FINANCIAL MANAGEMENT

CHAPTER 4
BUSINESS ORGANIZATION AND TRENDS
THE ORGANIZATION OF THE BUSINESS FIRM LEGAL POINT OF ACCOUNTING
VIEW POINT OF
BUSINESS FIRM
VIEW
 An entity designed to organize raw
The owner of a The business is an
materials, labor, and machines with the
proprietorship is nor entity separate
goal of producing goods and/or
separable from the from the owner.
services.
business and is Therefore, the
 It can be organized in one of
personally liable financial
three ways:
for all debts of the statements of the
 Proprietorship
business. business present
 Partnership
only those
 Corporation
assets and
liabilities
FIRMS
pertaining to the
 Purchase productive resources business.
from households and other firms.
The owner cannot
 Transform them into a
be paid salary or
different commodity, and
wages from the
 Sell the transformed product or business, but the
service to consumers. owner may
withdraw funds or
Note: other property from
 Business firms engage in retail or borrowing.
trading activities, transforming
purchased goods into a different
commodity does not necessarily take
place.
LEGAL FORMS OF BUSINESS ORGANIZATION
There are three types of business
organizations.
PROPRIETORSHIP
 Owned by a single person who
has complete control over
business decisions.
 The individual owns all the firm’s assets
and is responsible for all its
liabilities.
 The proprietorship may be an ideal
form of business organization when
the following conditions exist:
 The anticipated risk is minimum
and adequately covered by
insurance.
 The owner is either unable or
unwilling to maintain the
necessary organizational
documents and tax returns of
more complicated business
entities.
 The business does not
require extensive
WITHDRAWALS
 Treated as reduction of owner’s
equity or financial interest of the
owner in the business.

TAX
 The business itself does not pay
any income taxes.
 The income or loss of the business
is reported on the owner’s
personal income tax return.
ADVANTAGES OF SOLE
PROPRIERTORSHIP EASY
EXIT
 Requires no formal charter and
is inexpensive to form and
dissolve.

FULL OWNERSHIP AND CONTROL

 The owner has full control, reaps
all profits and bears all losses.

TAX SAVINGS
 The entire income generated by
the proprietorship passes directly
to the owner.
 This may result in a tax
advantage if the owner’s tax rate
is less than the tax rate of a
corporation.
FEW GOVERNMENT REGEULATIONS
 It has the greatest freedom as
compared with any form of
business organization.
DISADVANTAGES
UNLIMITED LIABILITY
 The owner is personally liable
or responsible for all business
debts.
 The owner’s personal assets can
be claimed by the creditors if the
firm defaults on its obligations.
LIMITATIONS IN RAISING CAPITAL
 Fund-raising ability is limited.
 Resources may be limited to the
assets of the owner.
 The growth may depend on his or
her ability to borrow money.
LACK OF CONTRINUTIY
 Upon death or retirement of the
owner, the proprietorship ceases to
exist.
PARTNERSHIP
 Legal arrange in which two or more
persons agree to contribute capital
or services to the business and divide
the profits or losses that may be
derived therefrom.
 May operate under varying degrees
of formality.
 May be either general or limited.
ADVANTAGES OF PARTNERSHIP
EASE OF FORMATION
 Require relatively little effort and
low start-up costs.
ADDITIONAL SOURCES OF CAPITAL
 It has the financial resources of
several individuals.
MANAGEMENT BASE
 It has broader management base
or expertise than a sole
proprietorship.
TAX IMPLICATION
 Does not pay any income taxes.
 The income or loss of the business
is distributed among the partner in
accordance with the partnership and
each partner reports his or her
portion whether distributed or not on
personal income tax return.
DISADVANTAGES
UNLIMITED LIABILITY
 General partners have unlimited
liability for the debts and litigations of
the business.
LACK OF CONTINUTY
 May be dissolve upon the withdrawal
or death of a general partners,
depending on the provisions of the
partnership.

GENERAL LIMITED DIFFICULT OF TRANSFERRING OWNERSHIP

PARTNERSHIP PARTNERSHIP
 It is difficult for a partner to liquidate
One in which each Containing one or or transfer ownership.
partner has more general  It varies with condition set forth in
unlimited liability for partners and one or the partnership agreement.
the debts incurred more limited
by the business partners.
LIMITATIONS IN RAISING CPAITAL
General partners Personal liability:
usually manage General partners:  It may have problems raising large
the firm and may unlimited amounts of capital because many
enter into Limited partners: sources of funds are available only
contractual limited to their to corporations.
obligations on the investment. CORPORATIONS
firm’s behalf.
Profits and assets Limited partners  Artificial being created by law.
ownership may be cannot be active in  Legal entity separate and distinct
divided in any way management. from its owners.
agreed upon by  It may own assets, borrow money,
members. and engage in other business entities
without directly involving the owners.

SHAREHOLDERS
 Also known as the owners
 They do not directly manage the
firm, instead select managers
designated as board of directors.
BOARD OF DIRECTORS
 The managers selected by the
shareholders to run the firm for them.
 Authorized to act in the
corporation’s behalf.
INCORPORATION PROCESS
 Initiated by filing the articles of
incorporation (AOI) and other
requirements with the Securities
and Exchange Commission (SEC).
 The AOI includes among other
the following:
 Incorporators
 Name of the corporation
 Purpose of the corporation
 Capital stock
 Authorized shares
CAPITAL STOCK
 After the corporation is legally form it
will then issue its capital stock.
STOCK CERTIFICATE
 Evidence of stock ownership.
BYLAWS
 Rules that govern the internal
management of the company.
 Established by the board of
directors and approved by the
shareholders.
 May be amended or extended
from time to time by shareholder.
ADVANTAGES
LIMITED LIABILITY
 Shareholders are liable only to the
extent of their investment in the firm’s
shares and not any other personal
assets.
EXCEPTION
 Government may pass through the
corporate shield to collect unpaid
taxes.
 Piercing the Corporate Veil.
UNLIMTED LIFE
 Continue to exist even after death
of the owners.
 Maximum legal life: 50 years
 May be renewed for desire
additional life not to exceed
50 years.
EASE IN TRANSFERRING OWNERSHIP
 Shareholders can easily sell their
ownership interest by selling their stocks
without affecting the legal form of
business organization.
ABILTIY TO SELL STOCKS
 It provides corporations with a
stronger financial base and the
capital needed for expansion.
ABILITY TO RAISE CAPITAL
 Can raise capital through the sale of
securities such as bonds to investors
who are lending money to the
corporations and equity securities
such as common stock to investors
who are the owners.
DISADVANTAGES
TIME AND COST OF FORMATION
 Registration of public companies
with the SEC may be time
consuming and costly.
REGULATION
 Subject to greater
government regulations
 Shareholders cannot just withdraw
assets.
 They can only receive corporate
assets when dividends are
declared and these amounts may
be subject to limits imposed by
law.
TAXES
 Corporations pay taxes on income
they have earned.
 The subject of taxation demands
the advice of a qualified tax
accountant.
IMPORTANT BUSINESS TRENDS
1. Increased globalization of business
2. Ever improving information technology
3. Corporate governance
4. Outsourcing
FINANCIAL MANAGEMENT
CHAPTER 5
UNDERSTANDING FINANCIAL STATEMENTS
FINANCIAL STATEMENTS
 How the business activities are reported.
 Report on company’s performance
and financial condition.
 It also reveals executive
management’s privilege and
information insights.
 Serve the needs of different users.
 Provide crucial input for strategic
planning as well as information
about relative success of those
plans which can be used as
corrective action and make new
operating, investing, and financing
decisions.
ACCOUNTING INFORMATION
 Should be used in the business context.
GENERAL OBJECTIVES OF FINANCIAL
STATEMENTS
The importance objectives of financial
statements are:
PROVIDING INFORMATION FOR ECONOMIC
DECISIONS
 Evaluation of the ability of an
enterprise to generate cash and cash
equivalents and the timing and
certainty of their generation.
 Determines the capacity of an
enterprise to pay its employees and
suppliers, meet interest payments,
repay loans and make distributions to
its owners.
PROVIDING INFOMRATION ABOUT FINANCIAL
POSITION
The financial position of an enterprise is
affected by economic resources such
as:
Information about economic resources
 useful in predicting the ability of the
enterprise to generate cash and
cash equivalents in the future.
Information about financial structure
 Predicting borrowing needs and how
future profits and cash flows will be
distributed among those with an
interest in the enterprise.
Information is useful
 How successful the enterprise is likely to
be raising further in finance.
Information about liquidity and solvency
 To mee the financial commitments
as fall due.
LIQUIDITY
 The availability of cash in the near
future after taking account of financial
commitments
SOLVENCY
 Availability of cash over the longer
term to meet financial commitments
as they fall due.
PROVIDING INFORMATION ABOUT
PERFORMANCE OF AN ENTERPRISE
 Provides information about the
performance and in particular
its profitability.
 Requires assessing potential
changes in the economic
resources.
 Information about variability of
performance
 Predicting the capacity of the
enterprise to generate cash flows from
its existing resource base.
PROVIDIG INFORMATION ABOUT CHANGES
IN FINANCIAL POSITION
 To assess its investing, financing, and
operating activities.
 Provides the user with a basis to
assess the ability of the enterprise to
generate cash and cash equivalents
and the needs 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 risks to facilitate efficient
contracting and risk- sharing.
 CLASSES OF USERS CUSTOMERS AND POTENTIAL STRAGEGIC
MANAGERS AND EMPLOYEES PARTNERS
 They need accounting information on POTENTIAL
the financial condition, profitability, and CUSTOMERS STRATEGIC
prospects of their companies as well PARTNERS
as comparative financial information To evaluate a
on competing companies and company’s ability
to provide products To estimate the
business opportunities.
and services as firm’s profitability to
 To raise financing for company, to
agreed. assess the fairness
mee disclosure requirement, and to
To assess the of returns on
serve as a basis for executive
company’s mutual
remuneration and bonuses for wage
reliability and transactions and
negotiations and to meet disclosure
staying power. strategic alliances
requirements.

INVESTORS AND ANALYSTS OTHER DECISION MAKES

 To decided whether to buy or sell
equity shares.
 Future profitability and the ability
to generate cash influence the
price of securities.
 Company’s ability to borrow money
at favorable terms.
 Varied from assessing damages for
environmental abuses to making
policy decisions involving economic,
social, taxation and other initiatives.
SOURCES OF INFORMATION ABOUT
ENTERPRISE

CREDITORS AND SUPPLIERS  Determined by manager’s

 To monitor and adjust their
contractual requirements and
environment with a business firm.
CREDITORS
 To help determine loan terms,
loan amounts, interest rates and
required collateral.
SUPPLIERS
 To establish credit terms and to
determine their long-term
commitment to supply chain
relations.
SHAREHOLDERS AND DIRECTORS
 To assess its profitability and risks.
 To evaluate managerial performance.
 To help make leadership decisions.
REGULATORY AND TAX AGENCIES
 To monitor the business firms’
compliance with laws, for public
protection, price setting and for
setting tax and other regulatory
practices.
assessment of the benefits and cost
disclosure.
FINANCIAL ACCOUTING INFORMATION
AUDITED ANNUAL REPORT
 Four financial statements:
1. Statement of financial
position (balance sheet
statement)
2. Statement of comprehensive
income
3. Statement of stockholders’ equity
4. Statement of cash flow
 This includes explanatory notes
and management’s discussion
and analysis of financial results.
UNAUDITED QUARTERLY OR INTERIM REPORTS
 Summary version of the four
financial statements and limited
additional disclosure.
PUBLICY LISTER COMPANIES
 They must file financial
accounting information with the
SEC.

ALL OTHER REGISTERED CORPORATION AND

PARTNERSHIPS
 Require filing annually audited
financial statements with
accompanying explanatory notes with
SEC.
 BENEFITS OF DISCLOSURE judgmental process.
 The company’s ability to disclose
reliable (audited) accounting
information enable them to better
compete in capital, labor, input
and output market.
 The better a company’s prospects,
the lower will be its cost of capital
as reflected in higher stock prices
or lower interest rate.
COST OF DISCLOSURE
 Can be substantial.
 The possibility for information to
produce competitive disadvantages is
high.
 Can also face possible lawsuits
when disclosure create
expectations that eventually are
not met.

DISCLOSURE COSTS
 Includes political cost.
 Its costs are high for highly visible
companies because they are
favorite target of public scrutiny.

CONSTRATINTS ON RELEVANT AND RELIABLE

INFORMATION
TIMELINESS
 undue delay=lose relevance
 may need to balance the relative
merits of timely reporting and the
provision of reliable information.
 to provide information on timely basis,
it may often be necessary to report
before all aspects of a transaction or
other events are known thus impairing
reliability.
 Conversely, reporting delayed until
all aspects are known=the
information maybe highly reliable but
of little use to users who have had to
make decisions in the interim
 A balance between relevance and
reliability is able to best satisfy the
economic decision-making needs of
the users.

BLANACE BETWEEN BENEFIT AND COST

 Pervasive constraint rather than
a qualitative characteristic.
 The benefits derived from
information should exceed the cost
of providing it.
 The evaluation of benefits and cost
is however, substantially a
BALANCE BETWEEN
QUALITATIVE
CHARACTERISTICS
 The aim is to achieve an appropriate
balance among the characteristics in
order to meet the objective of
financial statements.
 Matter of professional judgement

TRUE FAIR VIEW OR 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.

FINANCIAL STATEMENTS
 Reported periodically.
 Four financial statements:
 Statement of financial
position (balance sheet
statement)
 Statement of
comprehensive income
 statement of stockholders’ equity
 statement of cash flow

LINKAGE OF FINANCIAL STATEMENTS

 Also known as articulation
 Statement of financial position +
statement of comprehensive income
= linked by retained earnings
RETAINED EARNINGS
Updated each period and reflect
cumulative income that has not yet
been distributed to shareholders.

LONG-TERM PERSPECTIVE
The income statement does measure
change in company value. INVESTING ACTIVITIES
 Company assets.
STATEMENT OF FINANCIAL POSITION  Finance by a combination of
nonowner financing (liabilities) and
 Reports a company’s financial owner financing (equity).
position at a point in time, the
FINANCING ACTIVITEIS
company’s
resources (assets) namely, what the
company owns and also the source of  Combination of owner and
asset financing. nonowner financing.
 Financial statement title
sometimes begins with the word NONOWNER
OWNER FINANCING
consolidated. FINANCING
 Means it includes a parent Resource
company and one or more contributed to the
subsidiaries, companies that company by its Borrowed money.
the parent company owns. owners along with
 There are two ways a company any profit retained
can finance its assets: by the company.
 Owner financing Entails no Legal obligation to
 Nonowner financing such repay amounts
obligation for owned.
NONOWNER repayment. Failure to do so can
OWNER FINANCING
FINANCING result in severe
Can raise money Raise money from consequences for
from shareholder banks or other the borrower.
creditors and
suppliers WORKING CAPITAL
Both owners and nonowners hold clams  Current assets
on company assets  These assets turnover as they are
Owner claims Nonowner claims: used and the placed throughout the
on asset: equity liabilities (or debt) year.

ACCOUNTING EQUATION NET WORKING CAPITAL

Asset = liability + owner’s equity
 Difference between current assets
minus current liabilities
NET OPERATING WOKRING CAPITAL  Arises when revenue exceed expenses.
 Difference between current assets
and non-interest-bearing current
liabilities.

STATEMENT OF COMPREHENSIVE INCOME

 Company’s performance over a
period of time.
 Lists amount for revenues (sales),
expenses and other
comprehensive income
 Revenue less expense yield the
bottom- line net income amount.

COST OF GOODS SOLD (COST OF SALES)

 Additional expense account
 Added in the statement of
comprehensive income by
manufacturing and merchandising
companies

GROSS PROFIT (GROSS MARGIN)

 The subtotal
 Revenue less cost of goods solve
 The remaining expenses are
the reported below gross
profit.

OPERATING ACTIVITIES
 To produce, promote and sell
its products and services.
these activities extend from
input markets to output
markets.

INPUT MARKETS OUTPUT MARKETS

Generate revenues
It generates the (sales)
most expenses
Can also generate
(cost)
some expenses.

NET INCOME
NET LOSS
Occurs when expenses exceed revenue.

STATEMET OF STOCKHOLDERS’ EQUITY

 Report on changers in key types
of equity over a period of time.

CONTRIBUTED CAPITAL
Cash that the company received from the
sale of stock to stockholders/sharholders
less any funds expended for repurchase of
stock (treasury shares)

RETAINED EARNINGS
 Earned capital or reinvested capital.
 Cumulative total amount of income
that the company has earned and
that has been retained in the
business and not distributed to
shareholders in the form of dividends.
 Change in retained earnings
links consecutive statement of
financial position via the income
statement.

ENDING RETAINED EARNINGS

Beginning retained earnings + net income –
dividends.
 STATEMENT OF CASHFLOWS
 The change (increase or decrease) in
a company’s cash balance over a
period of time.
 Cash inflows and outflows from
operating, investing, and financing
activities over a period of time.
FINANCIAL MANAGEMENT
CHAPTER C
ASSESSMENT OF THE FIRMS OPERATING EFFICIENCY AND FINANCIAL POSITION THROUGH FINANCIAL
STATEMENT ANALYSIS
FINANCIAL STATEMENT ANALYSIS
 The process of extracting
information from financial
statements to better understand a
company’s current and future
performance and financial condition.
 Designed to determine the
relative strengths and
weaknesses of a company.
 Concentrates on financial
statement analysis, which
highlights the key aspects of a
firm’s operations.
 s involves a study of the relationships
between income statement and
balance sheet accounts, how these
relationships change over time (trend
analysis or horizontal analysis), and
how a particular firm compares with
other firms in its industry (bench-
marking or vertical analysis).
BASIC TOOLS IN FINANCIAL ANALYSIS
Horizontal Analysis or Trend Analysis
 A technique for evaluating a series of
financial statement data over a
period of time.
 Its purpose is to determine the
increase or decrease that has taken
place, expressed either an amount or
a percentage.
Vertical Analysis or Common Size Analysis
 It is a technique for evaluating
financial statement data that
expresses each item in a financial
statement as a percent of a base
amount.
Ratio Analysis
 This technique establishes
relationships among financial
statement accounts at given date or
period of time.
 These ratios analyze firm’s liquidity, the
use of leverage, asset management,
cost control, profitability, growth,
and valuation.
BASIC RULES IN
COMPUTING FINANCIAL RATIOS
 When calculating a ratio using
balance sheet amounts only, the
numerator and denominator should be
based on amounts as of 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 amount and
a balance sheet amount are sued at
the same time to calculate a ratio,
the balance sheet amount should be
expressed as an average for the time
period represented by the income
statement amount.
 If the beginning balance of a balance
sheet account is not available and
cannot be computed from the given
data, the ending balance of the
account is sued to represent the
average balance.
 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:
TURNOVER RATIOS CASH FLOW RATIOS
Sales and Sales and
purchases are purchases are
made on made in
credit. cash.
 As a rule, an operating year is
assumed to have 360 days, unless
specified otherwise.
 FINANCIAL RATIOS
Tests of Liquidity
It is a measure of adequacy of working capital.
Current Ratio It is the primary test of liquidity to meet
current obligations from current assets
It measures the number of times that the
current liabilities could be paid with the
Quick Ratio
available cash and nearcash assets (i.e., cash,
current receivables and marketable securities)

Working Capital Activity Ratios

Receivables It measures the number of times receivables
Turnover are recorded and collected during the
period.
It indicates the average number of days during
Average
which the company must wait before
Age of
receivables are collected.
Receivables
Inventory It measures the number of times that the
Turnover inventory is replaced during the period.
It indicates the average number of days during
Average Age
which the company must wait before the
of inventory
inventories are sold.

𝐶𝑜𝑠𝑡 𝑜𝑓 𝑚𝑎𝑡𝑒𝑟𝑖𝑎𝑙𝑠 𝑢𝑠𝑒𝑑

Raw Materials Turnover
𝐴𝑣𝑒. 𝑅𝑀 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦
𝐶𝑜𝑠𝑡 𝑜𝑓 𝑔𝑜𝑜𝑑𝑠 𝑚𝑎𝑛𝑢𝑓𝑎𝑐𝑡𝑢𝑟𝑒𝑑
Work In Process Turnover
𝐴𝑣𝑒. 𝑊𝐼𝑃 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦
𝐶𝑜𝑠𝑡 𝑜𝑓 𝑔𝑜𝑜𝑑𝑠 𝑠𝑜𝑙𝑑
Finished Goods Turnover
𝐴𝑣𝑒. 𝐹𝐺 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦
Normal Operating Cycle 𝐴𝑣𝑒. 𝐴𝑔𝑒 𝑜𝑓 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 + 𝐴𝑣𝑒. 𝐴𝑔𝑒 𝑜𝑓 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠
𝑁𝑒𝑡 𝐶𝑟𝑒𝑑𝑖𝑡 𝑃𝑢𝑟𝑐ℎ𝑎𝑠𝑒𝑠
Trade Payables Turnover
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑇𝑟𝑎𝑑𝑒 𝑃𝑎𝑦𝑎𝑏𝑙𝑒𝑠
360 𝑑𝑎𝑦𝑠
Average Age of Trade Payables
𝑃𝑎𝑦𝑎𝑏𝑙𝑒𝑠 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟
𝐶𝑜𝑠𝑡 𝑜𝑓 𝐺𝑜𝑜𝑑𝑠 𝑆𝑜𝑙𝑑 + 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐸𝑥𝑝𝑒𝑛𝑠𝑒
Current Assets Turnover
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠

Test of Solvency
Times Interest 𝐸𝐵𝐼𝑇 It determines the extent to
Earned 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝐸𝑥𝑝𝑒𝑛𝑠𝑒 which operations cover interest
expense.
𝑇𝑜𝑡𝑎𝑙 𝐿𝑖𝑎𝑏𝑖𝑙𝑡𝑖𝑖𝑒𝑠 Proportion of assets provided by
Debt-Equity Ratio creditors compared that provided
𝑇𝑜𝑡𝑎𝑙 𝐸𝑞𝑢𝑖𝑡𝑦 by owners
𝑇𝑜𝑡𝑎𝑙 𝐿𝑖𝑎𝑏𝑖𝑙𝑡𝑖𝑒𝑠 Proportion of total assets provided
Debt Ratio
𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 by creditors
𝑇𝑜𝑡𝑎𝑙 𝐸𝑞𝑢𝑖𝑡𝑦 Proportion of total assets provided by
Equity Ratio
𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 owners.

Test of Profitability
𝐼𝑛𝑐𝑜𝑚𝑒 Determines the proportion of sales
Return on Sales that went into company’s earnings.
𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠
𝐼𝑛𝑐𝑜𝑚𝑒 Efficiency with which assets are used
Return on Assets
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐴𝑠𝑠𝑒𝑡𝑠 to operate the business
 𝐼𝑛𝑐𝑜𝑚𝑒 Measures the amount earned
Return on Equity on the owners’ or stockholders’
𝐴𝑣𝑒𝑟𝑎𝑡𝑒 𝐸𝑞𝑢𝑖𝑡𝑦 investment.
Earnings Per 𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒 − 𝑃𝑟𝑒𝑓𝑒𝑟𝑟𝑒𝑑 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑡𝑠 Measures the amount of net income
Share 𝑊𝑡𝑑. 𝐴𝑣𝑒. 𝐶𝑜𝑚𝑚𝑜𝑛 𝑆ℎ𝑎𝑟𝑒𝑠 𝑂𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔 earned by each common share.

Market Tests
Price-Earnings 𝑃𝑟𝑖𝑐𝑒 𝑃𝑒𝑟 𝑆ℎ𝑎𝑟𝑒 It indicates the number of pesos
Ratio 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑃𝑒𝑟 𝑆ℎ𝑎𝑟𝑒 required to buy P1 of earnings.
𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑡 𝑃𝑒𝑟 𝑆ℎ𝑎𝑟𝑒 Measures the rate of return in the
Dividend Yield
𝑃𝑟𝑖𝑐𝑒 𝑃𝑒𝑟 𝑆ℎ𝑎𝑟𝑒 investor’s common stock investments.
𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑡 𝑃𝑒𝑟 𝑆ℎ𝑎𝑟𝑒 It indicates the proportion of earnings
Dividend Pay-Out
𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑃𝑒𝑟 𝑆ℎ𝑎𝑟𝑒 distributed as dividends

Stability Ratios
Measures the proportion
of owners’ equity to fixed
Fixed Assets to Total 𝐹𝑖𝑥𝑒𝑑 𝐴𝑠𝑠𝑒𝑡𝑠 assets. Indicative of over
Equity 𝑇𝑜𝑡𝑎𝑙 𝐸𝑞𝑢𝑖𝑡𝑦 or under investment by
owners and weakness in
trading the equity.
Indicates the possible
Fixed Assets to Total 𝑁𝑒𝑡 𝐹𝑖𝑥𝑒𝑑 𝐴𝑠𝑠𝑒𝑡𝑠
overexpansion of
Assets 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 plant and equipment
Tests roughly the
Sales to Fixed
𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠 efficiency of management
Assets (Plant
𝑁𝑒𝑡 𝐹𝑖𝑥𝑒𝑑 𝐴𝑠𝑠𝑒𝑡𝑠 in keeping plant
Turnover)
properties
employed.
Measures recoverable
𝐶𝑜𝑚𝑚𝑜𝑛 𝑆ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟𝑠′𝐸𝑞𝑢𝑖𝑡𝑦 amount by stockholders in
Book Value
the event of liquidation if
per share – 𝐶𝑜𝑚𝑚𝑜𝑛 𝑆ℎ𝑎𝑟𝑒𝑠 𝑂𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔 assets are realized at their
CS
book values.
𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒 𝐴𝑓𝑡𝑒𝑟 𝑇𝑎𝑥𝑒𝑠 It indicates ability to
Times Preferred
provide dividends to
Dividend Earned 𝑃𝑟𝑒𝑓𝑒𝑟𝑟𝑒𝑑 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑡𝑠 preferred stockholders.
Measures efficiency of the
Capital intensity 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 firm to generate sales
ratio 𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠 through employment of its
resources.
Times fixed charges 𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒 𝑏𝑒𝑓𝑜𝑟𝑒 𝑡𝑎𝑥𝑒𝑠 𝑎𝑛𝑑 𝑓𝑖𝑥𝑒𝑑 𝑐ℎ𝑎𝑟𝑔𝑒𝑠 Measures ability to meet
earned 𝐹𝑖𝑥𝑒𝑑 𝑐ℎ𝑎𝑟𝑔𝑒𝑠 + 𝑠𝑖𝑛𝑘𝑖𝑛𝑔 𝑓𝑢𝑛 𝑝𝑎𝑦𝑚𝑒𝑛𝑡 fixed charges

Tests of Over-all Short-Term Solvency or Short-Term Financial Position

𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠
Working Capital Turnover
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑊𝑜𝑟𝑘𝑖𝑛𝑔 𝐶𝑎𝑝𝑖𝑡𝑎𝑙
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑡𝑖𝑖𝑒𝑠
Defensive Interval Ratio
𝐶𝑎𝑠ℎ 𝑎𝑛𝑑 𝐶𝑎𝑠ℎ 𝐸𝑞𝑢𝑖𝑣𝑎𝑙𝑒𝑛𝑡
𝑁𝑒𝑡 𝑃𝑢𝑟𝑐ℎ𝑎𝑠𝑒𝑠
Payable Turnover
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑃𝑎𝑦𝑎𝑏𝑙𝑒
Fixed assets to long-term 𝐹𝑖𝑥𝑒𝑑 𝐴𝑠𝑠𝑒𝑡𝑠
liabilities 𝐿𝑜𝑛𝑔𝑡𝑒𝑟𝑚 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
Indicates adequacy of working
capital to support operation (sales)
Measures coverage of current
liabilities
Measures efficiency of the
company in meeting the
accounts payable.
Reflects extent of the utilization
of resources from long-term
debt. Indicative of sources of
additional funds.
Tests of Over-all Short-Term Solvency or Short-Term Financial Position
Rate of return on average
current assets
Operating Profit Margin
Cash flow margin
𝐼𝑛𝑐𝑜𝑚𝑒 Measures the profitability of
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠 current assets invested
𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑝𝑟𝑜𝑓𝑖𝑡 Measures profit generated after
𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠 consideration of operating
costs.
𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑐𝑎𝑠ℎ 𝑓𝑙𝑜𝑤 Measures the ability of the firm
𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠 to translate sales to cash.