FINANCIAL MANAGEMENT

CHAPTER 4
BUSINESS ORGANIZATION AND TRENDS
THE ORGANIZATION OF THE BUSINESS FIRM LEGAL POINT OF ACCOUNTING
VIEW POINT OF
BUSINESS FIRM
VIEW
 An entity designed to organize raw
The owner of a The business is an
materials, labor, and machines with the
proprietorship is nor entity separate
goal of producing goods and/or
separable from the from the owner.
services.
business and is Therefore, the
 It can be organized in one of
personally liable financial
three ways:
for all debts of the statements of the
 Proprietorship
business. business present
 Partnership
only those
 Corporation
assets and
liabilities
FIRMS
pertaining to the
 Purchase productive resources business.
from households and other firms.
The owner cannot
 Transform them into a
be paid salary or
different commodity, and
wages from the
 Sell the transformed product or business, but the
service to consumers. owner may
withdraw funds or
Note: other property from
 Business firms engage in retail or borrowing.
trading activities, transforming
purchased goods into a different
commodity does not necessarily take
place.
LEGAL FORMS OF BUSINESS ORGANIZATION
There are three types of business
organizations.
PROPRIETORSHIP
 Owned by a single person who
has complete control over
business decisions.
 The individual owns all the firm’s assets
and is responsible for all its
liabilities.
 The proprietorship may be an ideal
form of business organization when
the following conditions exist:
 The anticipated risk is minimum
and adequately covered by
insurance.
 The owner is either unable or
unwilling to maintain the
necessary organizational
documents and tax returns of
more complicated business
entities.
 The business does not
require extensive
WITHDRAWALS
 Treated as reduction of owner’s
equity or financial interest of the
owner in the business.

TAX
 The business itself does not pay
any income taxes.
 The income or loss of the business
is reported on the owner’s
personal income tax return.
ADVANTAGES OF SOLE
PROPRIERTORSHIP EASY
EXIT
 Requires no formal charter and
is inexpensive to form and
dissolve.

FULL OWNERSHIP AND CONTROL

 The owner has full control, reaps
all profits and bears all losses.

TAX SAVINGS
 The entire income generated by
the proprietorship passes directly
to the owner.
 This may result in a tax
advantage if the owner’s tax rate
is less than the tax rate of a
corporation.
FEW GOVERNMENT REGEULATIONS ADVANTAGES OF PARTNERSHIP
 It has the greatest freedom as
compared with any form of EASE OF FORMATION
business organization.  Require relatively little effort and
low start-up costs.
DISADVANTAGES
UNLIMITED LIABILITY ADDITIONAL SOURCES OF CAPITAL
 The owner is personally liable  It has the financial resources of
or responsible for all business several individuals.
debts.
 The owner’s personal assets can MANAGEMENT BASE
be claimed by the creditors if the  It has broader management base
firm defaults on its obligations. or expertise than a sole
proprietorship.
LIMITATIONS IN RAISING CAPITAL
 Fund-raising ability is limited. TAX IMPLICATION
 Resources may be limited to the  Does not pay any income taxes.
assets of the owner.  The income or loss of the business
 The growth may depend on his or is distributed among the partner in
her ability to borrow money. accordance with the partnership and
each partner reports his or her
LACK OF CONTRINUTIY portion whether distributed or not on
 Upon death or retirement of the personal income tax return.
owner, the proprietorship ceases to DISADVANTAGES
exist.
UNLIMITED LIABILITY
PARTNERSHIP
 General partners have unlimited
 Legal arrange in which two or more liability for the debts and litigations of
persons agree to contribute capital the business.
or services to the business and divide
the profits or losses that may be LACK OF CONTINUTY
derived therefrom.  May be dissolve upon the withdrawal
 May operate under varying degrees or death of a general partners,
of formality. depending on the provisions of the
 May be either general or limited. partnership.

GENERAL LIMITED DIFFICULT OF TRANSFERRING OWNERSHIP

PARTNERSHIP PARTNERSHIP
 It is difficult for a partner to liquidate
One in which each Containing one or or transfer ownership.
partner has more general  It varies with condition set forth in
unlimited liability for partners and one or the partnership agreement.
the debts incurred more limited
by the business partners.
LIMITATIONS IN RAISING CPAITAL
General partners Personal liability:
usually manage General partners:  It may have problems raising large
the firm and may unlimited amounts of capital because many
enter into Limited partners: sources of funds are available only
contractual limited to their to corporations.
obligations on the investment. CORPORATIONS
firm’s behalf.
Profits and assets Limited partners  Artificial being created by law.
ownership may be cannot be active in  Legal entity separate and distinct
divided in any way management. from its owners.
agreed upon by  It may own assets, borrow money,
members. and engage in other business entities
without directly involving the owners.

SHAREHOLDERS
 Also known as the owners
 They do not directly manage the  Maximum legal life: 50 years
firm, instead select managers  May be renewed for desire
designated as board of directors. additional life not to exceed
50 years.
BOARD OF DIRECTORS
 The managers selected by the EASE IN TRANSFERRING OWNERSHIP
shareholders to run the firm for them.
 Authorized to act in the  Shareholders can easily sell their
corporation’s behalf. ownership interest by selling their stocks
without affecting the legal form of
business organization.
INCORPORATION PROCESS
 Initiated by filing the articles of
ABILTIY TO SELL STOCKS
incorporation (AOI) and other
requirements with the Securities  It provides corporations with a
and Exchange Commission (SEC). stronger financial base and the
 The AOI includes among other capital needed for expansion.
the following:
 Incorporators ABILITY TO RAISE CAPITAL
 Name of the corporation  Can raise capital through the sale of
 Purpose of the corporation securities such as bonds to investors
 Capital stock who are lending money to the
 Authorized shares corporations and equity securities
such as common stock to investors
CAPITAL STOCK who are the owners.
 After the corporation is legally form it
DISADVANTAGES
will then issue its capital stock.
TIME AND COST OF FORMATION
STOCK CERTIFICATE  Registration of public companies
 Evidence of stock ownership. with the SEC may be time
consuming and costly.
BYLAWS
 Rules that govern the internal REGULATION
management of the company.
 Subject to greater
 Established by the board of
government regulations
directors and approved by the
 Shareholders cannot just withdraw
shareholders.
assets.
 May be amended or extended
 They can only receive corporate
from time to time by shareholder.
assets when dividends are
ADVANTAGES declared and these amounts may
be subject to limits imposed by
LIMITED LIABILITY law.
 Shareholders are liable only to the
extent of their investment in the firm’s TAXES
shares and not any other personal  Corporations pay taxes on income
assets. they have earned.
 The subject of taxation demands
EXCEPTION the advice of a qualified tax
 Government may pass through the accountant.
corporate shield to collect unpaid
taxes. IMPORTANT BUSINESS TRENDS
 Piercing the Corporate Veil.
1. Increased globalization of business
2. Ever improving information technology
UNLIMTED LIFE
3. Corporate governance
 Continue to exist even after death 4. Outsourcing
of the owners.
FINANCIAL MANAGEMENT
CHAPTER 5
UNDERSTANDING FINANCIAL STATEMENTS
FINANCIAL STATEMENTS
Information is useful
 How the business activities are reported.  How successful the enterprise is likely to
 Report on company’s performance be raising further in finance.
and financial condition.
 It also reveals executive Information about liquidity and solvency
management’s privilege and
 To mee the financial commitments
information insights.
as fall due.
 Serve the needs of different users.
 Provide crucial input for strategic
LIQUIDITY
planning as well as information
 The availability of cash in the near
about relative success of those
future after taking account of financial
plans which can be used as
commitments
corrective action and make new
operating, investing, and financing
SOLVENCY
decisions.
 Availability of cash over the longer
term to meet financial commitments
ACCOUNTING INFORMATION
as they fall due.
 Should be used in the business context.
GENERAL OBJECTIVES OF FINANCIAL PROVIDING INFORMATION ABOUT
STATEMENTS PERFORMANCE OF AN ENTERPRISE
The importance objectives of financial  Provides information about the
statements are: performance and in particular
PROVIDING INFORMATION FOR ECONOMIC its profitability.
DECISIONS  Requires assessing potential
changes in the economic
 Evaluation of the ability of an resources.
enterprise to generate cash and cash  Information about variability of
equivalents and the timing and performance
certainty of their generation.  Predicting the capacity of the
 Determines the capacity of an enterprise to generate cash flows from
enterprise to pay its employees and its existing resource base.
suppliers, meet interest payments,
repay loans and make distributions to PROVIDIG INFORMATION ABOUT CHANGES
its owners. IN FINANCIAL POSITION
PROVIDING INFOMRATION ABOUT FINANCIAL  To assess its investing, financing, and
POSITION operating activities.
 Provides the user with a basis to
The financial position of an enterprise is
assess the ability of the enterprise to
affected by economic resources such
generate cash and cash equivalents
as:
and the needs of the enterprise to
utilize those cash flows.
Information about economic resources
 useful in predicting the ability of the
enterprise to generate cash and DEMAND FOR FINANCIAL
cash equivalents in the future. ACCOUNTING
INFORMATION
 Decision makers and other
Information about financial structure stakeholders demand information on
 Predicting borrowing needs and how the company’s past and prospective
future profits and cash flows will be returns and risks to facilitate efficient
distributed among those with an contracting and risk- sharing.
interest in the enterprise.
 CLASSES OF USERS CUSTOMERS AND POTENTIAL STRAGEGIC
MANAGERS AND EMPLOYEES PARTNERS
 They need accounting information on POTENTIAL
the financial condition, profitability, and CUSTOMERS STRATEGIC
prospects of their companies as well PARTNERS
as comparative financial information To evaluate a
on competing companies and company’s ability
to provide products To estimate the
business opportunities.
and services as firm’s profitability to
 To raise financing for company, to
agreed. assess the fairness
mee disclosure requirement, and to
To assess the of returns on
serve as a basis for executive
company’s mutual
remuneration and bonuses for wage
reliability and transactions and
negotiations and to meet disclosure
staying power. strategic alliances
requirements.

INVESTORS AND ANALYSTS OTHER DECISION MAKES

 To decided whether to buy or sell  Varied from assessing damages for
equity shares. environmental abuses to making
 Future profitability and the ability policy decisions involving economic,
to generate cash influence the social, taxation and other initiatives.
price of securities.
 Company’s ability to borrow money SOURCES OF INFORMATION ABOUT
at favorable terms. ENTERPRISE

CREDITORS AND SUPPLIERS  Determined by manager’s

 To monitor and adjust their assessment of the benefits and cost
contractual requirements and disclosure.
environment with a business firm.
FINANCIAL ACCOUTING INFORMATION
CREDITORS AUDITED ANNUAL REPORT
 To help determine loan terms,  Four financial statements:
loan amounts, interest rates and 1. Statement of financial
required collateral. position (balance sheet
SUPPLIERS statement)
 To establish credit terms and to 2. Statement of comprehensive
determine their long-term income
commitment to supply chain 3. Statement of stockholders’ equity
relations. 4. Statement of cash flow
 This includes explanatory notes
SHAREHOLDERS AND DIRECTORS and management’s discussion
 To assess its profitability and risks. and analysis of financial results.
 To evaluate managerial performance.
 To help make leadership decisions. UNAUDITED QUARTERLY OR INTERIM REPORTS
 Summary version of the four
REGULATORY AND TAX AGENCIES financial statements and limited
 To monitor the business firms’ additional disclosure.
compliance with laws, for public
protection, price setting and for PUBLICY LISTER COMPANIES
setting tax and other regulatory  They must file financial
practices. accounting information with the
SEC.

ALL OTHER REGISTERED CORPORATION AND

PARTNERSHIPS
 Require filing annually audited
financial statements with
accompanying explanatory notes with
SEC.
 BENEFITS OF DISCLOSURE judgmental process.
 The company’s ability to disclose
reliable (audited) accounting
information enable them to better
compete in capital, labor, input
and output market.
 The better a company’s prospects,
the lower will be its cost of capital
as reflected in higher stock prices
or lower interest rate.
COST OF DISCLOSURE
 Can be substantial.
 The possibility for information to
produce competitive disadvantages is
high.
 Can also face possible lawsuits
when disclosure create
expectations that eventually are
not met.

DISCLOSURE COSTS
 Includes political cost.
 Its costs are high for highly visible
companies because they are
favorite target of public scrutiny.

CONSTRATINTS ON RELEVANT AND RELIABLE

INFORMATION
TIMELINESS
 undue delay=lose relevance
 may need to balance the relative
merits of timely reporting and the
provision of reliable information.
 to provide information on timely basis,
it may often be necessary to report
before all aspects of a transaction or
other events are known thus impairing
reliability.
 Conversely, reporting delayed until
all aspects are known=the
information maybe highly reliable but
of little use to users who have had to
make decisions in the interim
 A balance between relevance and
reliability is able to best satisfy the
economic decision-making needs of
the users.

BLANACE BETWEEN BENEFIT AND COST

 Pervasive constraint rather than
a qualitative characteristic.
 The benefits derived from
information should exceed the cost
of providing it.
 The evaluation of benefits and cost
is however, substantially a
BALANCE BETWEEN
QUALITATIVE
CHARACTERISTICS
 The aim is to achieve an appropriate
balance among the characteristics in
order to meet the objective of
financial statements.
 Matter of professional judgement

TRUE FAIR VIEW OR FAIR PRESENTATION

 Financial statements are frequently
described as showing a true and
fair view of the financial position,
performance and changes in
financial position of an enterprise.

FINANCIAL STATEMENTS
 Reported periodically.
 Four financial statements:
 Statement of financial
position (balance sheet
statement)
 Statement of
comprehensive income
 statement of stockholders’ equity
 statement of cash flow

LINKAGE OF FINANCIAL STATEMENTS

 Also known as articulation
 Statement of financial position +
statement of comprehensive income
= linked by retained earnings
RETAINED EARNINGS
Updated each period and reflect
cumulative income that has not yet
been distributed to shareholders.

LONG-TERM PERSPECTIVE
The income statement does measure
change in company value. INVESTING ACTIVITIES
 Company assets.
STATEMENT OF FINANCIAL POSITION  Finance by a combination of
nonowner financing (liabilities) and
 Reports a company’s financial owner financing (equity).
position at a point in time, the
FINANCING ACTIVITEIS
company’s
resources (assets) namely, what the
company owns and also the source of  Combination of owner and
asset financing. nonowner financing.
 Financial statement title
sometimes begins with the word NONOWNER
OWNER FINANCING
consolidated. FINANCING
 Means it includes a parent Resource
company and one or more contributed to the
subsidiaries, companies that company by its Borrowed money.
the parent company owns. owners along with
 There are two ways a company any profit retained
can finance its assets: by the company.
 Owner financing Entails no Legal obligation to
 Nonowner financing such repay amounts
obligation for owned.
NONOWNER repayment. Failure to do so can
OWNER FINANCING
FINANCING result in severe
Can raise money Raise money from consequences for
from shareholder banks or other the borrower.
creditors and
suppliers WORKING CAPITAL
Both owners and nonowners hold clams  Current assets
on company assets  These assets turnover as they are
Owner claims Nonowner claims: used and the placed throughout the
on asset: equity liabilities (or debt) year.

ACCOUNTING EQUATION NET WORKING CAPITAL

Asset = liability + owner’s equity
 Difference between current assets
minus current liabilities
NET OPERATING WOKRING CAPITAL  Arises when revenue exceed expenses.
 Difference between current assets
and non-interest-bearing current
liabilities.

STATEMENT OF COMPREHENSIVE INCOME

 Company’s performance over a
period of time.
 Lists amount for revenues (sales),
expenses and other
comprehensive income
 Revenue less expense yield the
bottom- line net income amount.

COST OF GOODS SOLD (COST OF SALES)

 Additional expense account
 Added in the statement of
comprehensive income by
manufacturing and merchandising
companies

GROSS PROFIT (GROSS MARGIN)

 The subtotal
 Revenue less cost of goods solve
 The remaining expenses are
the reported below gross
profit.

OPERATING ACTIVITIES
 To produce, promote and sell
its products and services.
these activities extend from
input markets to output
markets.

INPUT MARKETS OUTPUT MARKETS

Generate revenues
It generates the (sales)
most expenses
Can also generate
(cost)
some expenses.

NET INCOME
NET LOSS
Occurs when expenses exceed revenue.

STATEMET OF STOCKHOLDERS’ EQUITY

 Report on changers in key types
of equity over a period of time.

CONTRIBUTED CAPITAL
Cash that the company received from the
sale of stock to stockholders/sharholders
less any funds expended for repurchase of
stock (treasury shares)

RETAINED EARNINGS
 Earned capital or reinvested capital.
 Cumulative total amount of income
that the company has earned and
that has been retained in the
business and not distributed to
shareholders in the form of dividends.
 Change in retained earnings
links consecutive statement of
financial position via the income
statement.

ENDING RETAINED EARNINGS

Beginning retained earnings + net income –
dividends.
 STATEMENT OF CASHFLOWS
 The change (increase or decrease) in
a company’s cash balance over a
period of time.
 Cash inflows and outflows from
operating, investing, and financing
activities over a period of time.
FINANCIAL MANAGEMENT
CHAPTER C
ASSESSMENT OF THE FIRMS OPERATING EFFICIENCY AND FINANCIAL POSITION THROUGH FINANCIAL
STATEMENT ANALYSIS
FINANCIAL STATEMENT ANALYSIS Ratio Analysis
 The process of extracting  This technique establishes
information from financial relationships among financial
statements to better understand a statement accounts at given date or
company’s current and future period of time.
performance and financial condition.  These ratios analyze firm’s liquidity, the
 Designed to determine the use of leverage, asset management,
relative strengths and cost control, profitability, growth,
weaknesses of a company. and valuation.
 Concentrates on financial
statement analysis, which BASIC RULES IN
highlights the key aspects of a COMPUTING FINANCIAL RATIOS
firm’s operations.
 s involves a study of the relationships  When calculating a ratio using
between income statement and balance sheet amounts only, the
balance sheet accounts, how these numerator and denominator should be
relationships change over time (trend based on amounts as of the same
analysis or horizontal analysis), and balance sheet date.
how a particular firm compares with  The same is true for ratios using only
other firms in its industry (bench- income statement numbers.
marking or vertical analysis).  Exception: calculation of
growth ratios.
 If an income statement amount and
BASIC TOOLS IN FINANCIAL ANALYSIS
a balance sheet amount are sued at
Horizontal Analysis or Trend Analysis the same time to calculate a ratio,
 A technique for evaluating a series of the balance sheet amount should be
financial statement data over a expressed as an average for the time
period of time. period represented by the income
 Its purpose is to determine the statement amount.
increase or decrease that has taken  If the beginning balance of a balance
place, expressed either an amount or sheet account is not available and
a percentage. cannot be computed from the given
data, the ending balance of the
account is sued to represent the
average balance.
 If sales and/or purchases are given
without making distinction as to
Vertical Analysis or Common Size Analysis
whether made in cash or on credit,
 It is a technique for evaluating assumptions are made depending on
financial statement data that the ratio being calculated:
expresses each item in a financial
statement as a percent of a base TURNOVER RATIOS CASH FLOW RATIOS
amount.
Sales and Sales and
purchases are purchases are
made on made in
credit. cash.

 As a rule, an operating year is

assumed to have 360 days, unless
specified otherwise.
 FINANCIAL RATIOS
Tests of Liquidity
It is a measure of adequacy of working capital.
Current Ratio It is the primary test of liquidity to meet
current obligations from current assets
It measures the number of times that the
current liabilities could be paid with the
Quick Ratio
available cash and nearcash assets (i.e., cash,
current receivables and marketable securities)

Working Capital Activity Ratios

Receivables It measures the number of times receivables
Turnover are recorded and collected during the
period.
It indicates the average number of days during
Average
which the company must wait before
Age of
receivables are collected.
Receivables
Inventory It measures the number of times that the
Turnover inventory is replaced during the period.
It indicates the average number of days during
Average Age
which the company must wait before the
of inventory
inventories are sold.

𝐶𝑜𝑠𝑡 𝑜𝑓 𝑚𝑎𝑡𝑒𝑟𝑖𝑎𝑙𝑠 𝑢𝑠𝑒𝑑

Raw Materials Turnover
𝐴𝑣𝑒. 𝑅𝑀 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦
𝐶𝑜𝑠𝑡 𝑜𝑓 𝑔𝑜𝑜𝑑𝑠 𝑚𝑎𝑛𝑢𝑓𝑎𝑐𝑡𝑢𝑟𝑒𝑑
Work In Process Turnover
𝐴𝑣𝑒. 𝑊𝐼𝑃 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦
𝐶𝑜𝑠𝑡 𝑜𝑓 𝑔𝑜𝑜𝑑𝑠 𝑠𝑜𝑙𝑑
Finished Goods Turnover
𝐴𝑣𝑒. 𝐹𝐺 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦
Normal Operating Cycle 𝐴𝑣𝑒. 𝐴𝑔𝑒 𝑜𝑓 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 + 𝐴𝑣𝑒. 𝐴𝑔𝑒 𝑜𝑓 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠
𝑁𝑒𝑡 𝐶𝑟𝑒𝑑𝑖𝑡 𝑃𝑢𝑟𝑐ℎ𝑎𝑠𝑒𝑠
Trade Payables Turnover
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑇𝑟𝑎𝑑𝑒 𝑃𝑎𝑦𝑎𝑏𝑙𝑒𝑠
360 𝑑𝑎𝑦𝑠
Average Age of Trade Payables
𝑃𝑎𝑦𝑎𝑏𝑙𝑒𝑠 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟
𝐶𝑜𝑠𝑡 𝑜𝑓 𝐺𝑜𝑜𝑑𝑠 𝑆𝑜𝑙𝑑 + 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐸𝑥𝑝𝑒𝑛𝑠𝑒
Current Assets Turnover
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠

Test of Solvency
Times Interest 𝐸𝐵𝐼𝑇 It determines the extent to
Earned 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝐸𝑥𝑝𝑒𝑛𝑠𝑒 which operations cover interest
expense.
𝑇𝑜𝑡𝑎𝑙 𝐿𝑖𝑎𝑏𝑖𝑙𝑡𝑖𝑖𝑒𝑠 Proportion of assets provided by
Debt-Equity Ratio creditors compared that provided
𝑇𝑜𝑡𝑎𝑙 𝐸𝑞𝑢𝑖𝑡𝑦 by owners
𝑇𝑜𝑡𝑎𝑙 𝐿𝑖𝑎𝑏𝑖𝑙𝑡𝑖𝑒𝑠 Proportion of total assets provided
Debt Ratio
𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 by creditors
𝑇𝑜𝑡𝑎𝑙 𝐸𝑞𝑢𝑖𝑡𝑦 Proportion of total assets provided by
Equity Ratio
𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 owners.

Test of Profitability
𝐼𝑛𝑐𝑜𝑚𝑒 Determines the proportion of sales
Return on Sales that went into company’s earnings.
𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠
𝐼𝑛𝑐𝑜𝑚𝑒 Efficiency with which assets are used
Return on Assets
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐴𝑠𝑠𝑒𝑡𝑠 to operate the business
 𝐼𝑛𝑐𝑜𝑚𝑒 Measures the amount earned
Return on Equity on the owners’ or stockholders’
𝐴𝑣𝑒𝑟𝑎𝑡𝑒 𝐸𝑞𝑢𝑖𝑡𝑦 investment.
Earnings Per 𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒 − 𝑃𝑟𝑒𝑓𝑒𝑟𝑟𝑒𝑑 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑡𝑠 Measures the amount of net income
Share 𝑊𝑡𝑑. 𝐴𝑣𝑒. 𝐶𝑜𝑚𝑚𝑜𝑛 𝑆ℎ𝑎𝑟𝑒𝑠 𝑂𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔 earned by each common share.

Market Tests
Price-Earnings 𝑃𝑟𝑖𝑐𝑒 𝑃𝑒𝑟 𝑆ℎ𝑎𝑟𝑒 It indicates the number of pesos
Ratio 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑃𝑒𝑟 𝑆ℎ𝑎𝑟𝑒 required to buy P1 of earnings.
𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑡 𝑃𝑒𝑟 𝑆ℎ𝑎𝑟𝑒 Measures the rate of return in the
Dividend Yield
𝑃𝑟𝑖𝑐𝑒 𝑃𝑒𝑟 𝑆ℎ𝑎𝑟𝑒 investor’s common stock investments.
𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑡 𝑃𝑒𝑟 𝑆ℎ𝑎𝑟𝑒 It indicates the proportion of earnings
Dividend Pay-Out
𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑃𝑒𝑟 𝑆ℎ𝑎𝑟𝑒 distributed as dividends

Stability Ratios
Measures the proportion
of owners’ equity to fixed
Fixed Assets to Total 𝐹𝑖𝑥𝑒𝑑 𝐴𝑠𝑠𝑒𝑡𝑠 assets. Indicative of over
Equity 𝑇𝑜𝑡𝑎𝑙 𝐸𝑞𝑢𝑖𝑡𝑦 or under investment by
owners and weakness in
trading the equity.
Indicates the possible
Fixed Assets to Total 𝑁𝑒𝑡 𝐹𝑖𝑥𝑒𝑑 𝐴𝑠𝑠𝑒𝑡𝑠
overexpansion of
Assets 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 plant and equipment
Tests roughly the
Sales to Fixed
𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠 efficiency of management
Assets (Plant
𝑁𝑒𝑡 𝐹𝑖𝑥𝑒𝑑 𝐴𝑠𝑠𝑒𝑡𝑠 in keeping plant
Turnover)
properties
employed.
Measures recoverable
𝐶𝑜𝑚𝑚𝑜𝑛 𝑆ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟𝑠′𝐸𝑞𝑢𝑖𝑡𝑦 amount by stockholders in
Book Value
the event of liquidation if
per share – 𝐶𝑜𝑚𝑚𝑜𝑛 𝑆ℎ𝑎𝑟𝑒𝑠 𝑂𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔 assets are realized at their
CS
book values.
𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒 𝐴𝑓𝑡𝑒𝑟 𝑇𝑎𝑥𝑒𝑠 It indicates ability to
Times Preferred
provide dividends to
Dividend Earned 𝑃𝑟𝑒𝑓𝑒𝑟𝑟𝑒𝑑 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑡𝑠 preferred stockholders.
Measures efficiency of the
Capital intensity 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 firm to generate sales
ratio 𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠 through employment of its
resources.
Times fixed charges 𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒 𝑏𝑒𝑓𝑜𝑟𝑒 𝑡𝑎𝑥𝑒𝑠 𝑎𝑛𝑑 𝑓𝑖𝑥𝑒𝑑 𝑐ℎ𝑎𝑟𝑔𝑒𝑠 Measures ability to meet
earned 𝐹𝑖𝑥𝑒𝑑 𝑐ℎ𝑎𝑟𝑔𝑒𝑠 + 𝑠𝑖𝑛𝑘𝑖𝑛𝑔 𝑓𝑢𝑛 𝑝𝑎𝑦𝑚𝑒𝑛𝑡 fixed charges

Tests of Over-all Short-Term Solvency or Short-Term Financial Position

𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠 Indicates adequacy of working
Working Capital Turnover
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑊𝑜𝑟𝑘𝑖𝑛𝑔 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 capital to support operation (sales)
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑡𝑖𝑖𝑒𝑠 Measures coverage of current
Defensive Interval Ratio
𝐶𝑎𝑠ℎ 𝑎𝑛𝑑 𝐶𝑎𝑠ℎ 𝐸𝑞𝑢𝑖𝑣𝑎𝑙𝑒𝑛𝑡 liabilities
𝑁𝑒𝑡 𝑃𝑢𝑟𝑐ℎ𝑎𝑠𝑒𝑠 Measures efficiency of the
Payable Turnover company in meeting the
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑃𝑎𝑦𝑎𝑏𝑙𝑒 accounts payable.
Reflects extent of the utilization
Fixed assets to long-term 𝐹𝑖𝑥𝑒𝑑 𝐴𝑠𝑠𝑒𝑡𝑠 of resources from long-term
liabilities 𝐿𝑜𝑛𝑔𝑡𝑒𝑟𝑚 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 debt. Indicative of sources of
additional funds.
Tests of Over-all Short-Term Solvency or Short-Term Financial Position
Rate of return on average 𝐼𝑛𝑐𝑜𝑚𝑒 Measures the profitability of
current assets 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠 current assets invested
𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑝𝑟𝑜𝑓𝑖𝑡 Measures profit generated after
Operating Profit Margin
𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠 consideration of operating
costs.
𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑐𝑎𝑠ℎ 𝑓𝑙𝑜𝑤 Measures the ability of the firm
Cash flow margin
𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠 to translate sales to cash.