FINANCIAL MANAGEMENT 1

LECTURE HANDOUT 3 _____________________

FINANCIAL RATIOS

1. For each of the ratios listed below, indicate appropriate code letter, whether it is a liquidity ratio, profitability ratio
or solvency ratio.
Code Code
L Liquidity ratio S Solvency ratio
P Profitability ratio

P 1) Cash return on sales ratio L 6) Current cash debt coverage ratio

P 2) Return on assets ratio S 7) Acid-test ratio
L 3) Receivables turnover ratio S 8) Debt to total assets ratio
P 4) Earnings per share ratio L 9) Free cash flow
P 5) Payout ratio L 10) Inventory turnover ratio

2. Match the ratios with the appropriate ratio computation by entering the appropriate letter in the space provided:

A Current ratio F Times interest earned ratio

B Acid test ratio G Inventory turnover ratio
C Profit margin ratio H Average collection period
D Asset turnover ratio I Average days in inventory
E Price-earnings ratio J Payout ratio

G 1) Cost of goods sold H 6) 365 days

Average inventory Receivable turnover
C 2) Net income E 7) Market price per share
Net sales Earnings per share
J 3) Cash dividends I 8) 365 days
Net income Inventory turnover
D 4) Net sales F 9) Income before income taxes and interest
Average assets Interest expense
A 5) Current assets B 10) Cash+Short term investments+Receivables(net)
Current liabilities Current liabilities

3. Selected information from the comparative financial statements of IMPOSTOR Company for the year ended December 31,
appears below:
2010 2009 2010 2009
Accounts P 180,000 P 200,000 Cost of goods sold P 900,000 P 500,000
receivable
Inventory 140,000 160,000 Interest expense 50,000 25,000
Total assets 1,200,000 800,000 Income tax expense 60,000 29,000
Current liabilities 140,000 110,000 Net income 150,000 85,000
Long-term debt 400,000 500,000 Net cash provided by operating activities 220,000 135,000
Net credit sales 1,330,000 700,000
Answer the following questions relating to the year ended December 31, 2010 show computations:

1) Inventory turnover ratio for 2002 900 000/(300 000/2) 6.0

=6
2) Times interest earned ratio in 2002 260 000 /50 000 5.2
= 5.2
3) Debt to total assets ratio for 2002 540 000 / 1 200 000 0.45
= .45
4) Receivable turnover ratio for 2002 1 330 000 / (380 000 / 2) 7.0
=7
5) Return on assets ratio for 2002 200 000 / ( 2 000 000 / 2) 0.2
= .2
6) Cash return on sales ratio for 2002 220 000 / 1 330 000 0.17
= .1654

Page 1 of 6
FINANCIAL MANAGEMENT 1
LECTURE HANDOUT 3 _____________________
7) Current cash debt coverage ratio for 2002 220 000 / (250 000 / 2) 1.76
= 1.76

4. The comparative balance sheet for MALAY MO MADEVELOP (M3) is given below:

MALAY MO MADEVELOP
Comparative balance sheet
December 31

ASSET 2003 2002 LIABILITIES AND SHE 2003 2002

Cash P 30,000 P 45,000 Accounts payable P 75,000 P 90,000
Accounts receivable 97,500 90,000 Mortgage payable 8% 150,000 150,000
Inventory 90,000 75,000 Common stock P10 par 210,000 180,000
Plant assets (net) 300,000 270,000 Retained earnings 82,500 60,000
Total P P 480,000 Total P 517,500 P 480,000
517,500
Additional information for 2003:
1) Income before interest and taxes was P 168,000
2) Sales on account were P990,000. Sales returns and allowances amounted to P5,625
3) Cost of goods sold was P 676,500
4) Net cash provided by operating activities was P 185,625
5) Interest expense totalled P 12,000
Compute the following ratio at December 31, 2003: (use 365-days)

 Current ratio 217 500 / 75 000 2.9

= 2.9
 Acid test ratio 127 500 / 75 000 1.7
= 1.7
 Current cash debt coverage ratio 185 625 / (165 000 / 2) 2.25
= 2.25
 Receivables turnover ratio 990 000 – 5 625 / (187 000 / 2) 10.50
= 10.503
 Average collection period 365 / 10.5 34.76
= 34.761
 Inventory turnover 676 500 /(165 000 / 2) 8.2
= 8.2
 Average days in inventory 365 / 8.2 44.51
= 44.512
 Debt to total assets ratio 225 000 / 517 500 0.43
= 0.434
 Times interest earned 168 000 / 12 000 14
= 14
 Cash debt coverage ratio 185 625 / (465 000 / 2) 0.8
= .8

5. The financial statements of YOUR SONG Company appear below:

YOUR SONG Company

Comparative Balance Sheet
December 31

ASSETS 2002 2001 LIABILITIES AND SHE 2002 2001

Cash P 25,000 P 40,000 Accounts payable P 20,000 P 30,000
Short-term investments 15,000 60,000 Short-term notes payable 30,000 90,000
Accounts receivable (net) 50,000 30,000 Bonds payable 90,000 160,000

Page 2 of 6
FINANCIAL MANAGEMENT 1
LECTURE HANDOUT 3 _____________________
Inventory 50,000 70,000 Common stock 150,000 150,000
Property, plant and eqpt 260,000 300,000 Retained earnings 110,000 70,000
Total P 400,000 P 500,000 Total P 400,000 P 500,000

YOUR SONG Company

Income statement
For the year ended December 31, 2002

Net sales P 400,000

Cost of goods sold (240,000) P 160,000
Expenses:
Selling P 28,000
Administrative 24,000
Interest 18,000 (70,000)
Net income before tax P 90,000
Income tax (27,000)
Net income P 63,000

Additional information:
a) Cash dividends of P 23,000 were declared and paid in 2002
b) Weighted average number of shares of common stock outstanding during 2002 was 30,000 shares
c) Market value of common stock on December 31, 2002 was P 21 per share
d) Net cash provided by operating activities for 2002 was P 60,000

Using the financial statements and additional information, compute the following ratios for YOUR SONG Company:
 Current ratio 140 000 / 50 000 2.8
= 2.8
 Return on common stockholders’ equity 63 000 / 150 000 0.42
= .42
 Price-earnings ratio 21 / (63 000 / 30 000) 10
= 10
 Acid test ratio 90 000 / 50 000 1.8
= 1.8
 Receivables turnover 400 000 / (50 000 + 30 000 ) /2 10
= 10
 Times interest earned 108 000 / 18 000 6
=6
 Profit margin ratio 63 000 / 400 000 0.157
= .157
 Average days in inventory (@ 365 days) 365 / 4 91.25
Inventory Turnover = 240 000 / 60 000 = 4 = 91.25

 Average days in inventory (@ 360 days) 360 / 4 90

= 90

 Payout ratio (23 000 / 30 000) / (63 000 / 30 000) 0.365

= .3650
 Return on assets 81 000 / 450 000 0.18
= .18
 Cash return on sales ratio 60 000 / 400 000 0.15
= .15
 Cash debt coverage ratio 140 000 / 60 000 2.33
= 2.3334

6. Selected data from PANAHON KO TO Company are presented as follows: total assets $1,600,000; average assets $ 1,750,000;
net income $ 245,000; net sales $ 1,225,000; average common stockholders’ equity $ 1,000,000; net cash provided by operating
activities $ 294,000. Calculate the profitability ratios that can be computed from the information given:

Page 3 of 6
FINANCIAL MANAGEMENT 1
LECTURE HANDOUT 3 _____________________

 Profit margin 245 000 / 1 225 000 0.2

= .2
 Asset turnover 1 225 000 / 1 750 000 0.7
= .7
 Return on assets 245 000 / 1 750 000 0.14
= .14
 Return on common stockholders’ equity 245 000 / 1 000 000 0.245
= .245
 Cash return on sales 294 / 1 225 000 0.24
= .24

7. The balance sheet of TWIST AND SHOUT Corporation at the end of the current year indicates the following: Bonds payable, 8%
$ 4,000,000; 6% Preferred stock $100 par $ 1,000,000; Common stock $10 par $ 2,000,000. Income before income taxes was
$480,000 and income tax expense for the current year amounted to $ 144,000. Cash dividends paid on common stock were $
300,000, and the common stock was selling for $22 per share at the end of the year. There was no ownership changes during the
year. Determine the following:
 Times interest earned 800 000 / 320 000 2.5
= 2.5
 Earnings per share 276 000 / 200 000 1.38
= 1.38
 Price-earnings ratio 22 / 1.38 15.94
= 15.942

8. Selected amounts from HABANG MAY BUHAY Company’s balance sheet from the beginning of the year follow:
Cash $ 70,000 Marketable securities $ 12,000
Accounts receivable (net) 350,000 Inventory 460,000
Prepaid expenses 8,000 Plant and equipment (net) 950,000
Accounts payable 200,000 Accrued liabilities 60,000
Notes due within one year 100,000 Bonds payable in five years 140,000
During the year, the company completed the following transactions:

x. purchased inventory on account, $ 50,000

1) declared a cash dividend, $ 100,000
2) paid accounts payable $100,000
3) collected cash on accounts receivable $ 80,000
4) purchased equipment for cash $ 75,000
5) paid a cash dividend previously declared $ 30,000
6) borrowed cash on a short-term note with the bank $
60,000
7) sold inventory costing $70,000 for $100,000 on
account
8) wrote off uncollectible accounts in the amount of
$10,000. The company uses the allowance method of
accounting for bad debts
9) sold marketable securities costing $12,000 for cash
$9,000
10) issued additional shares of capital stock for cash
$200,000
11) paid off all short-term notes due $160,000

REQUIRED:
a) compute the following amounts and ratios as of the beginning of the year:

 working capital (70 000+350 000+ 8 000+12 000 + 460 000) – (200 540 000
000 + 100 000 + 60 000 )
= 540 000
 current ratio 900 000 / 360 000 = 2.5 2.5
 acid test ratio (70 000 + 350 000 + 12 000)/(200 000 +100 000 + 1.2
60 000) = 1.2

b) Indicate the effect of each of the transactions given above on working capital, the current ratio and the acid test ratio. Give
the effect in terms of increase, decrease, or none. Item (x) is given as an example of the format to use:

Effect on
Transactions Working capital Current Acid-test ratio
ratio

Page 4 of 6
FINANCIAL MANAGEMENT 1
LECTURE HANDOUT 3 _____________________
(x) purchased inventory on account None Decrease Decrease
1) declared a cash dividend Decrease Decrease Decrease
2) paid accounts payable $100 None Increase Increase
3) collected cash on accounts receivable $ 80 None None None
4) purchased equipment for cash $ 75 Decrease Decrease Decrease
5) paid a cash dividend previously declared $ 30 None Increase Increase
6) borrowed cash on a short-term note with the bank $ 60 None Decrease Decrease
7) sold inventory costing $70 Increase Increase None
8) wrote off uncollectible accounts in the amount of $10 Decrease Decrease Decrease
9) sold marketable securities costing $12 Decrease Decrease Decrease
10) issued additional shares of capital stock for cash $200 Increase Increase Increase
11) paid off all short-term notes due $160 None Increase Increase

9. The following ratios have been computed by SHARON Company for 2011:
Profit margin ratio 20% Times interest earned ratio 9 times
Receivable turnover ratio 3 times Acid test ratio 2:1
Current ratio 3:1 Debt to total assets ratio 20%

The 2011 financial statements for SHARON Company with missing information below:

SHARON Company
Comparative balance sheet
December 31

Assets 2011 2010 Liabilities and SHE 2011 2010

Cash $ 30,000 $ Accounts payable $ ?(7) $ 30,000
45,000
Short-term investment 10,000 25,000 Short-term notes payable 40,000 35,000
Accounts ? (6) 40,000 Bonds payable ? (10) 20,000
receivable(net)
Inventory ? (8) 50,000 Common stock 220,000 200,000
Property plant & eqpt 200,000 160,000 Retained earnings 60,000 35,000
Total assets $ ? (9) $320,00 Total liabilities and SHE $ ? (11) $ 320,000
0

SHARON COMPANY
Income statement
For the year ended December 31, 2011

Net sales $ 150,000

Cost of goods sold 75,000
Gross profit $ 75,000
Expenses:
Depreciation expense $? (5)
Interest expense 5,000
Selling expenses 8,000
Administrative expenses 12,000
Total expenses $? (4)
Income before income taxes $? (2)
Income taxes ? (3)
Net income $? (1)

Instruction: Use the above ratios and information from Sharon Company financial statements to fill in the missing information on
the financial statements. Follow the sequence indicated. Show computations to support your answers.

1. Profit-Margin Ratio = 20% = 𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒 / $ 150,000

Net Income = 20% ($ 150,000)
Net Income = $ 30,000

Page 5 of 6
FINANCIAL MANAGEMENT 1
LECTURE HANDOUT 3 _____________________
2. Times interest earned = 9 times
= EBIT/5,000
= (30,000 +5,000+Tax Expense)/5,000

Income before Income Tax = (9 * 5,000)-5,000

= 45,000 – 5,000
= $40,000

3. Income Taxes = Income before Income Tax – Net Income

= $40,000 - $30,000
=$10,000

4. Total Expenses = Gross Profit - Income before Income Tax

=$75,000 – $40,000
=$35,000

5. Depreciation Expense = Total Expenses – (Sum of all other Expenses)

= $35,000 – (5,000 + 8,000 + 12,000
=$35,000 – 25,000
=$10,000

6. Receivable turnover ratio = 3times

= 150,000/ [(AR, 2nd year +40,000)/2]
3 = 150,000 * 2 / (AR, 2nd year +40,000)
AR, 2nd year + 40,000 = 300,000/3
AR, 2nd year = 100,000 – 40,000
AR, 2nd year = $60,000

7. Acid Test Ratio = 2:1 = 2 = (30,000+10,000+60,000) / 40,000+𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑃𝑎𝑦𝑎𝑏𝑙𝑒

Accounts Payable +40,000 = 100,000/2
Accounts Payable = 50,000 – 40,000
Accounts Payable, 2011 = $10,000

8. Current Ratio = 3:1 =3 = (30,000+10,000+60,000+𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦) / 40,000+10,000

3 (50,000) = (30,000 + 10,000 + 60,000 + 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦)
Inventory, 2011= 150,000 – (30,000 + 10,000 + 60,000)
= 150,000 – 100,000
= $50,000

9. Total Assets, 2011 = Sum of all the Assets

= 30,000 + 10,000 + 60,000 + 50,000 + 200,000
= $350,000

10. Debt to Asset Ratio = 20% = ( 10,000+40,000+𝐵𝑜𝑛𝑑𝑠 𝑃𝑎𝑦𝑎𝑏𝑙𝑒) / 350,000

20% (350,000) = 10,000 + 40,000 + Bonds Payable
70,000 – 10,000 – 40,000 = Bonds Payable
Bonds Payable = $20,000

11. Total liability and SHE = Sum of all Liabilities and SHE accounts
= 10,000 + 40,000 + 20,000 +220,000 + 60,000
=$350,000

END OF EXERCISES

Page 6 of 6