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FUNDAMENTALS OF ACCOUNTANCY, BUSINESS, AND MANAGEMENT 2

SY 2020-2021
QTR1 Wk 7
Financial statement (FS) Analysis

MELC/s:
1. Define the measurement levels, namely, profitability, efficiency and financial
health (liquidity and solvency) (ABM_FABM12-Ig-h-12).
2. Compute and interpret financial ratios such as current ratio, working capital,
gross profit ratio, net profit ratio, receivable turnover, inventory turnover, debt-to-equity ratio, and the like.
(ABM_FABM12-Ig-h-14).

INTRODUCTION:
Review the previous sessions’ lesson. Using the Annual Report, answer the following questions that
were posted in the previous sessions:

Learning Task 1b
Directions: Recall the businesses that the learners have thought off in the previous session (Financial Analysis
1).
- How fast can they sell their inventory?
- How many days does it take to collect receivables from customers?
- How much revenue is generated for each peso of asset invested in the business?
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1.Financial Statement (FS) Analysis is the process of evaluating risks, performance, financial health,
and future prospects of a business by subjecting financial statement data to computational and
analytical techniques with the objective of making economic decisions(White et.al 1998).There are
three kinds of FS analysis techniques:
- Horizontal analysis
- Vertical analysis
- Financial ratios
Ratio analysis expresses the relationship among selected items of financial statement data. The relationship is
expressed in terms of a percentage, a rate, or a simple proportion (Weygandtet.al. 2013). A financial ratio is
composed of a numerator and a denominator.
For example, a ratio that divides sales by assets will find the peso amount of sales generated by every peso of
asset invested. This is an important ratio because it tells us the efficiency of invested asset to create revenue.
This ratio is called asset turnover. There are many ratios used in business. These ratios are generally grouped
into three categories: (a) profitability, (b) efficiency, and (c) financial health.

2. Profitability ratios measure the ability of the company to generate income from the use of its assets and
invested capital as well as control its cost.
The following are the commonly used profitability ratios:
2.1. Gross profit ratio reports the peso value of the gross profit earned for every peso of sales. We can infer the
average pricing policy from the gross profit margin.
GROSS PROFIT x 100%
NET SALES

2.2.Operating income ratio expresses operating income as a percentage of sales. It measures the percentage of
profit earned from each peso of sales in the company’s core business operations (Horngren et.al. 2013). A
company with a high operating income ratio may imply a lean operation and have low operating expenses.
Maximizing operating income depends on keeping operating costs as low as possible (Horngren et.al. 2013).
OPERATING INCOME x 100%
NET SALES

2.3.Net profit ratio relates the peso value of the net income earned to every peso of sales. This shows how much
profit will go to the owner for every peso of sales made.

NET PROFIT x 100%

NET SALES

2.4. Return on asset(ROA) measures the peso value of income generated by employing the company’s assets. It
is viewed as an interest rate or a
form of yield on asset investment. The numerator of ROA is net income. However, net income is profit for the
shareholders. On the other hand, asset is allocated to both creditors and shareholders. Some analyst prefers to
use earnings before interest and taxes instead of net
income. There are also two acceptable denominators for ROA – ending balance of total assets or average of
total assets. Average assets is computed as beginning balance + ending balance divided by 2.

NET INCOME x 100%

AVERAGE ASSET
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2.5 .Return on equity(ROE) measures the return (net income) generated by the owner’s capital invested in the
business. Similar to ROA, the denominator of ROE may also be total equity or average equity.

NET INCOME x 100%

AVERAGE EQUITY

SAMPLE FS to be used for the computations.

a. Profitability Ratios
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Profitability Ratios
Example.

b. Operational efficiency ratio

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-measures the ability of the company to utilize its assets. Operational efficiency is measured based on
the company’s ability to generate sales from the utilization of its assets, as a whole or individually. The
turnover ratios are primarily used to measure operational efficiency.
 - Asset turnover measures the peso value of sales generated for every peso of the company’s assets. The
higher the turnover rate, the more efficient the company is in using its assets.
 - Fixed asset turnover is indicator of the efficiency of fixed assets in generating sales.
 - Inventory turnover is measured based on cost of goods sold and not sales. As such both the numerator
and denominator of this ratio are measured at cost. It is an indicator of how fast the company can sell
inventory. An alternative to inventory turnover is “days in inventory”. This measures the number of
days from acquisition to sale.
 - Accounts receivables turnover the measures the number of times the company was able to collect on its
average accounts receivable during the year. An alternative to accounts receivable turnover is “days in
accounts receivable”. This measures the company’s collection period which is the number of days from
sale to collection.

c. Financial Health Ratios

- Debt ratio indicates the percentage of the company’s assets that are financed by debt. A high debt to
asset ratio implies a high level of debt.
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- Equity ratio indicates the percentage of the company’s assets that are financed by capital. A high
equity to asset ratio implies a high level of capital.
- Debt to equity ratio indicates the company’s reliance to debt or liability as a source of financing
relative to equity. A high ratio suggests a high level of debt that may result in high interest expense.
- Interest coverage ratio measures the company’s ability to cover the interest expense on its liability
with its operating income. Creditors prefer a high coverage ratio to give them protection that interest
due to them can be paid.
- Current ratio is used to evaluate the company’s liquidity. It seeks to measure whether there are
sufficient current assets to pay for current liabilities. Creditors normally prefer a current ratio of 2.
- Quick ratio is a stricter measure of liquidity. It does not consider all the current assets, only those that
are easier to liquidate such as cash and accounts receivable that are referred to as quick assets.
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DEVELOPMENT
Learning Task 2b.
Directions: Using the table below, compute the Profitability Ratios , Operational Efficiency Ratios, and
Financial Health Ratios. Show the formula and your solution.

Financial Health Ratios

1. Debt Equity Ratio
Formula= Total Debt/ Total Equity
= 467, 649 / 414,701
DEBT EQUITY RATIO= ?
Total Debt 2014 2013 Average
Account Payable 75,000 67,298 (75,000 + 67,298)/2= 71,149
Loan Payable 400,00 393,000 (400,000+ 393,000)2=396,500
Average/ Total debt = 467 ,649

Total equity or average equity = ( 416,000+ 413,402)/2

Total/Average equity =414,701
2014
Given :Total debt: 475,000
Total equity: 416,000
Formula ; Total Debt/ Total Equity
Debt equity ratio (2014) = 475,000/416,000 =?
2013
Given :Total debt: 67,298 + 393,000
Total equity: 413,402
Formula ; Total Debt/ Total Equity
Debt equity ratio 2013= 460,298/413,402=?
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2. Debt Ratio
3. Equity Ratio
4. Current Ratio
5. Quick Ratio
Profitability Ratios
1.Gross Profit Rate
2.Operating Income Margin
3.ROA
4. ROE

Operational Efficiency Ratios

1.Asset Turnover
2.Fixed Asset turn over
3.Inventory Turnover
4.Days in Inventory
5.Account Receivable Turnover
6.Day in Account Receivable

ENGAGEMENT
Learning Task 3b

Directions . Interpret the financial health ratio using the answer in Learning Task 2.
1. Debt Equity Ratio
2. Debt Ratio
3. Equity Ratio
4. Current Ratio
5. Quick Ratio
ASSIMILATION
Learning Task 4b.
Directions: Copy the given problem. Choose the letter that best answers the question. Show your
computation.
1. What is the debt equity ratio if the total debt is 500,000 and the total equity is 500,000?
a. 1 b. 2 c. 3 d.4 e.5
2.What is the debt ratio if the total debt is 800,000 and the total assets is 1,600,000?
a. 30% b. 40 % c. 50 % d.60% e. 70%
3. What is the interest coverage ration if the operating income is 300,000 and the interest expense is 15,000?
a. 20% b. 30 % c. 40 % d.50% e. 60%
4. What is the current ratio if the current assets is P 500,000 and the current liabilities is P 350,000?
a. 20% b. 30 % c. 40 % c.50% e. 60%
5. What is the quick ratio if the quick assets is 80,000 and the current liabilities is 40,000?
a. 1 b. 2 c. 3 d.4 e.5

Reference:
Teaching Guide for Senior High School (2016).FUNDAMENTALS OFACCOUNTANCY, BUSINESS,AND MANAGEMENT 2