Four main categories of financial ratios:

Liquidity
Profitability
Efficiency
Leverage

Liquidity -company’s ability to satisfy its short-term obligations as they come due.
Formulas:

Profitability -company’s ability to generate earnings.

 Return on equity -measures the amount of net income earned in relation to stockholders’
equity.
FORMULA:
ROE (return on equity) = Net income ÷ Stockholders’ equity

 Return on assets -measures the ability of a company to generate income out of its
resources/assets.
FORMULA:
ROA (return on asset) = Operating income ÷ Total assets

 Gross profit margin -provides information regarding the ability of a company to cover its
manufacturing cost from its sales.
-sales less cost of goods or cost of services.
FORMULA:
Gross profit margin = Gross profit ÷ Sales

 Operating profit margin -measures the amount of income generated from the core
business of a company.
FORMULA:
 Operating profit margin =Operating income ÷ Sales

 Net profit margin -measures how much net profit a company generates for every peso of
sales or revenues that it generates.
FORMULA:
Net profit margin = Net income ÷ Sales

Efficiency -refers to a company’s ability to be efficient in its operations. Specifically, it refers to

the speed with which various current accounts are converted into sales, and ultimately, cash.
Financial leverage refers to the company’s use of debt. It defines the company’s capital structure
which indicates how much of the total assets are financed by debt and equity.
Types of leverage ratios:
• Debt ratio – This ratio measures the proportion of total assets finance by total liabilities or
money
Provided by creditors (not by the business owners).
• Debt-to-equity ratio – A variation of debt ratio, shows the proportion of debt to equity.
• Interest coverage ratio (Times Interest Earned) – This ratio shows the company’s ability to pay
its fixed interest charges in relation to its operating income or earnings before interest and taxes.

Tips on Financial Management

Nature of Business – If the business is a risk then it has to be financed conservatively hence,
lower debt ratio.
State of Business Development – A newly formed business may have difficulty borrowing from
banks. Banks usually look for the historical financial performance of borrowers.
Macroeconomic conditions – If the overall economy is good then management can be more
aggressive in taking in risk through increased debt financing.
Prospects of the industry – A growing industry makes businesses more confident to take on more
financial risk.
Taxes – Interest expenses are tax deductible while cash dividends are not. By having more debt
than equity, businesses save on taxes as interest expense (multiplied by the tax rate) decreases
income tax due.
Management style –Management and the board of directors can be aggressive or conservative in
terms of taking on risk.
Financial Planning Tools and Concepts
Planning is an important aspect of the firm’s operations
-it provides road maps for guiding, coordinating, and controlling the firm’s actions to achieve its
objectives.
Management planning - setting the goals of the organization and identifying ways on how to
achieve them.
Long-term financial plans (STRATEGIC PLANNING)
-Long term goals set the direction of the company.
Short-term financial plans (TACTICAL PLANS)
-Short term goals are the specific steps or actions that will ultimately reach the company’s long
term goals.
Steps in Planning
A. Set goals or objectives.
B. Identify Resources.
C. Identify goal-related tasks.
D. Establish responsibility centers for accountability and timeline.
E. Establish the evaluation system for monitoring and controlling.
F. Determine contingency plans.
Criteria may be used for effective planning:
- Specific – target a specific area for improvement.
- Measurable – quantify or at least suggest an indicator of progress.
- Assignable – specify who will do it.
- Realistic – state what results can realistically be achieved, given available resources.
Time-related – specify when the result(s) can be achieved.
“There’s a S.M.A.R.T. way to write management’s goals and Objectives”.
Tools used in Budgeting
1.Sales Budget- The most important account in the financial statement in making a forecast is
sales since most of the expenses are correlated with sales.
2. Production Budget- provides information regarding the number of units that should be
produced over a given accounting period based on expected sales and targeted level of ending
inventories.
-It is computed as follows Budget

3.Operations Budget- refers to the variable and fixed costs needed to run the operations of the
company but are not directly attributable to the generation of sales.
4. Cash Budget, or cash forecast, is a statement of the firm’s planned inflows and outflows of
cash.
5. Projected Financial Statements- is a tool of the company to set an overall goal of what the
company’s performance and position will be for and as of the end of the year. It sets targets to
control and monitor the activities of the company.
‣ Projected Income Statement
‣ Projected Statement of Financial Position
‣ Projected Statement of Cash Flows
Steps on Financial Statement Projection.
a. Forecast Sales.
b. Forecast Cost of Sales and Operating Expenses
c. Forecast Net Income and Retained Earnings.
d. Determine balance sheet items that will vary with sales or whose balances will be highly
correlated to sales.
e. Determine payment schedule for loans.
f. Check for other information
g. Determine external funds needed (EFN).
h. Determine how external funds needed may be financed.