Exercises - FS Analysis, Part 2 (not graded)

After reading and comprehending the 2nd part of our discussion under Financial Statement
Analysis, you are now ready to take some exercises. This self-assessment activity covers three
parts:
a. True or false;
b. Comprehensive case for Ratio Analysis; and
c. Reconstruction of Financial Statements Using Ratios

Reminders:
1. This is not a graded assessment.
2. Write your answers including supporting computations in your JoL.
3. A Google Drive link is provided for the answers and solutions.
4. Use another color of ball pen when correcting your answers as an evidence that you actually
answered the items before looking at the solution.
5. Perfect score here is irrelevant.
6. The very purpose of this activity is to test yourself whether or not you have learned
something from the discussion.

Part 1: TRUE OR FALSE. Write TRUE if the statement is correct, otherwise write FALSE.

1. Financial statements that reflect financial data for two or more periods are often referred to
as comparative statements
2. Development of data that measure changes occurring from one accounting period to another
is a form of horizontal analysis
3. One form of horizontal analysis is the development of an index- number trend series
4. When preparing an index-number trend series, the first year presented must always be the
base (i.e. 100%)
5. Index numbers can only be computed when amounts are positive
6. Common size financial statements are a widely used vertical analysis technique
7. A common-size income statement usually shows each revenue or expense item as a
percentage of net sales
8. Comparability between enterprises is more difficult to obtain than comparability within a
single enterprise
9. Computation of ratios for an accounting period is a form of horizontal analysis
10. Generally, the first concern of a financial analyst is a firm’s liquidity
11. The working capital ratio is regarded as fundamental measurement of a company’s liquidity
12. Normally, an analyst would believe that a manufacturing company with a current ratio of 3
to 1 was in serious liquidity trouble
13. The acid test ratio is regarded primarily as a measure of a company’s long term liquidity
situation
14. Usually quick ratio of 1.5:1 would be considered satisfactory
15. The accounts receivable turnover is both a measure of liquidity and a measure of activity
16. Average receivables may also be expressed in terms of the number of days’ sales in
receivables
17. The receivable position and the approximate collection time may be evaluated by computing
the accounts receivable turnover
18. The inventory turnover is computed by dividing cost of goods sold by average inventory
19. A natural business year relates to a fiscal year ending when operations are at their lowest
point
20. Normally a relatively low inventory turnover is desirable
21. The ratio of the net sales to total assets is often called the profitability ratio
22. The ratio called profit margin on sales is a measure of the profit percentage per dollar of
sales
23. Return on investment (ROI) is a measure of overall asset productivity
24. The price earnings ratio is a measure of the relative attractiveness of common stock as an
investment

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 25. The use of borrowed funds is known as trading on the equity
26. The internal users of financial statement are managers, employees and creditors
27. Some external users of financial statement comprise existing shareholders and potential
investors
28. Horizontal analysis is a technique to compare company’s financial condition over a period
of time
29. Vertical analysis is a technique to evaluate each item in a financial statement as a percent
of a base amount or item
30. The four classification of ratio analysis are liquidity ratio, fixed asset ratio, profitability ratio
and efficiency ratios
31. Liquidity ratio measure the ability of a business to meet long term obligations
32. Solvency ratios measure the business’ very short-term ability to meet all financial
obligations
33. Total asset turnover measures the amount of sales generated by each dollar of asset
34. Debt to asset ratio measures the extent to which borrowed funds have been used to finance
the acquisition of assets
35. Price earnings ratio shows how much an investor is willing to pay for each dollar of earnings
given the actual market price

Part 2 – Comprehensive Ratio Analysis

You have just been hired as a loan officer at Luzon Bank. Your supervisor has given you a file
containing a request from Helix Company, a manufacturer of auto components, for a P1,000,000
five-year loan. Financial statement data on the company for the last two years are given below:

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 Meri Ramos, who just two years ago was appointed president of Helix Company, admits that the
company has been "inconsistent" in its performance over the past several years. But Ramos argues
that the company has its costs under control and is now experiencing strong sales growth, as
evidenced by the more than 25% increase in sales over the last year. Ramos also argues that
investors have recognized the improving situation at Helix Company, as shown by the jump in the
price of its ordinary shares from P20 per share last year to P36 per share this year. Ramos believes
that with strong leadership and with the modernized equipment that the P 1,000,000 loan will
permit the company to buy, profits will be even stronger in the future.

Anxious to impress your supervisor, you decide to generate all the information you can about the
company. You determine that the following ratios are typical of companies in Helix's industry:

Current ratio 2.3 to 1

Acid-test ratio 1.2 to 1
Average age of receivables 31 days
Inventory turnover 60 days
Return on assets 9.5%
Debt-to-equity ratio 0.65 to 1
Times interest earned 5.7
Price-earnings ratio 10

Required:

1. You decide first to assess the rate of return that the company is generating. Compute the
following for both this year and last year:
a. The return on total assets. (Total assets at the beginning of last year were P4,320,000.)
b. The return on ordinary equity. (Equity at the beginning of last year totaled P3,016,000.
There has been no change in preference or ordinary share over the last two years.)
c. Is the company's leverage positive or negative? Explain.

2. You decide next to assess the well-being of the ordinary shareholders. For both this year
and last year, compute:
a. The earnings per share.
b. The dividend yield ratio for ordinary.
c. The dividend payout ratio for ordinary.
d. The price-earnings ratio. How do investors regard Helix Company as compared to other
firms in the industry? Explain.

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 e. The book value per share of ordinary. Does the difference between market value per
share and book value per share suggest that the stock at its current price is a bargain?
Explain.
f. The gross margin percentage.

3. You decide, finally, to assess creditor ratios to determine both short-term and long-term
debt paying ability. For both this year and last year, compute:
a. Working capital.
b. The current ratio.
c. The acid-test ratio.
d. The average age of receivables. (The accounts receivable at the beginning of last year
totaled P520,000.)
e. The inventory turnover. (The inventory at the beginning of last year totaled P640,000.)
f. The debt-to-equity ratio.
g. The number of times interest was earned.

4. Evaluate the data computed in (1) to (3) above, and using any additional data provided in
the problem, make a recommendation to your supervisor as to whether the loan should be
approved.

Part 3 – Reconstruction of Statement Using Ratios

The following ratios and other data pertain to the financial statements of the Bulacan Company for
the year ended December 3 1, 2013.

Current ratio 1.75 to 1

Acid-test ratio 1.27 to 1
Working capital P33,000
Fixed assets to equity ratio 0.625 to 1
Inventory turnover (based on cost of closing inventory) 4X
Gross profit percentage 40%
Earnings per share P0.50
Average age of outstanding accounts receivable
(based on calendar year of 365 days) 73 days
Share capital outstanding 20,000 no par value shares
Earnings for the year as a percentage of share capital 25%

The company has no prepaid expenses, deferred, intangible assets or long-term liabilities.

Required:

Reconstruct in as much detail as is possible the company's statement of financial position and
income statement for the year ended December 31, 2013, show supporting computations in good
form.

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