FUNDAMENTALS OF ACCOUNTANCY,

BUSINESS, AND MANAGEMENT 2

COURSE MODULE

MR. LINOFEL M. DE DIOS, CPA

 FUNDAMENTALS OF ACCOUNTANCY, BUSINESS, AND
MANAGEMENT 2

MODULE TWO

REVIEW OF FINANCIAL STATEMENT PREPARATION, ANALYSIS,

AND INTERPRETATION, Part Four
[CHAPTER 2]
 SPECIFIC LEARNING OUTCOMES FOR THE MODULE

At the end of this lesson, the learners will be able to:

1. Define profitability
2. Solve profitability ratios (return on equity, return on assets, gross profit margin,
operating profit margin, net profit margin)
3. Analyze, interpret, and compare the profitability ratios of sample companies.
 LESSON 4 – REVIEW OF FINANCIAL STATEMENT PREPARATION, ANALYSIS, AND
INTERPRETATION, part four

Overview
Most financial decisions are made on the information provided by financial statements.
For example, a business owner relies on financial statements to determine how much
funds to borrow from the bank for the proposed business expansion. Similarly, financial
statements assist the bank manager in determining how much loans to extend to the
borrower based on his or her capacity to pay and the bank’s cash flow.

Learning Competencies

The learners shall be able to [1] to define the measurement levels namely: liquidity,
solvency stability, and profitability; and [2] compute, analyze, and interpret financial ratios,
such as current ratio, working capital, gross profit ratio, net profit ratio, receivable
turnover, inventory turnover, debt-to-equity, and the like

E PROFITABILITY refers to the company’s ability to generate earnings. It is one of the

most important goals of businesses.
N
 These are the return on equity, return on assets, gross profit margin, operating
G
profit margin, net profit margin.
A
 Return on equity measures the amount of net income earned in relation to
G stockholders’ equity.
E ROE (return on equity) = Net income ÷ Stockholders’ equity

 Return on assets measures the ability of a company to generate income out of its
resources/assets.

ROA (return on asset) = Operating income ÷ Total assets

 Gross profit margin shows how many pesos of gross profit is earned for every peso
of sale. It provides information regarding the ability of a company to cover its
manufacturing cost from its sales. Remember that gross profit is just sales less
cost of goods or cost of services.

Gross profit margin = Gross profit ÷ Sales

 Operating profit margin shows how many pesos of operating profit is earned for
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 every peso of sale. It measures the amount of income generated from the core
business of a company.

Operating profit margin = Operating income ÷ Sales

 Net profit margin measures how much net profit a company generates for every
peso of sales or revenues that it generates.

Net profit margin = Net income ÷ Sales

Compute for the financial ratios.

E
Sample Company Statement of Financial Position as of December 31, 2014
X
P ASSETS LIABILITIES AND STOCKHOLDERS’ EQUITY

L Cash P120,000.00 Accounts Payable P 70,000.00

O
Marketable Securities P 35,000.00 Short-term notes P 55,000.00
R
Accounts Receivable P45,000.00 Current Liabilities P125,000.00
E
Inventories P 130,000.00 Long-term debt P2,700,000.00
Current Asse P 330,000.00 Total Liabilities P2,825,000.00
Equipment P 2,970,000.00 Common Stock 500,000.00
P 1,600,000.00 Retained earnings P 1,575,000.00

Fixed Assets P 4,570,000.00 Stockholders’ equity P 2,075,000.00

Total Assets P 4,900,000.00 Total liabilities and equity P 4,900,000.00

Sample Company Statement of Financial Performance for the Year Ended

December 31, 2014

Sales Revenue P 2,000,000.00

Cost of Sales/Service P (1,300,000.00)

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 Gross Margin P 700,000.00
Operating Expenses P (199,000.00)
Operating Profit P 501,000.00
Other Income P 5,000.00
Other Expenses P (2,800.00)
Net Income before Tax P 503,200.00
Income Tax P (150,960.00)
Net Income after Tax P 352,240.00

Here is an extract of the statements of financial position of the three companies as of

December 31, 2014
JFC Petron Globe
Total Assets 54,119 391,324 179,507
Total Liabilities 26,041 277,632 124,969
Total Equity 28,078 113,692 54,538

Here is the condensed statement of financial performance of the three companies for
the year ended December 31, 2014.

JFC Petron Globe

Sales Revenue 90,671 482,535 103,235
Cost of Sales/Service (73,728) (463,100) (10,661)
Gross Margin 16,943 19,435 92,574
Operating Expenses (10,806) (11,830) (59,506)
Operating Profit 6,137 7,605 33,068
Other Income 748 1,736 1,255
Other Expenses (126) (5,528) (14,940)
Net Income before Tax 6,759 3,813 19,383
Income Tax (1,271) (804) (6,011)
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 Net Income after Tax 5,488 3,009 13,372

APPLICATION
1. Compute the ratios of the sample companies compare the three companies using
T the ratios computed.
A
S JFC Petron Globe
K
Return on equity 19.55% 2.65% 24.52%
Return on assets 10.14% 0.77% 7.45%
Gross profit margin 18.69% 4.03% 89.67%
Operating profit margin 6.77% 1.58% 32.03%
Net profit margin 6.05% 0.62% 12.95%

2. Why are the sample companies have different ratios. What could have possibly
caused these differences?
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3. What are the implications?

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Multiple-choice quiz about solving and interpreting profitability ratios.

1. Which of the following statements is true?
A. Gross profit margin is always less than net profit margin
B. Gross profit margin is always greater than net profit margin

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 C. Gross profit margin is can be less than or greater than net profit margin

2. A business has a decreasing gross profit however; gross margin percentage is

constant. What could be the possible reason?
A. Sales is increasing, but cost of sales is decreasing
B. Sales and cost of sales increase by the same percentage
C. Sales and cost of sales decrease by the same percentage

ESSAY QUESTION
1. Why it is important to use profitability ratios?
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REFLECTION

What did I learn?

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REFERENCE/S:

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Albert M. Gamatero, 2017, Business Finance, Diwa Learning Systems, Inc., Makati
City, Philippines, www.diwalearningtown.com;

Nick L. Aduana, 2017, Business Finance in the Philippines, C & E Publishing, Inc.,
Quezon City, Philippines, e-mail: info@cebookshop.com;

Arthur S. Cayanan, Daniel Vincent H. Borja, 2017, Business Finance, 1 st edition, REX
Book Store, Manila, Philippines, www.rexpublishing.com.ph

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