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FINANCIAL STATEMENTS (FS) ANALYSIS TOOLS AND TECHNIQUE

1. Horizontal analysis (trend or index analysis)

2. Vertical analysis
3. Financial ratios
4. Gross profit variation analysis
5. Cash flow analysis

Financial Ratios

Liquidity refers to the company’s ability to pay its current liabilities as they fall due.

Current Assets
Current Ratio, Banker’s Ratio or Working Capital Ratio =
Current Liabilities
Quick Assets
Quick ratio or Acid Test Ratio =
Current Liabilities

Working Capital Activity Ratios (Efficiency Ratios)

Income Statement Related Account No. of days in a year

“X” Turnover Average Age of “X”
Average Balance Sheet Account “X” Turnover
Average Age of Receivables
Receivables Net Credit Sale 360 days
(Average Collection Period)
turnover Average Receivables Receivables Turnover
(Days’ sales in receivables)
Average Age of Inventory
Inventory Cost of Goods Sold (Inventory Conversion Period) 360 days
Turnover Average Merchandise Inventory (Days’ Sales in Inventory) Inventory Turnover
(Average Sales Period)

Raw Materials Cost of Material Used

Turnover Average Raw Material Inventory
Work in Process Cost of Good Manufactured
Turnover Average Work in Process Inventory

Finished Goods Cost of Goods Sold

Turnover Average Finished Goods Inventory
Average Age of Trade Payables
Trade Payables Net Credited Purchases 360 days
(Payable Deferral Period)
Turnover Average Trade Payables Payables Turnover
(Days’ Purchases in Payables)

Current Assets Cost of Sales + Operating Expenses*

Turnover Average Current Assets
* These exclude depreciation, amortization and other expenses related to long-term assets.

Solvency refers to the ability of company to pay its debts

where “X” is deducted

Times “X” earned
“X”
_EBIT__
Times Interest Earned
Interest Expense

Times Preferred Dividends Earned __EAT__

(stability ratio) Preferred Dividends Paid

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 X
“X”-“Y” ratio
Y
_Total Liabilities__
Debt-Equity Ratio
Total Stockholders’ Equity
__Total Liabilities__
Debt Ratio
Total Assets
Total Stockholders’ Equity
Equity Ratio
Total Assets

Leverage

% ∆EBIT
Degree of Operating Leverage =
%∆Sales
%∆EAT
Degree of Financial Leverage =
% ∆EBIT
%∆EAT
Degree of Combined Leverage =
%∆Sales

PROFITABILITY

Income
Return on “X”
“X”
__Income__
Return on Sales
Sales
__Income__
Returns on Assets
Average Assets
Net Income – Preferred Dividends
Earnings Per Share
Weighted Average Common Shares Outstanding

ROS is also known as profit margin, operating profit margin and margin of profit

_”X”__
“X” margin
Sales

Dupont Formula

Return on Return on Asset Return on Return on Equity

Assets = Sales X turnover : Equity = Sales Turnover
(ROA) (ROS) (ATO) (ROE) (ROS) (ETO)

Net Profit Net Profit Sales Net Profit Net Profit Sales
Average Average Average Average
Sales Sales
Assets Assets Equity Equity
If used in the DuPont technique, income must be after interest, taxes and preferred stock dividends.

ROE = ROA / Equity Ratio

ROS x ETO = ROE x Equity Ratio = ROA =ATO x ROS

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Other Profitability Ratio

Price Per Share

Price –Earnings (p/e) ratio Earnings Per Share
Dividends Per Share
Dividend Yield Price Per Share
Dividends Per Share
Dividend Payout Earnings Per Share

STABILITY
Fixed Assets
Fixed Assets to Total Equity Total Equity
Fixed Assets (net)
Fixed Assets to Total Assets Total Assets
Sales to Fixed Assets Net Sales
(Plant Turnover) Fixed Assets (Net)
Common Stockholders’ Equity
Book Value Per Share – Common Stock Common Shares Outstanding
Net Income After Taxes
Times Preferred Dividend Earned Preferred Dividends
Total Assets
Capital Intensity Ratio
Net Sales
Net Income Before Taxes & fixed charges
Time Fixed Charges Earned
(Fixed Charges +sinking fund payment)**
**Fixed shall include rent, interests and other relevant fixed expenses; sinking fund payment must be expressed
before tax.

TESTS OF OVER-ALL SHORT-TERM SOLVENCY OR SHORT-TERM FINANCIAL POSITION

Net Sales
Working Capital Turnover Average Working Capital
Current Liabilities
Defensive Interval Ratio Cash & Cash Equivalent
Net Purchases
Payable Turnover
Average Accounts Payable
Fixed Assets
Fixed Assets to Long-Term Liabilities Long Term Liabilities

RATIOS INDICATIVE OF INCOME POSITION

Income
Rate of Return on Average Current Assets Average Current Assets
Operating Profit
Operating Profit Margin Net Sales
Operating Cash Flow
Cash Flow Margin Net Sales

Brain Exercises:

xlviii-Josephine is my aunt. Corazon is Josephine’s sister but not my aunt. Who is Corazon with respect to me?-iiivlx

lxii – A father is four times as old as his son. In twenty years, he will be twice as old. How old are they now? – iixl

lxiii – You must cut a birthday cake into exactly eight pieces, but you’re only allowed to make three straight cuts,
and you can’t move pieces of the cake as you cut. How can you do it? iiixl

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Exercise 1: VERTICAL AND HORIZONTAL ANALYSIS

Following are the financial statements of JBV Company:

JBV COMPANY
Condensed Statement of Financial Position
December 31, 2014 (In thousands)
ASSETS LIABILITIES AND STOCKHOLDERS’ EQUITY
Cash P 750 Current Liabilities P 500
Non-cash Current 1,250 Long- term Debts 1,000
Fixed Assets 3,000 Capital Stock 1,500
Retained Earnings 2,000
TOTAL ASSETS P5,000 TOTAL LIAB. & SHE P5,000
For 2013: Net sales, P1,600; CGS, P1,000; Operating Expenses, P300; Interests and tax charges, P200.
For 2014: Net sales, P2,000; CGS, P1,300; Operating Expenses, P300; Interest and tax charges, P220.

REQUIRED:
1. Prepare 2014 common size balance sheet and determine:
A) Current Ratio
B) Debt Ratio
C) Equity Ratio
2. Prepare 2014 common size income statement and determine:
A) Gross profit margin
B) Operating profit margin
C) Net profit margin
3. Compute trend percentages or prepare index analysis for the following:
A) Net sales
B) EBIT
C) Net income

Exercise 2: FINANCIAL RATIOS

ABC has 1,000,000 common shares outstanding. The price of the stock is P8. ABC declared dividends per share of
P0.10. The balance sheet at the end of 2013 showed approximately the same amounts as that at the end of 2014.
The financial statements for ABC Merchandising are as follows:

ABC Company, Income Statement for 2014 (in thousands)

Sales P4,700
Cost of goods sold 2,300
Gross Profit P2,400
Operating expenses:
Depreciation P 320
Other 1,320 1,550
Income before int. & tax P 850
Interest expense 150
Income before taxes P 700
Income taxes 280
Net income P 420
ABC Company, Balance sheet at December 31, 2014 (in thousands)

ASSETS LIABILITIES AND STOCKHOLDERS’ EQUITY

Cash P 220 Accounts payable P 190
Accounts receivable 440 Accrued expense 180
Inventory 410 Total current liabilities P 370
Total current assets P1,070 Long-term debt 1,960
Plant and equipment 5,600 Common stock 1,810
Accumulated depreciation (2,100) Retained Earnings 430
TOTAL ASSETS P4,570 TOTAL LIAB. & SHE P4,570

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REQUIRED: (round-off answers to two decimal places)
1. Current ratio 11. EPS
2. Acid-test ratio 12. P/E Ratio
3. Accounts receivable turnover 13. Dividends Yield
4. Inventory turnover 14. Payout ratio
5. Gross profit margin 15. Debt ratio
6. Operating profit margin 16. Debt- equity ratio
7. Return on sales (RoS) 17. Times Interest Earned
8. RoA – operational performance 18. Defensive interval ratio
9. RoA – total management effort 19. Cash flow to total debt
10. Return on Equity (RoE) 20. Cash flow margin
Exercise 3: CONSTRUCTION OF FINANCIAL STATEMENT

The following information is available concerning XYZ Company’s expected results in 2015 (in thousands of pesos).
Turnovers are based on year-end values.

REQUIRED: FILL IN THE BLANKS

Return on sales 6%
Gross profit percentage 40%
Receivable turnover 5 times
Inventory turnover 4 times
Current ratio 3:1
Ratio of total debt to total assets 40%
Condensed Income Statement

Sales P900
Cost of sales
Gross profit
Operating expenses
Net income
Condensed Balance Sheet

Cash P 30 Current liabilities

Receivables Long-term debt
Inventory Stockholders’ equity
Plant and Equipment 670
Total TOTAL
Exercise 4: RELATIONSHIPS

Answer the questions under the following independent situations: ( Use 360-day year).

A. The current ratio is 2.5 to 1; the acid- test ratio is 0.9 to 1; cash and receivables are P 270,000. The current
assets are composed of cash, receivables, and inventory. Compute:
1. Current Liabilities
2. Inventory

B. Accounts receivable equal 45 days’ credit sales. Annual sales of P 900,000 are spread evenly throughout the
year. Inventory turnover is 4 times. Compute:
1. Average accounts receivable
2. Operating cycle

C. Net sales total P 100,000. Net profit margin is 12%. Interest charges are earned 6 times.
1. How much is the operating income before interests and taxes (assume a tax rate of 40%)?
2. Suppose that the age of inventory is 30 days and the average amount of inventory for the year is P5,000 how
much the company’s operating expense?

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D. Given the following:
• Return on sales is 5%
• Return on assets is 10%
• Return on equity is 25%
• There is no preferred stock.
Compute: (Use Du Pont technique)
1. Assets turnover
2. Equity Ratio
3. Debt-equity ratio
4. Is the use of financial leverage positive or negative?
E. A company decided to go public. The number of common shares issued and outstanding is 125,000. Net income
available to common shareholders for the year amounted to P300, 000.
1) Assume that the payout ratio is 60%, how much of the total dividends shall a shareholder owning 10,000
common shares receive?
2) Assume that the payout ratio is 60% and the price per share is P20, what is the dividend yield?
3) Assume that the price-earnings ratio will be set 12 times and 25, 000 new shares will be issued:
A. How much is the initial public offering per share of the 25, 000 new shares.
B. How much is the net proceeds from issuance if underwriter spread is 2%?

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