what they hope to learn from financial statement analysis:
Creditors – want to be assured of receiving prompt payments from the company
a) Short-term creditors – include trade creditors and lending institutions
b) Long-term creditors – lending institutions and corporate bondholders
Equity investors – want to determine if the company will be able to distribute dividends in the future and if its shares will
rise in value
Management – objective is to monitor the company’s overall performance
There are at least four traditional techniques of interpreting financial statements, namely:
1) HORIZONTAL (COMPARATIVE ANALYSIS) – presents the differences in absolute amount and in percentage between
two periods (i.e., years, quarters etc..), two companies, actual and budgeted date, and other bases of analyses. The
difference could either be an increase or a decrease both in amount and in percentage. the percentage change is computed as
follows:
PERCENTAGE CHANGE = AMOUNT OF CHANGE / BASE
TREND ANALYSIS – the purpose of trend analysis is to track down what happened in the past and provide on what may
happen in the coming years. It uses indexes and ratios to simplify the visible complications and annoying presentation of
numbers contained in the financial reports. Financial data expressed in indexes and ratios are easily readable than those
presented in terms of millions.
Indexes are expressed in hundreds while ratios are expressed in normal decimal places
2)
VERTICAL ANALYSIS (common size analysis) – gets the proportional component of each of the variables in the
financial statements in relation to a chosen base. As in horizontal analysis, the financial statements are treated individually
and each is analyzed independent of the others.
•
•
•
FINANCIAL STATEMENT
Income statement
Balance sheet
Statement of cash flows
BASES (100%)
Net sales
Total assets
May be the total cash available for use
3) FINANCIAL MIX RATIOS
In the horizontal, trend and vertical analysis, each financial statement is considered a stand-alone report. The truth is, these
financial statements are interrelated and interlocked with one another. Examples contained in the income statement are directly
related with information contained in the balance sheet and cash flows as shown in the diagram:
Income
statement
Net sales
Cost of goods sold
Balance sheet
Cash; trade receivables
Cash; trade payables
Statement of Cash flow
Operating activities
Operating activities
Cash; Prepaid expenses
Operating activities
Accrued expenses
Accumulated
depreciation
Operating
activities,
Cash; Bonds payable
Investing
activities
and
Discount/Premium on
Financing activities
Other items
bonds, non-current
assets
Operating
activities,
Cash; Deferred income
Investing, Financing and
Income tax
tax; Property and
Operating activities
equipment
*non-cash
items
are
Long-term debt; Material
excluded
cash shortage; Cash
surrender value of life
insurance,
Since the financial statements are fundamentally-related,
theetc...
information contained in one statement could be related to the
Operating
expenses
information found in another. This is the essence of financial mix ratio analysis. In computing the financial mix ratios, the amount
used from the income statement is the net figures (i.e., net sales) while that from the balance sheet is the average amount (i.e.,
average inventory, etc.)
Four classification of financial mix ratio analysis:
• Profitability ratios – ability of the business to generate profit. It measures the ability of the business to generate profit in
relation to sales, investments, assets, equities or common shares outstanding.
• Growth ratios – are indicative of the organization’s potential and attractiveness as an investment option.
• Liquidity ratios – refers to the ability of the business to pay its obligations in cash as they mature. Therefore, the focal point of
the liquidity analysis is cash. It includes the ability of the management to convert its current assets into cash in a quick, stable
1
and regular manner. It also deals with the ability of management to use trade credits and stretch the payments to trade credits
in financing operating activities. In short, the liquidity position of an organization is directly related to its operating activities and
determines the speed of revolving cash in the operating cycle.
• Financial Leverage ratios – refers to the use of debt to increase shareholders’ equity. Using debt to finance business activities
would mean greater exposure to the risk of insolvency. The more leveraged the business, the higher the risk of insolvency is.
Financial leverage is a measure of risk.
SUMMARY OF FINANCIAL MIX RATIOS
RATIOS
FORMULAS
COMMENTS
 PROFITABILITY RATIOS – measures earnings in relation to some base, such as assets, sales or capital
 COST MANAGEMENT RATIOS – measures how well a firm controls its costs

Return on Sales
Net income / Net sales
✓
Also called as net profit rate; net profit margin;
measures profit percentage per peso sales

Gross profit rate
Gross profit / Net sales
✓
Measures gross profit percentage on sales to recover
operating expenses
✓
Measures overall asset profitability; indicates how
well assets have been employed by management
Net income
Average stockholders’ equity
✓
Measures percentage of income derived for every
peso of owners’ equity.
Net income
Average common stockholders’
equity
✓
Earnings available to common stockholders’ equals
net income less preferred dividends; this ratio
measures percentage of profit derived for every peso
of common equity money used; when compared to
the return on total assets; it measures the
percentage of profit derived for every peso of
common equity money used; when compared to the
return on total assets, it measures the extent to
which financial leverage is working for or against
common stockholders.
Contribution margin
Earnings before interest and
taxes (Operating income)
✓
Measures the number of times profit will increase or
decrease in relation to change in net sales.
Net income
Preferred dividend requirements
✓
Measures the adequacy of current earnings to meet
preferred dividend payments.
Net income + Interest expense
(net of tax)
Average total assets

Return on total assets
Net Income
Average total assets
Earnings Before Interest and
Taxes
Average total assets

Return
equity

Return
on
common
stockholders’ equity

Operating leverage

Times preferred dividend
earned


on
stockholders’
LIQUIDITY RATIOS – provides information about the firm’s ability to pay its current obligations and continue operations
ASSET MANAGEMENT RATIOS – measure how the firm uses its assets to generate revenue and income

Operating turnover
Collection period + Inventory
days
✓
Measures the speed of the business cycle; the
number of days cash was invested in the normal
business operations until it was recovered back

Inventory turnover
Cost of goods sold
Average Inventory
✓
Indicates the number of times inventories were
acquired and sold during the period

Inventory days
number of days in a year
inventory turnover
✓
Indicates the length of time spent before the average
inventory is sold to customers.
(note: know what will be the number of days to
be considered)
✓

Receivable turnover
Net CREDIT sales
Average trade receivables
✓
Indicates the efficiency in credit and collection
policies; trade receivables include open account and
on notes

Collection period
Number of days in a year
Receivable turnover
✓
Measures quickness in collecting trade receivables

Payable turnover
Net credit purchases
Average trade payables
✓
Measures effectiveness in using trade credit facility
from suppliers

Payable days
Number of days in a year
Payable turnover
✓
Indicates the number of days spent before paying
liabilities to merchandise suppliers

Materials turnover
Materials USED
Average materials inventory
✓
Indicates the number of times materials were used
on the average during the period

Work-in-process inventory
turnover
Cost of goods MANUFACTURED
Average work-in-process
inventory
✓
Indicates the number of times average work-inprocess inventories is converted to finished goods

Finished goods inventory
turnover
Cost of goods SOLD
Average finished goods inventory
✓
Indicates the number of times average finished
goods is sold during the period

Cash turnover
Cash operating expenses
Average cash balance
✓
Measures the ability of the business to meet
operating expenses payments given a particular cash
balance
2

Days to
expenses
pay
operating
Number of days in a year
Cash turnover
✓
Indicates the number of days spent before meeting
operating expense payments

Working capital turnover
Net sales
Average working capital
✓
Measures the adequacy and effective use of working
capital; indicates reasonableness of the amount of
current assets

Asset turnover
Net sales
Average total assets
✓
Measures effectiveness of assets utilization

Current assets turnover
Net sales (excluding depreciation
and amortization)
Average current assets
✓
Indicates the reasonableness of the amount of
current assets

Net working capital
Current assets – Current
liabilities
✓
Indicates the amount invested by the business to
operate its normal business activities

Current ratio
Current assets
Current liabilities
✓
Rough estimate on the ability of the business to
meet its currently maturing obligations; this ratio
varies in great disparity from one industry to another


Quick assets ratio
(acid test ratio)
Quick assets
Current liabilities
✓
A more severe test of immediate liquidity to meet
currently maturing obligations
 Quick assets include: cash, marketable
securities and receivables

Defensive interval ratio
Defensive assets
Average daily expenditures
✓
Measures the number of days defensive assets are
available to meet daily cash expenses
 Defensive assets include: cash, marketable
securities and trade receivable
 GROWTH RATIOS – measure the changes in the economic status of a firm over a period of time
 VALUATION RATIOS – measure the shareholder value as reflected in the price of the firm’s stock

Earnings per share
(Net income – Preferred
dividends)
Average common shares
outstanding
✓
Perhaps the most frequently quoted ratio of earnings
and growth performance; measures the value of
common stock by attributing to it a portion of the
company’s earnings

Price-earnings ratio
Market price per share
Earnings per share
✓
Measures the number of period investment in stock
will be recovered; measures the profitability of the
firm in relation to the market value of the stock;
measures investors’ beliefs on the growth potential
of the stock

Dividend yield ratio
Dividend per share
Market price per share
✓
Measures rate of cash return to investment in stock

Dividend payout ratio
Dividend per share
Earnings per share
✓
Represents the percentage of net income distributed
as dividends; a low ratio may indicate the
reinvestment of profits by a growth-oriented firm

Book value per share
Stockholders’ equity
Average shares outstanding
✓
Indicates the value of the stock on cost perspective;
the relevance of this ratio diminishes when the
balance sheet valuation does not approach fair
market values; may be computed for both common
and preferred stocks

LEVERAGE RATIOS (Solvency ratios or Stability ratios) – B measures the company’s use of debt to finance assets and
operations.
 Financial leverage – the use of debt to finance assets and operations; it is advisable to trade on equity when earnings
from borrowed funds exceed the cost of borrowing.
(1)As leverage increases, the risk borne by creditors as well as the risk that the firm may not be
able to meet its maturing obligation increases. (2) Since interest expense is tax deductible,
leverage increases the company’s return when it is profitable

Debt-to-equity ratio

Debt-to-assets ratio (debt
ratio)

Equity-to-assets
(equity ratio)

Equity multiplier

Times interest earned

Financial leverage
ratio
Total debt
Net stockholders’ equity
✓
Measures the use of debt to finance operations;
provides a measure of the relative amount of
resources contributed by the creditors and owners
Total debt
Total assets
✓
Measures the relative shares of creditors over the
total resources of the firm
Net stockholders’ equity
Total assets
✓
Measures the amount of resources provided by the
owners in the firm
Total assets (equity)
Net stockholders’ equity
Or
1/ equity ratio
✓
Indicates the number of times owners’ equity is
multiplied
Earnings before Interest and
Taxes (EBIT)
Interest expense
✓
Measures the long-term debt paying ability of the
firm; a high number of times interest is earned ratio
indicates that the business is under-leveraged and
its return on common equity could still be improved.
Earnings before interest and
taxes (EBIT)
(EBIT – Interest expense –
Preferred dividends before tax
✓
Measures the risk associated in using debt to finance
investments
3

Total (combined) leverage
Degree of operating leverage x
Degree of financial leverage
✓
Measures the overall leverage of the business; it
indicates the variability of the stockholders’ equity
with respect to changes in contribution margin,
earnings before interest and taxes, interest expense
and preferred dividends before tax

Fixed charges rate
Cash flows before fixed charges
Total fixed charges
✓
Measures the ability to meet fixed charges by cash
 Examples of fixed charges: rent, insurance,
taxes and depreciation

Total
assets-to-total
liabilities ratio
Total assets
Total liabilities
✓
Rough estimate of the firm’s ability to meet interest
payments to creditors

Non-current
assets-tolong-term liabilities ratio
Non-current assets
Long-term liabilities
✓
Shows the capability to meet non-current liabilities
using non-current resources
CASH FLOW RATIOS
 Earning power – The capacity of the firm’s operations to produce cash inflows
RATIOS
FORMULAS

Cash flow adequacy
Cash from operations + Long-term debt paid +
Purchases of assets

Long-term debt payment

Dividend payout on cash from operations
Dividends
Cash from operations

Reinvestment
Purchase of assets
Cash from operations

Total debt coverage
Total liabilities
Cash from operations

Depreciation-amortization impact

Cash flow to sales

Cash flow to net income

Cash flow return on sales

Cash flow liquidity ratio
Long-term debt payments
Cash from operations
Depreciation + Amortization
Cash from operations
Cash from operations
Sales
Cash from operations
Income from ordinary operations
Cash from operations
Total assets
Cash + Marketable securities + Cash flow from
operating Activities
Current liabilities
OTHER RATIOS
OPERATING CYCLE
(liquidity & management efficiency)
Average collection period of receivable + Average conversion
period of Inventories + Days Cash
CAPITAL INTENSITY RATIO
(liquidity & management efficiency)
Total Assets
Net sales
SALES TO FIXED ASSETS (PLANT ASSET
TURNOVER)
(liquidity & management efficiency)
RATE OF RETURN ON OWNERS’ EQUITY
(solvency)
DIVIDENDS PER SHARE
(stability)
RATE OF RETURN ON AVERAGE CURRENT
ASSETS
(stability)
DAYS CASH
(liquidity and management efficiency)
PERCENT OF EACH CURRENT ASSETS TO
TOTAL CURRENT ASSETS
Net sales
Average Fixed Assets (net)
Net income
Average Owners’ equity
Or
Return on Assets x Equity multiplier
Dividends paid/declared
Common shares outstanding
Net Income
Average Current Assets
Average cash balance
Cash operating costs
Number of days in a year
Amount of each current assets
Total current assets
One of the most popular representation of cash from operations is the EBITDA or EARNINGS BEFORE INTEREST,
TAX, DEPRECIATION AND AMORTIZATION.
FINANCIAL GEARING RATIOS – measure the financial risk of a company’s financial structure. Business risk can be calculated by
calculating a company’s operational gearing.
TWO GEARING RATIOS:

Financial gearing ratio
4
Ways to compute financial gearing ratio:
1) FGR = Prior Capital Charged / Equity Capital
2) FGR = Prior Capital Charged / Total capital employed
*Prior capital charged – capital employed in the business which has the right to receive interest and preference dividends before
any distribution is made to ordinary (common) shareholders (e.g. preference shares, interest-bearing long-term capital, and interestbearing short-term debt capital). In an alternative calculation of prior capital charged, the interest-bearing short-term
debt capital may be excluded.
*Equity capital – refers to the interest of the ordinary shareholders include that of the share capital, share premium and retained
earnings
*Total capital employed – sum of the non-current assets and net working capital.

Operating gearing ratio – same as operating leverage (Contribution Margin / Operating Income or EBIT)

EXERCISES
1. Which of the following is not a limitation of financial statement analysis?
a. Cost basis
c. Diversification of firms
b. Use of estimates
d. Availability of information
2. Horizontal analysis is also known as
a. Linear analysis
b. Vertical analysis
c.
d.
Trend analysis
Common size analysis
3. Ratios are used as tools in financial analysis
a. Instead of horizontal and vertical analysis
b. Because they can provide information that may not be apparent from inspection of the individual components
of a particular ratio
c. Because even single ratios by themselves are quite meaningful
d. Because they are prescribed by GAAP
4. A drop in the market price of a firm’s common stock will immediately affect its:
a. return o common stockholders’ equity
c. dividend payout ratio
b. current ratio
d. dividend yield ratio
5. Issuing new shares of stock in a five-for-one split of common stock would
a. decrease the book value per share of common
c. increase total stockholders’ equity
stock
d. decrease total stockholders’ equity
b. increase the book value per share of common
stock
6. If current assets exceed current liabilities, prepaying an expense on the last day of the year will
a. decrease the current ratio
c. decrease the acid test ratio
b. increase acid test ratio
d. increase the current ratio
7. A company’s current ratio and acid test ratios are both greater than 1. issuing bonds to finance purchase of an
office with the first instalment of the bonds due in the current year would
a. decrease net working capital
c. decrease the acid test ratio
b. decrease the current ratio
d. affect all of the above as indicated
8. Assume the current ratio is greater than 1. What is the effect of the collection of accounts receivable on the
current ratio and net working capital, respectively?
a.
b.
c.
d.
Current ratio
No effect
Increase
Increase
No effect
Net working capital
No effect
Increase
No effect
Increase
9. What is the effect of a purchase of inventory on account on the current ratio and on working capital, respectively?
(assume a current ratio greater than one prior to this transaction)
a.
b.
c.
d.
Current ratio
Decrease
No effect
Decrease
No effect
Working capital
No effect
Decrease
Decrease
No effect
10. At the beginning of the year, a company’s current ratio is 2.2 to 1 and its acid test ratio is 1.0 to 1. At the end of
the year, the company has a current ratio of 2.5 to 1 and an acid test ratio of 0.8 to 1. Which of the following
could help explain the divergence in the ratios from the beginning to the end of the year?
a. an increase in credit sales in relationship to
c. an increase in the collection rate of accounts
cash sales
receivable
b. an increase in inventory levels during the
d. selling marketable securities at a price below
current year
cost
11. A company’s current ratio and acid test ratio are both greater than 1. The collection of a current accounts
receivable of P29,000 would
a. increase the current ratio
c. not affect the current ratio or the acid test
b. decrease the current ratio
ratio
d. decrease the acid test ratio
5
12. Angel Corporation has a current ratio of 2 to 1 and an acid test ratio of 1 to 1. A transaction that would change
Angel’s acid test ratio but not its current ratio is
a. sale of short term marketable securities for
c. collection of accounts receivable
cash that results in a profit
d. payment of accounts payable
b. sale of inventory on account at cost
13. Assuming stable business condition, an increase in the accounts receivable turnover ratio would be explained by
a. stricter policies with respect to the granting of
c. slowdown in the collecting accounts receivables
credit to customers
from customers
b. easing of policies with respect to the granting
d. none of these
of credit to customers
14. KC had net income of P 2million in 2006. using the 2006 financial elements as the base data, net income
decreased by 70 percent in 2007 and increased by 175 percent in 2008. the respective net income reported by KC
for 2007 and 2008 are:
a. P600,000 and P5,500,000
c. P1,400,000 and P3,500,000
b. P5,500,000 and P600,000
d. P1,400,000 and P5,500,000
15. Assume that Princess reported a net loss of P50,000 in 2006 and net income of P250,000 in 2007. the increase in
income of P300,000
a. can be stated as 0%
c. cannot be stated as a percentage
b. can be stated as 100% increase
d. can be stated as 200% increase
16. Bea Company is preparing common-size financial statements. Bea has provided the following information:
Accounts receivable
Inventory
Total current assets
Total assets
Bonds payable
P10,000
20,000
35,000
84,000
21,000
Retained earnings
Sales revenue
Cost of goods sold
Income taxes expense
P7,000
75,000
62,000
22,000
1) How would Bea’s inventory appear on a common size balance sheet?
a. 11.9%
b. 23.8%
c. 57.15%
d. 65.3%
2) How would Bea’s retained earnings appear on a common size balance sheet?
a. 8.3%
b. 9.4%
c. 20.0%
d. 33.3%
17. Financial statements for Maja Company for the most recent year appear below:
Cash
Accounts receivable
Inventories
Prepaid expenses
Plant and equipment
Accumulated depreciation
Patents
Total assets
Sales
Cost of goods sold
Gross profit
Operating expenses
Net operating income
Interest expense
Net income before income tax
Income tax
Net income
Maja Company
Balance sheet
December 31
(in thousands)
P90 Accounts payable
150 Accrued expense payable
150 Income tax payable
10 Interest payable
300 Long-term bonds payable
(110) Common stock (P1 par)
10 Additional paid in capital
Retained earnings
P600 Total liabilities and equity
Maja Company
Income statement
For the year ended December 31
(in thousands)
P150
25
20
5
100
20
120
160
P 600
P1,200
750
P450
340
P110
10
P100
40
P60
The balances in the cash, accounts receivable, inventory, bonds payable, common stock, and additional paid in
capital accounts are unchanged from the beginning of the year. A P0.75 per share dividend was declared and paid
during the year. On December 31, Maja Company’s common stock was trading at P24 per share.
3) Maja Company’s current ratio at December 31 was closest to
a. 1.95 to 1
b. 2.67 to 1
c. 1.33 to 1
d. 2.00 to 1
4) Maja Company’s times interest earned ratio for the year was closest to
a. 11.0 to 1
b. 10.5 to 1
c. 12.0 to 1
d. 22.0 to 1
5) Maja Company’s quick ratio at December 31 was closest to
a. 0.45 to 1
b. 0.83 to 1
c. 2.00 to 1
d. 1.20 to 1
6) Maja Company’s inventory turnover ratio for the year was closest to
a. 8x
b. 3x
c. 5x
d. 7.5x
7) Maja Company’s average collection period (age of receivables) for the year was closest to (use 365 days)
a. 72 days
b. 8 days
c. 120 days
d. 46 days
8) Maja’s price earnings ratio at December 31 was closest to
a. 3
b. 8.25
c. 8
d. 7.25
9) Maja Company’s book value per share at December 31 was closest to
6
a. P7
b. P15
c. P24
10) Maja Company’s dividend payout ratio for the year was closest to
a. 75%
b. 25%
c. 5%
11) Maja Company’s debt to equity ratio at December 31 was closest to
a. 0.33 to 1
b. 0.50 to 1
c. 0.67 to 1
12) Maja Company’s dividend yield ratio for the year was closest to
a. 3.125%
b. 12.500%
c. 9.125%
d. P30
d. 3.125%
d. 1.00 to 1
d. 25.000%
18. Selected financial data from Iza Company for the most recent year appear below:
Sales
Cost of goods sold
Dividends declared and paid
P100,000
60,000
5,000
Interest expense
Operating expenses
The income tax rate is 30 percent.
1) Net operating income as a percentage of sales was closest to:
2) Net income as percentage of sales was closest to
3) Gross margin as a percentage of sales was closest to
P8,000
18,000
a. 0.14
a. 0.22
a. 0.40
b. 0.17
b. 0.14
b. 0.45
c. 0.22
c. 0.40
c. 0.35
d. 0.09
d. 0.10
d. 0.22
19. Financial statements for Karylle Company appear below:
Current assets:
Cash & marketable securities
Accounts receivable (net)
Inventory
Prepaid expenses
Total current assets
Non-current assets:
Plant & equipment (net)
Total assets
Sales (all on account)
Cost of goods sold
Gross margin
Operating expenses
Net operating income
Interest expense
Net income before taxes
Income tax (30%)
Net income
Karylle Company
Statement of Financial Position
December 31, 2002 and 2001
(in thousands)
2002
2001
Current liabilities:
P160
P150 Accounts payable
200
190 Accrued liabilities
200
190 Notes payable (short-term)
40
40 Total current liabilities
P600
570 Non-current liabilities:
Bonds payable
P1,360
P1,360 Total liabilities
Shareholders’ equity:
Preferred stock P5 par 15%
Common stock P15 par
Additional paid in capital-common stock
Retained earnings
Total stockholders’ equity
P1,960
P1,930 Total liabilities and stockholders equity
Karylle Company
Income statement
For the year ended December 31, 2002
(in thousands)
2002
2001
P100
80
110
P290
P130
80
130
P340
P450
P740
P500
P840
P100
180
180
760
P1,220
P1,960
P100
180
180
630
P1,090
P1,930
P2,780
1,940
840
330
P510
50
P460
138
P322
Dividends during 2002 totaled P192 thousand, of which P15 thousand were preferred dividends. The market price
of a share of common stock on December 31, 2002 was P310.
1) Karylle’s earnings per share of common stock for 2002 was closest to
a. P1.60
b. P25.58
c. P26.83
d. P38.33
2) Karylle’s dividend yield ratio on December 31, 2002 was closest to
a. 0.3%
b. 5.2%
c. 4.8%
d. 4.4%
3) Karylle’s return on total asset for 2002 was closest to
a. 0.173
b. 0.166
c. 0.148
d. 0.184
4) Karylle’s current ratio at the end of 2002 was closest to
a. 0.39 to 1
b. 0.49 to 1
c. 1.31 to 1
d. 2.07 to 1
5) Karylle’s accounts receivable turnover for 2002 was closest to
a. 14.5x
b. 14.3x
c. 9.9x
d. 9.6x
6) Karylle’s average sale period for 2002 was closest to (use 365 days)
a. 25.6 days
b. 36.7 days
c. 25.6 days
d. 36.9 days
7) Karylle’s times interest earned for 2002 was closest to
a. 10.2x
b. 16.8x
c. 6.4x
d. 9.2x
20. Kathryn Company is calculating its earning power ratios for the year ended December 31, 2013. here is the
relevant information:
Net income
Tax rate
Total dividends paid – preferred
Market price – preferred share
Total shares outstanding – preferred
Ending total assets
Ending stockholders’ equity
P500,000
40 percent
P42,500
110
85,000 shares
P7 million
P2.5 million
Interest expense
Total dividends paid – common
Market price – common share
Total shares outstanding – common
Beginning total assets
Beginning common stockholders’ equity
P30,000
120,000
40
120,000 shares
P6 million
P2 million
Kathryn’s preferred stock is convertible. Each share of preferred stock is convertible into two shares of common
stock. Compute for the following:
7
1) Earnings per share?
2) Fully diluted earnings per share?
3) Dividend yield ratio?
a. P2.44
a. P1.58
a. 0.9%
b. P3.81
b. P1.72
b. 1.5%
c. P4.17
c. P2.44
c. 2.5%
d. P5.38
d. P2.94
d. 4.0%
21. Toni Company has an acid rest ratio of 2.5 to 1. it has current liabilities of P40,000 and non current assets of
P70,000. If Toni’s current ratio is 3.1 to 1, its inventory and prepaid expenses must be
a. P12,400
b. P24,000
c. P30,000
d. P40,000
22. Anne Company has an acid test ratio of 1.5 to 1 and a current ratio of 2.5 to 1. current assets equal P200,000 of
which P10,000 is prepaid expenses. Anne’s inventory must be:
a. P30,000
b. P110,000
c. P70,000
d. P80,000
23. Coleen Company has a current ratio of 3.2 to 1 and an acid test ratio of 2.4 to 1. there are no prepaid expenses
and inventory equals P40,000. Coleen’s current liabilities must be
a. P40,000
b. P120,000
c. P50,000
d. P32,000
24. Julia Corporation asked you to interpret the following ratios provided by its accountant:
Acid test ratio
Times interest earned
Gross margin ratio
1.2
8
40%
Inventory turnover
Debt to equity ratio
Ratio of operating expenses to sales
6 times
0.9:1
15%
Total stockholders equity on December 31, 2013 was P900,000. Gross margin for 2012 amounted to P600,000.
Beginning balance of merchandise inventory was P200,000. the company’s long-term liabilities consisted of bonds
payable with interest at 15 percent. You decided to reconstruct the company’s financial statements based on the
limited information given to serve as basis for further analysis.
1) Operating income was computed at:
a. P525,000
b. P300,000
c. P375,000
d. none of these
2) Bonds payable totalled:
a. P312,500
b. P350,000
c. P400,000
d. none of these
3) Total current liabilities would be:
a. P462,500
b. P497,500
c. P504,500
d. none of these
4) The company’s total asset amounted to:
a. P317,000
b. P597,000
c. P697,000
d. none of these
LONG PROBLEMS WITH SOLUTIONS
1) (VERTICAL ANALYSIS) A comparative statement is given below for Jessy Company:
Sales
Cost of sales
Gross margin
Selling expenses
Administrative expenses
Total expenses
Net operating income
2002
Amount
Percentage
P5,000,000
(3,160,000)
P1,840,000
P900,000
680,000
P(1,580,000)
P260,000
2001
Amount
Percentage
P4,000,000
(2,400,000)
P1,600,000
P700,000
584,000
P(1,284,000)
P316,000
The president is concerned that net income is down in 2002 even though sales have increased during the year.
The president is also concerned that administrative expenses have increased since the company makes a
concerned effort during 2002 to “fat” out the organization. Required: Express each year’s income statement in
common-size percentages. Carry computations into one decimal place.
Answer:
2002
Sales
Cost of sales
Gross margin
Selling expenses
Administrative expenses
Total expenses
Net operating income
Amount
P5,000,000
(3,160,000)
P1,840,000
P900,000
680,000
P(1,580,000)
P260,000
Percentage
100%
63.20%
36.8%
18.00%
13.6%
31.6%
5.2%
2001
Amount
Percentage
P4,000,000
100%
(2,400,000)
60%
P1,600,000
40%
P700,000
17.5%
584,000
14.6%
P(1,284,000)
32.1%
P316,000
7.9%
2.4 million/ 4 million
Income
statement base
amount under
vertical
analysis is the
SALES or Net
Sales
2) (HORIZONTAL ANALYSIS) Gretchen’s sales, current assets and current liabilities (all in thousands of pesos) have
been reported as follows over the last four years (Year 4 is the most recent year):
Sales
Current assets
Current liabilities
Year 4
P5,400
1,448
318
Year 3
P4,950
1,332
324
Year 2
P4,725
1,368
330
Year 1
P4,500
1,280
300
Sales
Current assets
Current liabilities
Year 4
120
113.1
106
Year 3
110
104.1
108
Year 2
105
106.9
110
Year 1
100
100
100
Express all of the assets, liabilities and sales data in trend percentages (show percentages in each item). Use year
1 as the base year and carry computations to one decimal place.
Answer:
(P4,725,000 / 4,500,000) * 100
3) (FINANCIAL RATIOS) You have just been hired as a loan officer at Cristine Security Bank. Your supervisor has
given you a file containing a request from Jodi Company, a manufacturer of auto components, for a P1 million
five-year loan. Financial statement data on the company for the last two years are given below:
Assets
Current assets
Jodi Company
Comparative balance sheet
This year
Last year
8
•
Cash
P320,000
•
Marketable securities
0
•
Accounts receivable (net)
900,000
•
Inventory
1,300,000
•
Prepaid expenses
80,000
Total current assets
P5,700,000
Liabilities and stockholders’ equity
Liabilities
•
Current liabilities
P1,300,000
•
Bonds payable, 10%
1,200,000
Total liabilities
P2,500,000
Stockholders’ equity
Preferred stock 8% P30 par value
P600,000
Common stock P40 par value
2,000,000
Retained earnings
600,000
Total stockholders’ equity
P3,200,000
Total liabilities and stockholders’ equity
P5,700,000
Jodi Company
Comparative income statement
This year
Sales (all on account)
P5,250,000
Cost of goods sold
(4,200,000)
Gross margin
P1,050,000
Operating expenses
(530,000)
Net operating income
P520,000
Interest expense
(120,000)
Net income before tax
P400,000
Income tax (30%)
(120,000)
Net income
P280,000
Dividends paid:
•
Preferred stock
P48,000
•
Common stock
72,000
Total dividend paid
P(120,000)
Net income retained
P160,000
Retained earnings – beginning of year
P440,000
Retained earnings – end of the year
600,000
P420,000
100,000
600,000
800,000
60,000
P4,960,000
P920,000
1,000,000
P1,920,000
P600,000
2,000,000
440,000
P3,040,000
P4,960,000
Last year
P4,160,000
(3,300,000)
P860,000
(520,000)
P340,000
(100,000)
P240,000
(72,000)
P168,000
P48,000
36,000
P(84,000)
P84,000
P356,000
P440,000
Bea Rose Santiago, who just two years ago, was appointed president of Jodi Company, admits that the company
has been “inconsistent” in its performance over the past several years. But Bea argues that the company has its
costs under control, and is now experiencing strong sales growth as evidenced by the more than 25 percent
increase in sales over the last year. Bea also argues that investors have recognized the improving situation at Jodi
Company as shown by the jump in the price of its common stock from P20 per share last year to P36 per share
this year. Bea believes that with strong leadership and modernized equipment that the P1 million loan will permit
the company to buy, profits will be even stronger in the future. Anxious o impress your supervisor, you decide to
generate all the information you can about the company. You determine that the following ratios are typical of
companies in Jodi Company:
Current ratio
Average age of receivables
Return on assets
Times interest earned
2.3:1
31 days
9.5%
5.7
Determine the following ratios for this year:
Acid test ratio
Inventory turnover
Debt to equity ratio
Price-earnings ratio
1.2:1
60 days
0.65 to 1
10
a) Return on total assets
j) Working capital
b) Return on common equity
k) Current ratio
c) Is the company’s leverage positive or negative?
l)
Acid-test ratio
d) Earnings per share
m) Accounts receivable turnover
e) Dividend yield ratio for common
n) Average age of receivables (assume 365 days)
f) Dividend payout ratio
o) Inventory turnover
g) Price earnings ratio
p) Inventory conversion period (assume 365 days)
h) Book value per share common
q) Debt to equity ratio
i)
Gross margin percentage
r) Number of times interest was earned
Answer:
a. Return on total assets:
Answer
• Net income + [Interest x (1-tax rate)]
P280,000 + [(1,200,000 x 0.10) x (1-0.30)]
0.068
Average total assets
[(5,700,000+4,960,000) / 2]
• Net income / Average total assets
P280,000 / [(5,700,000+4,960,000)/2]
0.0525
• Operating income / Average total assets P520,000 / [(5,700,000+4,960,000)/2]
0.0976
b. Return on common equity:
• (Net income – Preferred dividends)
[P280,000 – (P600,000 x 0.08)]
Average Stockholders’ equity-common
[(3,200,000+3,040,000)/2]-600,000
0.092
c. Leverage is positive for this year, since the return on common equity is greater than the return on
total asset .
d. Earnings per share:
• (Net income – Preferred dividends)
P232,000 / (P 2 million / P40 par value)
P4.64
Average
#
of
common
shares
outstanding
e. Dividend yield ratio
• Dividend per share / market price per (P72,000 / 50,000 shares) / P36
0.04
share
f. Dividend payout ratio
• Dividend per share / earnings per share
(P72,000 / 50,000 shares) / P4.64
0.31
g. Price earnings ratio
• Market price per share / Earnings per P36 / P4.64
7.8
share
9
h.
Book value per share
• Common stockholders’ equity
Number of common shares outstanding
i.
Gross margin percentage
• Gross margin / sales
j. Net working capital
• Current assets – Current liabilities
k. Current ratio
• Current assets / Current liabilities
l.
Acid-test ratio
• Quick assets / Current liabilities
m. Accounts receivable turnover
• Net credit sales / Average receivable
n. Average age of receivables:
• Number of days in a year
Accounts receivable turnover
o. Inventory turnover
• Cost of sales / Average Inventory
p. Inventory conversion period
• Number of days in a year
Inventory turnover
q. Debt to equity ratio
• Total liabilities / Stockholders’ equity
r. Times interest earned
• Earnings before Interest and Taxes
Interest expense
(P3,200,000 – 600,000) / 50,000 shares
P52
P1,050,000 / P5,250,000
0.20
P2,600,000 – P1,300,000
P1,300,000
P2,600,000 / P1,300,000
2:1
P1,220,000 / P1,300,000
0.94 to 1
P5,250,000 / [(900,000+600,000)/2]
7 times
365 days / 7 times
52 days
P4,200,000 / [(1,300,000+800,000)/2]
4 times
365 days / 4 times
91 days
P2,500,000 / 3,200,000
0.78:1
P520,000 / P120,000
4.3 times
4) (EFFECTS OF TRANSACTIONS ON VARIOUS FINANCIAL RATIOS) Selected amounts from Alex Company’s balance
sheet from the beginning of the year follow:
Cash
Accounts receivable (net)
Prepaid expenses
Accounts payable
Notes due within one year
P70,000
350,000
8,000
200,000
100,000
Marketable securities
Inventory
Plant and equipment (net)
Accrued liabilities
Bonds payable in 5 years
P12,000
460,000
950,000
60,000
140,000
During the year, the company completed the following transactions:
a)
b)
c)
d)
e)
f)
g)
Purchased inventory on account, P50,000
Declared cash dividends P30,000
Paid accounts payable P100,000
Collected cash on accounts receivable P80,000
Purchased equipment for cash P75,000
Paid a cash dividend previously declared P30,000
Borrowed cash on a short-term note with the bank
P60,000
h)
i)
j)
k)
Sold inventory costing P70,000 for P100,000, on
account
Wrote off uncollectible accounts in the amount of
P10,000. The company uses the allowance method of
accounting for bad debts.
Issued additional shares of capital stock for cash,
P200,000
Paid off all short-term notes due P160,000
Required:
1. Compute the following ratios as of the beginning of the year: Working capital, Current ratio and Acid-test ratio
Answer:
• Working capital
• Current ratio
• Acid test ratio
P900,000 – P360,000
900,000/ 360,000
432,000 / 360,000
P540,000
2.5 to 1
1.2 to 1
2. Indicate the effect of the transactions given above on working capital, current ratio and acid test ratio. Give
the effect in terms of INCREASE, DECREASE or NONE.
Answer:
a)
b)
c)
d)
e)
f)
g)
h)
i)
j)
k)
l)
Entry
Merchandise Inventory
Accounts payable
Retained earnings
Dividends payable
Accounts payable
Cash
Cash
Accounts receivable
Equipment
Cash
Dividends payable
Cash
Cash
Notes payable due 1 year
Accounts receivable
Sales
Cost of sales
Merchandise inventory
Allowance for bad debts
Accounts receivable
Cash
Loss on sale of MS
Marketable securities
Cash
Common stock
Notes payable
Cash
Working capital
None
Effect on
Current ratio
Decrease
None
Increase
Increase
None
None
None
None
None
None
Decrease
Decrease
Decrease
None
Increase
Increase
None
Decrease
Decrease
Increase
Increase
Increase
None
None
None
Decrease
Decrease
Decrease
Increase
Increase
Increase
None
Increase
Increase
Acid test ratio
Decrease
The best way in
answering the effects
of every transaction
on ratio is by making
an entry
10
5) (CONSTRUCTION OF FINANCIAL STATEMENTS USING RATIOS) Financial analysis may b used to test the fairness
of the relationship among current financial data against those of prior financial information. Given established
financial relationships and few key amounts, a CPA could also prepare projected financial statements. Jessy
Corporation has in recent prior years maintained the following relationships among data on its financial
statements:
Net income rate on net sales
Ratio of selling expenses to net sales
Current ratio
Inventory turnover
Asset turnover
Ratio of total assets to intangible assets
Ratio of accounts receivable to accounts
payable
Ratio of working capital to stockholders’
equity
Number of times interest earned
5 percent
15 percent
3:1
5 times
1 per year
20:1
1.5:1
1:1.6
Gross income rate on net sales
Acid test ratio
Accounts receivable turnover
Composition of quick assets:
Cash
Marketable securities
Accounts receivable
Ratio of total liabilities to stockholders’ equity
Ratio of accumulated depreciation to cost of
fixed assets
35 percent
2:1
5 times
10 percent
30 percent
60 percent
1.4:1.6
1:3
2
For 2013, the company projects to have a net income of P150,000 which will result to P10 per share of common
stock. Additional information includes the following:
 Common stock has a par value of P50 per share and was issued at 20% premium
 8% preferred stock has a par value of P50 per share and was issued 10% premium
 Preferred dividends paid in 2012, P10,000 the same amount will be paid in 2013
 The company’s purchases and sales are all “on account”. For projection purposes, it is assumed that the above relationships
among the data on the financial statements of Jessy Corporation shall also hold true for 2013.
Required: Prepare a projected balance sheet for the year 2013 and a projected income statement for the ended
December 31, 2013. ignore income tax
Answer:
Net sales
Cost of goods sold
Gross margin
Jessy Corporation
Projected Income statement
For the year ended December 31, 2013
0.05 = P150,000 / net sales
Net sales = P150,000 / 0.05 ~ P3,000,000
P3,000,000 – P1,950,000 ~ P1,950,000
0.35 = Gross margin / P3,000,000
Gross profit: P3,000,000 x 0.35 ~ P1,050,000
Expenses:
Selling expenses
Administrative expenses
Interest
P3,000,000 x 0.15
P1,050,000 – (P150,000+450,000+150,000)
2 = (P150,000 + Interest) / Interest
2 Interest = P150,000 + interest
Interest = P150,000
Total expenses
Net income (GIVEN)
P 3,000,000
(1,950,000)
P1,050,000
P450,000
300,000
150,000
P(900,000)
P150,000
Jessy Corporation
Projected balance sheet
As of December 31, 2013
ASSETS:
Current assets:
 Cash
 Marketable securities
 Accounts receivable
 Inventory
 Prepaid expenses
Total current assets
Fixed assets
Land, building and equipment
Accumulated depreciation
Land, building and equipment
(net)
Intangible assets
Total assets
Liabilities and Stockholders’ equity
Liabilities
Current liabilities:
 Accounts payable
 Miscellaneous payable
Total current liabilities
Bonds payable
Total liabilities
Stockholders’ equity
 8% preferred stock
A/R = 60% of quick assets
Quick assets = P600,000 / 0.60 ~ P1,000,000
Cash = P1,000,000 x 0.10 ~ P100,000
P1,000,000 x 0.30 ~ P300,000
5 = P3 million / Accounts receivable
Accounts receivable = P3,000,000 / 5 ~ P600,000
5 = P1,950,000 / Inventory
Inventory = P1,950,000 / 5 ~ P390,000
P1,500,000 – (P1,000,000+390,000)
3 = Current assets / P500,000
Current assets = P500,000 x 3 ~ P1,500,000
1,350,000 / (1 – 1/3) ~ P2,025,000
P2,025,000 x 1/3
P3,000,000 – (1,500,000+150,000) ~ P1,350,000
20 = P3,000,000 / Intangible assets
Intangible assets = P3,000,000/20 ~ P150,000
1= P3,000,000 / total assets
Total assets = P3,000,000 x 1 ~ P3,000,000
600,000 / 1.5 ~ P400,000
500,000 – 400,000 + 100,000
2= P1,000,000 / Current liabilities
Current liabilities = P1,000,000 / 2 ~ P500,00
P100,000
300,000
600,000
390,000
Since the problem
does not state the
beginning balance
of AR, it is
assume that the
600,000 is the
ending balance of
the accounts
receivable. There
is no need to
multiply it by 2
since there is no
data concerning
the beginning
balance of AR
110,000
P 1,500,000
P2,025,000
(675,000)
P1,350,000
150,000
P3,000,000
P400,000
100,000
P500,000
P900,000
P1,400,000
P125,000
11
 Common stock
 Premium on stock
Retained earnings
Total liabilities and SHEquity
(140,000+125,000)
700,000
152,500
622,500
P3,000,000
12