FINANCIAL STATEMENT ANALYSIS

Financial Ratios:

Tests of Liquidity:

Current Ratio Current Assets It is a measure of adequacy of

Current Liabilties working capital. It is the primary
test of liquidity to meet current
obligations from current assets
Quick Ratio Quick Assets It measures the number of times
Current Liabilities that the current liabilities could be
paid with the available cash and
near-cash assets (i.e., cash,
current receivables and
marketable securities)

Working Capital Activity Ratios

Receivables Turnover Net Credit Sales It measures the number of times

Average Receivables receivables are recorded and
collected during the period.
Average Age of Receivables 360 days It indicates the average number of
Receivables Turnover days during which the company
must wait before receivables are
collected.
Inventory Turnover Cost of goods sold It measures the number of times
Ave . Merchandise Inventory that the inventory is replaced
during the period.
Average Age of inventory 360 days It indicates the average number of
Inventory Turnover days during which the company
must wait before the inventories
are sold.

Raw Materials Turnover Cost of materials used / average RM inventory

Work In Process Turnover Cost of goods manufactured / average WIP inventory
Finished Goods Turnover CGS / Average FG inventory
Normal Operating Cycle Ave. Age of Inventory + Ave. Age of Receivables
Trade Payables Turnover Net Credit Purchases / Average Trade Payables
Average Age of Trade Payables 360 days / Payables Turnover
Current Assets Turnover (CGS + OPEX) / Ave. Current Assets

Test of Solvency

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

Test of Profitability

Return on Sales Income / Net Sales Determines the proportion of sales

that went into company’s earnings.
Return on Assets Income / Average Assets Efficiency with which assets are
used to operate the business
Return on Equity Income / Average Equity Measures the amount earned on
the owners’ or stockholders’
investment.
Earnings Per Share (Net Income – Preferred Measures the amount of net
Dividends) / Wtd. Ave. Common income earned by each common
Shares Outstanding share.

Market Tests

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

Stability Ratios

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

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

 Working Capital Turnover Net Sales / Average Working Indicates adequacy of working
Capital capital to support operation (sales)
Defensive Interval Ratio Current Liabilities / Cash & Cash Measures coverage of current
Equivalent liabilities
Payable Turnover Net Purchases / Average Measures efficiency of the
Accounts Payable company in meeting the accounts
payable.
Fixed assets to long-term liabilities Fixed Assets / Long-term liabilities Reflects extent of the utilization of
resources from long-term debt.
Indicative of sources of additional
funds.

Ratios indicative of income position

Rate of return on average current Income / Average Current Assets Measures the profitability of
assets current assets invested
Operating Profit Margin Operating profit / net sales Measures profit generated after
consideration of operating costs.
Cash flow margin Operating cash flow / net sales Measures the ability of the firm to
translate sales to cash.

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

Net Sales 7,200

Cost of Goods Sold (a)
Selling and admin expenses 1,830
Interest expense (b)
Other expenses 150
Income before taxes 1,325
Income Tax (c)
Net income (d)

Other data:
Inventory Turnover 3.50
Beginning inventory 850
Ending inventory 810
Rate of return on net sales 0.11

Required: Complete Juan Company’s income statement

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

Cash 75 Total current liabilities 1,900

Receivables (a) Long-term note payable (e)
Inventories 725 Other long-term liabilities 980
Prepaid Expenses (b)
Total Current Assets (c) Stockholders' equity 2,325
Plant assets, net (d)
 Other Assets 2,000
Total Assets 6,800 Total Liabilities and SHE (f)

Gaddi’s current ratio is 0.80 and its acid test ratio is 0.40.

Required: Complete Gaddi Company’s balance sheet.

We are given the following information for the Coleman Machine Tools Corporation:

Sales (credit) 7,200,000

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. A/R
b. Marketable Securities
c. Fixed Assets
d. Long-term debt

Nickoly of N Company found these pieces of her average balance sheet and key ratio report in her Herschel
bag:

Cash ?   Gross Margin Percentage 25%

Accounts Receivable ?   Debt to equity ratio 0.25:1
Inventories 80   Current ratio 3:1
Fixed Assets, net ?   Inventory turnover 15 times
Current Liabilities 100   Days sales in receivables 15 days
Common Stock 100   (based on 360 days)
Retained Earnings ?    

Required: Add as much to her balance sheet as possible from the data provided.

Assume that net income was P 6,000. 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.