PROFITABILITY RATIO FORMULA ANALYSIS

GROSS PROFIT RATIO 𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡 What extend the SP of goods per unit may be
× 100
𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠 reduced without incurring losses on
operations
- No standard GP ration for
evaluation
NET PROFIT RATIO 𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒 Measure the overall profitability
× 100
𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠 - Higher the ratio, the better is the
profitability
OPERATING RATIO 𝐶𝑂𝐺𝑆 + 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐸𝑥𝑝𝑒𝑛𝑠𝑒𝑠 Shows operational efficiency of the business
× 100
𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠 - Lower operating ratio shows higher
operating profit
- Standard manufacturing concern:
75% to 80%
EXPENSE RATIO 𝑃𝑎𝑟𝑡𝑖𝑐𝑢𝑙𝑎𝑟 𝐸𝑥𝑝𝑒𝑛𝑠𝑒 Individual items of expense or a group of
× 100
𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠 items: cost of sales ratio, admin expense
ratio, selling expense ratio, etc.
RETURN ON ASSET 𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒 + (𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝐸𝑥𝑝 𝑥 (1 − 𝑡𝑎𝑥 𝑟𝑎𝑡𝑒) number of cents earned on each peso of
𝐴𝑣𝑒. 𝑜𝑓 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 assets.
- Higher values of ROA = business is
profitable
- Increasing trend of ROA = improving;
decreasing trend = deteriorating
RETURN ON EQUITY OR 𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒 − 𝑃𝑟𝑒𝑓𝑒𝑟𝑟𝑒𝑑 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠 - Higher values are generally favorable
RETURN ON CAPITAL 𝐴𝑣𝑒. 𝑆𝑡𝑜𝑐𝑘ℎ𝑜𝑙𝑑𝑒𝑟𝑠 ′ 𝐸𝑞𝑢𝑖𝑡𝑦 = company is efficient in generating
income
DIVIDENT YIELD RATIO 𝐶𝑜𝑚𝑚𝑜𝑛 𝑆𝑡𝑜𝑐𝑘 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠 Shareholders are interested in real sense in
𝑁𝑜. 𝑜𝑓 𝐶𝑜𝑚𝑚𝑜𝑛 𝑆𝑡𝑜𝑐𝑘 the earnings distributed and paid to them as
dividend
Then, - Knows the effective return he is
𝐴𝑛𝑠𝑤𝑒𝑟 going to get on the proposed
𝑀𝑎𝑟𝑘𝑒𝑡 𝑃𝑟𝑖𝑐𝑒 investment

DIVIDEND PAYOUT RATIO 𝐶𝑜𝑚𝑚𝑜𝑛 𝑆𝑡𝑜𝑐𝑘 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠 Which earnings per share have been used for
𝑁𝑜. 𝑜𝑓 𝐶𝑜𝑚𝑚𝑜𝑛 𝑆𝑡𝑜𝑐𝑘 paying dividends AND what portion of
earnings has been retained
Then
- Lower payout ratio, the higher will the
𝐴𝑛𝑠𝑤𝑒𝑟 amount of earnings ploughed back
𝐸𝑃𝑆 and vice versa
- Lower payout ratio or higher RE =
stronger financial position
EPS RATIO 𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒 − 𝑃𝑟𝑒𝑓𝑒𝑟𝑟𝑒𝑑 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠 Gives a view of the comparative earnings or
𝑁𝑜. 𝑜𝑓 𝐶𝑜𝑚𝑚𝑜𝑛 𝑆ℎ𝑎𝑟𝑒 earnings power of the firm
P/E RATIO 𝑀𝑎𝑟𝑘𝑒𝑡 𝑃𝑟𝑖𝑐𝑒 Helps the investor in deciding whether to buy
𝐸𝑃𝑆 or not to buy the shares of a particular
company at a particular market share
- Higher the P/E ratio the better it is
LIQUIDITY RATIO FORMULA ANALYSIS
CURRENT RATIO (WC RATIO) 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡 Tells us whether the CA are enough
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑦 to settle CL
- CR below 1 shows critical
liquidity problems – TCL
exceeds TCA
General rule: higher CR, the better it
is
Except: abnormally high value of the
CR may indicate existence of idle
asset
LIQUID RATIO (ACID TEST RATIO, QUICK RATIO) 𝐿𝑖𝑞𝑢𝑖𝑑 𝐴𝑠𝑠𝑒𝑡 Measures the firm’s capacity to pay
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑦 off current obligations immediately
- High liquid ratio = firm is
liquid
- Low liquid ratio = firm’s
liquidity position is not good
- ABSOLUTE LIQUIDITY Only the absolute liquid assets are
compared to liquid liability
Liquid asset: cash, bank, marketable
securities
Standard: 0.5:1 – acceptable norm
WORKING CAPITAL 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡 CA > CL – firms is not expected to
− 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑦 suffer from liquidity crunch
CA < CL – firms may not be able to
pay off its CL when due

ACTIVITY RATIO FORMULA ANALYSIS

INVENTORY TURNOVER 𝐶𝑂𝐺𝑆 To measure the inventory management
𝐴𝑣𝑒. 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 efficiency
- Higher value of inventory turnover -
better performance
- Lower value of inventory turnover -
indication of overstocking
However, a very high value may be
accompanied by loss of sales due to
inventory shortage

DAYS’ INVENTORY ON HAND 365 𝑜𝑟 360 Number of days a company takes to sell its
(AVERAGE SALE PERIOD) 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 average balance of inventory
- Lower value = favorable
- Higher value = unfavorable

ACCOUNT RECEIVABLE 𝑁𝑒𝑡 𝐶𝑟𝑒𝑑𝑖𝑡 𝑆𝑎𝑙𝑒𝑠 Efficiency of a business in collecting its credit
TURNOVER 𝐴𝑣𝑒. 𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒 sales
- Higher AR turnover – favorable
- Lower AR turnover – unfavorable

DAYS’ SALES OUTSTANDING 365 𝑜𝑟 360 Measure the ave. number of days a business
RATIO (AVERAGE COLLECTION 𝐴𝑅 𝑡𝑢𝑟𝑛𝑜𝑣𝑒𝑟 takes to collect its trade receivable
PERIOD) - Lower value = favorable
- Higher value = unfavorable
WORKING CAPITAL TURNOVER 𝑅𝑒𝑣𝑒𝑛𝑢𝑒 Measures pesos of revenue generated per
RATIO 𝑊𝑜𝑟𝑘𝑖𝑛𝑔 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 peso of investment in WC
- Higher the better
 LONG-TERM SOLVENCY OR FORMULA ANALYSIS
LEVERAGE RATIO
DEBT-TO-EQUITY RATIO 𝑇𝑜𝑡𝑎𝑙 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑦 Measures the degree to which the
𝑇𝑜𝑡𝑎𝑙 𝑆ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟𝑠 ′ 𝐸𝑞𝑢𝑖𝑡𝑦 assets of the business are financed by
the debts and the shareholders’ equity
of a business
- Lower value – favorable – less
risk
- Higher value – unfavorable –
relies more on external lenders

TIMES INTEREST EARNED 𝐸𝐵𝐼𝑇 Solvency ratio measuring the ability of

𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑒𝑥𝑝𝑒𝑛𝑠𝑒 a business to pay off its debts
- Higher value – favorable –
greater ability to repay its
interest and debt.

BOOK VALUE PER SHARE 𝑪𝒐𝒎𝒎𝒐𝒏 𝑺𝒕𝒐𝒄𝒌 𝑬𝒒𝒖𝒊𝒕𝒚 Note: Consider preferred
𝑵𝒐. 𝒐𝒇 𝑪𝒐𝒎𝒎𝒐𝒏 𝑺𝒕𝒐𝒄𝒌 dividends if it has feature of having
dividends being cumulative –
liquidation value of the preferred
stock.
Formula = Total SHE – Liquidation
Value of PS – Unpaid PD

(wala sa handouts: ref – Bobadilla reviewer)

FORMULA ANALYSIS
DEGREE OF FINANCIAL LEVERAGE 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐼𝑛𝑐𝑜𝑚𝑒 Measures the variability of income
(DOL) 𝐼𝑛𝑐𝑜𝑚𝑒 𝑎𝑓𝑡𝑒𝑟 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝐸𝑥𝑝𝑒𝑛𝑠𝑒 after interest expense in response to
the change in operating profit