CPAR

CPA REVIEW SCHOOL OF THE PHILIPPINES

Manila

MANAGEMENT ADVISORY SERVICES

MAS 9208

FINANCIAL MANAGEMENT
FINANCIAL MANAGEMENT – planning, organizing, directing, and controlling the financial
activities of funds of the enterprise. It involves applying general management principles to
financial resources of the firm.

SCOPE, ELEMENTS OF FINANCIAL MANAGEMENT:

1. INVESTMENT DECISIONS – includes investment in fixed assets (CAPITAL BUDGETING) as well as

investment in current assets (working capital decisions).

2. FINANCING DECISIONS – relate to raising of funds from various resources which will depend on
the decision on the type of source, priod of financing, cost of financing, and the expected
reruns therefrom.

3. DIVIDEND DECISION - decision with regards to the net profit distribution, which may be dividends
for shareholders and retained profits, considering the expansion and diversification plans
of the firm.

OBJECTIVES OF FINANCIAL MANAGEMENT

1. To ensure regular and adequate supply of funds to the firm.

2. To ensure adequate returns to the shareholders. Such returns depend on the earning capacity
of the firm, the market price of the corporation’s shares, and the expectations of the
shareholders.
3. To ensure optimum utilization of funds.
4. To ensure safety of investments.
5. To plan a sound capital structure, considering a balance between debt and equity capital.

FUNCTIONS OF FINANCIAL MANAGEMENT

1. ESTIMATION OF CAPITAL REQUIREMENTS – depends upon expected cots and profits and future
programs and policies of a firm. Estimations are made in such a way that the earning
capacity of a firm will increase.
2. DETERMINATION OF CAPITAL COMPOSITION – involves short-term and long-term debt-equity
analysis.

WORKING CAPITAL MANAGEMENT

WORKING CAPITAL MANAGEMENT – refers to the administration and control of current assets and
current liabilities to maximize the firm’s value by achieving a balance between
profitability and risk

WORKING CAPITAL FINANCING POLICIES

1. Matching Policy (also called self-liquidating policy or hedging policy) – matching the maturity of a
financing source with an asset’s useful life
• short-term assets are financed with short-term liabilities.
• long-term assets are funded by long-term financing sources

2. Conservative (Relaxed) Policy – operations are conducted with too much working capital; involves
financing almost all asset investments with long-term capital
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3. Aggressive (Restricted) Policy – operations are conducted on a minimum amount of working

capital; uses short-term liabilities to finance, not only temporary, but also part or all of
the permanent current asset requirement

4. Balanced Policy – balances the trade-off between risk and profitability in a manner consistent with
its attitude toward bearing risk.

WAYS OF MINIMIZING WORKING CAPITAL REQUIREMENT

1. Managing cash and raw materials efficiently.
2. Having efficiency in making collections and in the manufacturing operations.
3. Implementing effective credit and collection policies.
4. Reducing the time lag between completion and delivery of finished goods.
5. Seeking favorable terms from suppliers and other creditors.

FORECASTING FINANCIAL STATEMENT VARIABLES

ASSUMPTIONS:
1. All variables are tied directly with sales
2. The current levels of most balance sheet items are optimal for the current sales level.

STEPS:
1. Identify assets and liabilities that vary spontaneously with sales
2. Estimate the amount of net income that will be retained.
3. Compute the amount of External Financing Needed (EFN) by subtracting increase in spontaneous
liabilities and income retained from increase in total financing required (increase in assets due to
increase in sales).

EFN = ΔS x (SA/S0) – ΔS x (SL/S0) – (<ROS x S1> x <1 - Payout%>)

Where: SA/S0 = percentage relationship of spontaneous assets (variable assets) to sales

at period 0.

SL/S0 = percentage relationship of spontaneous liabilities (variable liabilities) to

sales at period 0.

CASH MANAGEMENT

CASH MANAGEMENT – involves the maintenance of the appropriate level of cash and investment in
marketable securities to meet the firm’s cash requirements and to maximize
income on idle funds.

REASONS FOR HOLDING CASH

1. Transaction Purposes – firms maintain cash balances that they can use to conduct the ordinary
business transactions; cash balances are needed to meet cash outflow requirements
for operational or financial obligations.
2. Compensating Balance Requirements – a certain amount of cash that a firm must leave in its
checking account at all times as part of a loan agreement. These balances give banks
additional compensation because they can be relent or used to satisfy reserve
requirements.
3. Precautionary Reserves – firms hold cash balance in order to handle unexpected problems or
contingencies due to the uncertain pattern of cash inflows and outflows.
4. Potential Investment Opportunities – excess cash reserved are allowed to build up in anticipation
of a future investment opportunity such as a major capital expenditure project.
5. Speculation – firms delay purchases and store up cash for use later to take advantage of possible
changes in prices of materials, equipment, and securities, as well as changes in
currency exchange rates.

THE CONCEPT OF FLOAT IN CASH MANAGEMENT

Float – difference between the bank’s balance for a firm’s account and the balance that the firm shows
on its own books.
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TYPES OF FLOAT:
1. Mail Float – peso amount of customers’ payments that have been mailed by a customer but
not yet received by the seller.
2. Processing Float – peso amount of customers’ payments that have been received by the seller
but not yet deposited.
3. Clearing Float - peso amount of customers’ checks that have been deposited but not yet
cleared.

CASH MANAGEMENT STRATEGIES

1. accelerate cash collections – reduce negative (mail and processing) float
2. control (slow down) disbursements
3. reduce the need for precautionary cash balance

Operating Cycle – The amount of time that elapses from the point when the firm inputs materials and labor
into the production process to the point when cash is collected from the sale of the
finished goods. Its two components are: average age of inventories and average
collection period of receivables. When the average age of accounts payable is subtracted
fro the operating cycle, the result is called cash conversion cycle.

Economic Conversion Quantity (Optimal Transaction Size) – the amount of marketable securities that must
be converted to cash (or vice versa), considering the conversion costs and opportunity
costs involved.

2 x conversion cost x annual demand for cash

ECQ = √
Opportunity Cost

Conversion Cost – the cost of converting marketable securities to cash

Opportunity Cost – the cost of holding cash rather than marketable securities (rate of interest that can
be earned on marketable securities).

MARKETABLE SECURITIES

MARKETABLE SECURITIES – short-term money market instruments that can easily be converted to cash

REASONS FOR HOLDING MARKETABLE SECURITIES (MS):

1. MS serve as substitute for cash (transactions, precautionary, and speculative) balances.
2. MS serve as a temporary investment that yields return while funds are idle.
3. Cash is invested in MS to meet known financial obligations such as tax payments and loan
amortizations.

RECEIVABLE MANAGEMENT

ACCOUNTS RECEIVABLE MANAGEMENT – formulation and administration of plans and policies related to
sales on account and ensuring the maintenance of receivables at a predetermined level and their
collectibility as planned.

WAYS OF ACCELERATING COLLECTION OF RECEIVABLES

1. Shorten credit terms.
2. Offer special discounts to customers who pay their accounts within a specified period.
3. Speed up the mailing time of payments from customers to the firm.
4. Minimize float, that is, reduce the time during which payments received by the firm remain
uncollected funds.

AIDS IN ANALYZING RECEIVABLES

1. Ratio of receivables to net credit sales 3. Average collection period
2. Receivable turnover 4. Aging of accounts
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INVENTORY MANAGEMENT

INVENTORY MANAGEMENT – formulation and administration of plans and policies to efficiently and
satisfactorily meet production and merchandising requirements and minimize costs
relative to inventories.

INVENTORY MODELS
A basic INVENTORY MODEL exists to assist in two inventory questions:
1. How many units should be ordered?
2. When should the units be ordered?

Economic Order Quantity – the quantity to be ordered, which minimizes the sum of the ordering and
carrying costs.

• Economic Order Quantity may be computed as follows:

where: a – cost of placing one order (or
ordering cost)
EOQ = 2aD
k D – annual demand in units
k – annual costs of carrying one
unit in inventory for one year

Assumptions of the EOQ Model

1. Demand occurs at a constant rate throughout the year.
2. Lead time on the receipt of the orders is constant.
3. The entire quantity ordered is received at one time.
4. The unit costs of the items ordered are constant; thus, there can be no quantity
discounts.
5. There are no limitations on the size of the inventory.

➢ When applied to manufacturing operations, the EOQ formula may be used to compute
the Economic Lot Size (ELS)

where: a – set-up cost

2aD D – annual production
ELS = k requirement
k – annual costs of carrying one
unit in inventory for one year
➢ When the EOQ figure is available, the average inventory is computed as follows:
Average Inventory = EOQ
2
➢ When to Reorder:
When to reorder is a stock-out problem. i.e., the objective is to order at a point in
time so as not to run out of stock before receiving the inventory ordered but not so early
that an excessive quantity of safety stock is maintained

Lead time – period between the time the order is placed and received
Normal time usage = Normal lead time x Average usage
Safety stock = (Maximum lead time – Normal lead time) x Average usage
Reorder point if there is NO safety stock required = Normal lead time usage
Safety stock + Normal lead time usage
Reorder point if there is safety stock required or
Maximum lead time x Average usage

SHORT TERM FINANCING

1. ACCOUNTS PAYABLE – the major source of unsecured short-term financing.

a. Credit terms: credit period, cash discount, cash discount period
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b. Analysis of credit terms:

• Taking the cash discount – If cash discount is to be taken, a firm should pay on the last day of
the discount period.
• Giving up cash discount – If the firm has to give up the cash discount, it should pay on the last
day of the credit period.

• Cost of giving up cash discount = [CD/(100% - CD)] x (360/N)

Where: CD = cash discount percentage

N = number of days payment can be delayed by giving up the cash discount

The above formula assumes that a firm gives up only one discount during the year. If a firm
continually gives up the discount during the year, the annualized cost is calculated as follows:

Annualized cost of giving up cash discount = [1 + (CD/(100% - CD)]360/N – 1]

c. Stretching Accounts Payable: A firm should pay the bills as late as possible without damaging its
credit rating. When a firm can stretch the payment of accounts payable, the cost of foregoing
the discount is reduced.

2. Bank Loans
a. Single-payment notes – If the interest is payable upon maturity, the effective interest rate is equal
to the nominal rate.

b. Discounted Note – The effective interest rate is higher than the nominal rate.

Interest
Effective interest rate =
Principal amount−Discounted Interest

If the term is less than a year, the interest rate is annualized.

c. Compensating Balance - an arrangement whereby a borrower is required to maintain a certain

percentage of amount borrowed as compensating balance in the current account of the
borrower.

ANALYSIS OF FINANCIAL STATEMENTS

A. Importance of Statement Analysis. The purpose of financial statement analysis is to assist
statement users in predicting the future.

Three techniques are commonly used to make comparisons and to detect trends.
• Peso and percentage changes in financial statement items.
• Common-size statements.
• Ratios.

B. Statements in Comparative and Common-Size Form. Two basic approaches are often used to
compare financial statements between companies or between different years for the same company:
horizontal (trend) analysis and vertical (common-size) analysis.

1. Horizontal Analysis; pesos and percentage changes on statements - the financial statements are
placed side-by-side. Two types of comparisons can then be made.
a. Trend percentages restate a time-series of financial data in terms of a base year. Particularly
when plotted against time, this approach allows the analyst to quickly gauge the rate and
direction of changes.
b. The difference (increase or decrease) between two statements can be shown in separate
columns in both peso and percentage forms. Showing changes in peso form helps to zero in
on key factors that have materially affected profitability or financial position. Showing changes
in percentage form helps to gain a feel of how unusual the changes might be.

2. Vertical Analysis; Common-size Statements. A common-size statement is one that shows each item
as a percentage of a total rather than in peso form. These kinds of statements make it much easier
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to compare firms of different sizes and to track balance sheet an `d income statement
relationships within a company over time as its size changes.

a. When preparing common-size statements for the balance sheet, the various items on the
balance sheet are typically stated as percentages of total assets.
b. When applying common-size techniques to the income statement, all items on the income
statement are usually stated as a percentage of total sales pesos.

C. Ratio Analysis

EXERCISES:
1. FORECASTING – As of December 31, 2022, the corporation’s financial records show that it had total
assets of P21 million and current liabilities of P4.2 million, excluding Notes Payable of P1.5 million.

Sales in 2022 amounted to P84 million. This is expected to increase by 20% in 2023.

The corporation is at full capacity, so its assets must grow in proportion to projected sales. The
projected after-tax profit margin is 8% and the forecasted profit retention ratio is 30%.

REQUIRED:
What was the capital intensity ratio in 2022? How much is the corporation’s additional funds
(AFN) needed for the coming year?

AFN = ↑A - ↑L – Profit Retained

AFN = (Cap intensity Ratio x ↑S) – (VLR x ↑S) – New Sales x PR x PRR

2. OPTIMAL TRANSACTION SIZE – Assume that the fixed cost of selling marketable securities is P1,000
per transaction and the interest rate on marketable securities is 8% per year. The company estimates
that it will make cash payments of P533,333.33 per month.

REQUIRED: Compute the

a. Optimal transaction size
b. the average cash balance
c. the number of times (during the year) the company has to convert marketable
securities to cash
d. the total cost of converting marketable securities to cash
e. the total carrying cost of cash.

OTS = √ 2𝑎𝑑
𝑘
where: a – conversion cost
D – annual cash requirement
k – carrying cost (opportunity cost)
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3. OPERATING AND CASH CONVERSION CYCLES – Consider the following data for Cycles Corporation:
TO Age
Sales P21,600,000
Purchases 10,800,000
Accounts receivable, beginning balance 960,000
Accounts receivable, ending balance 1,920,000
Finished goods inventory, beginning balance 360,000
Raw materials used 5,184,000
Average raw materials inventory 144,000
Average accounts payable 240,000

Cash sales are 20%, while credit purchases are 40% of the total purchases.
The gross profit ratio is 60%. There was no change in finished goods inventory from the beginning to
end of the year.

The firm spends P32.4 million in operating cycle investments each year, at a constant rate. Assume a
360-day year.
a. Calculate the firm’s operating cycle.
b. Calculate the firm’s cash conversion cycle.
c. Calculate the amount of resources needed to support the firm’s cash conversion cycle.

4. Abono, Inc. buys and sells fertilizers and pesticides to various retail hardware and nursery stores on
terms of “3/10, net 60”. The company currently does not grant credit to retailers that are classified as
“somewhat risky” customers. An estimated P7,300,000 in additional sales per year could be generated
if the company extended credit to such “somewhat risky” retailers. The estimated average collection
period for these customers is 70 days, and the expected bad-debt loss ratio is 10 percent. The company
also estimates that an additional inventory investment of P500,000 is required for the anticipated sales
increase. Approximately 15 percent of these customers are expected to take the cash discount. The
company’s gross profit ratio is 20%, and its required pretax rate of return on investments in current
assets is 18% percent.

REQUIRED:
DETERMINE THE FOLLOWING, USING 365 DAYS IN A YEAR IN YOUR CALCULATIONS:
1. Profitability of additional sales
2. Cost of additional investment in receivables.
3. Additional bad-debt loss
4. Cost of additional investment in inventory.
5. Additional cash discounts
6. Net change in pretax profits.

INVENTORIES

5. The Cloth Center sells fabrics to a wide range of industrial and consumer users. One of its products is
the denim cloth, used in the manufacture of jeans and carrying bags. The supplier for the denim cloth
pays all incoming freight. No incoming inspection for the denim is necessary because the supplier has
a track record of delivering high-quality merchandise. The purchasing officer of the Cloth Center has
collected the following information:

Annual demand for denim cloth 20,000 yards

Ordering costs per purchase order P160
Carrying costs per year 20% of purchase cost
Safety stock requirement None
Cost of denim cloth P8 per yard

REQUIRED:
1. Compute the economic order quantity.
2. How many orders would Cloth Center place under the EOQ policy?
3. Compute the annual ordering cost for the EOQ.
4. Compute the annual carrying cost for the EOQ.
5. Compute the total inventory-related cost at the EOQ.
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6. Previously, Cloth Center had been purchasing 2,500 yards of denim cloth per order. What is the
ordering cost per year under the previous policy? The annual carrying cost? How much money does
using the EOQ policy save the company over the policy of purchasing 2,500 units per order?

6. Pahangin Company assembles desk fans. The company purchases one of the components of the fan,
the blade, from outside suppliers. One unit of blade is used for each fan produced. On the average,
the company produces and sells 28,800 (80 per day) units of desk fans per year. The average purchase
lead time for the blade is 7 days. The maximum lead time is 10 days. The company works 360 days
per year.

REQUIRED:
a. Units of safety stock for the blade that the company should carry
b. The reorder point for the blade
c. Assume that the lead time is always 7 days and no delay in delivery has been experienced by
the company. What is the reorder point? How many units of safety stock must be kept by the
company in this case?

7. Toys Inc. sells educational toys. One raw material that it orders is plastic. The plastic is melted and
placed in molds to be used for the production of various toys. Information pertaining to the plastic raw
material is as follows:

Economic order quantity 20,000 kilos

Average daily usage 1,000 kilos
Maximum daily usage 1,500 kilos
Lead time 3 days

REQUIRED:
1. What is the reorder point assuming no safety stock is carried?
2. Should the company decide to carry safety stock, how many units should that be?
3. What is the reorder point assuming that safety stock is carried?

8. Economic order quantity for retailer. Olympians, Inc. operates a megastore featuring sports
merchandise. It uses an EOQ decision model to make inventory decisions. It is now considering
inventory decisions for its Los Ashkals football jerseys product line. This is a highly popular item. Data
for 2014 are as follows:

Expected annual demand for Ashkals jerseys 7,350

Ordering cost per purchase order P200
Carrying cost per year P6 per jersey

Each jersey costs Olympians P40 and sells for P80. The P6 carrying cost per jersey per year comprises
the required return on investment of P4.80 (12% of P40 purchase price) plus P1.20 in relevant
insurance, handling, and theft-related costs. The average purchasing lead time is 7 days. Olympians is
open 365 days a year.

REQUIRED: 1. Calculate the EOQ. 700 jerseys

2. Calculate the number of orders that will be placed each year. 11 orders
3. Calculate the total carrying cost and ordering cost per year. 2,100; 2,100
4. Calculate the reorder point. 141 jerseys
5. As stated, the average purchasing lead time is 7 days. Assume that there are times
when this lead time reaches a maximum of 10 days. How many units of safety stock
must the company have, and what should be the reorder point? 61 jerseys; 202 jerseys

1. d = 7,350 jerseys per year, a = P200, k = P6 per jersey per year

2(200)(7,350)
EOQ = √ = 700 jerseys
76

2. Number of orders per year = d/EOQ = 7350/700 = 10.5 = 11 orders

3. Ordering cost = 10.5 x P200 = 2,100; Carrying cost = 700/2 x 6 = 2,100

4. Reorder point = 7,350/365 x 7 days = 140.96 = 141 jerseys

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5. Safety stock = 7,350/365 x 3 = 60.41 = 61 jerseys

Reorder point = 7,350/365 x 10 = 201.37 = 202 jerseys

9. FOREGOING DISCOUNTS ON PURCHASES. The Needy Corporation needs to raise P10,000,000

for 1 year to supply working capital to a new sales outlet. Needy buys from its suppliers on terms of
3/10, net 60, and it currently pays on the 10th day and takes discounts. However, it could forgo the
discounts, pay on the 60th day, and thereby obtain the needed P10,000,000 in the form of costly trade
credit.

REQUIRED: What is the nominal cost of this trade credit? (Use 360 days per year.)

10. COST OF BANK LOANS. Pautang Company is negotiating with a bank for a P10 million, one-year
loan. The bank has offered Pautang Company the following alternatives. Calculate the effective annual
interest rate for each alternative. Which alternative is the most attractive?
a. A 10% annual rate on a simple interest loan, with no compensating balance required and interest
due at the end of the year.
b. A 12 percent annual rate on a simple interest loan, with a 20% compensating balance required
and interest due at the end of the year.
c. An 8% annual rate on a discounted loan, with a 20% compensating balance.
d. A 5% add-on annual interest, payable in equal monthly installments.

11. A company obtained a short-term bank loan of P5 million at an annual interest rate of 8%. As a
condition of the loan, the company is required to maintain a 20% compensating balance in its checking
account. The checking account earns interest of 2% per annum. Before the loan was granted, the
company maintained a balance of P200,000 in its checking account. Compute the effective interest rate
for this loan.

F/S ANALYSIS.

12. Kaemil Corporation reported the following figures:

2022 2021
Cash and cash equivalents P 2,450 P 2,094
Receivables 1,813 1,611
Inventory 1,324 1,060
Prepaid expenses 1,709 2,120
Total current assets P 7,296 P 6,885
Other assets 18,500 15,737
Total assets P25,796 P22,622
Total current liabilities 7,230 8,467
Long-term liabilities 4,798 3,792
Common stock 6,568 4,363
Retained earnings 7,200 6,000
Total liabilities and equity P25,796 P22,622

Sales P20,941
Cost of sales 7,055
Operating expenses 7,065
Operating income P 6,821
Interest expense 210
Income tax 2,563
Net income P 4,048

Required: 1. Horizontal analysis of Kaemil’s balance sheet for 2022 would report
a. cash as 9.5% of total assets c. current ratio of 1.01
b. 17% increase in cash d. inventory turnover of 6 times

2. Vertical analysis of Kaemil’s balance sheet for 2022 would report

a. cash as 9.5% of total assets c. current ratio of 1.01
b. inventory turnover of 6 times d. 17% increase in cash
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3. A common-size income statement for Kaemil would report (amounts rounded)

a. net income of 19% c. cost of sales at 34%
b. sales of 100% d. all of the above

4. Which statement best describes Kaemil’s acid test ratio?

a. greater than 1 c. Less than 1
b. Equal to 1 d. none of the above
5. Kaemil’s inventory turnover during 2022 was (amount rounded)
a. 6 times c. 8 times
b. 7 times d. not determinable from the given
data

6. During 2022, Kaemil’s days’ sales in receivables ratio (amounts rounded)

a. 34 days c. 32 days
b. 30 days d. 28 days

7. Which measure expresses Kaemil’s times-interest-earned ratio? (amounts rounded)

a. 54.7% c. 34 times
b. 19 times d. 32 times

8. The company has 2,500 shares of common stocks outstanding. What is Kaemil’s
earnings per share?
a. P1.62 c. P2.73
b. P1.75 d. 2.63 times

9. Kaemil’s stock has traded recently around P48 per share. Use your answer to Question
8 to measure the company’s price earnings ratio. (Round to the nearest whole number)
a. 1.01 c. 48
b. 30 d. 78

13. A skeleton of Juan Company’s income statement appears as follows (amounts in thousands):

Net sales P 7,200

Cost of goods sold 2,905 (a)
Selling and admin expenses 1,830
Interest expense 990 (b)
Other expenses 150
Income before taxes P 1,325
Income tax 533 (c)
Net income 792 (d)
Other data:
Inventory turnover 3.50
Beginning inventory P850
Ending inventory P810
Rate of return on net sales 0.11

REQUIRED: Complete Juan Company’s income statement.

14. A skeleton of Rosario Company’s balance sheet appears as follows (amounts in thousands):

Cash P 75 Total current liabilities P 1,900

Receivables 685 (a) Long-term note payable 1,595 (e)
Inventories 725 Other long-term liabilities 980
Prepaid expenses 35 (b)
Total current assets 1520 (c) Stockholders’ equity 2,325
Plant assets net 3,280 (d)
Other assets 2,000 Total liabilities and
Total assets P6,800 stockholders’ equity 6,800 P (f)

Rosario’s current ratio is 0.80 and its acid test ratio 0.40.
REQUIRED: Complete Rosario Company’s balance sheet.
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15. We are given the following information for the Coleman Machine Tools Corporation.

Sales (credit) P7,200,000

Cash 300,000
Inventory 2,150,000
Current liabilities 1,400,000
Asset turnover 1.20 times
Current ratio 2.50 times
Debt-to-assets ratio 40%
Receivables turnover 8 times

Current assets are composed of cash, marketable securities, accounts receivable, and inventory.

Calculate the following balance sheet items.

a. Accounts receivable. 900

b. Marketable securities. 150
c. Fixed assets. 2.5M
d. Long-term debt. 1M

16. Rosatoroa Company has P80,000,000 in assets and P50,000,000 of debt. It reports net income of
P4,800,000.

a. What is the return on assets?

b. What is the return on stockholders’ equity?
c. If the firm has an asset turnover ratio of 3 times, what is the profit margin (return on sales)?

17. A. Zarucki of Z Company found these pieces of his average balance sheet and key ratio report in his
gerbil cage:
Cash 153 ? Gross margin percentage 25%
Accounts receivable 67 ? Debt to equity ratio 0.25:1
Inventory 80 Current ratio 3:1
Fixed assets (net) 200 ? Inventory turnover 15 times
Current liabilities 100 Days sales in receivables 15 days
Common stock 100 (based on 360 days)
Retained earnings 300 ?

REQUIRED: Add as much to his balance sheet as possible from the data provided.

18. Assume that net income was P6,000. No other information is known, except the following:
Return on equity 10% Return on sales 4%
Gross margin percentage 60% Income tax rate 40%
Current ratio 3:1 Return on assets 5%
Inventory turnover 4 Days sales in receivables 90
Long-term debt to equity 2:3

REQUIRED: Using the preceding ratios, construct an income statement and a balance sheet with as
much detail as possible.

Sales P150,000
Cost of goods sold 60,000
Gross profit P 90,000
Operating expenses 80,000
Operating income P 10,000
Income tax 4,000
Net income P 6,000

Cash P 7,500 Current liabilities P 20,000

Accounts receivable 37,500 Long-term debt 40,000
Inventory 15,000 Total liabilities P60,000
Total current assets P 60,000
Fixed assets 60,000 Equity 60,000
Total assets P120,000 Total liabilities and equity P120,000
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Other Financial Management Topics

1. Tungol Company currently has 3.6 million shares of stock outstanding and will report earnings of
P7.20 million in the current year. The company is considering the issuance of 400,000 additional
shares that will net P50 per share to the corporation.
a. What is the immediate dilution potential for this new stock issue?
b. Assume the Tungol Company can earn 10 percent on the proceeds of the stock issue in time
to include it in the current year's results. Should the new issue be undertaken based on
earnings per share?
c. If the 400,000 additional shares can only be issued at P30 per share and the company can
earn 5 percent on the proceeds, should the new issue be undertaken based on earnings per
share?

2. Wonder Drug Co. has a net income of P20 million and 8 million shares outstanding. Its common stock
is currently selling for P35 per share. Wonder plans to sell common stock to set up a major new
production facility with a net cost of P34,200,000. The production facility will not produce a profit for
one year, and then it is expected to earn a 12 percent return on the investment. PISO Company, an
investment banking firm, plans to sell the issue to the public for P30 per share with a spread of 5
percent.
a. How many shares of stock must be sold to net P34,200,000?
b. Why is the investment banker selling the stock at less than its current market price?
c. What are the earnings per share (EPS) and the price-earnings ratio before the issue (based on
a stock price of P35)? What will be the price per share immediately after the sale of stock if
the P/E stays constant (based on including the additional shares computed in part a)?
d. Compute the EPS and the price (P/E stays constant) after the new production facility begins to
produce a profit.

3. The Spears Corporation is about to go public. It currently has after-tax earnings of P7.5 million and
2.5 million shares are owned by the present stockholders (the Spears family). The new public issue
will represent 600,000 new shares. The new shares will be priced to the public at P20 per share, with
a 5 percent spread on the offering price. There will also be P200,000 in out-of-pocket costs to the
corporation.
a. Compute the net proceeds to the Spears Corporation. 11,200,000
b. Compute the earnings per share immediately before the stock issue. 7.5/2.5 = 3
c. Compute the earnings per share immediately after the stock issue. 7.5/3.1 = 2.42
d. Determine what rate of return must be earned on the net proceeds to the corporation so there
will not be a dilution in earnings per share during the year of going public. 1.8m/11.2m = 16.07%
e. Determine what rate of return must be earned on the proceeds to the corporation so there will
be a 5 percent increase in earnings per share during the year of going public. 2.265m/11.2m =
20.22%

SELF TEST

WORKING CAPITAL MANAGEMENT AND FINANCIAL STATEMENTS ANALYSIS

1. Smith Company presents the following data for 2022.

Inventories, beginning of year P 310,150
Inventories, end of year 340,469
Cost of Goods Sold 2,103,696
Net Sales 8,690,150

The number of days' sales in inventory is:

a. 65.8 c. 59.1
b. 60.8 d. 58.1

2. Shaffer Company presents the following data for 2022.

Net Sales, 2023 P3,007,124
Net Sales, 2022 93,247
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Cost of Goods Sold, 2023 2,000,326

Cost of Goods Sold, 2022 1,000,120
Inventory, beginning of 2023 341,169
Inventory, end of 2023 376,526

The merchandise inventory turnover for 2023 is:

a. 5.6 c. 7.5
b. 15.6 d. 7.7

3. Ingram Dog Kennels had the following financial statistics for 2022:
Long-term debt P400,000
(average rate of interest is 8%)
Interest expense 35,000
Net income 48,000
Income tax 46,000
Operating income 107,000
What is the times interest earned for 2022?
a. 11.4 times c. 3.1 times
b. 3.3 times d. 3.7 times

4. Jordan Manufacturing reports the following capital structure:

Current liabilities P100,000

Long-term debt 400,000
Deferred income taxes 10,000
Preferred stock 80,000
Common stock 100,000
Premium on common stock 180,000
Retained earnings 170,000

What is the debt ratio?

a. 0.48 c. 0.93
b. 0.49 d. 0.96

5. The following data were gathered from the annual report of Desk Products.

Market price per share P30.00

Number of common shares 10,000
Preferred stock, 5%
P100 par P10,000
Common equity P140,000

The book value per share is:

a. P30.00 c. P14.00
b. P15.00 d. P13.75

QUESTION NOS. 6 THROUGH 10 ARE BASED ON THE FOLLOWING INFORMATION:

The data presented below show actual figures for selected accounts of McKeon Company for the
fiscal year ended May 31, 2022, and selected budget figures for the 2023 fiscal year. McKeon’s
controller is in the process of reviewing the 2022 budget. McKeon Company monitors yield or
return ratios using the average financial position of the company. (Round all calculations to three
decimal places if necessary)
5/31/23 5/31/22
Current assets P210,000 P180,000
Noncurrent assets 275,000 255,000
Current liabilities 78,000 85,000
Long-term debt 75,000 30,000
Common stock (P30 par value) 300,000 300,000
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Retained earnings 32,000 20,000

2023 Operations

Sales(all credit) P350,000

Cost of goods sold 160,000
Interest expense 3,000
Income taxes (40% tax rate) 48,000
Dividends declared and paid in 2023 60,000
Administrative expenses 67,000

Current Assets
5/31/23 5/31/22
Cash P 20,000 P10,000
Accounts receivable 100,000 70,000
Inventory 70,000 80,000
Other 20,000 20,000

6. McKeon Company’s debt-to-total-asset ratio for 2023 is

a. 0.352 b. 0.315 c. 0.264 d. 0.237

7. The 2023 accounts receivable turnover for McKeon Company is:

a. 1.882 b. 3.500 c. 5.000 d. 4.118

8. Using a 365-day year, McKeon’s inventory turnover is:

a. 2.133 b. 2.281 c. 1.995 d. 4.615

9. McKeon Company’s total asset turnover for 2023 is

a. 0.805 b. 0.761 c. 0.722 d. 0.348

10. The 2023 return on assets for McKeon Company is

a. 0.261 b. 0.148 c. 0.157 d. 0.166

QUESTION NOS. 11 THROUGH 17 ARE BASED ON THE FOLLOWING INFORMATION:

Duval Company is a manufacturer of industrial products and employs a calendar year for financial
reporting purposes. These questions present several of Duval’s transactions during the year.
Assume that total quick assets exceed total current liabilities both before and after each
transaction described. Further assume that Duval has positive profits during the year and a credit
balance throughout the year in its retained earnings account.

11. Payment of a trade account payable of P64,500 would

a. Increase the current ratio but the quick ratio would not be affected.
b. Increase the quick ratio but the current ratio would not be affected.
c. Increase both the current and quick ratios.
d. Decrease both the current and quick ratios.

12. The purchase of raw materials for P85,000 on open account would
a. Increase the current ratio c. Decrease the current ratio
b. Increase net working capital d. Decrease net working capital

13. The collection of a current accounts receivable of P29,000 would

a. increase the current ratio
b. Decrease the current ratio and the quick ratio
c. increase the quick ratio
d. Not affect the current or quick ratios
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14. Obsolete inventory of P125,000 was written off during the year. This transaction
a. Decreased the quick ratio c. Increased the net working capital
b. Increased the quick ratio d. Decreased the current ratio

15. The issuance of new shares in a five-for-one split of common stock

a. Decreases the book value per share of common stock
b. Increases the book value per share of common stock
c. Increases total shareholders’ equity
d. Decreases total shareholders’ equity

16. The issuance of serial bonds in exchange for an office building, with the first installment of the
bonds due late this year
a. Decreases net working capital c. Decreases the current ratio
b. Decreases the quick ratio d. Affects all of the answers as indicated

17. The early liquidation of a long-term note with cash affects the
a. Current ratio to a greater degree than the quick ratio
b. Quick ratio to a greater degree than the current ratio
c. Current and quick ratio to the same degree
d. Current ratio but not the quick ratio

18. The equity section of Jones Corporation's statement of financial position is presented below.

Preferred stock, 6%, P100 par P40,000,000

Common stock, P4 par 10,000,000
Additional paid-in capital 20,000,000
Retained earnings 10,000,000
Equity 80,000,000

The preferred stock is cumulative and non-participating. All preferred dividends have been paid,
and liquidation value is P110 per preferred share. What is the book value per share of Jones
Corporation's common stock?
a. P100 b. P16 c. P14.40 d. P4

19. Baylor Company paid out one-half of last year's earnings in dividends. This year, Baylor's earnings
increased by 20%, and the amount of its dividends increased by 15%. Baylor's dividend payout
ratio for the current year is
a. 50% b. 57.5% c. 47.9% d. 78%

20. Typically, which of the following would be considered to be the most indicative of a firm's short-
term debt paying ability?
a. working capital c. current ratio
b. acid test d. cash ratio

22. Which of the following ratios does not represent some form of comparison between accounts in
current assets and accounts in current liabilities?
a. working capital c. current ratio
b. acid-test ratio d. merchandise inventory turnover

23. Which of the following ratios would generally be used to measure a firm's overall liquidity position?
a. working capital c. current ratio
b. acid-test ratio d. cash ratio

24. Which of the following would best indicate that the firm is carrying excess inventory?
MAS 9208 WORKING CAPITAL MANAGEMENT
AND FINANCIAL STATEMENTS ANALYSIS Page 16 of 19

a. a decline in sales
b. a decline in the current ratio
c. a decline in days' sales in inventory
d. stable current ratio with declining quick ratios

25. Total asset turnover measures the ability of a firm to:

a. generate profits on sales c. generate sales through the use of assets
b. buy new assets d. move inventory

26. Return on assets cannot fall under which of the following circumstances?
Net Profit Margin Total Asset Turnover
a. decline rise
b. rise decline
c. rise rise
d. decline decline

27. The price/earnings ratio:

a. measures the past earning ability of the firm
b. is a gauge of future earning power as seen by investors
c. relates price to dividends
d. relates price to total net income

28. Which of the following ratios usually reflects investors opinions of the future prospects for the
firm?
a. dividend yield c. book value per share
b. price/earnings ratio d. earnings per share
29. Which of the following is not a measure of asset utilization?
a. Inventory turnover
b. Average accounts receivable collection period
c. Fixed asset turnover
d. Debt to total assets

30. What financial analysis technique would imply benchmarking with other firms?
a. Horizontal analysis c. Vertical analysis
b. Cross-sectional analysis d. Ratio analysis

31. In comparing the current ratios of two companies, why is it invalid to assume that the company
with the higher current ratio is the better company?
a. The current ratio includes assets other than cash.
b. A high current ratio may indicate inadequate inventory on hand.
c. A high current ratio may indicate inefficient use of various assets and liabilities.
d. The two companies may define working capital in different terms.

32. Shepherd Enterprises has an ROE of 15 percent, a debt ratio of 40 percent, and a profit margin
of 5 percent. The company’s total assets equal P800 million. What are the company’s sales?
(Assume that the company has no preferred stock.)
a. P1,440,000,000 c. P2,400,000,000
b. P360,000,000 d. P120,000,000

33. Deb & Co. has a debt ratio of 0.50, a total assets turnover of 0.25, and a profit margin of 10%.
The president is unhappy with the current return on equity, and he thinks it could be doubled.
This could be accomplished (1) by increasing the profit margin to 14% and (2) increasing debt
utilization. Total assets turnover will not change. What new debt ratio, along with the 14% profit
margin, is required to double the return on equity?
a. 0.75 b. 0.70 c. 0.65 d. 0.55

QUESTION NOS. 34 and 35 ARE BASED ON THE FOLLOWING INFORMATION:

The Dawson Corporation projects the following for the year 2020.
MAS 9208 WORKING CAPITAL MANAGEMENT
AND FINANCIAL STATEMENTS ANALYSIS Page 17 of 19

Earnings before interest and taxes P35 million

Interest expense P 5 million
Preferred stock dividends P 4 million
Common stock dividend payout ratio 30%
Common shares outstanding 2 million
Effective corporate income tax rate 40%

34. The expected common stock dividend per share by Dawson Corporation for 2020 is
a. P2.34 b. P2.70 c. P1.80 d. P2.10

35. If Dawson Corporation’s common stock is expected to trade at a price-earnings ratio of eight, the
market price per share (to the nearest peso) should be
a. P104 b. P56 c. P72 d. P68

36. Beatnik Company has a current ratio of 2.5 and a quick ratio of 2.0. If the firm experienced P2
million in sales and sustains an inventory turnover of 8.0, what are the firm's current assets?
A. P1,000,000 B. P500,000 C. P1,500,000 D. P1,250,000

37. JC Goods, Inc. has a total assets turnover of 0.30 and a profit margin of 10%. The president is
unhappy with the current return on assets, and he thinks it could be doubled. This could be
accomplished (1) by increasing the profit margin to 15% and (2) by increasing total assets
turnover. What new asset turnover ratio, along with the 15% profit margin, is required to double
the return on assets?
a. 35% b. 45% c. 40% d. 50%

QUESTION NOS. 38 THROUGH 40 ARE BASED ON THE FOLLOWING INFORMATION:

The condensed balance sheet as of December 31, 2022 of San Matias Company is given below.
Figures shown by a question mark (?) may be computed from the additional information given:

ASSETS LIAB. & STOCKHOLDERS’ EQUITY

Cash P 60,000 Accounts payable P ?
Trade receivable-net ? Current notes payable 40,000
Inventory ? Long-term payable ?
Fixed assets-net 252,000 Common stock 140,000
Retained earnings ?
Total Assets P 480,000 Total L & SHE P 480,000

Additional information:
Current ratio (as of Dec. 31, 2022) 1.9 to 1
Ratio of total liabilities to total stockholders’ equity 1.4
Inventory turnover based on sales and ending 15 times
inventory
Inventory turnover based on cost of goods sold and 10 times
ending inventory
Gross margin for 2022 P500,000

38. The balance of accounts payable of San Matias as of December 31, 2022 is
a. P40,000 b. P80,000 c. P95,000 d. P280,000

39. The balance of retained earnings of San Matias as of December 31, 2022 is
a. P60,000 b. P140,000 c. P200,000 d. P360,000

40. The balance of inventory of San Matias as of December 31, 2022 is

a. P68,000 b. P100,000 c. P168,000 d. P228,000

QUESTION NOS. 41 THROUGH 44 ARE BASED ON THE FOLLOWING INFORMATION:

MAS 9208 WORKING CAPITAL MANAGEMENT
AND FINANCIAL STATEMENTS ANALYSIS Page 18 of 19

La Bekha Corporation asked you to interpret the following ratios provided by its accountant.
Acid-test ratio 1.2
Times interest earned 8
Gross margin ratio 40%
Inventory turnover 6
times
Debt to equity ratio 0.9:1
Ratio of operating expenses to sales 15%

Total stockholders’ equity on December 31, 2022 was P900,000. Gross margin for 2022 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 to serve as basis for further
analysis.

41. Operating income was computed at

a. P525,000 c. P375,000
b. P300,000 d. Answer cannot be determined

42. Bond payable totaled

a. P312,500 c. P400,000
b. P350,000 d. Answer cannot be determined.

43. The total current liabilities would be

a. P462,500 c. P504,500
b. P497,500 d. Answer cannot be determined.
44. The company’s total current assets amounted to
a. P317,000 c. P697,000 b. P597,000 d. Answer cannot be determined.

45. A company has just been taken over by new management that believes it can raise earnings
before taxes (EBT) from P600 to P1,000, merely by cutting overtime pay and reducing cost of
goods sold. Prior to the change, the following data applied:

Total assets: P8,000 Debt ratio: 45%

Tax rate: 35% BEP ratio: 13.3125%
EBT: P600 Sales: P15,000

These data have been constant for several years, and all income is paid out as dividends. Sales,
the tax rate, and the balance sheet will remain constant. What is the company’s cost of debt?
a. 12.92% b. 13.23% c. 13.51% d. 13.75%

1. C 11. C 21. 31. C 41. C

2. A 12. C 22. D 32. A 42. A
3. D 13. D 23. C 33. C 43. B
4. B 14. D 24. D 34. D 44. C
5. C 15. A 25. C 35. B 45. A
6. B 16. D 26. C 36. D
7. D 17. B 27. B 37. C
8. A 18. C 28. B 38. B
9. B 19. C 29. D 39. A
10. C 20. C 30. B 40. B
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