ANALYSIS OF
FINANCIAL
STATEMENTS
As mentioned in
financial statements is to
financial
position,
financial position of an
of users in making
reading and understanding the financial statement
analysis and interpretation of such statements is
other users are expected to make informed
information derived from financial statement
and evaluating the firm’s past performance, its
business potentials.
chapter 9 “the objective of
provide information about the
performance, and changes in
entity that is useful to a wide range
economic decisions.” Merely
per se is not enough. A thorough
necessary if management and
judgments and decisions. The
analysis can be used in assessing
present condition and future
Financial statement analysis is the process of identifying financial strengths and weaknesses of the firm by
properly establishing relationship between the items in the financial statements and other related information to
arrive at an evaluation and conclusion as to the soundness of the financial position and the results of operations of
an enterprise.
Analysis of a business is a broader evaluating activity focusing on the strengths and weaknesses of an enterprise
based on internal factors and relating such to the problems and opportunities as perceived based on external
factors. Analysis of financial statements, on the other hand, limits the evaluation to the data in the financial
statements and other related information.
THREE TYPES OF COMPARISONS
Items from financial statements are usually not particularly informative when viewed in isolation. In assessing the
financial performance of a company, managers are interested in making comparison with the results of other
periods, items with significant items, the different units and, most often, with the results of other companies. There
are three (3) types of comparisons to improve the decision usefulness of financial information.
A. Intra-company basis. Comparisons within a company are often useful to detect changes in financial
relationships and significant trends. For example, a comparison of the company’s current year’s cash amount
with the prior year’s cash amount shows either an increase or decrease. Likewise, a comparison of the
company’s year-end cash amount with the amount of its total assets at year-end shows the proportion of total
assets in the form of cash.
B. Inter-company basis. Comparisons with other companies provide insight into a company’s competitive
position. For example, Jollibee’s total sales for the year can be compared with the total sales of its competitors
in the fastfood area, such as McDonalds and Jollibee.
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C. Industry averages. Comparisons with industry averages provide information about a company’s relative
position within the industry. The ratios of a firm are compared with those of similar firms or with industry
averages or norms to determine how the company is faring relative to its competitors. For example, Levi’s
Straus’ financial data can be compared with the averages for its industry compiled by financial ratings
organizations such as Reuters, Dun (Dun’s Review) & Bradstreet (Key Business Ratios), Robert Morris Associates
(Annual Statement Studies), Moody’s, Yahoo!, and Standard & Poor’s.
METHODS AND TECHNIQUES IN ANALYSIS
Three (3) basic approaches are often used to compare financial statements between companies, between different
years, different items, or performances by units for the same company: horizontal (trend) analysis, vertical
(common-size) analysis, and ratio analysis. These basic tools are used in comparative analysis to highlight the
significance of financial statement data. Following are the most important tools and techniques of financial
statement analysis:
I. HORIZONTAL OR TREND ANALYSIS. This is an analytical method by which comparative statements are
presented to show changes in each item as of different dates or for different period as a means of determining
improvement or deterioration of the financial condition or results of operations of a business enterprise.
A. Increase/Decrease Method. It highlights the peso as well as the percentage increase or decrease of
each item in the comparative statements. The percentage change in comparative statements is
computed by doing these steps:
1. Compute the difference between the amount for a comparison year and the amount of a base
(earlier) year.
PESO CHANGE = Amount in Comparison year - Amount in Base year
2. Divide the peso amount of change computed in (1) by the amount of the base year. However, this
is not done if the base year figure is negative or zero.
% CHANGE =
PESO CHANGE
AMOUNT IN BASE YEAR
x 100
 This method only enables the analyst to compare financial statements for two accounting
periods.
B. Trend Percentages or Index Numbers. The changes in financial statement items from a base year to
following years are often expressed as trend percentages to show the extent and direction of change.
It emphasizes changes that have occurred from period to period and are useful in comparing data
covering several years. To compute for trend percentages, these steps are followed:
1. A base year is selected and each item in the financial statements for the base year is given a weight
of 100%.
2. Express each item in the financial statements for following years as percentage of its base year
amount. This is done by dividing an item in the years after the base year by the amount of such
item in the base year.
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TREND % =
AMOUNT IN COMPARISON YR
AMOUNT IN BASE YEAR
x 100
 This method is used in comparing data from financial statements of more than two years.
To illustrate, the comparative statement of financial position and statement of comprehensive income of PRUTAZ
Corporation for two years taken from Chapter 9 are shown below and on the next pages
A. HORIZONTAL ANALYSIS: INCREASE (DECREASE) METHOD
PRUTAZ Corporation
Comparative Statement of Financial Position
As of December 31, 2013 and 2014
Assets
2014
Current Assets
Cash and cash equivalents
Trade receivables, net
Merchandise inventory
Total
Non-current Assets
Property, plant and equipment, net
Investment in equity securities
Goodwill
Total
Total Assets
Liabilities and Shareholders’ Equity
Current Liabilities
Accounts payable
Income tax payable
Total
Non-current liabilities
Bonds payable
Total Liabilities
Shareholders’ equity
Ordinary share capital,P10 par
Reserves
Accumulated profits
Total shareholders’ equity
Total liabilities and shareholders’ equity
2013
INCREASE(DECREASE)
Amount
%
P 202,600
300,000
320,000
P 822,600
P 160,000
180,000
400,000
P 740,000
42,600
120,000
(80,000)
82,600
26.63
66.67
(20.00)
11.16
P 355,000
325,000
250,000
P 930,000
P1,752,600
P 550,000
300,000
250,000
P1,100,000
P1,840,000
(195,000)
25,000
(170,000)
(87,400)
(35.45)
8.33
(15.45)
(4.75)
P 150,000
290,000
P 440,000
P
80,000
330,000
P 410,000
70,000
(40,000)
30,000
87.5
(12.12)
7.32
300,000
P 740,000
500,000
P 910,000
(200,000)
(170,000)
(40.00)
(18.68)
P 500,000
255,000
257,600
P1,012,600
P1,752,600
P 500,000
230,000
200,000
P 930,000
P1,840,000
25,000
57,600
82,600
(87,400)
10.87
28.80
8.89
(4.75)
PRUTAZ Corporation
Comparative Statement of Comprehensive Income
For the Years Ended, December 31, 2013 and 2014
2014
2013
INCREASE(DECREASE)
AMOUNT
%
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Net sales
Less: Cost of sales
Gross Profit
Less: Operating Expenses
Selling expenses
Administrative expenses
Total
Net operating income
Less: Interest expense
Net income before taxes
Less: Income taxes (30%)
Net income after tax
Add: Other comprehensive income
Unrealized gain on investment on
equity securities
Comprehensive income
P7,000,000
5,920,000
P1,080,000
P5,950,000
4,960,000
P 990,000
1,050,000
960,000
90,000
17.65
19.35
9.09
P 540,000
160,000
P 700,000
P 380,000
60,000
P 320,000
96,000
P 224,000
P 490,000
147,000
P 637,000
P 353,000
60,000
P 293,000
87,900
P 205,100
50,000
13,000
63,000
27,000
27,000
8,100
18,900
10.20
8.84
9.89
7.65
9.22
9.22
9.22
25,000
P 249,000
P 205,100
25,000
43,900
21.40
B. HORIZONTAL ANALYSIS: TREND PERCENTAGES
PRUTAZ Corporation
Comparative Statement of Financial Position
As of December 31, 2013 and 2014
( in %)
Assets
Current Assets
Cash and cash equivalents
Trade receivables, net
Merchandise inventory
Total
Non-current Assets
Property, plant and equipment, net
Investment in equity securities
Goodwill
Total
Total Assets
Liabilities and Shareholders’ Equity
Current Liabilities
Accounts payable
Income tax payable
Total
2014
2013
126.63
166.67
80.00
111.16
100
100
100
100
64.55
108.33
100.00
84.55
95.25
100
100
100
100
100
2014
2013
187.50
87.88
107.32
100
100
100
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Non-current liabilities
Bonds payable
Total Liabilities
Shareholders’ equity
Ordinary share capital,P10 par
Reserves
Accumulated profits
Total shareholders’ equity
Total liabilities and shareholders’ equity
60.00
81.32
100
100
100.00
110.87
128.80
108.89
95.25
100
100
100
100
100
PRUTAZ Corporation
Statement of Comprehensive Income
For the Years Ended, December 31, 2013 and 2014
( in %)
Net sales
Less: Cost of sales
Gross Profit
Less: Operating Expenses
Selling expenses
Administrative expenses
Total
Net operating income
Less: Interest expense
Net income before taxes
Less: Income taxes (30%)
Net income after tax
Add: Other comprehensive income
2014
117.65
119.35
109.09
2013
100.00
100.00
100.00
110.20
108.84
109.89
107.65
100.00
109.22
109.22
109.22
100.00
100.00
100.00
100.00
100.00
100.00
100.00
100.00
121.40
100.00
Unrealized gain on investment on equity securities
Comprehensive income
II. VERTICAL ANALYSIS. This is a technique, also known as common-size analysis, for evaluating financial
statement data that expresses each item in a financial statement within a year as percent of a base amount. It
is an analysis in which a statistic is calculated for the relationship between two items on a single financial
statement. The formula is:
AMOUNT OF LINE ITEM
BASE ITEM AMOUNT
Vertical analysis is the
x 100
procedure
of
preparing
and
presenting
common
size
statements. Common-size financial statement or 100% statement is one that shows the items appearing on it
in percentage form as well as in peso form. Each item is stated as a percentage of some total of which that
item is a part. Key financial changes and trends can be highlighted by the use of common size statements.
% =
a. Common-size statement of financial position - TOTAL ASSETS represent 100%. Other items in the
statement of financial position are expressed as percentages of total assets by dividing each item by
the total assets.
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b. Common-size statement of comprehensive income - NET SALES or NET OPERATING REVENUE is set
at 100%. Each item in the statement of comprehensive income is divided by net sales/net operating
revenue to express these items as percentage of net sales.
To illustrate, the common-size statement of financial position and statement of comprehensive income of PRUTAZ
Corporation are shown below and the next page.
PRUTAZ Corporation
Common-size Statement of Financial Position
As of December 31, 2013 and 2014
Assets
Current Assets
Cash and cash equivalents
Trade receivables, net
Merchandise inventory
Total
Non-current Assets
Property, plant and equipment, net
Investment in equity securities
Goodwill
Total
Total Assets
Liabilities and Shareholders’ Equity
Current Liabilities
Accounts payable
Income tax payable
Total
Non-current liabilities
Bonds payable
Total Liabilities
Shareholders’ equity
Ordinary share capital,P10 par
Reserves
Accumulated profits
Total shareholders’ equity
Total liabilities and shareholders’ equity
2014
%
2013
%
P 202,600
300,000
320,000
P 822,600
11.56
17.12
18.26
46.94
P 160,000
180,000
400,000
P 740,000
8.70
9.78
21.74
40.22
P 355,000
325,000
250,000
P 930,000
P1,752,600
20.26
18.54
14.26
53.06
100.00
P 550,000
300,000
250,000
P1,100,000
P1,840,000
29.89
16.30
13.59
59.78
100.00
P 150,000
290,000
P 440,000
8.56
16.55
25.11
P
80,000
330,000
P 410,000
4.35
17.93
22.28
300,000
P 740,000
17.12
42.22
500,000
P 910,000
27.17
49.46
P 500,000
255,000
257,600
P1,012,600
P1,752,600
28.53
14.55
14.70
57.78
100.00
P 500,000
230,000
200,000
P 930,000
P1,840,000
27.17
12.50
10.87
50.54
100.00
PRUTAZ Corporation
Common-size Statement of Comprehensive Income
For the Years Ended, December 31, 2013 and 2014
Net sales
Less: Cost of sales
Gross Profit
Less: Operating Expenses
Selling expenses
2014
P7,000,000
5,920,000
P1,080,000
%
100.00
85.57
15.43
2013
P5,950,000
4,960,000
P 990,000
%
100.00
83.36
16.64
P 540,000
7.71
P 490,000
8.24
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Administrative expenses
Total
Net operating income
Less: Interest expense
Net income before taxes
Less: Income taxes (30%)
Net income after tax
Add: Other comprehensive income
Unrealized gain on investment on equity
securities
Comprehensive income
160,000
P 700,000
P 380,000
60,000
P 320,000
96,000
P 224,000
2.29
10.00
5.43
0.86
4.57
1.37
3.20
147,000
P 637,000
P 353,000
60,000
P 293,000
87,900
P 205,100
2.47
10.71
5.93
1.01
4.92
1.48
3.45
25,000
P 249,000
0.36
3.56
P 205,100
3.45
III. RATIO ANALYSIS. These are percentages, turnovers, or ratios expressing the relationship between selected
items derived from the statement of financial position or from the statement of comprehensive income or
from both. Since the financial statements are fundamentally related, we also have to relate information
contained in one statement with the related information found in another. This is called inter-financial
statements analysis or simply financial mix ratio analysis. As indicators of profitability, liquidity, growth and
leverage, they are used to determine the possible areas of weaknesses and strengths of an organization in
comparison with a standard. All examples are taken from the data of PRUTAZ CORPORATION.
A. LIQUIDITY /SHORT-TERM SOLVENCY RATIOS
Liquidity ratios measure the ability of a company to meet its current obligation. Following are the most important
liquidity ratios:
1. Current Ratio. The current ratio is another way to express the relation between current assets and current
liabilities. This ratio is also known as "working capital ratio". It is computed as follows:
Current Ratio =
Current Assets
Current Liabilities
DEFINE WORKING CAPITAL (CA-CL)
Significance: A ratio equal to or near 2 : 1 is considered as a standard or normal or satisfactory. The idea of
having double the current assets as compared to current liabilities is to provide for the delays and losses in the
realization of current assets. However, the rule of 2 :1 should not be blindly used while making interpretation
of the ratio. This is because of the reason that current ratio measures the quantity of the current assets and
not the quality of the current assets. A current ratio of less than 1 may be considered unacceptable since in
that case current liabilities would exceed current assets—a warning that there may soon be a cash flow
problem.
Example:
2014
2013
Current Assets
822,600
740,000
Divided by: Current Liabilities
440,000
410,000
Current Ratio
1.87
1.80
2. Liquid / Acid Test / Quick Ratio. It is used as a complementary ratio to the current ratio. The acid-test ratio
is a more rigorous test of a company’s ability to meet its short-term debts than the current ratio since it
excludes less liquid current assets such as inventories and prepaid expenses. It measures the firm’s ability to
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pay off short-term obligations without relying on the sale of inventories. The acid-test ratio is computed as
follows:
Acid Test Ratio =
Current Assets – Inventories - Prepayments
Current Liabilities
Significance:
Usually a high liquid ratio is an indication that the firm is liquid and has the ability to meet its current or liquid
liabilities in time and on the other hand a low liquidity ratio represents that the firm's liquidity position is not
good. As a convention, generally, a quick ratio of "one to one" (1:1) is considered to be satisfactory.
Example:
2014
2013
Quick Assets
502,600
340,000
Divided by: Current Liabilities
440,000
410,000
Quick Ratio
1.14
0.83
B. ACTIVITY / EFFICIENCY RATIOS
Activity ratios are calculated to measure the efficiency with which the resources of a firm have been employed.
These ratios are also called turnover ratios because they indicate the speed with which assets are being turned
over into sales. Following are the most important activity ratios:
1. Accounts Receivable Turnover. Accounts receivable turnover is a measure of how quickly accounts
receivables are turned into cash or how quickly receivables are collected. Accounts receivable turnover in days
provides information about the number of days the average balance of accounts receivable is outstanding
before cash is collected. Note that current receivables include any notes receivable as well as accounts
receivable.
Accounts Receivable TO =
Sales on Account
Average Accounts Receivable**
1.
2.
3.
4.
**Average Accounts receivable = (Accts Receivable, beg + Accts Receivable, end)/2
Significance: Accounts receivable turnover ratio or debtors’ turnover ratio indicates the number of times the
receivables are turned over a year. The higher the value of receivables turnover the more efficient is the
management of debtors or more liquid the debtors are.
Example:
2014
Net Sales
7,000,000
Divided by: Ave. Accounts Receivable
(180,000 + 300,000)/2
240,000
A/R Turnover
29.17
2. Average Collection Period. This ratio is used to evaluate credit management and account collection
practices.
Ave Collection Period =
360 days
Accounts Receivable Turnover
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Significance: This ratio measures the quality of debtors. A short collection period implies prompt payment by
debtors. It reduces the chances of bad debts. Similarly, a longer collection period implies too liberal and
inefficient credit collection performance. An increase in the accounts receivable turnover (and a decrease in
the average collection period) would usually be considered favorable.
Example:
2014
No. of days in a year
360
Divided by: A/R turnover
29.17
Ave. Collection period in Days
12.34
3. Inventory Turnover. The inventory turnover ratio measures how quickly inventory is converted into sales.
Inventory turnover in days provides information about the number of days inventory is held before being sold.
It gives us an indication of how long it takes the firm to convert its inventory into cash.
Inventory TO =
Cost of Goods Sold
Average Inventory**
**Average Inventory = (Inventory, beg + Inventory, end)/2
The inventory turnover and current ratio are related. The combination of a high current ratio and a low
inventory turnover ratio, relative to industry norms, suggests that the firm has an above-average inventory
level and/or that part of the inventory is obsolete or damaged.
Significance: Usually a high inventory turnover/stock velocity indicates efficient management of inventory
because more frequently the stocks are sold. A low inventory turnover implies over-investment in inventories,
dull business, poor quality of goods, stock accumulation, accumulation of obsolete and slow moving goods and
low profits as compared to total investment. The inventory turnover ratio is also an index of profitability.
Example:
2014
Cost of goods sold/cost of sales
5,920,000
Divided by: Ave. inventory
(400,000 + 320,000)/2
360,000
Inventory Turnover
16.44
Work in Process Inventory Turnover. The inventory turnover ratio measures how quickly inventory is
manufactured. It gives us an indication of over or under investment in work in process.
WIP Inventory TO =
Cost of Goods Manufactured
Average WIP Inventory
Raw materials Inventory Turnover. The inventory turnover ratio measures how quickly raw materials is used.
It gives us an indication of the sufficiency of raw materials in stock.
RM Inventory TO =
Raw Materials used
Average RM Inventory
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4. Average Sales Period / Average Age of Inventory / Inventory Holding Period. It calculates the number of
days, on average, that elapsed between finished goods production and sale of product
Ave Age of Inventory =
360 days
Inventory Turnover
Significance: An increase in the inventory turnover (and a decrease in the average sale period) would usually
be considered favorable.
Example:
2014
No. of days in a year
360
Divided by: Inventory turnover
16.44
Ave. Age of Inventory in Days
21.90
C. LEVERAGE / LONG-TERM SOLVENCY
Long term solvency or leverage ratios convey a firm's ability to meet the interest costs and payment schedules of
its long term obligations. Leverage ratios look at the extent that a company has depended upon borrowing to
finance its operations. As a result, these ratios are reviewed closely by bankers and investors. Most leverage ratios
compare assets or net worth with liabilities. A high leverage ratio may increase a company's exposure to risk and
business downturns, but along with this higher risk also comes the potential for higher returns. Some of the major
measurements of leverage include:
1. Times-Interest-Earned Ratio. The times-interest-earned ratio is a measure of a firm’s ability to meet interest
payments. It indicates the relation between interest payments and the earnings that are available to make
those interest payments. Earnings before interest expense and income taxes is also referred to as “net
operating income”. This ratio is computed as follows:
Times interest Earned =
Earnings before interest exp and income taxes
Interest expense
Significance: The times-interest-earned ratio, also known as, interest coverage ratio is very important from
the lender’s point of view. It is an index of the financial strength of an enterprise. In general, a higher interest
coverage ratio means that the small business is able to take on additional debt.
Example:
2014
2013
Earnings before interest & income taxes
380,000
353,000
Divided by: Interest expense
60,000
60,000
Times interest earned
6.33
5.88
2. Debt to Asset Ratio. This is referred to also as financial leverage. It measures the portion of a company's assets
that is provided by borrowing. It involves financing assets with funds that have been provided by creditors or
preferred shareholders at a fixed rate of return. A debt ratio greater than 1.0 means the company has negative
net worth, and is technically bankrupt. The debt ratio is calculated as:
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Debt to Asset ratio =
Total Liabilities
Average Total Assets
Significance: If assets in which the funds are invested earn a rate of return greater than the fixed rate of return
required by the suppliers of the funds, then financial leverage is positive and the ordinary shareholders benefit.
As the percentage of assets financed by creditors increases, the riskiness of the company increases.
Example:
2014
Total Liabilities
740,000
Divided by: Ave. Total assets
(1,840,000 + 1,752,600)/2
1,796,300
Debt to Asset Ratio
.41 or 41.20%
3. Debt to Equity Ratio. Long-term creditors would like a reasonable balance between the capital provided by
creditors and the capital provided by shareholders. Creditors would like the debt-to-equity ratio to be relatively
low. This balance is measured by the debt-to-equity ratio:
Debt to Equity ratio =
Total Liabilities
Average Shareholders’ Equity
Significance: A company is generally considered safer if it has a low debt to equity ratio—that is, a higher
proportion of owner-supplied capital—though a very low ratio can indicate excessive caution. In general, debt
should be between 50 and 80 percent of equity.
Example:
2014
Total Liabilities
740,000
Divided by: Ave. Shareholders’ equity
(930,000 + 1,012,600)/2
971,300
Debt to Equity Ratio
.76 or 76.19%
D. PROFITABILITY
Profitability ratios show the combined effects of liquidity, asset management, and debt management on a firm's
operating results. Profitability ratios measure the earning ability of a company and the extent to which invested
funds are being used efficiently. However, it is important to note that many factors can influence profitability ratios,
including changes in price, volume, or expenses, as well the purchase of assets or the borrowing of money. Some
of the most popular profitability ratios are:
1. Gross Margin Ratio/ Gross Profit Ratio. It measures the margin on sales the company is achieving. It can be
an indication of manufacturing efficiency or marketing effectiveness. It reflects efficiency with which a firm
produces its products. As the gross profit is found by deducting cost of goods sold from net sales, higher
the gross profit better it is.
Gross Profit
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Gross profit (margin) ratio =
Net Sales
Significance: There is no standard GP ratio for evaluation. It may vary from business to business. However,
the gross profit earned should be sufficient to recover all operating expenses and to build up reserves after
paying all fixed interest, charges and dividends.
Example:
2014
2013
Gross Profit
1,080,000
990,000
Divided by: Net sales
7,000,000
5,950,000
Gross profit ratio (in %)
15.43
16.64
2. Return on Sales (Profit Margin). It is the percentage of net profit to net sales. It measures the overall
profitability of the company, or how much is being brought to the bottom line. It is an income statement ratio
and a high profit margin indicates good cost control.
Return on Sales =
Net Income
Net Sales
Significance:
In general terms, net profitability shows the effectiveness of management or the firm’s capacity to face adverse
economic conditions such as price competition, low demand, etc. Obviously, the higher the ratio, the better is
the profitability.
Example:
Net Income
Divided by: Net sales
Return on Sales (in %)
3.
2014
224,000
7,000,000
3.20
2013
205,100
5,950,000
3.45
Total Assets Turnover. It measures a company's ability to use assets to generate sales.
Total assets turnover =
Net Sales
Average total assets
Significance: Although the ideal level for this ratio varies greatly, a very low figure may mean that the company
maintains too many assets or has not deployed its assets well, whereas a high figure means that the assets
have been used to produce good sales numbers.
Example:
2014
Net sales
7,000,000
Divided by: Ave. Total assets
(1,840,000 + 1,752,600)/2
1,796,300
Total Assets Turnover
3.90
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4.
Return on Assets. The return on total assets is a measure of how profitably assets have been employed. The
return on total assets attempts to measure what the return on total assets would be if the company had no
long-term debt in its capital structure. The after-tax interest expense is added back to net income to eliminate
the interest expense associated with debt. Return on assets (ROA) considers the return to investors on all
assets invested in the company.
Return on Total Assets =
Net income + [Interest Expense x (1- tax rate)]
Average total assets
Significance: A very low ROA usually indicates inefficient management, whereas a high ROA means efficient
management. However, this ratio can be distorted by depreciation or any unusual expenses.
Example:
2014
Net Income(224,000 + 42,000)
266,000
Divided by: Ave. Total assets
(1,840,000 + 1,752,600)/2
1,796,300
Return on Total Assets
.15 or 14.8%
5. Return on Equity. Return on common equity (or return on equity, ROE) is the most important measure of
profitability for investors. It represents the amount of income generated per peso of book value of equity or
common equity. It is a financial ratio which is monitored by financial analysts, business managers and investors
because it is an important metric showing how successful is the management of the company in creating value
for the business and its stakeholders
Return on Equity =
Return on Ordinary Equity =
Net income
Net income
– Preferred
dividends
Average
total equity
Average ordinary shareholders’ equity
Example:
Net Income
Divided by: Ave. Total equity
(930,000 + 1,012,600)/2
Return on Equity
6.
2014
224,000
971,300
.23 or 23.06%
Earnings per Share. The earnings per share is a good measure of profitability and when compared with EPS of
similar companies, it gives a view of the comparative earnings or earnings power of the firm. Earnings per
share is computed as follows:
Earnings per share =
Net income – Preferred dividends
Average No. of ordinary share outstanding
Significance: EPS ratio calculated for a number of years indicates whether or not the earning power of the
company has increased.
Example:
2014
Net Income
224,000
Divided by: Ave. No of ordinary shares
50,000
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Earnings per share
4.48
7. Price-Earnings Ratio. The relation between the market price of a share of stock and the stock’s current earnings
per share is often stated in terms of a price-earnings ratio. This ratio tells us how much investors are willing to
pay for a peso of current earnings. The price-earnings ratio is computed as follows:
Price earnings ratio =
Market price per share
Earnings per share (EPS)
Significance: The price-earnings ratio is widely used by investors as a general guideline in gauging stock values.
If the ratio is unusually high or low for a company in relation to its industry, an analyst may suspect that the
stock is overvalued or undervalued. In general, investors regard companies with higher price-earnings ratios as
being less risky and/or more likely to enjoy higher growth in the future.
8. Dividend Payout Ratio. The dividend payout ratio gauges the portion of current earnings being paid out in
dividends. This ratio is computed as follows:
Dividend payout ratio =
Dividend per share
Earnings per share (EPS)
Significance: A high or low dividend payout ratio is neither good nor bad taken by itself. A low payout ratio
may be an indication that the company has excellent internal investment opportunities and therefore foregoes
paying dividends.
Example:
2014
Dividend per share (P166,400/50,000sh)*
3.328
Divided by: Earnings per share
4.480
Dividend payout ratio
.74
*taken from the additional data under the cash flow statement of chapter 9
9. Dividend Yield Ratio. The dividend yield ratio is primarily of interest to retirees and other shareholders who
need a steady stream of cash income from their investments. Such shareholders “buy dividends” and compare
dividend yields to the returns they could earn on bonds and other fixed income securities. Historically some
shares’ dividends have been so reliable that investing in the stock is believed to be almost as safe as putting
money in the bank. The dividend yield ratio is computed as follows:
10. Book
Dividend per share
Value Per
Share.
The
book
value per share measures the amount that would be distributed to holders of each share of ordinary share if
all assets were sold at their balance sheet carrying amounts and if all creditors were paid off. The book value
per share is computed as follows:
Dividend yield ratio =
Market price per share
Book value per share =
Ordinary shareholders’ equity
No. of ordinary shares outstanding , end
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Significance: Because book values of assets can be quite out of date, this ratio is of limited use. The
denominator in this ratio is the number of common shares outstanding at the end of the year rather than the
average number of common shares outstanding.
Example:
2014
Ordinary shareholders’ equity
1,012,600
Divided by: No of ordinary shares
50,000
Book value per share
20.25
LIMITATIONS OF FINANCIAL STATEMENTS ANALYSIS
Financial statement analysis by means of horizontal, vertical and ratio analysis has several inherent limitations. The
analysts/users should bear them in mind in evaluating the performance and status of a single enterprise or of
several enterprises compared to each other. Some of these limitations are:
1. The results of analytical procedures applied emphasize only certain trends and changes in individual items
and relationships. The reason behind the trend or change is not provided. The analyst should investigate
further to answer the question - “Why”?
2.
Ratios and percentages are affected by any change in accounting procedures the company may have
adopted in the current period in relation to prior periods. Erroneous conclusions may be drawn from the
results of analysis unless the user of the information is aware of such changes.
3.
Conventional financial statements do not reflect the effects of changing price levels. Misperceptions can
result for the failure to account for the effects of inflation or deflation.
4.
Use of different accounting procedures by two or more companies will result in ratios and percentages
that are not comparable. Adjustments will have to be made if an intelligent comparison is to be made
regarding the performance and status of two or more companies. Comparability assumes the use of the
same accounting principles and procedures.
5.
Information reflected on financial statements is not exact and not final. Estimates and judgment are
applied by the accountant in measuring operating results and financial position. Thus, the financial report
is basically a mixture of facts and opinions. It follows that analytical data are intrinsically tentative in
character and single measurements should not be given too much weight and importance.
6.
Financial statements, which are the basis of financial analysis, are historical reports. They merely provide
a basis for predicting future events. Moreover, they only include matters that are capable of
quantification. Other vital information such as industry changes, management changes, competitors’
actions, technological developments, government actions and union activities are not provided by the
traditional financial statements.
INTERPRETATION
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Financial statement analysis is just one tool or means of interpreting intelligently financial data. It is a
guide so that users of the financial data can arrive at better decisions whether they are to invest, to lend, to keep
the investment or dispose of it, etc. To arrive at some informed conclusions however, the statement user must be
able to interpret the results of financial analysis. In other words, there should be a standard against which the
result of analysis could be compared. This standard may be summarized as follows:
1.
2.
3.
4.
Personal standards which are based on the analyst’s own experience and observation;
Budgeted standards which come from the company’s goals and plans as reflected on the budget;
Historical standards which refer to the company’s performance in the past; and
Rule of thumb standards which are general and obtained from other companies’ financial standards, trade
publication and published references.
As a summary, the following steps make up the steps in financial statement analysis.
1. Identify the economic characteristics and competitive dynamics of the industry in which a particular
firm participates.
2. Identify the strategies the firm pursues to gain and sustain a competitive advantage.
3. Assess the quality of the firm’s financial statements and, if necessary, adjust them for such desirable
characteristics as sustainability or comparability
4. Analyze the current profitability and risk of the firm using information in the financial statements.
5. Prepare forecasted financial statements.
6. Value the firm.
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DISCUSSION QUESTIONS
1. In financial statement analysis, what is the basic objective of observing trends in data and ratios?
2. Distinguish between trend percentages and component percentages. Which would be better suited for
analyzing the change in sales over a term of several years?
3. What is the quick ratio? Under what circumstances are short-term creditors most likely to regard a company’s
quick ratio as more meaningful than its current ratio?
4. Identify the ratios or other analytical tools used to evaluate profitability. Explain briefly how each is computed.
5. Net sales of Major General Store have been increasing at a reasonable rate, but net income has been declining
steadily as a percentage of these sales. What appears to be the problem?
6. Why might earnings per share be more significant to a shareholder in a large corporation than the total amount
of net income?
7. ABC Co. has a current ratio of 3 to 1. Ono Corp. has a current ratio of 2 to 1. Does this mean that ABC’s operating
cycle is longer than Ono’s? Why?
8. Assume that Congress announces its intention to limit the prices and profits of pharmaceutical companies as
part of an effort to control health care costs. What effect would expect this announcement to have on the
price-earnings ratios and stock prices of pharmaceutical companies such as GlaxoSmithKline? Explain.
9. Spencer Company earned a 16 percent return on its total assets. Current liabilities are 10 percent of total
assets. Long-term bonds carrying an 11 percent coupon rate are equal to 30 percent of total assets. There are
no preferential shares. Is this application of leverage favorable or unfavorable from the viewpoint of Spencer’s
shareholders?
10. An investor states, “I bought this share for P50 several years ago and it now sells for P100. It paid P5 per share
in dividends last year so I’m earning 10 percent on my investment. Evaluate this statement.
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Name:
Date:
Professor:
Schedule:
Score:
A THEORIES
T10-1A: MATCHING TYPE

Match the items below by entering the appropriate letter code in the space provided.
A. Receivable turnover
K. Current ratio
B. Leverage ratios
L. Inter-comparability
C. Intra-comparability
M. Acid-test ratio
D. Price earnings ratio
N. Vertical analysis
E. Solvency
O. Asset Turnover
F. Return on Equity
P. Debt to Equity ratio
G. Horizontal analysis
Q. Dividend yield ratio
H. Inventory Turnover
R. Liquidity
I. Book value per share
S. Return on sales
J. Gross profit ratio
T. Efficiency ratios
_______1.
A technique to evaluate each item in a financial statement as a percent of a base amount or
item.
_______2. It is the ability of a business to meet long term obligations.
_______3. It measures the amount of sales generated by each peso of asset.
_______4. A ratio that shows how much an investor is willing to pay for each peso of earnings given the
actual market price.
_______5. The proportion of assets provided by creditors compared to that provided by owners.
_______6. It is the ability of a company to convert receivables to cash measured by the number of
collection cycles.
_______7. It is a measure of the average number of times a company’s inventory has been sold during a
year.
_______8. It is the percentage of net profit to net sales.
_______9. Comparisons with other companies.
_______10. It is also known as working capital ratio.
_______11. A measure of long-term solvency.
_______12. The most important measure of profitability for investors
_______13. It is primarily of interest to retirees and other shareholders who need a steady stream of
cash income from their investments
_______14. It is an analytical method by which comparative statements are presented to show changes
in each item for different periods.
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_______15. It is a more rigorous test of a company’s ability to meet its short-term debts
Name:
Date:
Professor:
Schedule:
Score:
T10-2A: COMPLETION STATEMENTS
Identify the appropriate term/s that will best complete the individual statements.
1. Statements that express all items in a particular financial statement as a percentage of some common
base are called_________________________ statements.
2. Basic EPS is calculated as net income minus ____________________________divided by the weighted
average number of shares outstanding.
3. The book value per share measures the amount that would be distributed to holders of each
______________________share.
4.
The three basic approaches often used to compare financial statements are:_____________________,
______________________ and ______________________.
5. The quick ratio is computed as current assets
_________________________ divided by current liabilities.
less
_______________________
and
6. Return on assets is defined as _______________________ divided by total average assets.
7. The times-interest-earned ratio is computed as earnings before ___________________ and
_______________________ divided interest expense.
8. Debt to asset ratio is _______________________ liabilities over total assets.
9. Ratio analysis is an indicator of ___________________________,
__________________________________ and ______________________.
____________________,
10. As a limitation of financial statement analysis, financial statements are ___________________ reports.
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Name:
Date:
Professor:
Schedule:
Score:
T10-3A: TRUE OR FALSE
On the space provided, write TRUE if the statement is correct, if incorrect, write FALSE.
___________1.
___________2.
___________3.
___________4.
___________5.
___________6.
___________7.
___________8.
___________9.
___________10.
___________11.
___________12.
___________13.
___________14.
___________15.
___________16.
Financial statements that reflect financial data for two or more periods are often referred
to as comparative statements.
Development of data that measure changes occurring from one accounting period to
another is a form of horizontal analysis
A common-size income statement usually shows each revenue or expense item as a
percentage of net sales.
Comparability between enterprises is more difficult to obtain than comparability within a
single enterprise.
Generally, the first concern of a financial analyst is a firm’s liquidity.
The acid test ratio is regarded primarily as a measure of a company’s long term liquidity
situation
The accounts receivable turnover is both a measure of liquidity and a measure of activity.
Normally a relatively low inventory turnover is desirable.
The price earnings ratio is a measure of the relative attractiveness of ordinary shares as an
investment.
Horizontal analysis is a technique to compare company’s financial condition over a period
of time.
When calculating the return on assets, you should use average total assets.
If a company has no liabilities, its return on equity will equal its return on assets.
Inventory turnover is generally a more important ratio for a manufacturing firm than a
service firm.
Common-size statements are useful for intercompany comparisons.
Profitability ratios show the combined effects of liquidity, asset management, and debt
management on operations.
If a firm has high current and quick ratios, this is always a good indication that a firm is
managing its liquidity position well.
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Name:
Date:
Professor:
Schedule:
Score:
T10-4A: MULTIPLE CHOICE - CONCEPTUAL
Select the letter of the best possible answer to each of the following items.
_____1.
Which of the following statements concerning financial ratios is incorrect?
A. Accounting principles and methods used by a company will not affect financial ratios.
B. The informational value of a ratio in isolation is limited.
C. A ratio is one number expressed as a percentage or fraction of another number.
D. Calculation of financial ratios is not sufficient for a complete financial analysis of a company.
_____2.
Which of the following statements is correct?
A. All other things being equal, the more efficiently a company utilizes its assets, the greater will
be its return on investment.
B. All other things being equal, if return on equity increases, the return on assets must have also
increased.
C. All other things being equal, if the number of days inventory held increases, the return on
assets will increase.
D. All other things being equal, if the gross margin decreases, the inventory turnover must have
increased.
_____3.
Liquidity of a company is generally defined as a measure of:
A. the ability of a company to pay its employees in a timely manner
B. the ability to pay interest and principal on all debt
C. the ability to pay dividends
D. the ability to pay current liabilities
_____4.
Which of the following ratios is not generally considered to be helpful in assessing short-term liquidity?
A. Acid-test ratio
B. Current ratio
C. Days' to collect receivable
D. Total asset turnover
_____5.
While determining the most profitable company from the given number of companies, which of the
following would be the best indicator of relative profitability?
A. Highest net income
B. Highest retained earnings
C. Highest return on equity
D. Highest operating margin
Other things held constant, which of the following will not affect the current ratio, assuming an initial
current ratio greater than 1.0?
_____6.
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21
A.
B.
C.
D.
E.
Fixed assets are sold for cash.
Long-term debt is issued to pay off current liabilities.
Accounts receivable are collected.
Cash is used to pay off accounts payable.
A bank loan is obtained, and the proceeds are credited to the firm's checking account.
_____7.
Which of the following actions can a firm take to increase its current ratio?
A. Issue short-term debt and use the proceeds to buy back long-term debt with a maturity of
more than one year.
B. Reduce the company’s days sales outstanding to the industry average and use the resulting
cash savings to purchase plant and equipment.
C. Use cash to purchase additional inventory.
D. Statements A and B are correct.
E. None of the statements above is correct.
_____8.
Earnings per share is affected by
A. net income
B. number of shares
C. dividends
D. A & B only
E. A, B & C
_____9.
A firm is considering actions which will raise its debt ratio. It is anticipated that these actions will have
no effect on sales, operating income, or on the firm’s total assets. If the firm does increase its debt ratio,
which of the following will occur?
A. Return on assets will increase.
B. Basic earning power will decrease.
C. Times interest earned will increase.
D. Profit margin will decrease.
E. Total assets turnover will increase.
_____10. Five areas that financial ratios concentrate on are:
A. liquidity, profitability, debt, efficiency, market related;
B. profitability, strategy, liquidity, auditing, share prices;
C. liquidity, current ratio, quick ratio, interest cover, dividend cover;
D. market related, share prices, dividend policy, debt policy, strategy
E. none of the above
Name:
Date:
Score:
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Professor:
Schedule:
B EXERCISES

E10-1B: (Horizontal analysis – Increase /Decrease
Method)
Following is the comparative statement of financial position of SPINACH Company:
SPINACH COMPANY
Comparative Statement of Financial Position
December 31, 2014 and 2013
(in thousands of pesos)
Current Assets
Plant Assets
Total Assets
Assets
2013
P 440
675
P1,115
2012
P 280
520
P 800
Liabilities and Shareholders' Equity
Current Liabilities
Long-term Debt
Ordinary Share
Accumulated Profits
Total liabilities and Shareholders' Equity
P 280
250
325
260
P1,115
P 120
160
320
200
P 800
Instruction: Perform a horizontal analysis of SPINACH Company’s financial statement. Show the increases and
decreases in each account in absolute peso values and percentages. Use the format provided.
SPINACH COMPANY
Comparative Statement of Financial Position
December 31, 2014 and 2013
(in thousands of pesos)
Assets
Current Assets
Plant Assets
Total Assets
Liabilities and Shareholders' Equity
Current Liabilities
Long-term Debt
Ordinary Share
Accumulated Profits
Total liabilities and Shareholders' Equity
Name:
Year
2013
2012
P 440
P 280
675
520
P1,115
P 800
P 280
250
325
260
P1,115
Date:
Increase (Decrease)
Amount
%
P 120
160
320
200
P 800
Score:
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Professor:
Schedule:
E10-2B: (Horizontal analysis – Trend Percentages)
RADDISH Company's sales and current assets have been reported as follows over the last four years:
Year 4
P800,000
94,880
35,000
75,000
78,000
47,000
235,000
Sales
Net Income
Cash
Accounts Receivable
Inventory
Prepaid Expenses
Total Current Assets
Year 3
P700,000
92,050
30,000
50,000
75,000
39,000
194,000
Year 2
P600,000
74,400
24,000
58,000
80,000
11,000
173,000
Year 1
P570,000
68,400
18,000
45,000
75,000
25,000
163,000
Instruction:
A. Compute for the trend percentages of the selected data for RADDISH Company.
YEAR 4
YEAR 3
YEAR 2
YEAR 1
Sales
Net income
Cash
Accounts Receivable
Inventory
Prepaid expenses
Total current assets
B.
Name:
Compare the years’ results and make an evaluation on which is the best year. Explain your answer.
Date:
Score:
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Professor:
Schedule:
E10-3B: (Vertical Analysis)
Following is the comparative income statement of CABBAGE Company:
Cabbage Company
Income Statement
For the years ended December 31, 2014 and 2013
Net sales
Cost of goods sold
Gross profit
Selling expenses
Administrative expenses
Total operating expenses
Income before income tax
Income tax
Net income
2014
P 800,000
(350,000)
P 450,000
(P150,000)
(37,000)
(P187,000)
P 263,000
(40,000)
P 223,000
2013
P 700,000
(320,000)
P 380,000
(P110,000)
(20,000)
(P130,000)
P 250,000
(32,000)
P 218,000
Instruction: Perform a vertical analysis on the financial statements of Cabbage Company. Convert all income
statement accounts to common units, using net sales as the base. Use the format provided.
Cabbage Company
Income Statement
For the years ended December 31, 2014 and 2013
Net sales
Cost of goods sold
Gross profit
Selling expenses
Administrative expenses
Total operating expenses
Income before income tax
Income tax
Net income
Name:
2014
Amount
Percent
P 800,000
(350,000)
P 450,000
(P150,000)
(37,000)
(P187,000)
P 263,000
(40,000)
P 223,000
Date:
2013
Amount
Percent
P 700,000
(320,000)
P 380,000
(P110,000)
(20,000)
(P130,000)
P 250,000
(32,000)
P 218,000
Score:
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Professor:
Schedule:
E10-4B: (Indicators of Profitability)
Selected data from the STRINGBEANS Company at year end are presented below:
Total assets
Average total assets
Net income
Net sales
Average ordinary share capital
Net cash provided by operating activities
Ordinary Shares of outstanding
P2,000,000
2,200,000
250,000
1,300,000
1,000,000
275,000
10,000
Instruction: Determine the following:
A. Return on Sales
B. Return on Assets
C. Return on Ordinary Equity
A. RETURN ON SALES
1
1
2
2
3
3
4
4
B. RETURN ON ASSETS
1
1
2
2
3
3
4
4
C. RETURN ON ORDINARY EQUITY
1
1
2
2
3
3
4
4
Name:
Date:
Score:
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Professor:
Schedule:
E10-5B: (Indicators of Liquidity and Leverage)
Financial statements of CARROTS Corporation are reproduced below. The market price of Carrot’s ordinary share
was P20 per share on November 30, Year 2.
Carrots Corporation
Statement of Financial Position
As of November 30
(in thousands of pesos)
Year 2
Cash
P 3,000
Trading securities
1,000
Accounts receivable (net)
14,000
Merchandise inventory
24,000
Total current assets
P 42,000
Property, plant, and equipment (net)
68,000
Long-term investments
10,000
Total assets
P120,000
Year 1
P 2,000
1,000
11,000
16,000
P 30,000
60,000
10,000
P100,000
Accounts payable
Wages payable
Total current liabilities
Bonds payable, 10%
Total liabilities
Ordinary share capital, no par, 10,000,000 shares
Accumulated profits
Total shareholders’ equity
Total liabilities and shareholders’ equity
P 4,000
1,000
P 5,000
20,000
P 25,000
P 25,000
50,000
P 75,000
P100,000
P 5,000
1,000
P 6,000
20,000
P 26,000
P 25,000
69,000
P 94,000
P120,000
Carrots Corporation
Statement of Income
For the Year Ended November 30, Year 2
(in thousands of pesos)
Sales (all on credit)
Cost of goods sold
Gross margin
Operating expenses
Net operating income
Interest expense
Net income before income tax
Income tax expense
Net income
Name:
P200,000
(120,000)
80,000
(38,000)
42,000
(2,000)
40,000
(15,000)
P 25,000
Date:
Score:
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Professor:
Schedule:
Instruction: Determine the following for Carrots Corporation
A.
B.
C.
D.
E.
Current Ratio
Acid-test ratio
Inventory turnover
Days’ supply in inventory
Receivable turnover
F. Average collection period
G. Times interest earned
H. Debt to asset ratio
I. Debt-to-equity
A. CURRENT RATIO
1
1
2
2
3
3
4
4
B. ACID-TEST RATIO
1
1
2
2
3
3
4
4
C. INVENTORY TURNOVER
1
1
2
2
3
3
4
4
D. DAYS SUPPLY IN INVENTORY
1
1
2
2
3
3
4
4
E. RECEIVABLE TURNOVER
1
1
2
2
3
3
4
4
Name:
Date:
Score:
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Professor:
Schedule:
F. AVERAGE COLLECTION PERIOD
1
1
2
2
3
3
4
4
G. TIMES-INTEREST-EARNED RATIO
1
1
2
2
3
3
4
4
H. DEBT TO ASSET RATIIO
1
1
2
2
3
3
4
4
I. DEBT TO EQUITY
1
1
2
2
3
3
4
4
E10-6B: (Indicators of Profitability/Growth)
Selected data for LETTUCE Company follow:
Preference share, par value P50, 10% ..............................
Ordinary share, par value P20 ..........................................
Share premium – ordinary share......................................
Retained earnings .............................................................
Net income .......................................................................
Dividends on preference share ........................................
Dividends on ordinary share ............................................
Market price per share, Dec 31 ........................................
Instruction:
A.
B.
C.
Determine the following
Price-earnings ratio
Dividend yield ratio
Payout ratio
Year 2
P100,000
400,000
100,000
140,000
80,000
10,000
50,000
28.00
Year 1
P100,000
400,000
100,000
120,000
60,000
10,000
40,000
21.00
D. Return of Equity
E. Book value per share
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Name:
Date:
Professor:
Schedule:
Score:
A. PRICE EARNINGS RATIO
1
1
2
2
3
3
4
4
B. DIVIDEND YIELD RATIO
1
1
2
2
3
3
4
4
C. DIVIDEND PAY-OUT RATIIO
1
1
2
2
3
3
4
4
D. RETURN ON EQUITY
1
1
2
2
3
3
4
4
E. BOOK VALUE PER SHARE
1
1
2
2
3
3
4
4
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C PROBLEMS
P10-1C: MULTIPLE CHOICE - PROBLEMS 
1. During the year ELLE Company purchased P400,000 of inventory. The inventory balance at the beginning of the
year was P150,000 and the cost of goods sold for the year was P425,000. The inventory turnover for the year
was:
A. 2.83
B. 2.91
C. 3.09
D. 3.40
2. EM Co.'s budgeted sales and budgeted cost of sales for the coming year are P212,000,000 and P132,500,000
respectively. Short-term interest rates are expected to be 5%. Assume that all inventories must be financed
with short-term debt. If EM could increase inventory turnover from its current 8 times per year to 10 times per
year, its expected interest cost savings in the current year would be:
A. P0
B. P81,812
C. P165,625
D. P331,250
3. ENN Corporation has interest expense of P16,000, sales of P600,000, a tax rate of 30%, and after-tax net income
of P56,000. What is the firm's times-interest-earned ratio?
A. 6.0
B. 5.0
C. 4.5
D. 3.5
4. OHW Company's debt to equity ratio is 0.6. Current liabilities are P120,000, long term liabilities are P360,000,
and working capital is P140,000. Total assets of the company must be:
A. P 600,000
B. P 800,000
C. P1,200,000
D. P1,280,000
5. The accounts receivable for PEA Company was P140,000 at the beginning of the year and P180,000 at the end
of the year. The accounts receivable turnover for the year was 8.5 and 15% of total sales were cash sales. The
total sales for the year were:
A. P1,400,000
B. P1,360,000
C. P1,600,000
D. P1,800,000
6. The QYU, Inc. has sales of P5 million per year (all credit) and an average collection period of 35 days. What is
its average amount of accounts receivable outstanding?
A. P479,452
C. P150,000
B. P142,857
D. P500,000
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31
7. AHR Company has provided the following data: Inventory and prepaid expenses, P35,000; Current ratio, 2.2;
Acid-test ratio 1.5. AHR Company's current liabilities were:
A. P40,000
B. P50,000
C. P63,000
D. P44,100
8. ESS Company's current liabilities are P50,000, its long-term liabilities are P150,000, and its working capital is
P80,000. If ESS Company's debt-to-equity ratio is 0.32, its total long-term assets must equal:
A. P625,000
B. P745,000
C. P825,000
D. P695,000
9. The market price per share of TEE Co. stock at the beginning of the year was P60.00 and at the end of the year
was P72.00. Net income for the year was P48,000. Dividends to the preferred stockholders for the year totaled
P12,000, and dividends of P2.50 per share were paid on the 6,000 shares of common stock outstanding during
the year. The price-earnings ratio at year end was:
A. 6
B. 10
C. 11
D. 12
10. YOU Company has 40,000 shares of common stock outstanding that it originally issued for P30 per share. The
following data pertains to these shares for the most recent year: Book value, December 31 – P60 per share;
Market value, January 1 – P75 per share; Market value, December 31 – P80 per share. The total dividend on
common stock was P360,000. The dividend yield ratio for the year was:
A. 11.25%
B. 12.00%
C. 15.00%
D. 30.00%
11. As a short-term creditor concerned with a company's ability to meet its financial obligation to you, which one
of the following combinations of ratios would you most likely prefer?
Current ratio
TIE
Debt Ratio
A.
0.5
0.5
0.33
B.
1.0
1.0
0.50
C.
1.5
1.5
0.50
D.
2.0
1.0
0.67
E.
2.5
0.5
0.71
P10-2C: (Effects of Management Decisions on Ratios)
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Most decisions made by management impact the ratios analysts use to evaluate performance. Instruction:
Indicate(by letter) whether each of the actions listed below will immediately increase (I), decrease(D), or have no
effect (N) on the ratios shown. Assume each ratio is less than 1.0 before the action is taken.
ACTION
CURRENT
RATIO
ACID-TEST
RATIO
DEBT TO
EQUITY
Issuance of long-term bonds
Issuance of short-term notes
Payment of accounts payable
Purchase of inventory on account
Purchase of inventory for cash
Purchase of equipment with a four-year note
Retirement of bonds
Sale of common shares
Write-off of obsolete inventory
Purchase of short-term investment for cash
Decision to refinance on a long-term basis
some currently maturing debt
Issuance of treasury shares
Collection of accounts receivables
Paid in advance rent
Rendered services for cash
P10-3C: (Horizontal analysis – Increase /Decrease Method)
Financial statements for SUGARBEETS Corporation are presented below. The market price of Sugarbeets' ordinary
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share was P25 per share on December 31, 2014. During 2014, dividends of P2 million were paid to preference
shareholders and P10 million to ordinary shareholders.
SUGARBEETS Corporation
Comparative Statement of Financial Position
December 31, 2014 and 2013
(in thousands of pesos)
Assets
Current assets:
Cash ..........................................................................................
Trading securities .....................................................................
Accounts receivable (net) ........................................................
Inventory ..................................................................................
Total current assets .....................................................................
Non-Current assets:
Property, plant, and equipment (net) ......................................
Long-term investments ............................................................
Total assets ..................................................................................
Liabilities and Shareholders’ Equity
Current liabilities:
Accounts payable .....................................................................
Wages payable .........................................................................
Total current liabilities .................................................................
Non-current liabilities:
Bonds payable, 10% .................................................................
Total liabilities..............................................................................
Shareholders’ equity:
Preference shares, 10%, 1,000,000 shares ..............................
Ordinary shares, 5,000,000 shares, no par ..............................
Accumulated profits .................................................................
Total shareholders’ equity ...........................................................
Total liabilities and shareholders’ equity.....................................
2014
2013
P 4,000
2,000
20,000
28,000
P 54,000
P 3,600
1,200
16,800
28,800
P 50,400
75,000
12,000
P141,000
81,600
12,000
P144,000
P 7,000
1,000
P 8,000
P 6,000
1,200
P 7,200
24,000
P 32,000
24,000
P 31,200
P 20,000
30,000
59,000
P109,000
P141,000
P 20,000
30,000
62,800
P112,800
P144,000
SUGARBEETS Corporation
Comparative Income Statement
For the years ended December 31, 2014 and 2013
(in thousands of pesos)
2013
2012
Sales (all on credit) ......................................................................
P280,000
P280,000
Cost of goods sold .......................................................................
(200,000)
(168,000)
Gross margin ...............................................................................
P 80,000
P112,000
Operating expenses.....................................................................
(40,000)
(38,000)
Net operating income .................................................................
P 40,000
P 74,000
Interest expense ..........................................................................
(5,000)
(4,000)
Net income before income tax ....................................................
P 35,000
P 70,000
Income tax expense.....................................................................
(14,000)
(28,000)
Net income ..................................................................................
P 21,000
P 42,000
Instruction: Perform a horizontal analysis on SUGARBEETS Corporation’s financial statements. Show the
increases and decreases in each account in absolute peso values and percentages.
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P10-4C: (Vertical analysis / Decision making)
Instruction:
A.
Perform a vertical analysis on the financial statements of SUGARBEETS Corporation. Convert all income
statement and statement of financial position accounts to common units, using net sales and total assets
as the base.
B.
Based on the horizontal and vertical analysis made, evaluate which year Sugarbeets performed better.
P10-5C: (Financial Ratios)
Financial statements for BITTERGOURD Company appear below:
BITTERGOURD Company
Income Statement
For the Year Ended December 31, 2014
(in thousands of pesos)
Sales (all on account) ........................................................
Cost of goods sold.............................................................
Gross margin .....................................................................
Operating expenses ..........................................................
Net operating income .......................................................
Interest expense ...............................................................
Net income before taxes ..................................................
Income taxes (30%) ..........................................................
Net income .......................................................................
P 2,000
(1,400)
P 600
(240)
P 360
(50)
P 310
(93)
P 217
BITTERGOURD Company
Statement of Financial Position
December 31, 2014 and 2013
(in thousands of pesos)
Assets
Current assets:
Cash and Cash equivalents..........................................
Accounts receivable, net.............................................
Inventory .....................................................................
Prepaid expenses ........................................................
Total current assets ........................................................
Noncurrent assets:
Plant & equipment, net ..................................................
Total assets .....................................................................
Liabilities and Shareholders’ Equity
Current liabilities:
Accounts payable ........................................................
2014
2013
P 140
120
100
50
P 410
P 130
110
110
40
P 390
1,840
P2,250
1,830
P2,220
P 100
P 100
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Accrued liabilities ........................................................
Notes payable, short term ..........................................
Total current liabilities....................................................
Noncurrent liabilities:
Bonds payable .............................................................
Total liabilities ................................................................
Shareholders’ equity:
Preference share capital,P5 par, 5% ...........................
Ordinary share capital, P10 par ..................................
Share premium - ordinary ...........................................
Accumulated profits....................................................
Total shareholders’ equity..............................................
Total liabilities & shareholders’ equity ...........................
80
210
P 390
80
230
P 410
460
P 850
500
P 910
P 100
200
260
840
P1,400
P2,250
P 100
200
260
750
P1,310
P2,220
Dividends during 2014 totaled P127,000, of which P5,000 were preference dividends. The market price of an
ordinary share on December 31, 2014 was P140.
Instruction: Compute the following for 2014:
1. Earnings per share of common stock ordinary share
9. Current ratio
2. Price-earnings ratio
10. Acid-test ratio
3. Dividend payout ratio
11. Accounts receivable turnover
4. Dividend yield ratio
12. Average collection period
5. Return on total assets
13. Inventory turnover
6. Return on shareholders’ equity
14. Average sales period
7. Book value per share
15. Times interest earned
8. Working capital ratio?
16. Debt-to-equity ratio
P10-6C: (Liquidity Ratios)
The following data are taken from the balance sheet at the end of the current year.
Accounts payable
Accounts receivable
Accrued liabilities
Cash
Income tax payable
Inventory
Marketable securities
Notes payable, short-term
Prepaid expenses
P245,000
210,000
4,000
90,000
10,000
240,000
350,000
85,000
15,000
Instruction:
Determine the (A) working capital, (B) current ratio, and (C) quick ratio. Present figures used in your computations.
Round ratios to the nearest tenth
P10-7C: (Interpretation of Ratios)
Instructions: Compute for the missing information. Underline the best choice within the statements.
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For each company listed below, compute the debt ratio, which reveals the proportion of assets financed with debt.
Debt ratio = Total liabilities / Total assets
($ in millions)
Date
Total Assets Total Liabilities Debt Ratio
Microsoft (MSFT)
6/30/2008
$
72,793
$
36,507
50.15%
Wal-Mart Stores (WMT)
1/31/2009
$ 163,429
$
98,144
?
Ford Motor Company (F)
12/31/2008
$ 218,328
$ 235,639
?

Wal-Mart is primarily financed with (debt / equity), resulting in a debt ratio that is (less / more) than
50.00%, while a company primarily financed with equity will have a debt ratio that is (less / more) than
50.00%. Ford has a debt ratio greater than (50% / 100%), indicating its liabilities are (greater / less)
than its assets.
For each company listed below, compute Return on Sales (ROS), which reveals the portion of each revenue dollar
that results in profit. ROS = Net income / Sales revenue
($ in millions)
Year Ended
Revenue
Net Income
ROS
Microsoft (MSFT)
6/30/2008
$ 60,420
$
17,681
29.26%
Wal-Mart Stores
(WM
1/31/2009
$ 405,607
$
13,400
?
T)
Ford Motor Company
12/31/2008
$ 146,277
$ (14,672)
?
(F)

Wal-Mart Stores has (greater / less) revenue than Microsoft, but Microsoft has a (higher / lower) ROS
ratio than Wal-Mart. The ROS ratio for Microsoft indicates ________of every revenue dollar resulted in
profit (net income), but for Wal-Mart Stores only _________ of every revenue dollar resulted in profit.
Ford Motor Company reports a (positive / negative) ROS, indicating (revenue / net income) is negative.

The corporation with the strongest ROS ratio is (MSFT / WMT / F).
For each company listed below, compute Asset Turnover, which reveals how efficiently assets are used to generate
revenue. Asset Turnover = Sales Revenue / Total Assets
($ in millions)
Year Ended
Revenue
Total Assets
Asset Turnover
Microsoft (MSFT)
6/30/2008
$ 60,420
$ 72,793
0.8300
Wal-Mart Stores
(
W
1/31/2009
$ 405,607
$ 163,429
?
M
T)
Ford Motor
Co
m
12/31/2008
$ 146,277
$ 218,328
?
pa
ny
(F)
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 The asset turnover ratios computed above are in the range (less than 3 / 3 or more).
 (MSFT / WMT / F) has the strongest asset turnover, indicating the company makes profits by
generating a large volume of revenue using relatively few assets. Wal-Mart generates
_________ in revenue for every $1 invested in assets.
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