CHAPTER 4: Financial Ratio Analysis and Their Implications to Management

CONCEPT DISCUSSION

Thoroughly discuss the following:

1. Coverage of FSA ratios in terms of liquidity, asset utilization, debt utilization and
profitability. (however, i'm not sure how to answer the question. :) )

Financial Statements Analysis Ratios in terms of liquidity, covers all Current

assets. The ratios are calculated to find out the liquidity position of an organization.
Liquidity means an ability to pay as and when some obligations are due. It is the
lifeblood of any business organization because the lack of liquidity can bring bankruptcy
situations for the organization. For calculating liquidity ratios, we use current assets and
current liabilities. The important liquidity ratios are the current ratio, acid-test ratio or
quick ratio, cash ratio.

Financial Statements Analysis Ratios in terms of asset utilization, covers all assets
except for the highly liquid assets. It calculates the total revenue earned for every dollar
of assets a company owns. Hence, this involves the sales or net sales versus the
accounts receivables, inventories, other current and noncurrent assets. It tells the
management that when there is an increasing asset utilization, it means that the
company is being more efficient with each dollar of assets it has.

Financial Statements Analysis Ratios in terms of debt utilization, covers the debt and
equity utilization in the aspect of financing, and interest payment of the company. It
provides information about a company's long-term financial health. Generally speaking,
the more debt than equity a company has (as a percentage of assets), the less healthy
it is financially. The debt utilization covers the current and noncurrent accounts
payables, the interest payment of debt and sssssthe equity of the company.

2. The significance of the following:

a. Liquidity

Liquidity refers to how easily an asset can be converted into cash without
affecting the market price. It’s obvious then that cash is the most liquid
 asset you can have, particularly of a relatively stable currency like USD.
Liquidity ratios are an important class of financial metrics used to
determine a debtor's ability to pay off current debt obligations without
raising external capital. Common liquidity ratios include the quick ratio,
current ratio, and days sales outstanding.

b. Asset Utilization

Asset Utilization is important to a company because its success is often

tied to its ability to manage and leverage its assets. An optimal asset
utilization ratio means the company is being more efficient with each
dollar of assets held.

c. Debt Utilization

Debt utilization ratios provide a comprehensive picture of the company's

solvency or long-term financial health. The debt ratio is a financial ratio
that indicates the percentage of a company's assets that are provided via
debt. The higher the ratio, the greater the risk associated with the firm's
operation.

d. Profitability

Profitability ratios are metrics that assess a company's ability to

generate income relative to its revenue, operating costs, balance sheet
assets, or shareholders' equity. Profitability ratios show how efficiently a
company generates profit and value for shareholders

CONCEPT APPLICATION

TREN Corporation

Comparative Statements of Financial Position

December 31, 2015

(in Thousand Pesos)

Increase(decrease)

Assets 2015 2014 AMOUNT PERCENTAGE

Current Assets

Cash & Cash Equivalent 1074%

 24,890 2,120 22,770

Held for Trading

-
10,000 10,000

Trade & Other Receivables 167%

16,000 6,000 10,000

Inventory - -15%

8,960 10,600 1,640

Total Current Assets 220%

59,850 18,720 41,130

Non-Current Asset

Property, Plant & Equipment - -7%

150,000 161,280
11,280

Investment in Equity - -20%

16,000 20,000 4,000

Total Non-current Assets - -8%

166,000 181,280
15,280

TOTAL ASSETS 13%

225,850 200,000
25,850

Liabilities and Shareholder's Equity

Current Liabilities

Trade & Other Payables 151%

8,400 3,350 5,050

Unearned Revenues - -9%

10,600 11,650 1,050

 Notes Payable-current 50%
300
900 600

Total Current Liabilities 28%

19,900 15,600 4,300

Non-Current Liabilities

Notes Payable- non-current - -26%

100,000
73,550 26,450

TOTAL LIABILITIES - -19%

115,600
93,450 22,150

Shareholder's Equity

Ordinary Share, P100 par 33%

80,000 60,000 20,000

Premium on Ordinary Share 60%

16,000 10,000 6,000

Total paid-in-capital 37%

96,000 70,000 26,000

Retained Earnings 153%

36,400 14,400 22,000

TOTAL SHAREHOLDER'S EQUITY 57%

132,400
84,400 48,000

TOTAL LIABILITIES & 13%

SHAREHOLDERS EQUITY 225,850 200,000
25,850

TREN Corporation
 Comparative Statements of Financial Position

December 31, 2015

(in Thousand Pesos)

Increase(decrease)

2015 2014 AMOUNT PERCENTAG

E

Sales 80,000 20%

480,000 400,000

Less: Cost of Goods Sold 84,000 30%

364,000 280,000

Gross Income - 4,000 -3%

116,000 120,000

Add: Other Income - 1,000 -6%

15,000 16,000

Total Income - 5,000 -4%

131,000 136,000

Less: Other Expenses 12,400

-
12,400

Finance Cost(Interest) - 4,600 -24%

14,400 19,000

Total Expenses 7,800 41%

26,800 19,000

Net Income before taxes -12,800 -11%

104,200 117,000

Less: Income Tax - 3,058 -9%

32,334 35,392

Net Income after taxes - 9,742 -12%

 71,866 81,608

1. Liquidity Ratio
1.1. Current Ratio
a. Computation

Current Ratio
= Current Asset/Current Liabilities
2015 2014
=59,850/19,900 =18,720/15,600
=3.00:1 =1.20:1

b. In 2015, Current Ratio is 3:1. This means that for every 1 peso of liability,
the company has 3 pesos of Current Asset to pay its currently maturing
obligations, while in 2014, the current ratio is 1.2:1, this means that for
every 1 peso of liabilities, the company has 1 pesos and 20 centavos to
pay its currently maturing obligations.

*a high current ratio does not necessarily mean that the company is able to
meet its current maturing debts and a low current ratio may be able to pay
current maturing debts, because the composition of its current asses is
easily convertible to cash like having collectible receivables and highly
saleable trading securities. Current Ratio’s significance could be best
evaluated by comparing this with industry competitors or the company’s
trend of liquidity over a longer period (5 years).

1.2. Acid-test Ratio

a. Computation

Acid Test / Quick Asset Ratio

=Quick Assets (Cash & cash equivalents + Trade Securities + Acc.
Receivables)/Current Liabilities
2015 2014
=(24,890+10,000+16,000)/19 =(2,120+6,000)/15,600
,900
=2.55:1 =0.5205:1

b. In 2015, Quick asset ratio was 2.55:1. This means that for every 1 peso of
liabilities, the company 2 pesos and 55 centavos quick assets to pay its currently
maturing obligations, while in 2014, quick asset ratio is 0.5205:1, this means that,
for every 1 peso of liabilities, the company has only 52 centavos quick assets to
 pay its currently maturing debt. Therefore, in 2014, the company isn’t liquid
enough to pay its currently maturing debt.

*Inventories are not included in the computation because of its uncertainty

as to when the item will be converted to cash. The higher the quick ratio, the
more liquid the firm is and thus, can pay its current maturing debt/obligations.

2. Asset Utilization
2.1. Accounts Receivables
a.

AR Turnover= Net Sales/ Ave, Accounts Receivables

2015

=480,000/((16,000+6,000)/2)

=43.63 times

Days’ Sales in Average Receivables/Average Collection Period

= 365days/AR Turnover

=8.36 days

b. The accounts receivables turnover rate at 43.63 times signifies the

number of times the average receivables are collected during the
year. Although it is incomparable to 2014 due to lacking sufficient
data, it still collects its receivables efficiently as it only takes an
average of 8.36 days to convert its receivables to cash. Thus,
management is putting effective measures and controls to fast track
the collection of its receivables.
2.2. Inventories
a.

Inventory Turnover= COGS/Ave. Merchandise Inventory

2015

=364,000.00/((8,960.00+10,600.00)/2)

=37.22 times

Number of Days in Inventory/Average Sale Period

= 365days/InventoryTurnover

=9.81days
 b. The inventory turnover rate at 37.22 times signifies the number of
times the average inventory is sold during the year. Although it is
incomparable to 2014 due to lacking sufficient data, it still sells its
goods efficiently as it only takes an average of 9.81 days to convert
its inventories to cash. Thus, management is using good quality
products and/or using effective sales and marketing measures to
advertise its products.
2.3. Property, Plant and Equipment

a.

PPE/Fixed Asset Turnover

=Net Sales/Ave. Net PPE

2015

=480,000/((150,000+161,280)/2)

=3.08:1

b. The property, plant and equipment(PPE) or fixed asset

turnover at 3.08:1.00 signifies the efficiency of management to generate
revenue from its PPE. At every Php 1.00 of PPE it generates a sale in
average of Php 3.08.

2.4. Total Asset Turnover

a.

Total Asset Turnover

=Net Sales/Average Total Asset

2015

=480,000.00/((225,850+200,00)/2)

=2.25:1 or 225%

b. The total asset turnover at 2.25:1.00 or 225% signifies the

efficiency of management to generate revenue from its total assets.
At every Php 1.00 of total assets it generates a sale in average of
Php 2.25.
3. Debt Utilization
3.1. Debt to Equity Ratio
a.
 Debt to Equity Ratio
=Total Liabilities/Total Shareholders’ Equity

2015 2014

=93,450/132,400 =115,600/84,400

=0.71:1 or 71% =1.37:1 or 137%

b. The debt to equity ratio measures the relationship of the capital

provided by creditors to the capital provided by the owners. If
2014’s debt to equity ratio is compared to 2015’s, it can be
concluded that the debt to equity ratio decreased from 137% of
2014 to 71% of 2015, which means that the risk was lowered
through increase of financing from owners.
3.2. Debt Ratio
a.

Debt Ratio
=Total Liabilities/Total Asset

2015 2014

=93,450/225,850 =115,600/200,000

=0.41:1 or 41% =0.578:1 or 57.80%

b. The debt to equity ratio measures the relationship of the firm’s

assets coming from creditors. If 2014’s debt ratio is compared to
2015’s, it can be concluded that the debt ratio decreased from
57.80% of 2014 to 41% of 2015, which means that the trade on
equity was lowered.
3.3. Number of Times Interest Earned

a.

Number of Times Interest Earned

=Net Income before interest and income tax or Operating Income/
Annual Interest Expense

2015 2014

=131,00/14,400 =129,600/19,000

=9.10 times =6.82 times

 B. The number of times interest earned signifies the firm’s capacity
in paying its fixed interest charges. If 2014’s number of times
interest earned is compared to 2015’s, it can be concluded that the
number of times interest earned increased from 6.82 times of 2014
to 9.10 times of 2015..

4. Profitability