Luis Alvaro
Benjohn Espiritu
Ria Mempin
Analyzing Financial Statements involves evaluating three characteristics of an entity: its
liquidity, its profitability and its solvency.
Intracompany Basis - this basis compares an item or financial relationship within an entity in the
current year with the same item or relationship in one or more prior years.
Industry Averages - this basis compares an item or financial relationship of an entity with
industry averages or norms published by financial ratings organizations.
Horizontal Analysis - is a technique for evaluating a series of financial statement data over a
period of time.
Trend Analysis(horizontal analysis) - a technique for evaluating a series of financial statement
data over a period of time.
Vertical Analysis - is a technique for evaluating financial statement data that expresses each item
in a financial statement in terms of a percent of a base amount.
- a method of analyzing financial statements in which you can compare
individual line items to a baseline item.
Ratio Analysis - expresses the relationship among selected items of financial statement data
-compares one indicator to another. Ratios can give you significant insight.
Working Capital - this equation describes the amount of capital used to run day-to-day business
operations. It is necessary to finance an entity's cash conversion cycle.
working capital = current assets - current liabilities
Current Ratio - describes the ability of an entity to meet current debt obligations with assets that
are readily available.
current ratio = current assets/current liabilities
Quick Ratio or Acid-Test Ratio - tells whether the entity could pay all its current liabilities even
if none of the inventory is sold.
quick ratio = quick assets/current liabilities
Accounts Recievable Turnover - measures the entity's ability to collect from credit customers.
accounts recievable turnover = net credit sales/average net accounts recievable
Average Age of Recievables - provides a rough approximation of the average time that it takes to
collect recievables.
average age of recievables = 365 days/accounts recievable turnover
Inventory Turnover - is a measure of the number of times an entity sold its average level of
inventory during the period.
inventory turnover = cost of goods sold/average merchandise inventory
Average Age of Inventory - provides a rough measure of the length of time it takes to acquire,
sell and replace inventory.
average age of inventory = 365 days/inventory turnover
Operating Cycle - this measures the average time period between buying the inventory and
recieving cash proceeds from its sales.
Return on total assets - is a measure of management's efficiency in using its assets to earn profits.
Return on total assets = profit + interest expense/ average total assets
Return on ordinary equity - shows the relationship between profit and ordinary shareholders'
investment in the entity.
Return on ordinary equity = profit - preference dividends/ average ordinary equity
Leverage - trading on the equity
Basic earnings per ordinary share - is a measure of the profit earned on each ordinary share.
BEPS = profit - preference dividends/ average number of ordinary shares outstanding
Price-Earnings (P/E) Ratio - indicates the degree to which investors value an entity.
Price-Earnings Ratio = market price per ordinary share/basic earnings per ordinary share
Dividend Yield - is the ratio of dividends per share to the share's market price. This ratio
measures the percentage of a share's market value that is returned annually as dividends.
Dividend Yield = cash dividends per ordinary share/market price per ordinary share
Solvency Ratios - measure the ability of the entity to survive over a long period of time.
Times Interest Earned - is a measure of how readily an entity ca meet interest payments with
profit earned from operations.
Times Interest Earned = profit before interest expense and income taxes/annual interest expense
Debt to total assets ratio (debt ratio) - shows the percentage of the entity's assets financed by
debt.
Debt to total assets ratio = total liabilities/total assets
Equity to total assets ratio (equity ratio) - shows the percentage of the firm's assets financed by
shareholders.
Equity ratio = 100% - Debt Ratio
Sample Problems :
You have been assigned the task of evaluating Gumban, Inc.'s management of merchandise
inventory and recievables. You decided that inventory turnover, accounts recievable turnover,
and average age of recievables statistics will prove valuable in your analysis. The following data
are available from Gumban's annual report :
Merchandise Inventory :
Jan. 1 P 245,000
Dec. 31 375,000
Accounts Recievable :
Jan. 1 250,000
Dec. 31 297,000
Cost of Goods Sold 2,480,000
Cash Sales 1,000,000
Total Sales 5,100,000
Gumban's Credit Terms Net 30 days
Required : Calculate inventory turnover, accounts recievable turnover, and average age of
recievables.
The following information was taken from the statement of financial position of Blanche
Corporation :
Cash P 13,250
Accounts Recievable 33,000
Merchandise Inventory 40,000
Prepaid Expenses 9,950
Accounts Payable 25,200
Accrued Payables 1,800
Notes Payable (due in 6 months) 10,000
Required : Calculate the working capital, current ratio and quick ratio.
You have been asked to evaluate the liquidity position of Burgos Fitness Center. The following
data are from Burgos' annual report :
Cash P130,000
Trading Investments 60,000
Accounts Recievable:
Jan.1 156,000
Dec.31 214,000
Merchandise Inventory
Jan.1 252,000
Dec.31 186,000
Current Liabilities 240,000
Cost of Goods Sold 3,000,000
Credit Sales 5,000,000
Required: using these data, calculate Burgos'
1. Working Capital 4. Inventory turnover
2. Current ratio 5. Accounts recievable turnover
3. Quick ratio 6. Average age of recievables
