MAS - 02 - 2019 - REVISED - FS - ANALYSIS - AND - ITS - ANALYSIS With Amnswers

Republic of the Philippines
BATANGAS STATE UNIVERSITY
MANAGEMENT (MANAGERIAL) ACCOUNTING

MODULE 2
UNDERSTANDING FINANCIAL STATEMENTS AND ITS ANALYSIS
LECTURE /FOCUS NOTES
Name: ________________________________________________ SR Code: _______________________

Course/Year: __________________________________________ Date: __________________________
LE AR NING OB JE C TI V E S
After studying this chapter, you should be able to:

 Know and understand the meaning of financial statements
 Enumerate and explain the different kinds of financial statements
 Analyze financial statements using two forms of common-size analysis: horizontal analysis and
vertical analysis.
 Explain why historical standards and industrial averages are important for ratio analysis.
 Calculate and use liquidity ratios to assess the ability of a company to meet its current
obligations.
 Calculate and use leverage ratios to assess the ability of a company to meet its long- and short-
term obligations.
 Calculate and use profitability ratios to assess the extent to which a company’s resources are
being used efficiently.
INTRODUCTION
This chapter provides the framework and several tools to help us analyze companies and value
their securities. At this point, it is useful to imagine yourself as a specific user of financial statements.
To be able to analyze a company effectively or infer its value, it is important that one must understand
the company’s business activities .This can be accomplished through the financial statements
.Financial statements report on company’s performance and financial condition and reveal executive
management privilege information and insights.
CHAPTER OUTLINE
DEFINITION OF FINANCIAL STATEMENT
These are means by which the information accumulated and processed in financial accounting
is periodically communicated to the users. Stated differently FS are the end product or main output of
financial accounting purposes. These are structured financial representation of the financial position
and financial performance of an entity. FS are presented at least annually. When an entity’s end of
reporting period changes and FS are presented for a period longer or shorter than one year ,a n entity
shall disclose: (1) the period covered(2)the reason for using a period(3) the fact the amounts presented
in the FS are not entirely comparable. Management of an entity has the primary responsibility for the
preparation and presentation of FS of the entity. General Purpose FS are statements that have been
prepared for use by those who are not in a position to require an entity to prepare reports tailored to
their particular information needs.
6 COMPONENTS OF FS
1. Statement of Financial Position( Balance Sheet)

2. Statement of Financial Performance( Income statement)
3. Statement of comprehensive Income
4. Statement of Changes in Equity
5. Statement of Cash Flows
6. Notes comprising significant accounting policies and other explanatory notes
GENERAL OBJECTIVES OF FINANCIAL STATEMENTS

The important objectives of financial statements are:
1. Providing Information for Economic Decision
MGT ACCTG-UNDERSTANDING FINANCIAL STATEMENT AND ITS ANALYSIS Page 1

The economic decisions that are taken by the users of financial statements require an
evaluation of the ability of an enterprise to generate cash and cash equivalents, and the
timing and certainly of their generation.
2. Providing Information About Financial Position
The Financial position of an enterprise is affected by the economic resources such as:
a. Information about the economic resources controlled by the enterprises and its capacity
in the past to modify this resources is useful in predicting the ability of the enterprise to
generate cash and cash equivalent in the future.
b. Information about financial structure is useful in predicting future borrowing needs and
how future profits and cash flows will be distributed among those with an interest in the
enterprise.
c. Information is useful in predicting how successful the enterprise is likely to be in raising
further finance.
d. Information about liquidity and solvency is useful in predicting the ability of the
enterprise to meet the financial commitments as fall due. Liquidity refers to the
availability of cash in the near future after taking account of financial commitments and
solvency refers to the availability of cash over the longer term to meet financial
commitments as they fall due.
3. Providing Information About Performance of an Enterprise
Another important objectives of the financial statements is that, it provides information
about the performance and in particular its profitability, which is required in order to asses
potential changes in the economic resources that are likely to control in future.
4. Providing Information about Changes in Financial position
The financial statements provide information concerning changes in the financial position of
an enterprise, which is useful in order to assess its investing, financing and operating
activities during the operating period. This information is useful in providing the user with a
basis to assess the ability of the enterprise to utilize those cash flows.
DEMAND FOR FINANCIAL ACCOUNTING INFORMATION
Decision makers and other stakeholders demand information on the company’s past and prospective
returns and risk to facilities efficient contracting and risk-sharing.
The broad classes of users that demand financial accounting information include the following:
1. Managers and Employees
2. Inventors and Analysts
3. Creditors and suppliers
4. Shareholders and Directors
5. Regulatory and Tax Agencies
6. Customers and Potential Strategic Partners
7. Other decision makers
SOURCES OF INFORMATION ABOUT BUSINESS ENTERPRISE

In general, the quantity and quality of accounting information that companies supply are
determined by manager’s assessment of the benefits and costs of disclosure. In the Philippines,
publicly listed companies must file financial accounting information with the Securities and Exchange
Commission (SEC). These are;
1. The audited annual report that includes the four financial statements (Statements of Financial
Position [traditionally known as the balance sheet statement], Statement of Comprehensive
Income, Statement of Stockholders’ Equity, and Statement of Cash Flows) with explanatory
notes and the management’s discussion and analysis of financial results.
2. The unaudited quarterly or interim reports that include summary version of the four financial
statements and limited additional disclosure.
All other registered corporations and partnerships are likewise required to file annually audited
financial statements with accompanying explanatory notes with SEC.
CONSTRAINTS ON RELEVANT AND RELIABLE INFORMATION
1. Timeliness
If there is undue delay in the reporting of information, it may lose its relevance. Management
may need to balance the relative merits of timely reporting and the provision of reliable
information. To provide information on a timely basis, it may often be necessary to report
before all aspects of a transaction or other event are known, thus impairing reliability.
2. Balance Between Benefits and Cost
The balance between benefits and cost is a pervasive constraint rather than a qualitative
characteristics. The benefits derived from information should exceed the cost of providing it.
The evaluation of benefits and costs is however, substantially a judgmental process.
3. Balanced Between Qualitative Characteristics
In practice, a balancing or trade-off between qualitative characteristics is often more necessary.
Generally, the aim is to achieve an appropriate balance among the characteristics in order to

meet the objective of financial statements. The relative importance of the characteristics in
different causes is matter of professional judgment.
4. True Fair View of Fair Presentation
Financial statements are frequently described as showing a true and fair view of the financial
position, performance and changes in financial position of an enterprise. Although, this
framework does not deal directly with such concepts, the applications of the principal
qualitative characteristics and of appropriate accounting standards, normally results in
financial statements that convey what is generally understood as a true and fair view of such
information’s.
FINANCIAL STATEMENT ANALYSIS
USERS OF FINANCIAL STATEMENT ANALYSIS

The various users and uses of financial statement analysis follows:
 Managers
o To evaluate operations
o To control
o To plan and budget
o To anticipate future needs and problems
 Lenders
o To evaluate creditworthiness
 Investors
o To predict future earnings and cash flow
o To predict the company’s potential
Limitations of Financial Statement Analysis

 Dissimilar business units may make analysis difficult.
 Inflation can cause balance sheet items to be incomparable.
 Manipulation of ratios by management may occur.
 The choice of different generally accepted accounting principles can affect ratios and harm
comparability.
 Generalizations are difficult to make.
 Ratios are accounting data (some balance sheet information, e.g. fixed assets)
Common Financial Ratios

 Liquidity or Solvency Ratio
These ratios are an indication of the ability of the firm to meet the obligations as they arise. Liquidity
ratios include the following:
 Current ratio- this is the best single indicator of the company’s ability to meet short-term
obligations.
o In general, the higher the current ratio, the better.
Current Assets
Formula: Current ratio = ---------------------
Current liabilities
 Quick Or Acid test Ratio- This Indicate instant debt playing ability of the firm.
o Just like current, the higher the better.
Quick Assets*
Formula: Quick Ratio= -----------------------
Current Liabilities
*Quick Assets include cash, marketable securities and receivables

 Assets Management (Activity) Ratios
These ratios measure how effectively assets are managed.
 Inventory Turnover Ratio- This is an indication of the number of times inventory is restocked,
or “turned over”, during the period.
o The higher the ratio, the better.
o Sometimes ending inventory is used in the denominator, but the average is better.
o Ratios can be computed for different classes of inventory (raw materials, work-in
process, finished goods).
o Using LIFO during a period of inflation will raise this ratio.
Cost of Sales
Formula: -------------------------
Average Inventory
 Accounts Receivable Turnover- This is an indication of the efficiency of the collection process.
o The higher the ratio the better.
Credit Sales
Formula: -----------------
Average AR
 Number of Days of Inventory- this is a measure of the efficiency of inventory management. It

measures the average day’s inventory is held before sale.
o The lower the number of days, the better.
365 or 360 Average Inventory

Formula: ------------------- = -------------------------- x 365 or 360
Inventory TO Cost of Sales
 Number of Days Receivable- this is the average time to collect a receivable. It is a measure of
the efficiency of the collection process.
o The lower the number of days, the better.
o Also known as the “average collection period”.
365 or 360 Average AR
Formula: ----------------- = ------------------ x 365 or 360
Receivable Credit Sales
Turnover
Average AR
Alternate Computation = --------------------
AverageDaily
Sales
 Number of Days in Operating Cycle = Number of Days of Inventory + Average Collection Period.
o The period from the time cash is expended for inventory until the time the same is
collected from customers for sales of the same inventory.
Average Inventory Average AR

Formula: --------------------------- + --------------------- x 365
Cost of Sales Credit Sales
 Debt Management (Leverage) Ratios

o These ratios measure the extent of debt financing or “leverage”.
o Financial leverage is important because of the following reasons:
 Debt is usually the cheapest source of capital.
 Owners can maintain control by using funds via debt.
 Equity provides a “Margin of Safety” for creditors. Little equity relative to debt
will probably raise the cost of the debt due to the riskier nature of the loan.
 Leverage off debt will increase the return on owners’ equity.
o Debt to Equity Ratio- this is an indication of the degree of leverage used.
 The lower the ratio, the lower the risk involved.
Total Debt
Formula: ---------------
Total SHE
o Debt to Equity Ratio / Equity Ratio- debt to asset and equity ratios indicate the
proportion of assets financed via debt and equity, respectively.
Total Debt

Formula: Debt to Asset Ratio = -----------------
Total Assets
Shareholders’ Equity
Equity Ratio = -------------------------------
Total Assets
o Times Interest Earned- this measures the ability to meet interest obligations from
current earnings.
 The higher the ratio, the better.

 This is an example of a coverage ratio.
Earnings before Interest and Taxes (EBIT)
Formula: -----------------------------------------------------------
Interest Expense
 Fixed Charge Coverage- this measures the ability of a company to meet both interest and lease
obligations.
EBIT + Lease Obligations

Formula: -----------------------------------------
Interest + Lease Obligations
 Cash Flow Coverage- this is a more comprehensive coverage ratio that measures the ability to
meet financial requirements with currently generated cash flows.
Cash Inflows
Formula: -------------------------------------------------------------------------
Interest + Preferred Dividends + Principal Payments
+ Lease before tax before tax
Payments
 Times Preferred Dividends Earned- this indicates how many times dividends paid to preferred
shareholders are earned.
Net Income
Formula: ----------------------------
Preferred Dividends
 Profitability Ratios
o These ratios measure income relative to some base.
o These are more general because profit is a result of many factors (operating decisions,
leverage, etc.)
o Net Profit Margin on sales- this measures “bottom line” net income per peso of sales.
 This ratio varies widely from one industry to another.

 It provides some measure of the ability to absorb cost increases or sales decline.
Net Income Available to Common Shareholders

Formula: -------------------------------------------------------------------
Net Sales
 Return on Common Equity- this ratio measures the rate of return on equity.
o The return can be increased through the use of “Positive Leverage” (more debt where
interest rate is less than return on equity).
o Net income available to common shareholders is generally net income less preferred
dividends.
Net Income available to common shareholders

Formula: -----------------------------------------------------------------
Average Common Equity
 Return on Assets- This ratio measures the rate of return on assets.
Net Income available to common shareholders

Formula: -----------------------------------------------------------------
Average Total Assets
 Market Value and Per Share Ratios

o These ratios relate the stock price, earnings and dividends on a per share basis.

o Like profitability ratios, these ratio are more general in nature and reflect investors’
appraisal of the company’s performance and prospects.
Market Price per Share
 Price/Earnings (P/E) Ratio= ------------------------------------------
Average Outstanding Shares
o These ratios are the main measurement tool of the financial markets in evaluating the
price of stock.
o Price-earnings ratios are based on historical earnings, but P/E ratios are higher for
companies with high growth prospects and/or low riskiness.

 Earnings Per Share= ------------------------------------------
Average Outstanding Shares
o For financial statement purposes, sometimes two EPS figures are required– “primary”
and “fully diluted”.
Dividend per Share

 Yield on Common Stock= ---------------------------------
o This measures the return on an investment in the stock, excluding any appreciation or
depreciation in the market price of the stock.
Dividends on Common Stock
 Dividend Payout Ratio= ----------------------------------------------------
Net Income less Preferred Dividend
o This ratio means the portion of the net income paid out as cash dividends to
shareholders.
o Most companies take a long term viewpoint and don’t adjust the dividend each year
with fluctuation in income.
Net Assets Available to Common Share

 Book Value per Share= -------------------------------------------------------
Common Shares Outstanding
oThe numerator is net equity less the amount needed to liquidate the preferred
shareholders’ interest.
o The denominator is generally the average common shares and common stock
equivalents.
 Common Size Financial Statements
o These are used to compare with other smaller or larger companies, or for the same
company overtime.
o To draft a common size Balance Sheet, simply divide each balance sheet amount by the
total assets.
 The result is each balance sheet component expressed as a percentage of the
whole.
 Total assets equal 100%
o To draft a common size income statement, simply divide each income statement amount
by the total revenue.
o Common size financial statements can be compared to industry norms or to industry
leaders.
FS ANALYSIS
Involves the evaluation of the firm’s past performance, present condition, and business potentials.
The analysis provides information about the following, among others:
 Profitability of the business firm
 Ability to meet company obligations
 Safety of investment in the business
 Effectiveness of management in running the firm
Financial Statements (FS) Analysis Tools and Techniques

1. Horizontal analysis (trend or index analysis)
2. Vertical analysis
3. Financial ratios

4. Gross profit variation analysis
5. Cash flow analysis
Horizontal Analysis
Horizontal or index analysis involves comparison of figures shown in the financial statements
or two or more consecutive periods. The difference of the amount between two periods is calculated,
and the percentage change from one period to the next is computed using the earlier period as the
base.
Percentage Change ( %) = Most Recent Value – Based Period Value

----------------------------------------------------------
Based Period Value
Comparisons can be made between an actual amount compared against a budgeted amount, with the
‘budget’ serving as the base or pattern of performance.
Limitation: If negative or a zero amount appears in the base year, percentage change cannot
be computed.
Vertical Analysis
Vertical analysis is the process of comparing figures in the financial statements of a single
period. It involves conversion of figures in the statements to a common base. This is accomplished by
expressing all figures in the statement as percentages of an important item such as total assets (in the
balance sheet) or net sales (in the income statement). These converted statements are called common
size statements or percentage composition statements.
Percentage composition statements are used for comparing:
1. Multiple years of data from the same firm
2. Companies that are different in size
3. Company to industry averages
Ratio Analysis
Ratio analysis is involves development of mathematical relationship among accounts in the
financial statements. Ratios calculated from these statements provide users and analysts with relevant
information about the firm’s liquidity, solvency, and profitability.
BASIC RULES ON RATIO CALCULATIONS

 When calculating a ratio using balance sweet sheet numbers only, the numerator and
numerator and denominator should be from the same balance sheet date. The same is true for
ratios using only income statement numbers. Exception: calculation of growth ratios.
 If an income statement account and a balance sheet account are both used to calculate a ratio,
the balance sheet account should be expressed as an average for the time period represented
by the income statement account.
 If the beginning balance of a balance sheet account is not available, the ending balance is
normally used to represent the average balance of the account.
 If sales and/or purchases are given without making distinction as to whether made in cash or
on credit, assumptions are made depending on the ratio being calculated.
o Turnover ratios: sales and purchases are made on credit.
o Cash flow ratios: sales and purchases are made in cash.
 Generally, the number of days in a month or year is not critical to the analysis: a year may
have 360 days, 52 weeks, and 12 months; alternatively, a year may be compromised of 365
calendar days, 300 working days or any appropriate number of days.
Financial Ratios
 Test of Liquidity (Liquidity refers to the company’s ability to pay its current liabilities as they
fall due.)
It is a measure of adequacy of

Current Ratio Current Assets working capital. It is the primary
(Banker’s Ratio) Current Liabilities test of solvency to meet current
(Working Capital Ratio) obligations from current assets.
It measures the number of times
Quick Ratio Quick Assets that the current liabilities could
(Acid Test Ratio) Current Liabilities be paid with the available cash
and near-cash assets (i.e., cash,
current receivables and
marketable securities).
Working Capital Activity Ratios (Efficiency Ratios)
Income statements account No. of days in a year

Turnover -------------------------------------- Average -----------------------------
Average Balance Sheet Account age Turnover
It is the time required to complete one

collection cycle from the time
Receivables Turnover Net (credit)Sales receivables, then collected, to the time
---------------------------- new receivables are collected
Average receivables
Average Age of Receivables It indicates the average number of days
(Average Collection Period) 360 days during which the company must wait
(Day’s Sales in receivables) ----------------------------- before receivables are collected.
Receivables Turnover
Inventory Turnover Cost of goods Sold It measures the number of times that
------------------------------------- the inventory is replace during the
Ave. Merchandise Inventory period
Average Age of Inventory* It indicates the average number of days
(Invention Conversion 360 days during which the company must wait
Period) --------------------------- before the inventories are sold.
(Day’s Sales in Inventory) Inventory Turnover
Raw materials Turnover Costs of Materials Used

-------------------------------------------
Average Raw Material Inventory
Work in Process Turnover Cost of Goods Manufactured

-----------------------------------------------
Average Work in Process Inventory
Finished Goods Turnover Cost of Goods Sold

-----------------------------------------------
Average Finished Goods Inventory
Operating Cycle (in Days) Average Age of Inventory +

Average Age of Receivables
Trade Payables Turnover Net Credit Purchases
---------------------------------
Average Trade Payables
Trade Payables Turnover Net Credit Purchases

---------------------------------
Average Trade Payables
Average Age of Trade Payables 360 days It indicates the length of time
(Payable Deferral Period) (Days’ ------------------------- during which payables remain
purchases in Payables) Payables Turnover unpaid.
Current Assets Turnover Cost of Sales + Operating It measures the movement and
Expenses** utilization of current assets to meet
----------------------------------- operating requirements.
Average Current Assets
*In some accounting finance texts, average inventory age is also called as the average sales period.

**These exclude depreciation, amortization, and other expenses related o long term assets.
 Tests of Solvency (Solvency refers to the ability of company to pay its debts)
These ratios involve leverage ratios. ‘Leverage’ refers to how much of company’s resources are financed
by debt and/or preferred equity, both of which require fixed payment of interest and dividends.
EBIT It determines the extent to which

Times Interest Earned ---------------------- operations cover interest expense.
Interest Expense
Total Liabilities Proportion of assets provided by creditors
Debt-Equity Ratio -------------------- compared to that provided by owners.
Total Stockholders’ Equity
Debt Ratio Total Liabilities Proportion of total assets provided by

-------------------- creditors.
Total Assets
Total Stockholders’ Equity Proportion of total assets provided by
Equity Ratio -------------------------- owners.
Total Assets
 Test of Profitability
Income Determines the portion of sales

Return on Sales -------------- that went into company’s
Net Sales earnings
Income Efficiency with which assets are
Return on Assets ---------------------- used to operate the business.
Average Assets
What income figure should be used?
 If the attention is to measure operational performance, income is expressed as before interest

and tax; alternatively, income before after-tax interest may be used to exclude the effect of
capital structure.
 If the intention is to evaluate total managerial effort, income is expressed after interest and tax.
 The practice of expressing income after interest but before tax is now being discouraged.
 Income should include dividends and interest earned if the said investments are included in
asset base.
 If used in the DuPont technique, income must be after interest, tax and preferred stock
dividends.
Return on Equity = Return on Sales x Assets Turnover x Equity Multiplier
Return on Equity Income Measures the amount

--------------------- earned on the owners’ or
Average Equity stockholders’ investment.
Earnings Per Share Net Income – Preferred Dividends Measures the amount of
--------------------------------------------------- net income earned by each
Wtd. Ave. Common Shares Outstanding common share.
 Market Test
Price-Earnings (P/E) Ratio Price Per Share It indicates the number of pesos
-------------------------- required to buy P 1 of earnings
Earnings Per Share
Dividend Yield Dividend Per Share Measure the rate of return in the
--------------------------- investors common stock
Price Per Share investments
Dividend Pay-Out Common Dividend Per Share It indicates the proportion of
--------------------------------------- earnings distributed as dividends
Earnings Per Share
Other Meaningful Ratios
 Ratios Used To Evaluate Long-Term Financial Position or Stability

Fixed Assets to Total Fixed Assets Measures the proportion of owners’
Equity ------------------- equity to fixed assets. Indicative of
Total Equity over or under investment by owners
and weakness in trading on the
equity*
Fixed Assets to Total Fixed Assets (Net) Indicates possible over expansion of
Assets ------------------------------ plant and equipment
Total Assets
Sales to Fixed Assets Net Sales Test roughly the efficiency of

(Plant Turnover) ---------------------------- management in keeping plant
Fixed Assets (Net) properties employed.
Book Value Per Share – Common Stockholders’ Equity Measures recoverable amount by
Common Stock ----------------------------------------- common stockholders in the event
Common Shares Outstanding of liquidation if assets are realized
at their book values.
Times Preferred Net Income After Taxes It indicates ability to provide

Dividend Earned -------------------------------- dividends to preferred stockholders.
Preferred Dividends
Capital Intensity Ratio Total Assets Measures efficiency of the firm to
----------------- generate sales through employment
Net sales of its resources.
Times Fixed Charges Net Income before taxes & Measures ability to meet fixed
Earned fixed charges charges.
-------------------------------------------
-
(fixed charges + sinking fund
payment)
 TESTOF OVERALL SHORT-TERM SOLVENCY OR SHORT-TERM FINANCIAL POSITION
Working Capital Turnover Net Sales Indicates adequacy of working

---------------- capital to support operation (sales)
Average Working Capital
Defensive Interval Ratio Current Liabilities Measures coverage of current
------------------------ liabilities
Cash & Cash Equivalent
Payable Turnover Net Purchases Measures efficiency of the company

--------------------- in meeting the accounts payable.
Average Accounts Payable
Fixed Assets to Long-term Fixed Assets Reflects extent of the utilization of
liabilities ------------------- resources from long term debt.
Long Term Liabilities Indicate of sources of additional
funds.
 RATIOS INDICATIVE OF INCOME POSITION
Rate of Return on Average Income Measures the profitability of

Current Asset ------------ current assets invested.
Average Current Assets
Operating Profit Margin Operating Profit Measures profit generated after
---------------------- consideration of operating costs.
Net Sales
Cash Flow Margin Operating Cash Flow Measures the ability of the firm to
----------------------------- translate sales to cash
Net Sales

******************************************************************************************************************
Goodluck and Godbless!!!
THE END JUSTIFIES THE MEANS.
----Good Luck and God Bless in your COMPREHENSIVE EXAM .----
----“Do not settle for less. Always aim for the best.”-
*******************************************************END *****************************************************
SAMPLE STRAIGHT PROBLEMS

UNDERSTANDING FINANCIALSTATEMENTS AND ITS ANALYSIS
The following are the balance sheet and income statement data of
Balance Sheet Accounts(December 31) 2015 2013
Cash P150,000 P283,000
Marketable Securities 850,000 1,000,000
Accounts Receivable, net 500,000 1,000,000
Inventories 750,000 500,000
Land 500,000 500,000
Building, net 550,000 500,000
Machinery and Equipment, net 1,700,000 1,500,000
Goodwill 400,000 400,000
Deferred Charges 100,000 90,000
Notes payable, Trade 100,000 150,000
Accounts Payable, Trade 610,000 790,000
Expenses Payable 40,000 60,000
Long-term Notes-Due 2018 2,500,000 2,250,000
15% Preferred Stock, P100 par 500,000 500,000
Retained Earnings 250,000 523,000
2008 Income Statement Accounts
Sales 5,250,000
Sales Return and Allowances 250,000
Inventory, December 31 2008 500,000
Inventory, December 31 2007 750,000
Purchases 2,750,000
Selling Expenses 400,000
Administrative Expenses (Including Depreciation of P250,000) 600,000
Interest on Long-Term Notes 250,000
Income Taxes, 35%
Additional Information:

1. Dividends paid on preferred stock 75,000
2. Dividends paid on common stock 162,000
3. Market price per share on common stock 18
REQUIREMENTS:
1. Prepare comparative balance sheets for 20014 and 2015 showing peso and percentage increases or
decreases (Horizontal Analysis).
2. Prepare income statement for the year ended December 31, 2015with common size percentages (Vertical
Analysis).
3. Prepare comparative common-size balance sheets as of December 31, 2014 and 2015(Vertical Analysis).
4. Evaluate the firms’ short-term solvency for 2008 by computing:
a. Working Capital
b. Current Ratio
c. Acid-test Ratio
d. Cash Flow from Operations to Current Liabilities
e. Receivable Turnover
f. Age of Receivables (Use 380 days)
g. Inventory Turnover
h. Days’ Supply in Inventory
i. Working Capital Turnover
j. Current Asset Turnover
5. Evaluate the firms’ long-term solvency for 2015 by computing:
a. Debt to Equity Ratio
b. Cash Flow from Operations to Total Liabilities
c. Times Interest Earned
d. Times preferred Dividends earned.
6. Evaluate the firms’ operational efficiency for 2015by computing:
a. Gross Margin Ratio
b. Profit Margin Ratio
c. Return on Total Assets
d. Return on Owners ‘Equity
e. Asset Turnover Ratio
7. Evaluate the firms’ profitability for 2015by computing:
a. Return on Common Stockholders’ Equity
b. Earnings per Share (EPS)
c. Price-earnings Ratio
d. Pay-out Ratio to Common Shares
e. Dividend Yield per Share on Common Stock
8. Make an investment analysis for 2015 by computing:
a. Equity Ratio
b. Creditors Equity to Total Assets
c. Book Value per Share on Common Stock

SOLUTION TO EXAMPLE PROBLEM 1:
1. PRT COMPANY
COMPARATIVE BALANCE SHEETS
As of December 31, 2014 and 2015
Increase (Decrease)
ASSETS 2014 2015 Pesos Percentage
Current Assets:
Cash 150,000 283,000 133,000 88.7%
Marketable Securities 850,000 1,000,000 150,000 17.6%
Accounts Receivable, net 500,000 1,000,000 500,000 100.0%
Inventories 750,000 500,000 (250,000) (33.3%)
Total Current Assets 2,250,000 2,783,000 533,000 23.7%
Non-current Assets:
Land 500,000 500,000 - -
Building, net 550,000 500,000 (50,000) (9.1%)
Machinery and Eq nt, net 1,700,000 1,500,000 (200,000) (11.8%)
Goodwill 400,000 400,000 - -
Deferred Charges 100,000 90,000 10,000)
(10.0%)
Total Non-current Assets 3,250,000 2,990,000 (260,000 (8.1%)
TOTAL ASSETS 5,500,000 5,773,000 273,000 5.0%
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities:
Notes Payable, Trade 100,000 150,000 50,000 50.0%
Accounts Payable, Trade 610,000 790,000 180,000 29.5%
Expenses Payable 40,000 60,000 20,000 50.0%
Total Current Liabilities 750,000 1,000,000 250,000 33.3%
Non-current Liabilities:
Long-term Notes-Due 2018 2,500,000 2,250,000 (250,000) (10.0%)
Stockholders’ Equity
15% Preferred Stock. P100 par 500,000 500,000 - -
Common Stock, P10 par 1,500,000 1, 500,000 - -
Retained Earnings 250,000 523,000 273,000 109.2%
Total Stockholders’ Equity 2,250,000 2,523,000 273,000 12.1%
TOTAL LIABILITIES & STOCKHOLDERS’ EQUITY 5,500,000 5,773,000 273,000

5.0%
2. PRT COMPANY
INCOME STATEMENT
For the Year December 31, 2015
(With Common-size Percentages)
Amount Percentage
Sales 5,250,000 105.00
Less Sales Returns and Allowances 250,000 5.00
Net Sales 5,000,000 100.00
Cost of Goods Sold:
Inventory, December 31, 2007 750,000 15.00
Add: Purchases 2,750,000 55.00
Total Goods Available for Sale 3,500,000 70.00
Less: Inventory , December 31, 2008 500,000 10.00
Cost of Goods Sold 3,000,000 60.00
Gross Margin on Sales 2,000,000 40.00
Selling and Administrative Expenses:
Selling Expenses 400,000 8.00
Administrative Expenses 600,000 12.00
Total Selling and Administrative Expenses 1,000,000 20.00
Net Operating Income 1,000,000 20.00
Less: Interest Expense 250,000 5.00
Net Income Before Income taxes 750,000 15.00
Less: Provision for Income tax, 35% 262, 500 5.25

NET INCOME 87,500 9.75
3. PRT COMPANY
COMPARATIVE COMMON-SIZE BALANCE SHEET
As of December 31, 2014 and 2015
ASSETS 2014 2015
Current Assets:
Cash 2.73 4.90
Marketable Securities 15.45 17.32
Account Receivable, net 9.09 17.32
Inventories 13.64 8.66
Total Current Assets 40.91 48.21
Non-current Assets:
Land 9.09 8.66
Building, net 10.00 8.66
Machinery and Equipment, net 30.91 25.98
Goodwill 7.27 6.93
Deferred Charges 1.82 1.56
Total Non-current Assets 59.09 51.79
TOTAL ASSETS 100.00 100.00
LIABILITIES AND STOCKHOLDERS’ EQUITY

Current Liabilities:
Notes Payable, Trade 1.82 2.60
Account Payable, Trade 11.09 13.69
Expenses Payable 0.73 1.04
Total Current Liabilities 13.64 17.33
Non-current Liabilities
Long-term Notes-Due 2018 ` 45.45 38.97
Stockholder’s Equity
15% Preferred stock, P100 par 9.09 8.66
Common Stock, P10 par 27.27 25.98
Retained Earnings 4.55 38.97
Total Stockholder’s Equity 40.91 43.70
TOTAL LIABILITIES & STOCKHOLDER’S EQTY 100.00 100.00
4a. Current Assets:
Cash 283,000
Marketable Securities 1,000,000
Accounts Receivable, net 1,000,000
Inventories 500,000 2,783,000
Current liabilities:
Notes Payable, Trade 150,000
Accounts Payable, Trade 790,000
Expenses Payable 60,000 1,000,000
Working Capital for 2008 1,783,000
4b. Current Ratio = 2,783,000/1,000,000 2.78 : 1
4c. Quick Assets:

Cash 283,000
Marketable Securities 1,000,000
Accounts Receivable, net 1,000,000 2,283,000
Current Liabilities: 1,783,000
Acid Ratio 1.28: 1
4d. Net Income 487,500
Add: Depreciation 250,000
Inc. in Accounts Receivable (500,000)
Dec. in Inventories 250,000
Inc. in Notes Payable, Trade 50,000
Inc. in Accounts Payable, Trade 180,000
Inc. in Expenses Payable 20,000 250,000
Cash Inflow from Operations 737,500
Average Current Liabilities = (750,000+1,000,000)/2 875,000
Cash Inflow from Operations to current Liabilities 84%%
4e. Net Credit Sales 5,000,000
Average Receivables = (500,000+1,000,000)/2 = 750,000
Receivable t turnover 6.67 times
4f. Age of Receivables = 360 days/ 6.67 times= 54 days
4g. Cost of Goods Sold 3,000,000

Average Inventory = (750,000 + 500,000 = 625,000
Inventory Turnover 4.8 times
4h. Days Supply in Inventory = 360 days/ 4.8 times = 75 days
4i. Net sales 5,000,000
Average Working Capital = (1,783,000 +1,500,000*)/2 = 1,641,500
Working Capital Turnover 3.05 times
4j. Net Sales 5,000,000
Average Current Assets = (2,250,000 + 2,783,000)/2 = 2,516,500
Current Assets Turnover 1.99 times
5a. Total Liabilities = (1,000,000 + 2,250,000) = 3,250,000

Total Stockholders’ Equity 2,523,000
Debt to Equity Ratio 1.29 times

5b. Cash Inflow from Operations 737,500
Average Total Liabilities = (3,250,000 + 3,250,000)/2 3,250,000
Cash Inflow from Operations to Total Liabilities 22.7%
5c. Net Operating Income 1,000,000
Interest Expenses 250,000
Time Interest Earned 4 times
Annual Preferred Dividend Requirement 75,000
Times Preferred Dividend Earned 6.5 times
6a. Gross Margin on Sales 2,000,000
Net Sales 5,000,000
Gross Margin Ratio 40%
6b. Net Income 487,500
Net Sales 5,000,000
Profit Margin Ratio 9.75%
6c. Net Income + Interest Expense (Net of Tax)
487,500 + [250,000 – (250,000 * 35%)] = 650,000
Average Total Assets 2,636,500
Return on Total Assets 11.53%
Total Stockholders Equity 2,523,000
Return on Owner’s Equity 19.32
6e. Net Sales 5,000,000
Average Total Assets (5,500,000 + 5,773,000)/2 5,636,500
Assets Turnover Ratio .8901
7a. Net Income – Preferred dividends (487,500 – 75,000) = 412,500
Average Common Stockholders’ Equity (1,750,000 + 2,035,000)/2 1,901,500
Returns on Common Stockholders’ Equity 21.69%
7b. Net Income – Preferred Dividends (487,500 – 75,000) = 412,500
Number of Common Shares Outstanding (1,500,000/10) = 150,000
Earnings Per Share 2.75/share
7c. Market Price per Common Share 18.00
Earnings Per Share 2.90
Price Earnings Ratio 6.21:1
7d. Common Dividends 162,000

Net Income – Preferred Dividends (487,500 – 75,000) = 412,500
Payout Ratio to Common 39:1
7e. Dividends Per Common Share (162,000/150,000 shares) = 1.08
Market Price Per Common Share 18.00
Dividend Yield on Common 6%
8a. Total Stockholders’ Equity 2,523,000
Total Assets 5,773,000
Equity Ratio .44:1
8b. Total Liabilities 3,250,000
Total Assets 5,773,000
Creditors’ Equity to Total Assets 56:1
8c. Common Stockholders’ Equity 2,023,000
Number of Common Shares Outstanding (1,500,000/10) = 150,000
Book Value per Common Share 13.49/share

SAMPLE EXCERCISES: FINANCIAL STATEMENT ANALYSIS
1. VERTICAL AND HORIZONTAL PRODUCTS
Following are the financial statements of ARNZQUIN Company:
ARNZQUIN COMPANY
Condensed Statement of Financial Position
December 31, 2015 (In thousands)
ASETS LIABILITIES AND STOCKHOLDER’S EQUITY
CASH P75 Current Liabilities P50

Non-Cash Current 125 Long term Debts 150
Fixed Assets 300 Capital stock 200
Retained Earnings 100
TOTAL ASSETS P500 TOTAL LIAB. & SHE P500
For 2015: Net sales, P2, 000; CGS, P1, 300; Operating Expenses, P300; Interests and tax
charges, P220.
For 2014: Net sales, P1, 600; CGS, P1, 000; Operating Expenses, P300; Interests and tax
charges, P200.
REQUIRED:
1. Prepare 2015 common-size balance sheet and determine:
A) Current ratio
B) Debt ratio
C) Equity ratio
2. Prepare 2015 common-size income statement and determine:

A) Gross profit margin
B) Operating profit margin
C) Net profit margin
3. Perform index analysis or compute trend percentages for
A) Net sales
B) EBIT
C) Net income
2. LIQUIDITY ANALYSIS
Indicate the effects of each of the following transactions on the company’s (A) current
ratio and (B) acid-test ratio. There are three possible answers: (+) increase, (-) decrease,
and (0) no effect. Before each transaction takes place, both ratios are greater than 1 to
1.
Effects on
-------------
(A)Current ratio (B) Acid-test Ratio
+ +
Transactions:
Example: Sell merchandise or cash
1. Buy inventory in account.
2. Pay an account payable.
3. Borrow cash on a short-term loan.
4. Issue long-term bonds payable.
5. Collect an account receivable.
6. Record accrued expenses payable.
7. Sell a plant asset for cash at a profit.
8. Sell a plant asset for cash at loss.
9. Buy marketable securities, for cash.
10. Sell merchandise on credit.
3. 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 2006 showed approximately the same
amounts as that the end of 2007. The financial statements for ABC Merchandising are as follows.

ABC Company, Income Statement for 2015 (in thousands)
Sales P4, 700
Costs of goods sold 2,300
Gross profit P2, 400
Operating expenses:
Depreciation P320
Other 1,230 1,550
Income before interest and taxes P850
Interest expense 150
Income before taxes P700
Income taxes 280
Net income P420
ABC Company, Balance Sheet at December 31, 2007 (in thousands)
Assets liabilities and SHE
Cash P220 Accounts payable P190
Accounts receivable 440 Accrued expenses 180
Inventory 410 Total current liabilities P370
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 liabilities and SHE P4, 570
REQUIRED: (round-off answer to two decimal places)

1. Current ratio (2. 89: 1) 11. EPS (0. 42)
2. Acid-test ratio (1. 78. 1) 12. P/E Ratio (19.05)
3. Accounts receivable turnover (10. 68 times) 13. Dividend Yield (1.25%)
4. Inventory turnover (5.61 times) 14. Payout ratio (23.81%)
5. Gross profit margin (51.06%) 15.Debt ratio (50.98%)
6. Operating profit margin (18.09%) 16. Debt-equity Ratio (1.40:1)
7. Return on sales (RoS) (8.94%) 17. Times interest earned (5.67 times)
8. RoA – operational performance (18.60%) 18. Defensive interval ratio (1.68:1)
9. RoA – total management effort (9.19%) 19. Cash flow total debt (31.76%)
10. Return on equity (RoE) (18.75) 20. Cash flow margin (15.74%)
4. CONSTRUCTION FINANCIAL STATEMENTS

The following information is available concerning WWW company’s expected results in 2007 (in
thousands of pesos). Turnovers are based on year-end values.
REQUIRED: Fill in the blanks.
Return on sales 6%
Gross profit percentage 40%
Inventory turnover 4 times
Receivables turnover 5 times
Current ratio 3 to 1
Ratio total debt to total assets 40%
Condensed Income Statement

Sales P 900
Cost of Sales
Gross profit
Operating expenses
Net Income
Condensed Balance Sheet

Cash P 30 Current liabilities P ___
Receivables ___ Long-term debt ___
Inventory ___ Stockholder’s equity ___
Plant and equipment 670 ___
Total P___ Total P___
5. RELATIONSHIP. Answer the question 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 only current assets are cash, receivables, and inventory. Compute:

1) Current liabilities
2) Inventory
B. Accounts receivables equal 45 days’ credit sales. Annual sales of P900, 000 are spread
evenly throughout the year. Inventory turnover is 4 times. Compute:
1) Average accounts receivables
2) Operating cycle
C. Net sales total P100, 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 amounted to P5, 000, how much was the company’s operating
expenses?
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 the following:
1. Asset turnover
2. Net income
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 P 300,000.
1. Assume pay-out ratio of 60%:
A) How much of the total dividends shall a shareholder owning 10,000
common shares receive?
B) Determine dividend yield if price per share is P20.


MODULE 2
DIAGNOSTIC EXERCISES-THEORIES/PROBLEMS
Name: ________________________________________________ SR Code: ___________Score:_______

Course/Year: __________________________________________ Date: __________________________
II. Problems
Problem 1: The assets of J&R Associates consist entirely of current assets and net plant and
equipment. The firm has total assets of P2.5 million, and equipment of P2 million. It has notes payable
of P150, 000, long-term debt of P750, 000, and total common equity of P1.5 million. The firm does
have accounts payable and accruals on its statement of financial position. The firm only finances with
debt and common equity, so it has no preferred stock on its statement of financial position.
Required:
a. What is the amount of total liabilities and equity that appears on the firm’s statement of
financial position?
b. What is the balance of current assets on the firms of financial position?
c. What is the balance of current liabilities on the firm’s statement of financial position?
d. What is the amount of accounts payable, and accruals on its statement of financial position?
e. What is the firm’s net working capital?
f. What is the firm’s net operating working capital?
FINANCIAL STATEMENT ANALYSIS: PRBOBLEMS
1) Horizontal and vertical analysis. The financial position of Twig Company at the end of 2002 and
2003 is as follows:
(in thousands)
2003 2002
Assets
Cash P 3, 000 P 5,000
Accounts receivable 40,000 25,000
Inventory 27,000 30,000
Long-term investments 15,000 0
Land, buildings and equipment (net) 100,000 75,000
Intangible assets 10,000 10,000
Other assets 5,000 20,000
Total assets 200,000 165,000
Liabilities
Current liabilities P 30,000 P 47,000
Long-term liabilities 88,000 74,000
Total liabilities 118,000 121,000
Stockholder’s equity
8% Preferred stock 10,000 9,000
Common stock 54,000 42,000
Additional paid-in capital 5,000 5,000
Retained earnings 13,000 12,000
Total stockholder’s equity 82,000 44,000
Total liabilities and stockholder’s equity 200,000 165,000
Sales and cost of goods sold insignificantly change 2003 in relation with 2002.
Required:

1. Prepare a comparative balance sheet showing peso and percentage changes for 2017 as compared
with 2016.
2. Prepare a common-size balance sheet as of De. 31, 2016 and 2017.
3. Based on your data derived in requirements 1 and 2, comment on the financial position of the Twig
Company as of Dec. 31, 2017.
2) Horizontal and vertical analysis. The operating activities of Metro Company for the year ended Dec.
31, 2003 and 2002 are summarized below:
(in thousands)
2016 2017
Sales P 45,000 P 50,000
Sales returns 1,000 2,000
Net sales 44,000 48,000
Cost of goods sold 24,000 35,000
Gross profit 20,000 13,000
Selling and general expenses 12,000 10,000
Operating income 8,000 3,000
Other expenses 3,000 3,500
Income (loss) before income tax 5,000 ( 500)
Income tax (refund) 2,000 ( 200)
Net income (loss) P 3,000 P ( 300)
Required:
1. Prepare a comparative income statement showing peso and percentage changes for 2017 as
compared with 2016.
2. Prepare a comparative income statement offering a percentage analysis of component revenue
expense items of net sales for each year.
3. Based on the above percentage, comment on the Metro Company’s results operations for 2003.
3) Common-size balance sheet. The balance sheet of south Corporation and North Corporation at December 31,
2003 are shown below
(in thousand pesos)
South North
Assets
Current assets P 51,000 P 240,000
Long-term investments 5,000 280,000
Land, buildings and equipment (net) 48,000 520,000
Intangible assets 6,000 100,000
Other assets 5,000 60,000
Total assets 115,000 1,200,000
Liabilities and Stockholder’s equity
Current liabilities P 15,000 P 180,000
Long-term liabilities 25,000 300,000
Deferred revenues 5,000 70,000
Preferred stock 5,000 100,000
Common stock 30,000 200,000
Additional paid-in –capital 25,000 185,000
Retained earnings 10,000 165,000
Total liabilities and stockholder’s equity 115,000 1,200,000
Required:
1. Prepare a common-size balance sheet for South and North Corporation.
2. Based on your common-size balance sheet, which company is better, financial position wise?
Why?


DIAGNOSTIC EXERCISES-THEORIES & PROBLEMS
Name :________________________SR Code:________________ Score:___________

Course/Year:_________________ Date:______________________
I. THEORY
1. Which of the following does not belong to the list?
A. Common-size financial statements.
B. Peso and percentage changes on financial statements.
C. Financial ratios.
D. Long-form report.
2. When a balance sheet amount is related to an income statement amount in computing ratio
A. The income statement amount should be converted to an average for the year.
B. Comparison with industry ratios is not meaningful.
C. The balance sheet amount should be converted to an average for the year.
D. The ratio loses its historical perspective because a beginning of the year amount is
combined with an end of the year amount.
3. A major problem in comparing profitability measures among companies is the
A. Lack of general agreement over which profitability.
B. Differences in the size of the companies.
C. Differences in the accounting methods used by the companies.
D. Differences in the dividend policies of the companies.
1. Index numbers would probably be most interested in which ratio?
A. Trend analysis. C. Vertical analysis.
B. Ratio analysis. D. Common-size statements.
2. An income statement showing only component percentages is known as
A. Common pesos statement
B. Condensed income statement.
C. Common-size income statement.
D. Comparative income statement.
3. Horizontal, vertical, and common-size analyses are techniques that are used by analysts in
understanding the financial statements of companies. Which of the following is an example of
vertical common-size analysis?
A. Commission expense in 2006 is 10% greater than it was in 2005.

B. A comparison in financial ratio between two or more firms in the same industry.
C. A comparison of financial form between two or more firms in different industries.
D. Commission expense in 2006 is 5% of sales.
4. It refers to the practice of financing assets with borrowed capital. Its extensive use may impact
on the return on common stockholders’ equity to be above or below the rate or return on total
assets.
A. Discounting. C. Leverage.
B. Mortgage. D. Arbitrage.
5. Securing of funds for investment at a fixed rate of return to fund suppliers to enhance the well
being of the common stockholders is known as:
A. Financial leverage. C. Prudent borrowing.
B. Fund management. D. Financial arbitrage.
6. In the process of investing of surplus cash, the term “riding the yield curve” refers to
A. Diversifying securities portfolio so that the firm has an equal balance of long-term
versus short-term securities.
B. Swapping different maturities of similar quality debt securities in order to obtain higher
yield.
C. Purchasing only the longest maturities for given rates of return.
D. Adherence to the liquidity preference theory of securities investment.
7. When compared to a debt-to-asset ratio, a debt-to-equity ratio would
A. Be lower than the debt-to-asset ratio.
B. Be higher than the debt-to-asset ratio.
C. Be about the same at the debt-to-asset ratio.
D. Have no relationship at all to the debt-to-asset ratio.
8. If the ratio of total liabilities to stockholders equity increases, a ratio that must would also
increase is
A. Time interest ratio. C. Total liabilities to total assets.
B. The current ratio. D. Return on stockholder’s equity
9. A measure of the company’s long-term debt paying ability is
A. Return on assets. C. Dividend payout.
B. Times interest earned. D. Length of the operating cycle.
10. All of the following statements are correct except:
A. The matching of asset and liability maturities is considered desirable because this
strategy minimizes interest rate risk.
B. Default risk refers to the inability of the firm to pay off its maturing obligations.
C. The matching of assets and liability maturities lowers default risk.
D. An increase in the payables deferral period will lead to reduction in the need to non-
spontaneous funding.
11. The following situations are descriptive of SBD Corporation. Which would be considered as the
most favourable for the common stockholders?
A. Book value per share of common stock is substantially higher than market value per
share; return on common stockholders’ equity is less than the rate of interest paid to
creditors.

B. Equity ratio is high; return on assets exceeds the cost of borrowing.
C. SBD stops paying dividends on its cumulative preferred stock; the price earnings ratio
of common stock is low.
D. Equity ratio is low; return on assets exceeds the cost of borrowing.
12. Financial ratios, which assess the profitability of company, include all of the following except
the
A. Dividend yield ratio C. Earnings per share ratio
B. Gross profit percentage D. Return on sales ratio
13. Which of the following statements is incorrect?
A. Profitability evaluation ratios have higher power than solvency determination ratios
predicting for performance for both income and solvency.
B. Gross profit percentages do not vary a great deal among industries.
C. It is appropriate to compare a company’s current financial ratio with same financial

ratio for (1) that company is prior year and/or (2) the ratio for the industry in which the
company is affiliated.
D. Companies where product costs present a high percentage of total cost could be
expected to have a low gross profit percentage
14. This ratio of analytical measurement measures the productivity of assets regardless of capital
structures.
A. Return on total assets C. Current ratio
B. Quick ratio D. Debt ratio
15. How are trade receivables used in the calculation of each of the following?
Acid test (quick) ratio Receivable turnover
A. Numerator Numerator
B. Numerator Denominator
C. Denominator Denominator
D. Not used Numerator
16. If the current assets exceeds liabilities payments to creditors made on the last day of the month
will
A. Decrease current ratio C. Decrease net working capital
B. Increase current ratio D. Increase net working capital
17. GRX, Inc. has a current ratio of 4:1. Which of the following transactions would normally
increase its current ratio?
A. Purchasing inventory on account C. Selling inventory in account
B. Purchasing machinery for cash D. Collecting on accounts receivable
18. Inventory turnover indicates:

A. How many times in the course of the year the company is able to sell the amount of its
average inventory.
B. The flow assumption, which provides the most current valuation in the balance sheet.
C. The average time period between the purchase of inventory and conversion this
inventory back to cash.
D. A pattern of transferring unit cost from the inventory account to the cost of goods sold.
19. If Penta Mfg. Company decided to change from the FIFO inventory method to LIFO method during a
period of rising prices, its
A. Current ratio would be reduced.
B. Debt-to-equity ratio would be decreased.
C. Inventory turnover would be reduced.
D. Cash flow would be reduced

20. All of the following statements are valid except:
A. The short-term creditor is more interested in cash flow and in working capital management than
he is in how much accounting net income is reported.
B. If the return on total assets is higher than the after tax cost of long term debt then leverage is
positive, and the common stockholders will benefit.
C. The results of financial statements analysis are of value only when viewed in comparison with the
results of other periods or other firms.
D. The inventory turnover is computed by dividing sales by average inventory.
II. PROBLEMS:
1. RUS Inc. has the following data as at year ending December 31, 2006:
Total assets P 5, 000, 000
Common shares 2, 500, 000
Preferred stock outstanding 1, 000, 000
Net income 750, 000
Depreciation expense 500, 000
There were no changes in number of shares outstanding during the year, AMK’s ratio of cash flow to
total liabilities is:
A. 30% C. 20%
B. 50% D. 60%
2. Alpha Company’s net accounts receivable were P500, 000 at December 31, 2005, and P600,
000 at December 31, 2006. Net cash sales for 2006 were P200, 000. The accounts receivable
turnover for 2006 was 5.0. What were Alpha’s net sales for 2006?
A. P 2, 950, 000 C. P 3, 200, 000
B. P 3, 000, 000 D. P 5, 500, 000
Questions 3 and 4 are based on the following information: Global Corporation registered accelerated
increase in its net income from P437, 500 in 2005 to P1, 260, 000 in 2006. Rate of return on current
assets increased from 25% in 2005 to 30% in 2006. Current asset turnover, on the other hand, went
up o 2.87 turnovers in 2006 from 2.45 turnovers in 2005.
3. The average investment in current assets of Global Corporation in 2006 was:
a. P 2, 975, 000 C. P 4, 200, 000
b. P 1, 750, 000 D. P 5, 950, 000
4. The cost of goods sold and operating expenses, including depreciation, in 2006 amounted to:
a. P 10, 794, 000 C. P 6, 022, 500
b. P 5, 022, 500 D. P 10, 253, 000
Items 5 through 8 are based n the following information: You are requested to reconstruct the account
Global Link Supplies for analysis. The following data were made available to you:
Gross margin for 2006 amounted to P472, 500. Ending balance of merchandise inventory was P300,
000. Long-term liabilities consisted of bonds payable with interest rate of 20%. Total stockholder’s
equity as of December 31, 2006 was P750, 000.
Gross margin ratio 35%
Debt-to-equity ratio 0.8 to 1
Times interest earned 10
Quick ratio 1.3 to 1
Ratio of operating expenses to sales 18%
5. What is the operating income for 2006?
a. P 472, 500 C. P 206, 500
b. P 243, 000 D. P 229, 500
6. How much was the bonds payable?
a. P 400, 000 C. P 114, 750
b. P 200, 750 D. P 370, 500
7. Total current liabilities would amount to
a. P 600, 000 C. P 485, 250
b. P 714, 750 D. P 550, 000
8. Total current assets would amount to
a. P 630, 825 C. P 580, 000
b. P 780, 000 D. P 930, 825
Items 9 through 13 are based on the following information. Mendez Corporation discloses the
following in relation to its financial statements for 2006:
Cash P 37, 500
Plan and equipment 441, 000
Total assets 648, 000
Income tax payable 37, 500
Common stock 450, 000
Gross margin for 2006 450, 000
Accounts receivable, inventory, accounts payable,
Long-term debt, and retained earnings ?

Total liabilities divided by total stockholder’s equity 0.8
Inventory turnover based on sales and ending inventory 15 times
Inventory turnover based on cost of goods sold and
Ending inventory 10.5 times
Current ratio, at year-end 1.5 to 1
9. What was the balance in trade accounts payable?
a. P 169, 500 C. 100, 500
b. P 138, 000 D. 207, 000
10. What was the balance in retained earnings?

a. P (90, 000) C. P (132, 000)
b. P 90, 000 D. P 132, 000
11. The balance in the inventory account is

a. P 30, 000 C. P 100, 000
b. P 45, 000 D. P 135, 000
12. The balance of accounts receivable is
a. P 138, 000 C. P 38, 000
b. P 92, 000 D. P 69, 500
13. The balance of long-term debt is
a. P 100, 000 C. P 150, 000
b. P 92, 000 D. P 130, 000
Questions 14 through 17 are based on the following information: Panga Company asked you to
interpret the following ratios provided by its accountant on December 31, 2006:
Acid-test ratio 1.2
Times interest earned 8
Gross margin ratio 40%
Inventory turnover 6
Debt-to-equity ratio 0.9 to 1
Ratio of operating expenses to sales 15%
Total stockholder’s equity on December 31, 2006 was P900, 000. Gross margin for 2006 amounted to
P600, 000. Beginning balance of merchandise inventory was P200, 000. The company’s long-term
liabilities consisted of bonds payable with interest at 15%. You decided to reconstruct the company’s
financial statements based on the limited information given serve as a basis for further analysis.
14. Panga’s operating income in 2006 is:
a. P 525, 000 C. P 375, 000
b. P 300, 000 D. P 225, 000
15. Panga’s bonds payable balance at December 31, 2006 is
a. P 312, 500 C. P 400, 000
b. P 350, 000 D. P 562, 500
16. The current liabilities balance at December 31, 2006 is
a. P 462, 500 C. P 04, 500
b. P 497, 500 D. P 810, 000
17. The company’s current assets amount to
a. P 317, 000 C. P 697, 000
b. P 597, 000 D. P 622, 000
Questions 18 through 20 are based on the following data pertaining to Marina Company for the
calendar year 2006:
Sales P 2, 000, 000
Gross profit on sales 900, 000
Net income 150, 000
Purchases 1, 000, 000
Inventory at the end of year 250, 000
Accounts receivable at beginning of year 600, 000
Accounts receivable at the end of year 400, 000
Stockholders’ equity at the end of year
Common stock outstanding (unchanged
during the year) – 30, 000 shares
at par of P1 per share P 300, 000
Retained earnings 500, 000 800, 000
Dividends paid during the year totalled P 0.25 per share. The market price per share of Marina’s stock
was P5 at the end of the year.
18. Marina’s inventory turnover for 2006 was
a. 2.0 times C. 4.4 times
b. 2.2 times D. 3.0 times
19. Marina’s accounts receivable turnover for 2006 was
20. The price-earnings ratio on Marina’s common stock at the end of the year was

a. 2.0 to 1 C. 10.0 to 1
b. 2.5 to 1 D. 20.0 to 1
Questions 21 through 23 are based on the following information: selected data taken from the
financial statements of Johnny Company for the year indicated:
(Use 360 days in a year) 2004 2005 2006
Accounts receivable, net P 40, 000 P 42, 500 P 45, 000
Inventory 40, 000 50, 000 45, 000
Current assets 120, 000 140, 000 130, 000
Total assets, net 700, 000 750, 000 725, 000
Current liabilities 70, 000 80, 000 50, 000
Cash sales 400, 000 420, 000 450, 000
Credit sales 120, 000 125, 000 131, 250
Cost of sales 310, 000 324, 000 345, 000
21. What should be the age of receivables for 2006?
a. 110 days C. 13 days
b. 120 days D. 10 days
22. What is the estimated number of days in inventory for 2005?
a. 50 days C. 70 days
b. 60 days D. 80 days
23. What is the working capital turnover for 2006?
a. 7.15 C. 9.9
b. 8.3 D. 9.0
Questions 24 through 26 are based on the following information. The following selected financial data
were taken from the accounting records of Melanie Corporation:
Melanie Corporation
Selected Financial Data
December 31
2006 2005
Cash P 170, 000 P 90, 000
Accounts receivable, net 450, 000 400, 000
Merchandise inventory 540, 000 420, 000
Short-term marketable securities 80, 000 40, 000
Land and building, net 1, 000, 000 1, 000, 000
Mortgage payable – current portion 60,000 50, 000
Accounts payable and accrued liabilities 240, 000 220, 000
Short-term notes payable 100, 000 140, 000
24. At December 31, 2006, Melanie’s current ratio was
a. 1.50 to 1.00 C. 2.06 to 1.00
b. 1.75 to 1.00 D. 3.10 to 1.00
25. At December 31, 2006, Melanie’s quick (acid) test ratio was
a. 1.50 to 1.00 C. 2.06 to 1.00
b. 1.75 to 1.00 D. 3.10 to 1.00
26. For 2006, Melanie’s accounts receivable turnover was
a. 1.17 C. 6.67
b. 1.5 D. 7.06
Questions 27 through 30 are based on the following information: Mojo Jojo Company is
calculating its ratios relating to debt-paying ability for the year ended December 31, 2006.
Below is the relevant information:
Sales revenue P 325, 000
Cost of goods sold and operating expense 75, 000
Interest expense 20, 000
Income tax expense 6, 000
Net income 9, 000
12-30-06 01-01-06
Cash P 10, 000 P 16, 000
Accounts receivable 25, 000 15, 000
Inventory 45, 000 60, 000
Accounts payable 24, 000 28, 000
Taxes payable 11, 000 13, 000
The company uses 365 days in a year.
27. What is Mojo’s current ratio at December 31, 2006?
a. 2.220 to 1 C. 3.259 to 1
b. 2.286 to 1 D. 3.420 to 1
28. What is Mojo’s average collection period for accounts receivable in 2006?
a. 22.15 days C. 16.25 days
b. 22.46 days D. 13.00 days

29. What is Mojo’s inventory turnover in 2006?
30. What is Mojo’s times interest earned?
a. 12.50 C. 3.750
b. 16.25 D. 11.50
Question 31 and 32 are based on the following selected information from the accounting
record of Nobody Company:
Net accounts receivable at December 31, 2000 P900, 000
Net accounts receivable at December 31, 2001 1,000,000
Accounts receivable turnover 5 to 1
Inventories at December 31, 2000 1,100,000
Inventories at December 31, 2001 1,200,000
Inventory turnover 4 to 1
Assumed number of days in a business year 300 days
31.What was Nobody’s gross margin for 2001?

a. P150,000 b. 200,000 c. 250,000 d. 400,000
32.What was the number of days’ sales in average receivables and the number of days’ sales in average
inventories for 2001, respectively?
a. 30 and 30 b.60 and 60 c.60 and 75 d. 63 and 77
33The following information is available from Troso Corp.’s financial records for 2000:
Sales
Net Credit Sales P500, 000
Net Cash sales 250,000
Accounts Receivable
Balance, January 1, 2000 P75, 000
Balance, December 31, 2000 50,000
How many times did Troso’s accounts receivable turn over in 2000?
a. 15
b. 12
c. 10
d. 8
34.During 2000, band Co. purchased P960, 000 of inventory. The cost of goods sold for 2000 was
P900, 000, and the ending inventory at December 31, 2000 was P180, 000. What was the inventory
turnover at 2000?
a. 6.4
b. 6.0
c. 7.2
d. 5.0
35.Selected data from Sheraton Corporation’s year-end financial statements are presented below. The
difference between average and ending inventory is immaterial.
Current ratio 2.0
Quick ratio 1.5
Current liabilities P120, 000
Inventory turnover (based on cost good sold) 8 times
Gross profit margin 40%
Sheraton’s net sales for the year were
a. P800, 000
b. P480, 000
c. P1,200,000
d. P240, 000
*****************************************************************************************************************
Goodluck and Godbless!!!
THE END JUSTIFIES THE MEANS.
----Good Luck and God Bless in your .----
----“Do not settle for less. Always aim for the best.”-
*******************************************************END ****************************************************

Prepared by:
Asst. Prof. ARNOLD QUINTO MALALUAN

BSA,MBA,MPA,MICB,RCA,LPT,REB,CMITAP,SPBE
Course Instructor
Email add: arnoldmalaluan21@gmail.com
Cell numbers: 0909-0340-686/0917-4330143/039-270-6648

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Republic of the Philippines

BATANGAS STATE UNIVERSITY

MANAGEMENT (MANAGERIAL) ACCOUNTING

Name: ________________________________________________ SR Code: _______________________

After studying this chapter, you should be able to:

DEFINITION OF FINANCIAL STATEMENT

1. Statement of Financial Position( Balance Sheet)

GENERAL OBJECTIVES OF FINANCIAL STATEMENTS

MGT ACCTG-UNDERSTANDING FINANCIAL STATEMENT AND ITS ANALYSIS Page 1

SOURCES OF INFORMATION ABOUT BUSINESS ENTERPRISE

CONSTRAINTS ON RELEVANT AND RELIABLE INFORMATION

MGT ACCTG-UNDERSTANDING FINANCIAL STATEMENT AND ITS ANALYSIS Page 2

FINANCIAL STATEMENT ANALYSIS

USERS OF FINANCIAL STATEMENT ANALYSIS

o To plan and budget

o To anticipate future needs and problems

o To predict future earnings and cash flow

o To predict the company’s potential

Limitations of Financial Statement Analysis

 Inflation can cause balance sheet items to be incomparable.

 Manipulation of ratios by management may occur.

 Generalizations are difficult to make.

Common Financial Ratios

o In general, the higher the current ratio, the better.

o Just like current, the higher the better.

MGT ACCTG-UNDERSTANDING FINANCIAL STATEMENT AND ITS ANALYSIS Page 3

 Number of Days of Inventory- this is a measure of the efficiency of inventory management. It

365 or 360 Average Inventory

Average Inventory Average AR

 Debt Management (Leverage) Ratios

MGT ACCTG-UNDERSTANDING FINANCIAL STATEMENT AND ITS ANALYSIS Page 4

 The higher the ratio, the better.

EBIT + Lease Obligations

 This ratio varies widely from one industry to another.

Net Income Available to Common Shareholders

Net Income available to common shareholders

 Return on Assets- This ratio measures the rate of return on assets.

Net Income available to common shareholders

 Market Value and Per Share Ratios

MGT ACCTG-UNDERSTANDING FINANCIAL STATEMENT AND ITS ANALYSIS Page 5

Market Price per Share

Dividend per Share

Net Assets Available to Common Share

 Profitability of the business firm

 Ability to meet company obligations

 Safety of investment in the business

 Effectiveness of management in running the firm

Financial Statements (FS) Analysis Tools and Techniques

MGT ACCTG-UNDERSTANDING FINANCIAL STATEMENT AND ITS ANALYSIS Page 6

5. Cash flow analysis

Percentage Change ( %) = Most Recent Value – Based Period Value

Percentage composition statements are used for comparing:

1. Multiple years of data from the same firm

2. Companies that are different in size

3. Company to industry averages

BASIC RULES ON RATIO CALCULATIONS

o Turnover ratios: sales and purchases are made on credit.

o Cash flow ratios: sales and purchases are made in cash.

MGT ACCTG-UNDERSTANDING FINANCIAL STATEMENT AND ITS ANALYSIS Page 7

Working Capital Activity Ratios (Efficiency Ratios)

Income statements account No. of days in a year

It is the time required to complete one

Name: __________________________ SR Code: _