FINANCIAL STATEMENT ANALYSIS

Equation, Definition and Uses of Financial Ratios

Ratio Definition and Uses Formula/ Equation

1. Current ratio A liquidity and efficiency ratio that Sf
measures a firm's ability to pay off its Current Assets/Current
short-term liabilities with its current Liabilities
assets.
2. Acid test ratio A liquidity ratio that measures the (Current Assets-
ability of a company to pay its current Inventory)/
liabilities when they come due with only Current Liabilities
quick assets.
3. Cash ratio A liquidity ratio that measures a firm's (Cash + Cash Equivalents)
ability to pay off its current liabilities /
with only cash and cash equivalents. Current Liabilities
4. Working capital to A measure of a company’s ability to
Total Assets ratio cover its short term financial obligations (Current Assets – Current
(Total Current Liabilities) by comparing Liabilities)/
its Total Current Assets to its Total Total Assets
Assets.
5. Debt ratio A solvency ratio that measures a firm's
total liabilities as a percentage of its Total Liabilities /
total assets. It shows the company's Total Assets
ability to pay off its liabilities with its
assets. This assess the risk that a
company will fail to pay its debt.
6. Equity ratio A ratio that shows how much of the
total company assets are owned Total Capital /
outright by the investors. Also, it Total Assets
measures how much of a firm's assets
were financed by investors. In other
words, this is the investors' stake in the
company.
7. Debt to Equity ratio A ratio that shows the percentage of
company financing that comes from Total Liabilities/
creditors and investors. A higher debt to Total Capital
equity ratio indicates that more creditor
financing is used than investor financing
(shareholders).
8. TIE ratio A ratio that measures the proportionate Earnings Before Interests
amount of income that can be used to & Taxes/
cover interest expenses in the future. Interests Expense
9. Cash coverage ratio A ratio that is useful for determining the (Earnings Before
 amount of cash available to pay for a Interests & Taxes +
borrower's interest expense, and is Depreciation +
expressed as a ratio of the cash available Amortization)/
to the amount of interest to be paid. Interest Expense
10. Asset Turnover An efficiency ratio that measures a
company's ability to generate sales from
its assets by comparing net sales with Net Sales/
average total assets. In other words, this Average Total Assets
ratio shows how efficiently a company
can use its assets to generate sales.
11. AR Turnover An efficiency ratio or activity ratio that
measures how many times a business
can turn its accounts receivable into Net Credit Sales/
cash during a period. In other words, the Average Accounts
accounts receivable turnover ratio Receivable
measures how many times a business
can collect its average accounts
receivable during the year.
12. AP Turnover A ratio that shows a company's ability to
pay off its accounts payable by
comparing net credit purchases to the
average accounts payable during a Net Credit Purchases/
period. This ratio helps creditors analyze Average Accounts
the liquidity of a company by gauging Payable
how easily a company can pay off its
current suppliers and vendors.
13. Inventory Turnover An efficiency ratio that shows how
effectively inventory is managed by
comparing cost of goods sold with Cost of Sales/
average inventory for a period. This Average Inventory
measures how many times average
inventory is "turned" or sold during a
period.
14. AR period A comparison of the receivables to the
sales activity of a business. This 360/
comparison is used to evaluate how long Accounts Receivable
customers are taking to pay a company. Turnover
15. AP period A ratio that measures the number of 360/
days that a company takes to pay its Accounts Payable
suppliers. Turnover

16. Inventory period A measure of the average number of 360/

days inventory is held Inventory Turnover
17. Cash Conversion A cash flow calculation that attempts to Normal Operating Cycle
Cycle measure the time it takes a company to – Accounts Payable
convert its investment in inventory and Period
other resource inputs into cash.
18. Normal Operating The number of days a company takes in Accounts Receivable
Cycle realizing its inventories in cash. Period + Inventory
Period
19. Return on Sales A financial ratio that measures a
company’s performance by analyzing (Net Income/
what percentage of total company Net Sales) x 100%
revenues are actually converted into
company profits.
20. Return on Assets A profitability ratio that measures the
net income produced by total assets
during a period by comparing net
income to the average total assets. (Net Income/
In other words, measures how Average Assets) x 100%
efficiently a company can manage its
assets to produce profits during a
period.
21. Return on Equity A profitability ratio that measures the
ability of a firm to generate profits from (Net Income/
its shareholders investments in the Average Equity) x 100%
company. In other words, the return on
equity ratio shows how much profit
each peso of common stockholders'
equity generates.
22. Gross Profit Margin A profitability ratio that compares the
gross profit of a business to the net (Gross Profit/
sales. In other words, the gross profit Net Sales) x 100%
ratio is essentially the percentage
markup on merchandise from its cost.
23. Operating Profit The operating profit margin is the profit
Margin that a business earns from its operating (Earnings Before
activities. It reveals the financial viability Interests & Taxes /
of the core operations of a business Net Sales) x 100%
before any extraneous financial or tax-
related effects.
24. Net Profit Margin The percentage of revenue left after all
expenses have been deducted from (Net profits / Net sales)
sales. The measurement reveals the x 100%
amount of profit that a business can
extract from its total sales.
25. Earnings per share A market prospect ratio that measures
the amount of net income earned per
share of stock outstanding. In other (Net Income – Dividends
words, this is the amount of money each to Preference shares)/
share of stock would receive if all of the No. of Ordinary Shares
profits were distributed to the outstanding
outstanding shares at the end of the
year.
26. Payout ratio The proportion of earnings paid out as
dividends to shareholders, typically
expressed as a percentage. The payout Dividends per share/
ratio is a key financial metric used to Earnings per share
determine the sustainability of a
company’s dividend payments.
27. Plowback ratio In fundamental analysis, it measures the
amount of earnings retained after 1 – payout ratio
dividends have been paid out.
28. Dividend Yield A financial ratio that measures the
amount of cash dividends distributed to
common shareholders relative to the
market value per share. The dividend Dividends per share/
yield is used by investors to show how Market Price per share
their investment in stock is generating
either cash flows in the form of
dividends or increases in asset value by
stock appreciation.
29. Price Earnings Ratio A market prospect ratio that calculates
the market value of a stock relative to its
earnings by comparing the market price Market Price per share/
per share by the earnings per share. In Earnings per share
other words, the price earnings ratio
shows what the market is willing to pay
for a stock based on its current earnings.
30. Du Pont Equation A financial ratio based on the return on
equity ratio that is used to analyze a ROA = Return on Sales x
company's ability to increase its return Asset Turnover
on equity. This model breaks down the
return on equity ratio to explain how ROE = Return on Assets x
companies can increase their return for Net Income/ Ave. Equity
investors.

I. Essay

1. Why is it necessary for a company to analyze its financial statement?

It is necessary to analyze financial statements for making decisions for the

future. Also, to learn the strengths and weaknesses of the firm.

2. Why is it necessary for an investor to analyze the financial statement of a certain

company?
 It is important for the investor to analyze financial statement to learn how
risky it is to invest to a firm. This is the basis whether to invest to a company or
not.

3. Why is it necessary for the public to analyze the financial statement of a certain
company?
There are several reasons why it is necessary to analyze financial statements
to the public. Firstly, so the public will learn about the profitability of the company.
This could be their basis whether to invest to the company or not. For the employees
to learn the stability and progress of their company. If the company is performing
great, then they can look forward to a salary increase or additional benefits. For the
creditors to learn about the company’s ability to pay. Lastly, for everybody to learn if
they are paying their share of taxes.

SOURCES OF ANSWERS:

Internet Sources:

http://www.myaccountingcourse.com/financial-ratios/
http://www.accountingtools.com
http://financialanalysishub.com/working-capital-to-total-assets/
http://accountingexplained.com
http://www.investopedia.com
http://www.randelltiongson.com/top-10-life-insurance-companies-in-the-philippines/
https://en.wikipedia.org

Book Source: Encyclopedia Britannica

Application of Financial Ratio and Analysis

Example:

2016 2017

ASSETS

Cash P 100 P200

AR 200 100

Merchandise Invty 100 200

Prepaid Expense 100 100

LIABILITIES AND EQUITY

AP 50 300

Bonds Payable 200 100

SHE 250 200

Net Sales 500 600

COS 200 300

GP 300 300

OpEX 200 100

EBIT 100 200

Interest Expense 20 10

EBT 80 190

Tax Expense 24 57

Net Income 56 133

Additional Information

1. Depreciation Expense is 20% of Operating Expense

2. Preferred Dividend is P 33
3. No. of outstanding common shares is 10
4. Dividend per share is 1
5. Market price per share is 10
Compute the FS Ratio for the year 2017
 Computation Industry Analysis
Average
1. Current ratio =600/300 2:1 It is good because
=2:1 it is equal to the
industry average.
This means that
the company can
pay as much as two
times with current
assets to cover
current liabilities.
2. Acid test ratio =(600-100)/300 1.5 : 1 It is good because
=1.67:1 it is above the
industry average.
The company can
pay more quick
assets to pay for
current liabilities
when they come
due.
3. Cash ratio =200/300 1:1 It is bad because it
=0.67 is below the
industry average.
There is not
enough cash and
cash equivalents to
cover current
liabilities when
they come due.
4. Working capital to Total =(600-300)/600 1:1 This is bad because
Assets ratio =0.50:1 it is below industry
average. While
other companies
obtains 1:1
Working Capital to
Total Assets Ratio.
This means that in
only half of the
total assets are
working for profit.
5. Debt ratio =(400/600)x100% 50% This is bad because
=67% it is above the
industry average.
This means that a
large portion of the
asset of the
business is funded
 with liabilities. The
company is weak in
in ability to pay of
its liabilities with
its asset.
6. Equity ratio =(200/600)x100% 50% This is bad because
=33% it is below the
industry average.
This means that
the owners are not
willing to invest to
the company. Also,
the investment is
funded by
liabilities.
7. Debt to Equity ratio =400/200 1:1 This is bad because
=2:1 it is above the
industry average.
This means that
creditors funds the
business 2 times
compare to the
owners.
8. TIE ratio =200/10 5 times This is good
=20 because it is above
the industry
average. The
company can pay
20 times for
interest expense
with EBIT in the
future.
9. Cash coverage ratio =(200+20)/10 6 times This is good
=22 because it is above
the industry
average.
10. Asset Turnover =600/[(500+600)/2] 6 times It is initially good
=600/550 but compare to the
=1.09 industry average, it
is bad. Other
companies obtain 6
times ATO while
this company
obtains 1.09.
11. AR Turnover *Net sales is used 10 times It is bad because it
=600/[(200+100)/2] is below the
=600/150 industry average.
 =4 This means that
the company turn
their accounts
receivable into cash
only 4 times a year.
While other
companies AR
Turnover is 10
times.
12. AP Turnover *Cost of Sales is 5 times It is bad because it
used is below the
=300/[(50+300)/2] industry average.
=300/175 The company
=1.71 purchase many
times lesser
compare to other
companies. This
means the
inventory is not
replenished and
not sold.
13. Inventory Turnover =300/[(100+200)/2] 5 times It is bad because it
=300/150 is below the
=2 industry average.
This means that
the business is
holding the assets
3 time longer
compare to other
companies.
14. AR period =360/4 20 days This is bad because
=90 days it is greater than
the industry
average. It takes 90
days for the
customers pay the
company while
other companies
only wait 20 days.
15. AP period 360/1.71 5 days This is bad because
=210 days it is greater than
the industry
average. It takes
too long for the
company to pay its
creditors/suppliers.
16. Inventory period =360/2 20 days It is bad because it
 =180 days is greater than the
industry average.
The inventory stays
in the business 160
days longer
compare to other
companies.
17. Cash Conversion Cycle =6-(1.71) 35 days It is good because
=4.29 days it is shorter than
the industry
average. This
means that the
business can
convert cash on
hand faster than
other companies.
18. Normal Operating Cycle =4+2 40 days This is good
=6 days because it is
shorter than the
industry average.
This means that
the business
requires less cash
to maintain its
operations.
19. Return on Sales = (133/600)x100% 10% It is good because
=22% the company’s
total revenue are
actually converted
into profit 12%
more than the
average industry.
20. Return on Assets =(133/550)x100% 10% It is good because
=24% it is above the
industry average.
The company is
efficient in
managing its assets
to produce profit in
a year.
21. Return on Equity =(133/225)x100% 10% It is good because
=59.11% it is above the
industry average.
The percentage of
generating profits
using the
shareholders
 investments is very
high.
22. Gross Profit Margin =(300/600)x100% 20% This is good
=50% because it is above
the industry
average.
23. Operating Profit Margin =(200/600)x100% 15% This is good
=33.33% because it is above
the industry
average.
24. Net Profit Margin =(133/600)x100% 10% This is good
=22.17% because it is above
the industry
average.
25. Earnings per share =(133/33)/10 20 per share This is bad because
=10 it is below the
industry average.
This means that
there is less
available earnings
for ordinary
shareholders.
26. Payout ratio =1/10 .5 This is good
=0.10 because it is above
the industry
average. This is
means that there is
greater dividends
to shareholders.
27. Plowback ratio =1-(0.10) .5 It is good because
=0.90 it is above the
industry average.
This means that
retained earnings is
very high compare
to other
companies.
28. Dividend Yield =(1/10)x100% 10% This is good. This
=10% means that the
value of the
company is high
and the stock price
is also high. But
company obtained
only average
dividend yield
compare to other
 companies.
29. Price Earnings Ratio =10/10 5:1 This is bad because
=1:1 it is below the
industry average.
This means that
the companies has
less capability to
grow compare to
other companies.
30. Equity Multiplier =550/225 2 This is bad because
=2.44 it is above the
industry average.
This means that
the firm has a huge
amount of debt.

*This is not yet done. The Recommendation and Solution is not yet
given/made…..

Steps in Interpreting Financial Statements

1. Apply Financial Ratios
2. Analyze Initial Interpretation If It Is Good or Bad to the Company.
3. Asses If It Is Good or Bad According to/Based on the Industry
Average. State the Assessment or Interpretation.
4. State the Problem.
5. Provide Solution. Interpret what could be increased or decreased
in the Financial Statements or what else to do-that could not be
quantified (non-accounting).