FINANCIAL STATEMENT ANALYSIS

INTRODUCTION
Financial statement analysis attempts to evaluate a business entity for financial and
management decision-making purposes. It explores some aspect of a firm’s profitability or its
Izon
risk, s t-term and long-term liquidity or both. It attempts to measure the firm’s
operational efficiency and investment provided by the owners and creditors.

A complete set of financial statements, as explained previously, includes the balance

sheet, income statement, statement of changes in owner’s equity and statement of cash flows.
The first two are important in financial analysis. The various financial statement analysis
tools that used in evaluating the firm's present and future financial condition will be
discussed. These tools include horizontal, vertical, and ratio analysis, which give relative
measures of the performance and financial condition of the company.

Lesson 1 Interested Parties to the Financial Statements

 The analysis of financial statements means different things to different people. It is of
interest to creditors, present and prospective investors, and the firm's own management.

A creditor is primarily interested in the firm's debt-paying ability. A short-term

creditor, such as a vendor or supplier is ultimately concerned with the firm's ability to pay its
bills and therefore wants to be assured that the firm is liquid. A long-term creditor such as a
bank or bondholder, on the other hand, is interested in the firm's ability to repay interest and
principal on borrowed funds.

An investor is interested in the present and future level of return (earnings) and risk
(liquidity, debt, and activity). You, as an investor, evaluate a firm's stock based on an
examination of its financial statements. This evaluation considers overall financial health,
economic and political conditions, industry factors, and future outlook of the company. The
analysis attempts to ascertain whether the stock is overpriced, underpriced, or priced in
proportion to its market value. A stock is valuable to you only if you can predict the future
financial performance of the business. Financial statement analysis gives you much of the
data you will need to forecast earnings and dividends.

Management must relate the analysis to all of the questions raised by creditors and
investors, since these interested parties must be satisfied for the firm to obtain capital as
needed.

Lesson 2 Major Tools of Financial Statement Analysis

1. Comparative Statements- The presentation of financial information for current and prior
periods, which allows the statement user to compare changes in the individual items.
2. Horizontal Analysis- The presentation of financial statement data on a percentage basis over
time. An index value of 100 is assigned to each particular base year. In succeeding years, the
peso/dollar amount of each item is divided by the peso/dollar amount of the same item in
base year. The result is the presentation of the relative growth or decline of each item in terms
of the base year.
3. Vertical Analysis- The presentation of each item on a financial statement as a percentage of
an appropriate base amount. Statements presented in this form are known as Common-size
Statements. In an income statement, the base amount is Total Net Sales expressed as 100%.
In the balance sheet, the base amount is Total Assets or Total Liabilities and Owner’s Equity
expressed also as 100%.
4. Ratio Analysis- It provides an indication of a firm’s financial strengths and weaknesses and
should generally be used in conjunction with other evaluation techniques. Ratios are useful
tools of financial statement analysis because they summarize data in a form easy to
understand, interpret, and compare.
Key Terms
Working Capital The excess of current assets over current liabilities.
Common-Size Statement A statement that show the items appearing in
percentages rather than in peso/dollar denomination.
Trend Percentages The expression of several years’ financial datat in
percentage form in terms of a base year.
Financial leverage the financing of assets in a company with funds that
have been acquired from creditors of from
 preference stockholders at affixed rate of return.This
is often referred to as Trading on Equity.
Cash flow to Total Debt Cash flow is defined as Net Income plus
depreciation, amortization, and depletion. Total debt
is defined as Total Liabilities plus Preference Stock.

Lesson 3 What Are Comparative Financial Statements?

Preparing Comparative Financial Statements is the most commonly used technique

for analyzing financial statements. This technique determines the profitability and financial
position of a business by comparing financial statements for two or more time periods.
Hence, this technique is also termed as Horizontal Analysis. Typically, the income statements
and balance sheets are prepared in a comparative form to undertake such an analysis.

Furthermore, there is a provision attached to comparing the financial data showcased

by such statements. This relates to making use of the same accounting principles for
preparing each of the comparative statements. In case the same accounting principles are not
followed to prepare such statements, then the difference must be disclosed in the footnotes.
Comparative Balance Sheet and Income Statement
A comparative balance sheet showcases:
 Assets and liabilities of business for the previous year as well as the current year
 Changes (increase or decrease) in such assets and liabilities over the year both in
absolute and relative terms
Thus, a comparative balance sheet not only gives a picture of the assets and liabilities
in different accounting periods. It also reveals the extent to which the assets and liabilities
have changed during such periods.

Furthermore, such a statement helps managers and business owners to identify trends
in the various performance indicators of the underlying business.

What To Study While Analyzing A Comparative Balance Sheet?

A business owner or a financial manager should study the following aspects of a

comparative balance sheet:

1. Working Capital
Working capital refers to the excess of current assets over current
liabilities.This helps a financial manager or a business owner to know about the
liquidity position of the business.

2. Changes in Long-Term Assets, Liabilities, and Capital

The next component that a financial manager or a business owner needs to
analyze is the change in the fixed assets, long-term liabilities and capital of a
business. This analysis helps each of the stakeholders to understand the long-term
financial position of a business.
 3. Profitability
Working capital refers to the excess of current assets over current
liabilities.This helps a financial manager or a business owner to know about the
liquidity position of the business.
Steps To Prepare a Comparative Balance Sheet

1. Step 1 Firstly, specify absolute figures of assets and liabilities relating to the

accounting periods considered for analysis.

2. Step 2 Find out the absolute change in the items mentioned in the balance sheet.

This is done by subtracting the previous year’s item amounts from the current year

ones.
3. Step 3 Finally, calculate the percentage change in the assets and liabilities of the
current year relative to the previous year.
Percentage Change = (Absolute Increase or Decrease)/Absolute Figure of the
Previous Year’s Item) * 100
Figure 3.1 Horizontal analysis

Figure 3.2 Comparative income statement

Vertical Analysis
Vertical analysis is a kind of financial statement analysis wherein each item in the
financial statement is shown in percentage of the base figure. This is one of the popular
methods of financial statements used as it is simple and also called a common size analysis.
Here all the items in the income statement are stated as a percentage of gross sales. All the
items in the balance sheet are stated as a percentage of the total assets. Whereas the opposite
of the vertical analysis of financial statement is the Horizontal analysis always looks at the
amount from the financial statement over the horizon of many years.
In the vertical analysis of financial statements, the percentage is calculated by using
the below formula:
Vertical Analysis formula = Individual Item / Base Amount *100

To increase the effectiveness of vertical analysis multiple year’s statement or reports

can be compared and comparative analysis of statements can be done. This analysis makes
easier to compare the financial statements of one company with another and across the
companies as one can see the relative proportion of accounts.
Example of the vertical analysis of financial statement which shows the total in
amount and in percentage.
Where the

total sales of company A are $1000000 and

the cost of goods sold is $400000.
Salary paid to the workers of the company is
$300000 office rent paid is $30000
utilities worth $40000 and
other expenses are $60000.
 Vertical Analysis Formula = Individual Item / Total Sales * 100

Figure 3.3. Vertical analysis

The above vertical analysis example shows the net profit of the company where we
can see the net profit in both amount and percentage. Where the same report can be used to
compare with other industry. Where the income statement can be compared with previous
years and the net income can be compared where it helps to compare and understand the
percentage of rising or loss of income percentage.

The below vertical analysis example helps to understand the comparison.

Figure 3.4. Comparative vertical analysis

In the above vertical analysis example, we can see that the income decreases from
1  year to 2nd year and the income increases to 18% in the 3rd year. So by using this method, it
st

is easy to understand the net profit as it is easy to compare between the years. In that, we can
easily understand that the total expenses gradually increased from 43% to 52% and the net
income got reduced from 1st year to 2nd year. In the 3rd year, the COGS got decreased when
compared to the previous years and the income got increased.

Let us now calculate the Vertical Analysis of the Balance Sheet with the help of
another example.

Vertical Analysis Formula = Individual Item / Total Assets (Liabilities) * 100

Another illustration of vertical analysis:
Figure 3.5. Vertical analysis of income statement

Vertical analysis of financial statement provides a comparable percentage which can

be used to compare with the previous years.Different organization statements can be
compared as the comparison is made in percentage.
Vertical analysis is also very useful to compare the financial statements with the
previous year’s statement and analyze the profit or loss of the period. Where it helps to
understand the percentage/share of the individual items. Where it helps to understand the
structural composition of the various components like cost, expenses, assets, and liabilities.
The vertical analysis of financial statement does not help to take a firm decision as
there is no standard percentage or ratio regarding the change in the components of the income
statement or the balance sheet.
The accounting conventions are not followed vigilantly in the vertical analysis.
Liquidity of the organization cannot be measured exactly by using the analysis.
Quality analysis is not done by using vertical analysis of financial statements. As
there is no consistency in the ratio of the elements.
 This method is one of the easiest methods of analyzing the financial statement. This
method is easy to compare with the previous reports and easy to prepare. But this method is
not useful to make firm decision and measurement of the company value cannot be defined.

Lesson 4 Financial Ratios

Ratio analysis is a quantitative method of gaining insight into a company's liquidity,

operational efficiency, and profitability by studying its financial statements such as the
balance sheet and income statement.

Conclusions drawn from Ratio Analysis:

1. Short-term solvency- The ability of a firm to meet its current obligations as they
mature.
2. Long-term solvency- the ability of the firm to meet interest payments, preference
dividends, and other charges. Long-term solvency is a required precondition for
the repayment of the principal.
3. Operational efficiency- the ability of the business entity to generate income and
earn a satisfactory return on investments.
4. Profitability- the ability of the firm to generate income and earn satisfactory
returns to ordinary stockholders.
5. Investment analysis- measures total investment provided by stockholders and
resources provided by the creditors.

EVALUATION OF SHORT TERM SOLVENCY

RATIO FORMULA SIGNIFICANCE
Current Ratio Current Assets__ Measures ability to meet
Current Liabilities currently maturing obligations
from existing current assets.
Provides a more severe test of
Acid-Test or Quick Ratio Cash + Marketable Securities immediate solvency.
+Net Receivables Measures ability to discharge
Current Liabilities currently maturing obligations
based on most liquid (quick)
assets.
This will overcome the
Cash flow from Cash flow from Operations deficiency of Current Ratio
operations to Current Current Liabilities and Quick ratio if the current
Liabilities assets and quick assets are
unusually large or small. A
healthy ratio is 40% or more.

Receivable Turnover Net Credit Sales Confirms fairness of

Average Receivables* receivable balance. Provides
*Represent Trade Notes and an indication of the efficiency
Accounts Receivable (net) of credit policies and
collection.
No. of days in a year as
Age of Receivables given or 360 days
Receivable Turnover
 Or
Ending Accounts Receivable
Average Daily Sales
Inventory (FG) Turnover Cost of Goods Sold Measures relative control over
Average Inventory inventory management.

Raw Materials Turnover Cost of Raw Materials Used Measure relative control over
Ave. Raw Materials Invtry inventory investment.

Day’s Supply of No. of days in the year as Indicates the number of days
inventory given or 360 days inventory is held for sale.
Inventory Turnover Reflects on efficiency of
Or inventory policies.
Ending Inventory
Average Daily Cost of Goods Sold

Working Capital Net Sales Measures of adequacy and

Turnover Average Working Capital effective use of working
capital.
WC= CA- CL

Current Asset Turnover Net Sales Provides an indication of the

Average Current Assets reasonableness of the amount.
Or
Cost of Goods Sold + Operating
Expenses (excluding Depreciation)
Average Current Assets

EVALUATION OF LONG-TERM SOLVENCY

RATIO FORMULA SIGNIFICANCE
Measures the proportion of
Debt Ratio or Debt to Asset Ratio Total Liabilities debt in a company’s capital
Total Assets structure
Measures the relative amount
Debt to Equity Ratio Total Liabilities of resources provided by
Shareholders’ Equity owners and creditors. Indicates
extent of leverage used and
creditor protection in case of
insolvency.
This will overcome the
Cash Flow from Operations to Total Cash Flow from deficiency of debt to equity
Liabilities Operations ratio that do not consider the
Average Total availability of Cash to cover
Liabilities various levels of debt. A 20%
ratio or more is a healthy sign.

Times Interest Earned Income before Interest Measures ability of the firm to
 Expense and meet interest payments.
Income Taxes
Interest Expense

Times Preferred Dividends Earned Net Income Measures the adequacy of

Annual Preferred current earnings for the
Dividend payment of preferred
Requirement dividends.

EVALUATION OF OPERATIONAL EFFICIENCY

RATIO FORMULA SIGNIFICANCE

Gross Profit Ratio Gross Margin Indicates the average mark-up

Net Sales available to cover Selling and
Administrative expenses.

Profit Margin Ratio Net Income Measures efficiency of earning

Net Sales net income from sales.

Return on Total Assets Net Income + Interest Measures the productivity of

Expense (Net of Tax assets to generate income.
Average Total Assets

Return on Owners’ Equity Net Income Measures rate of earnings on

Shareholders’ Equity resources provided by owners.

Asset Turnover Ratio Net SalesMeasures how efficiently

Average Total Assets
assets are used to produce
sales.
EVALUATION OF PROFITABILITY

Return on Investment Net Income Measures return to owners’

Investment and potential investors on their
investment.

Return on Ordinary Shareholders’ Net Income- Preferred Measures return on ordinary

Equity Dividends shareholders in aggregate.
Average Ordinary
Shareholders’ Equity

Earnings per Share (EPS) Net Income- Preferred Measures the amount of
Dividends earnings attributable to each
Number of Ordinary ordinary share.
Shares Outstanding

Price-Earnings Ratio Market Price per Indicates relationship of

 Ordinary Share market price of ordinary shares
Earnings per Share to net earnings.

Pay-out Ratio to Ordinary Ordinary Dividends Measures portion of net income

Net Income-Preferred to ordinary shareholders paid
Dividends out in dividends.
Or
Dividends per Share
Earnings per share
Dividend per
Dividend Yield on Ordinary Share Ordinary Share Measures cash flow return on
Market Price per ordinary share investment.
Ordinary Share
INVESTMENT ANALYSIS

Shareholders’ Equity Measures total investment

Equity Ratio Total Assets provided by shareholders.
Measures the amount of
Creditors’ Equity to Total Assets Total Liabilities resources provided by
Total Assets creditors.

Book Value per Share Ordinary Measures net assets applicable

Shareholders’ Equity to each ordinary share.
Number of Ordinary
Shares Outstanding

OTHER FINANCIAL RATIOS

Return on Average Current Assets Net Income Measures the return on average
Average Current current assets utilized.
Assets

Plant Asset Turnover Net Sales Measures the relation between

Average Plant Assets sales and the investment in
Plant, Property and Equipment

Leverage Ratio AverageTotalAssets Measures the relation between

Average Shareholders’ investment in total assets to
Equity Investment share of owners.

Lesson 6 Problems and Limitations of Ratio

Some problems and limitations may be encountered in analyzing financial statements.

1. Problem with percentage increases and decreases.
2. Differences between companies.
 3. Differences in accounting methods and estimates.
4. Valuation problem.
5. Use of averages.
6. Lack of sufficient information:

Current Ratio:

Charlie’s Skate Shop sells ice-skating equipment to local hockey teams. Charlie is applying
for loans to help fund his dream of building an indoor skate rink. Charlie’s bank asks for his balance
sheet so they can analysis his current debt levels. According to Charlie’s balance sheet he reported
$100,000 of current liabilities and only $25,000 of current assets. Charlie’s current ratio would be
calculated like this:

As you can see, Charlie only has enough current assets to pay off 25 percent of his current liabilities.
This shows that Charlie is highly leveraged and highly risky. Banks would prefer a current ratio of at
least 1 or 2, so that all the current liabilities would be covered by the current assets. Since Charlie’s
ratio is so low, it is unlikely that he will get approved for his loan.

Acid-test Ratio
Let’s assume Carole’s Clothing Store is applying for a loan to remodel the storefront.
The bank asks Carole for a detailed balance sheet, so it can compute the quick ratio. Carole’s
balance sheet included the following accounts:
Cash: $10,000
Accounts Receivable: $5,000
Inventory: $5,000
Stock Investments: $1,000
Prepaid taxes: $500
Current Liabilities: $15,000
The bank can compute Carole’s quick ratio like this.

As you can see Carole’s quick ratio is 1.07. This means that Carole can pay off all of her current
liabilities with quick assets and still have some quick assets left over.

Debt Ratio
 Dave’s Guitar Shop is thinking about building an addition onto the back of its
existing building for more storage. Dave consults with his banker about applying for a new
loan. The bank asks for Dave’s balance to examine his overall debt levels.
The banker discovers that Dave has total assets of $100,000 and total liabilities of $25,000.
Dave’s debt ratio would be calculated like this:

As you can see, Dave only has a debt ratio of .25. In other words, Dave has 4 times as
many assets as he has liabilities. This is a relatively low ratio and implies that Dave will be
able to pay back his loan. Dave shouldn’t have a problem getting approved for his loan.

Debt to Equity Ratio

Assume a company has $100,000 of bank lines of credit and a $500,000 mortgage on its
property. The shareholders of the company have invested $1.2 million. Here is how you calculate the
debt to equity ratio.

Cash flow from Operations to Total Liabilities

Suppose XYZ & Co. is seeking out a loan to build a new manufacturing plant. The
lender needs to review the company’s financial statements to determine XYZ & Co.’s credit
worthiness and ability to repay the loan. Properly evaluating this risk will help the bank
determine appropriate loan terms for the project.
One such measurement the bank’s credit analysts look at is the company’s coverage
ratio. To calculate, they review the statement of cash flows and find last year’s operating cash
flows totalled $80,000,000 and total debt payable for the year was $38,000,000.

Cash flow coverage ratio = $80,000,000 / $38,000,000 = 2.105

Additionally, a more conservative approach is used to verify, so the credit analysts calculate
again using EBIT, along with depreciation and amortization. The statement of cash
flows showed EBIT of $64,000,000; depreciation of $4,000,000 and amortization of
$8,000,000.
Cash flow coverage ratio = ($64,000,000 + $4,000,000 + $8,000,000) / $38,000,000 = 2
The credit analysts see the company is able to generate twice as much cash flow than
what is needed to cover its existing obligations. Depending on its lending guidelines, this may
or may not meet the bank’s loan requirements.

Comprehensive Problem and Solution

The following are the balance sheet and income statement data of ABC Company:

Balance Sheet Accounts (December 31) 2019 2020

Cash P 150,000 P 283,000

Marketable Securities 850,000 1,000,000
Accounts Receivable, net 500,000 1,000,000
Inventories 750,000 500,000
Land 500,000 500,000
Building, net 550,000 500,000
Machinery and Equipment, net 1,700,000 1,500,000
Goodwill 400,000 400,000
Deferred charges 100,000 90,000
Notes Payable, Trade 100,000 150,000
Accounts Payable, Trade 610,000 790,000
Expenses Payable 40,000 60,000
Long-term Notes due 2027 2,500,000 2,250,000
15% Preference Shares, P100 par 500,000 500,000
Ordinary Shares, P10 par 1,500,000 1,500,000
Retained Earnings 250,000 523,000

2020 Income Statement Accounts

Sales 5,250,000
Sales Returns and Allowances 250,000
 Inventory, December 31, 2020 500,000
Inventory, December e1, 2019 750,000
Purchases 2,750,000
Selling Expenses 400,000
Administrative Expenses (including Depreciation of P250,000) 600,000
Interest on Long-term Notes 250,000
Income Taxes, 32%

Additional Information
1. Dividends paid on preference shares 75,000
2. Dividends paid on ordinary shares 162,000
3. Market price per share on ordinary shares 18

Requirements:

1. Prepare comparative balance sheets for 2019 and 2020, showing peso and percentage
increases or decreases (Horizontal Analysis).
2. Prepare income statement for the year ended December 31, 2020 with common size
percentages (Vertical Analysis).
3. Prepare comparative common-size balance sheets as of December 31, 2019 and 2020
(Vertical Analysis).
4. Evaluate the firm’s short-term solvency for 2020 by computing:
a. Working Capital
b. Current Ratio
c. Acid-test Ratio
d. Cash flow from Operations to Current Liabilities
e. Receivable Turnover
f. Age of Receivables (Use 380 days)
g. Inventory turnover
h. Days Supply in Inventory
i. Working Capital Turnover
j. Current Asset Turnover

5. Evaluate the firm’s long-term solvency for 2020 by computing:

a. Debt to Equity Ratio
b. Cash Flow from Operations to Total Liabilities
c. Times Interest earned
d. Times Preference Dividends earned

6. Evaluate the firm’s operational efficiency for 2020 by computing

a. Gross Margin Ratio
b. Profit Margin Ratio
c. Return on Total Assets
d. Return on Owners’ Equity
e. Asset Turnover Ratio
 7. Evaluate the firm’s profitability for 2020 by computing
a. Return on Ordinary Shareholders’ Equity
b. Earnings per Share (EPS)
c. Price-earnings Ratio
d. Pay-out Ratio to Ordinary Shares
e. Dividend Yield per Share on Ordinary Shares

8. Make an investment analysis for 2020 by computing

a. Equity Ratio
b. Creditors Equity to Total Assets
c. Book Value per Share on Ordinary Shares

SOLUTION

1.
ABC COMPANY
COMPARATIVE BALANCE SHEET
As of December 31, 2019 and 2020

Increase
(Decrease)
Percen
ASSETS 2019 2020 Pesos t
Current Assets:
Cash 150,000 283,000 133,000 88.7
1,000,00
Marketable Securities 850,000 0 150,000 17.6
1,000,00
Accounts Receivable, net 500,000 0 500,000 100.0
(250,000
Inventories 750,000 500,000 ) (33.3)
2,250,00 2,783,00
Total Current Assets 0 0 533,000 23.7
Non-current Assets:
Land 500,000 500,000 - -
Building, net 550,000 500,000 (50,000) (9.1)
1,700,00 1,500,00 (200,000
Machinery and Eqt., net 0 0 ) (11.8)
 Goodwill 400,000 400,000 - -
Deferred Charges 100,000 90,000 (10,000) (10.0)
3,250,00 2,990,00 (260,000
Total Non-Current Assets 0 0 ) (8.0)

5,500,00 5,773,00
TOTAL ASSETS 0 0 273,000 5.0

LIABILITIES AND STOCKHOLDERS'

EQUITY
Current Liabilities:
Notes Payable, Trade 100,000 150,000 50,000 50.0
Accounts Payable, Trade 610,000 790,000 180,000 29.5
Expenses Payable 40,000 60,000 20,000 50.00
1,000,00
Total Current Liabilities 750,000 0 250,000 33.30
Non-Current Liabilities:
2,500,00 2,250,00 (250,000
Long-Term Notes- Due 2030 0 0 ) (10.00)
Stockholders' Equity:
15% Preferred Stock, P100 par 500,000 500,000 - -
1,500,00 1,500,00
Common stock, P10 par 0 0 - -
Retained Earnings 250,000 523,000 273,000 109.20
2,250,00 2,523,00
Total Stockholder's Equity 0 0 273,000 12

TOTAL LIABILITIES AND

5,500,00 5,773,00
STOCKHOLDER'S EQUITY 0 0 273,000 5

2.

ABC COMPANY
INCOME STATEMENT
For The Year December 31, 2020
(with Common-Size Percentages)

Percen
Amount t
Sales 5,250,000 105.0
Less: Sales Returns and Allowances 250,000 5.0
Net Sales 5,000,000 100.0
Cost of Goods Sold:
Inventory, December 31, 2019 750,000 15.0
 Add: Purchases 2,750,000 55.0
Total Goods Available for Sale 3,500,000 70.0
Less: Inventory, December 31,
2020 500,000 10.0
Cost of Goods Sold 3,000,000 60.0

Gross Margin on Sales 2,000,000 40.0

Selling and Administrative Expenses:

Selling Expenses 400,000 8.0
Administrative Expenses 600,000 12.0
Total Selling and Administrative
Exp. 1,000,000 20.0

Net Operating Income 1,000,000 20.0

Less: Interest Expense 250,000 5.0

Net Income Before Income Taxes 750,000 15.0

Less: Provision for Income Taxes,
32% 240,000 4.8

NET INCOME 510,000 10.2

3.

ABC COMPANY

COMPARATIVE COMMON-SIZE BALANCE SHEETS

As of December 31, 2019 and 2020

ASSETS 2019 2020

Current Assets:

Cash 2.73 4.90

Marketable Securities 15.45 17.32

 Accounts Receivable, net 9.09 17.32

Inventories 13.64 8.67

Total Current Assets 40.91 48.21

Non-current Assets:

Land 9.09 8.66

Building, net 10.00 8.66

Machinery and Eqt., net 30.91 25.98

Goodwill 7.27 6.93

Deferred Charges 1.82 1.56

Total Non-Current Assets 59.09 51.79

100.0 100.0
TOTAL ASSETS 0 0

LIABILITIES AND STOCKHOLDERS'

EQUITY

Current Liabilities:

Notes Payable, Trade 1.82 2.60

Accounts Payable, Trade 11.09 13.69

Expenses Payable 0.73 1.04

Total Current Liabilities 13.64 17.33

Non-Current Liabilities:

Long-Term Notes- Due 2030 45.45 38.97

Stockholders' Equity:

15% Preferred Stock, P100 par 9.09 8.66

Common stock, P10 par 27.27 25.98

Retained Earnings 4.55 9.06

Total Stockholder's Equity 40.91 43.70

TOTAL LIABILITIES AND
100.0 100.0
STOCKHOLDER'S EQUITY 0 0

4.a Current Assets:

Cash 283,000
1,000,00
Marketable Securities 0
1,000,00
Accounts Receivable, net 0
Inventories 500,000 2,783,000
Current Liabilities:
Notes Payable, Trade 150,000
Accounts Payable, Trade 790,000
Expenses Payable 60,000 1,000,000

Working Capital for 2020 1,783,000

4b Current Ratio = 2,783,000/1,000,000= 2.78:1

4c Quick Assets:
Cash 283,000
1,000,00
Marketable Securities 0
1,000,00
Accounts Receivable, net 0
2,283,00
Total Quick Assets 0
Divide by ÷
1,000,00
Current Liabilities 0
Acid-Test Ratio 2.28:1

4d Net Income 510,000

Add: Depreciation 250,000
Inc in Accounts Receivable (500,000)
Dec in Inventories 250,000
 Inc in Notes Payable, Trade 50,000
Inc. in Accounts Payable,
Trade 180,000
Inc in Expenses Payable 20,000 250,000
Cash Inflow from Operations 760,000
Divide by Average Current Liabilities ÷
(750,000+1,000,000)/2 875,000
Cash Inflow from Operations to Current Liabilities 87%

5,000,00
4e Net Credit Sales 0
Average Receivables (500,000+1,000,000)/2 750,000

Receivable Turn0ver = 6.67 times

4f Age of Receivables = 360 days/6.67 times = 54 days

3,000,00
4g Cost of Goods sold 0
Average Inventories (750,000+500,000)/2 625,000

Inventory
Turnover = 4.8 times

4h Days supply in Inventory = 360 days/4.8 times = 75 days

Net 5,000,00
4i sales 0
1,641,50
Average working capital (1,783,000+ 0
1,500,000)/2
Working Capital turnover = 3.05 times

Net 5,000,00
4j Sales 0
2,516,50
Ave Current Assets (2,250,000+2,783,000)/2 0

Current Asset Turnover = 1.99 times

 3,250,00
5a Total Liabilities (1,000,000 + 2,250,000) 0
2,523,00
Total Stockholders' Equity 0

Debt to Equity
Ratio = 1.29 times

5b Cash Inflow from Operations 760,000

3,250,00
Ave Total Liabilities (3,250,000+3,250,000)/2 0

Cash Inflow from Operations to Total

Liabilities = 23.40%

1,000,00
5c Net Operating Income 0
Interest Expense 250,000

Times Interest Earned = 4 times

5d Net Income 510,000

Annual Preferred Dividend Requirement 75,000

Times Preferred Dividend Earned = 6.8 times

6a Gross Margin on Sales 2,000,000

Net Sales 5,000,000

Gross Margin Ratio = 40%

6b Net Income 510,000

Net Sales 5,000,000

Profit Margin Ratio = 10.20%

6c Net Income + Interest Expense (Net of Tax)

[510,000+(250,000-(250,000*32%)] 680,000
Ave Total Assets (5,500,000+5,773,000)/2 5,636,500
 Return on Total Assets = 12.06%

6d Net Income 510,000

Total Stockholders' Equity 2,523,000

Return on Owner's Equity = 20.21%

6e Net Sales 5,000,000

Average Total Assets 5,636,500

Assets Turnover Ratio = .89:1

7a Net Income-Preferred Dividends (510,000-75,000) 435,000

Ave Common Stockholders' Equity 1,901,500
(1,750,000+2,053,000)/2

Return on Common Stockholder's Equity = 22.88%

7b Net Income- Preferred Dividends 435,000

Number of Common Shares Outstanding 150,000
1,500,000/1
0

Earnings per Share = 2.90/share

7c Market price per Common Share 18

Earnings per
Share 3

Price Earnings
Ratio = 6.21:1

Common
7d Dividends 162,000

Net Income- Preferred Dividends 435,000

 (510,000- 75,000)

Payout Ratio to Common = .37:1

Dividends per Common

7e Share

(162,000/150,000 shares) 1.08

Market price per Common Share 18

Dividend Yield on Common = 6.00%

8a Total Stockholders' Equity 2,523,000

Total Assets 5,773,000

Equity Ratio = .44:1

8b Total Liabilities 3,250,000

Total Assets 5,773,000

Creditors' Equity to Total Assets = .56:1

Common Stockholders'
8c Equity 2,023,000
Number of Common Shares
Outstanding 150,000

(1,500,000/10)
 13.49/shar
Book Value per Common Share = e

ASSESSMENT

Problem:
The data shown below were obtained from the financial records of the BST Corporation for the year
ended December 31, 2020.
 Sound Break Corporation
Income and Retained Earnings Statement
For the year Ended December 31, 2020

Net Sales P1,000,000

Cost of Goods Sold:
Inventory, Dec. 31, 2019 P250,000
Purchases 720,000
Total Goods Available P970,000
Inventory 220,000 750,000
Gross Margin on Sales P 250,000
Selling and Administrative (including
Depreciation of P20,000) 125,000
Net Income before Tax P 125,000
Provision for Income Tax 35,000

Net Income for the Year P 90,000

Retained Earnings, beginning 130,000
Total P 220,000
Dividends Paid 30,000
Retained Earnings, December 31, 2020 P 190,000

Sound Break Corporation

BALANCE SHEET
December 31, 2019 and 2020

ASSETS 2019 2020

Current Assets:
Cash P 75,000 P 85,000
Marketable Securities 25,000 25,000
Trade Receivables, net 185,000 245,000
Inventory, at cost 250,000 220,000
Prepaid Expenses 15,000 10,000
Total Current Assets P550,000 P585,000
Property and Other Assets:
Equipment, net P340,000 P320,000
Other Assets 15,000 15,000
Total Property and Other Assets P355,000 P335,000

Total Assets P905,000 P920,000

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities:
Trade Payables P185,000 P165,000
Accrued Expenses 20,000 25,000
Other Current Liabilities 10,000 10,000
Total Current Liabilities P215,000 P200,000
 Long-Term Liability
Mortgage Payable P120,000 P120,000
Stockholders’ Equity
Capital Stock, P100 par P300,000 P300,000
Additional Paid-In Capital 30,000 30,000
Retained Earnings Appropriated 80,000 80,000
Retained Earnings Unappropriated 160,000 190,000
Total Stockholders’ Equity P570,000 P600,000
Total Liabilities and Stockholders’ Equity P905,000 P920,000
REQUIRED:
Compute the following ratios and measurements for 2020:
a. Amount of working capital.
b. Current ratio
c. Acid-test (Quick) Ratio
d. Cash flow from Operations to Current Liabilities
e. Inventory Turnover
f. Rate of Gross Profit on sales
g. Book Value per Share of Stock.
h. Ratio of Net Income to Net Sales
i. Net Earnings per share of stock
j. Rate of Return on invested capital
k. Cash flow from Operations to Total Liabilities
l. Ratio of Stockholders’ Equity to Total Liabilities

SUMMARY
For the purposes of making good decisions, an analysis and interpretation of the financial
statements must be made, and this involves a thorough study of the figures shown in the face of the
statements and an evaluation of the firm’s present condition and future potential.
Different analytical tools and techniques may be used for financial statements analysis.
Among the tools are horizontal, vertical analyses, and ratio analyses.
Horizontal analysis involves the computation of absolute and percentage changes between
and among account balances of two or more accounting periods. The use of more than two
accounting periods enables the analyst to observe and develop trends in the accounts.
Vertical analysis involves the comparison of figures within a financial statement of one
period. To facilitate the comparisons, common-size statement is expressed as a percentage of a certain
total-amount- total sales in the income statement and total assets in the balance sheet.
Ratio analysis involves the development of meaningful relationships between two figures that
can come from the same statement or from two different statements. Ratio analysis may be classified
into short-term solvency or liquidity, long-term solvency, operational efficiency, profitability and
investment or market tests.
Ratio analysis involves some limitations with which the analyst must be aware of, such as the
inaccuracy due to the use of averages, peso valuations, and differences in the use of accounting
methods.

References:
Gitman, L. J, Zutter, C. J. (2012). Principles of Managerial Finance. Boston, MA. Pearson
Education, Inc.

Harina, R. M. (2005). Management Advisory Services. Second Edition. Mandaluyong City.

National Book Store.

Roque, R.S., (2016). Management Advisory Services. Malabon, MM. Roque Press, Inc.

Accountant’s Guide to Financial Management. (2008). California, USA. Delta Publishing

Company. https://www.apexcpe.com/Publications%5C771003.pdf

https://quickbooks.intuit.com/in/resources/accounting-taxes/comparative-financial-
statements/
https://www.investopedia.com/terms/r/ratioanalysis.asp
https://www.myaccountingcourse.com/financial-ratios/current-ratio

GO UP lang palagi, BSA’Tin!!!

 Go Up
SB19

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Tanging liwanag ang nakikita

Sa t'wing ipipikit aking mata
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Ibibigay ko ang aking puso
Sa pag-abot ng pangarap, 'di hihinto
 Handa 'kong harapin ang lahat, yeah
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(We go up)
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