FABM 2 Module 6: Analysis and Interpretation of Financial Statements

What Have I Learned So Far?

1. HRL Manufacturing Company owner Roberto wanted to check his company’s

liquidity ratios. Refer to the information provided below.

Cash P 55,000
Notes Receivable 18,500
Accounts Receivable (net) 110,250
Accounts Payable 200,000
Accrued Expenses 35,000
Prepaid Expenses 15,000
Inventories 455,850
Unearned Income 10,000
Mortgage Payable 85,000

Compute the following:

Liquidity Ratios
a. Working Capital

Current Assets
Cash P 55,000
Notes Receivable 18,500
Accounts Receivable (net) 110,250
Prepaid Expenses 15,000
Inventories 455,850 654,600

Current Liabilities
Accounts Payable 200,000
Accrued Expenses 35,000
Unearned Income 10,000 245,000

Working Capital P 409,600

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a. Current Ratio
= 2.67:1.00
 b. Quick Ratio
= 0.67:1.00

2. LeAnn Singsing runs a clothes boutique, SingLe Boutique, that has the following
information. Compute the profitability ratios for her business entity a
(a) gross profit margin ratio,
Gross Profit Margin Ratio = Gross Profit
Net Revenue or Net Sales

= 45,860
251,300

= 18.25%

(b) gross profit based on cost of sales,

Gross Profit = Net Sales - Cost of Sales

= 251,300 - 205,440

= 45,860

(c) return on sales or net profit margin ratio,

Return on Sales or Net Profit Margin Ratio = Net Profit after Taxes
Net Revenue or Net Sales

= 17,360
251,300

= 6.9%

(d) return on assets, and

Return on Assets = Net Profit After Taxes
Average Total Assets

= 17,360
387,500

= 4.48%

(e) return on equity.

Return on Equity = Net Profit after Taxes
Average Owner’s Equity

= 17,360
165,000

= 10.52%

Account Beginning Balance Ending Balance

Total Assets (net) P 350,000 P 425,000

LeAnn Singsing, Capital 150,000 180,000

Sales 256,800

Sales Returns and Allowances 5,500

Cost of Sales 80% of Sales (205,440)

Expenses including
depreciation amounting to P 22,000
5,750

Interest Expense 6,500

3. Marianna Alindogan is a financial consultant for a noodle restaurant operating in a

strip mall. She needs to see the acid test ratio for the restaurant based on the
information below. What do the following ratios mean to the business?

a. Current Ratio 2.50:1:00

b. Working Capital P 425,000
c. Inventories 65,000
d. Current Assets 708,300
Current Liabilities = 283,300
 - The following data shows that the business is doing well and that the
company is more likely to repay the creditor, as well as that it has enough
liquid assets to fund its short-term liabilities.

Beyond Walls

You are the chief accountant of a group of companies owned by Mrs. Magdalena
Co. The owner asked you to prepare a presentation of the financial highlights of her two
companies that are both engaged in trading. Magda Trading deals with packaging
materials while Lena Trading is engaged with office and supplies. Your staff has
provided you the following information for your perusal:

Account Magda Trading Lena Trading

Cash P 85,000 P 57,500

Accounts Receivable (net) 102,500 72,850

Inventories 80,000 45,000

Prepaid Expenses 12,000 3,500

Other assets (net) 585,750 345,000

Current Liabilities 255,000 52,750

Mortgage Payable 35,000 125,000

Owner’s Equity 420,000 100,000

Sales (50% on credit) 955,000 135,800

Cost of Sales 620,750 108,640

Gross Profit on Sales 35% 20%

Gross Profit 334,250 27,160

Average Inventory 75,000 50,000

Average Receivables 100,000 25,000

Number of Business Days 365 365

1. Find out the liquidity status of the two trading companies by determining the
ratios and measures as follows:
a. Inventory turnover (assume average inventory of Magda for two years
was P75,000 and Lena was P50,000)

Magda Trading Lena Trading

Inventory turn-over = = 620,750 = 108,640

Cost of Sales 75,000 50,000
Average Inventory = 8 times = 2 times

b. Average age of inventory

Magda Trading Lena Trading
Average age of inventory = =
365
=
365
365 𝐷𝑎𝑦𝑠 8 2
𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟
= 45.625 / 46 = 182.5 / 183

c. Accounts receivable turnover (assume average receivables of Magda for

two years was P 100,000 and Lena was P25,000)
Magda Trading Lena Trading
Accounts receivable turnover= = 477,500 = 67,900
Net Credit sales 100,000 25,000
Average Accounts Receivable = 4.76 / 5 = 2.72 / 3

d. Collection period
Magda Trading Lena Trading
Collection Period = = 365 = 365
365 days 5 3
Accounts Receivable Turnover = 73 = 122

e. Acid test ratio

Magda Trading Lena Trading
Acid Test or Quick Ratio     =     = 187,500 = 130,350
Quick Assets 255,000 52,750
Current Liabilities = 0.74:1.00 = 2.47:1.00

f. Current ratio
Magda Trading Lena Trading
Current Ratio = Current Assets = 279,500 = 178,850
 Current Liabilities 255,000 52,750
= 1.20:1.00 = 3.39:1.00

g. Operating cycle
Magda Trading Lena Trading
Operating Cycle = Collection = 73 + 46 = 122 + 183
Period (days) + Average Age of = 119 Days = 305 Days
Inventory (Days)

2. Determine the status of the liquid assets of the two trading companies
- Based on the computed data, there is a potential that Magda Trading may be
unable to get short-term funding to fulfill their urgent obligations due to some
poor outcomes, but the company's overall position is looking good so far. Lena
Trading looks to be performing well since its ratios are great. Magda and Lena
Trading appear to be in good health, but there is a gap between them.

3. Determine which of the two companies is more stable.

- Lena Trading, because based on the data, it appears to be operating well, as
its ratios are great.

Beyond Walls

1. As the accounting consultant for the Sobrang Galing Enterprises, your task is to
provide strategic and practical advice on the financial management concerns of
the business. They provided you a copy of their condensed SCI for the year
ended 31 December 2020.

Sales P 1,250,000
Cost of Goods Sold 575,000

Gross Profit 675,000

Expenses (including depreciation of P35,000) 125,000

Net Operating Profit 550,000

Interest Expense 45,000

Net Profit 505,000

Current Liabilities 350,000

Mortgage Payable (spread over three years in equal

installments) 750,000

Owner’s Equity 1,500,000

Compute the following financial ratios:

a. Times interest earned ratio
Times Interest Earned Ratio = Net Profit before Interest and Income Taxes
Annual Interest Expense

= 550,000
45,000

= 12 Times

b. Debt-service coverage ratio

Debt-Service Coverage Ratio
= Net Profit before Interest
Payments on Principal and Interest
= 550,000
45,000
= 12

c. Gross profit margin ratio

Gross Profit Margin Ratio = Gross Profit
Net Revenue or Net Sales

= 675,000
 1,250,000

= 54%

d. Return on sales
Return on Sales or Net Profit Margin Ratio = Net Profit after Taxes
Net Revenue or Net Sales

= 505,000
1,250,000

= 40.4%
e. Return on equity
Return on Equity = Net Profit after Taxes
Average Owner’s Equity

= Not Applicable

f. Return on assets
Return on Assets = Net Profit After Taxes
Average Total Assets

= Not applicable

2. As the chief accountant for Onager Resources, you have been requested by the chief
operating officer to present an analysis of how the company has performed financially,
specifically how it has managed its sales, promotions expenses and salaries of the
sales staff within three years of operation from 2018 to 2020. The information is
provided below.

Account 2020 2019 2018

Sales P 285,000 P 220,000 P 155,000

Promotional expenses 10,000 8,500 5,500

 Salaries of salespeople 48,500 34,000 10,500

a. Compute the promotions and salaries of the salespeople as a percentage of

sales using vertical analysis.

Vertical Analysis
Account 2020 2019 2018 2020 2019 2018
Sales P 285,000 P 220,000 P 155,000 82.99% 83.81% 90.64%
Promotional expenses 10,000 8,500 5,500 2.91% 3.24% 3.22%
Salaries of salespeople 48,500 34,000 10,500 14.12% 12.95% 6.14%

TOTAL P 343,500 P 262,500 P 171,000 100% 100% 100%

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Compute the changes in three accounts during the three years by using
horizontal
Horizontal Analysis
Account 2020 2019 2018 2020 2019
Increase % Increase
(Decrease) (Decrease)
Sales P 285,000 P 220,000 P 155,000 65,000 29.55% 65,000
Promotional expenses 10,000 8,500 5,500 1500 17.65% 3000
Salaries of 48,500 34,000 10,500 14,500 42.65% 23,500
salespeople
P 343,500 P 262,500 P 171,000
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TOTAL 81,000 30.86% 91,500
b. aalysis
c. Find the trend(s) in the expense items and relate it to the sales figures over the
periods