SUBJECT : BUSINESS FINANCE

STRAND : ACCOUNTANCY, BUSINESS AND MANAGMENT

TOPIC : FINANCIAL RATIOS - PROFITABILITY
TEACHER : MICHAEL D. BACULANTA

FINANCIAL STATEMENT ANALYSIS

Financial statement analysis involves gaining an understanding of an organization's

financial situation by reviewing its financial reports.
The results can be used to make investment and lending decisions.
Financial statement analysis is definitely used by management for monitoring
performance and for identifying strategies to further improve the company’s operations.

USERS OF FINANCIAL STATEMENT ANALYSIS

Creditors. Anyone who has lent funds to a company is interested in its ability to pay
back the debt, and so will focus on various cash flow measures.
Investors. Both current and prospective investors examine financial statements to learn
about a company's ability to continue issuing dividends, or to generate cash flow, or to
continue growing at its historical rate (depending upon their investment philosophies).
Management. The company controller prepares an ongoing analysis of the company's
financial results, particularly in relation to a number of operational metrics that are not
seen by outside entities.
Regulatory authorities. If a company is publicly held, its financial statements are
examined by the Securities and Exchange Commission (if the company files in the
United States) to see if its statements conform to the various accounting standards and
the rules of the SEC.

FINANCIAL RATIOS

Profitability ratios
Efficiency ratios
Liquidity ratios
Leverage ratios

PROFITABILTY RATIOS

Return on equity (ROE)

Return on assets (ROA)
Gross profit margin
Operating profit margin
Net profit margin

RETURN ON EQUITY (ROE)

ROE is a profitability measure that should be interest to stock market investors.

It measures the amount of net income earned in relation to stockholders’ equity.

ROE =( Net Income ÷ Stockholders’ Equity) x 100%

ROE = (Net Income ÷ Stockholders’ Equity) x 100%

ROE = (2 659 087 ÷ 12 478 559) X 100%
ROE = 0.21309 X 100%
ROE = 21.31%

Analysis

Return on equity measures how efficiently a firm can use the money from
shareholders to generate profits and grow the company. Unlike other return on
 investment ratios, ROE is a profitability ratio from the investor’s point of view—
not the company.

In other words, this ratio calculates how much money is made based on the
investors’ investment in the company, not the company’s investment in assets.

Investors want to see a high return on equity ratio because this indicates that the
company is using its investors’ funds effectively.

RETURN ON ASSETS (ROA)

ROA measures the ability of a company to generate income out of its resources.
This ratio can be useful in making investment decisions. However, if the expected ROA
with the expansion is greater than the borrowing rate, then the management may
consider borrowing to finance expansion.
For example, if a company has an opportunity to expand and is not sure how to finance
the expansion, the ROA can be used in making decision.
If the borrowing rate is greater than ROA, then it does not make sense to borrow for
expansion.
𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐼𝑛𝑐𝑜𝑚𝑒
ROA = 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠
x 100%
4 048 696
ROA = 22 298 020
x 100%
ROA = 0.18157 x 100%
ROA = 18.16 %

ANALYSIS

The return on assets ratio measures how effectively a company can earn a
return on its investment in assets.
It only makes sense that a higher ratio is more favorable to investors because it
shows that the company is more effectively managing its assets to produce
greater amounts of net income.
A positive ROA ratio usually indicates an upward profit trend as well.

GROSS PROFIT MARGIN

Gross profit margin is profitability ratio that measures the ability of a company to cover
its cost of goods sold from its sales.
𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡 𝑀𝑎𝑟𝑔𝑖𝑛
GPM = 𝑆𝑎𝑙𝑒𝑠
x100%
𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡 𝑀𝑎𝑟𝑔𝑖𝑛
GPM = 𝑆𝑎𝑙𝑒𝑠
x100%
10 546 355
GPM = x 100%
52 501 085
GPM = 0.20087 x 100%
GPM = 20.09%
Companies in a very competitive industry have to watch out for this gross profit margin
because stiff competition can substantially bring down this margin.

If the manager of a company wants to improve its gross profit margin, two things can
be done:

1. Raise prices
2. Find ways to bring down production cost. For trading and merchandising companies,
find a supplier which can sell finished goods to the company at low prices

ANALYSIS
 The profit margin ratio directly measures what percentage of sales is made up of net
income.
This ratio also indirectly measures how well a company manages its expenses
relative to its net sales.

OPERATING PROFIT MARGIN

Operating profit margin measures the amount of income generated from the core
business of a company.
𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐼𝑛𝑐𝑜𝑚𝑒
OPM = 𝑆𝑎𝑙𝑒𝑠
x 100%
4 048 696
OPM = 52 501 085
x 100%

OPM = 0.07711 X 100%

OPM = 7.71%

ANALYSIS

The operating profit margin ratio is a key indicator for investors and creditors to see
how businesses are supporting their operations.
On the other hand, if a company requires both operating and non-operating income
to cover the operation expenses, it shows that the business’ operating activities are
not sustainable.
A higher operating margin is more favorable compared with a lower ratio because
this shows that the company is making enough money from its ongoing operations
to pay for its variable costs as well as its fixed costs.

NET PROFIT MARGIN

Net profit margin measures how much net profit a company generates for every peso of
sales or revenues that it generates.
𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒
NPM = 𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠
x 100%
2 659 087
NPM = 52 501 085
x 100%
NPM = 0.05064 x 100%
NPM = 5.06%

ANALYSIS

A company can have a high operating profit margin but may end up with a low or even
a negative net profit margin if the company is heavily indebted.
This situation was observed with many local cement companies after the 1997 Asian
financial crisis where cement companies reported positive operating profit margins but
reported negative net profit margins.
This situation indicates that the core business is good but financing may not be
appropriate because the cement companies relied too much on borrowed funds to
finance their expansion.