FIN 004 Financial Management I

Module #4

Name: _________________________________________ Class number: _________________

Section: _________ Schedule: ______________________ Date: _________________________

Lesson title: Financial Statement Analysis Part 2 Materials:

Lesson Objectives: SAS
At the end of this module, I should be able to: References:
1. Prepare and interpret financial statements in comparative and Timbang, Ferdinand L; Financial
common-size form. Management: Part I
2. Compute and infer financial ratios that managers use to
assess for different users.

Productivity Tip:
Wake up with determination! This module consists of variety formulas. Do not pressure yourself to
memorize them. Instead, analyze them with creativity! Encourage your friend to memorize them or
have them posted in an area that you can see them always. In that way, I’m sure you’ll be sleeping
with satisfaction! As Larry Page says, “Deliver more than expected.”

A. LESSON PREVIEW/REVIEW
1) Introduction

A LOOK BACK
Lesson 2 provided an
overview of Financial
Statement Analysis. We
create and interpret
financial reports like the
Statement of
Comprehensive Income
and Statement of Financial
Position with special focus
on Statement of Cash
Flows.

A LOOK
AHEAD
After evaluating
previous financial
reports, in Lesson 4,
we measure
appropriate budgets A LOOK AT THIS
for each functional
and create a master MODULE
budget and financial
projection.
In Lesson 3, we continue
the discussion of analysis
of financial statements,
but this time through the
use of financial ratios. We
will differentiate the
content and purposes of
these financial ratios and
relate them to actual
business environment.

1
FLM 1.0
 FIN 004 Financial Management I
Module #4

Name: _________________________________________ Class number: _________________

Section: _________ Schedule: ______________________ Date: _________________________

Where’s the Beef?

PROBLEM: Fast-food restaurants such as McDonald’s, Wendy’s, and Burger King faced an
interesting challenge – how do we hold our gross margin percentage steady in the face of climbing
beef prices?

One option was to pass the higher raw material cost on to customers in the form of higher
prices; however, the slumping economy suggested that a price increase would diminish customer
demand.

SOLUTION: Instead, the restaurants tried to encourage their diners to buy more profitable menu
items such as chicken and salads.
Example:
 Wendy’s – once known for its advertising logan “Where’s the Beef?’
focused its advertising efforts on a new line of premium salads and a new
flavor of boneless wings.
 Burger King – planned to introduce bone-in-pork ribs for a limited time.

Source: Paul Ziobro, “Fast-Food Joints Push Chicken as Beef Prices Hit New Highs,” The Wall Street Journal,
May 20, 2010, p. B1.

2) Activity 1: What I Know Chart, part 1 (3 mins)

If you’re the manager, how would you consider various internal and external factors? Please try
answering the question below by writing your ideas in the first column What I Know. It's all right if
you write key terms or phrases that you think are relevant to questions.

What I Know Questions: What I Learned

1. The president of a plastics
company was quoted in a business
journal as stating, “We haven’t had
a dollar of interest-paying debt in
over 10 years. Not many
companies can say that.” As a
stockholder in this company, how
would you feel about its policy of
not taking on debt?

B. MAIN LESSON
1) Activity 2: Pre-Printed Content Notes

FS ANALYSIS implicates the assessment of a company’s past performance, present condition,

and business potentials by way of analyzing the financial statements to gain information about

2
FLM 1.0
 FIN 004 Financial Management I
Module #4

Name: _________________________________________ Class number: _________________

Section: _________ Schedule: ______________________ Date: _________________________

(among others):
 Profitability of the business firm
 The firm’s ability to meet its obligations (liquidity and solvency)
 Safety of the investment in the business (stability)
 Effectiveness of management in running the firm (activity)
 Over-all company marketability

Three techniques are normally used to make comparisons and to identify trends.
 Peso and percentage changes in financial statement items.
 Common-size statements.
 Ratios.

LO1: Prepare and interpret financial statements in comparative and common-size form.
Statements in Comparative and Common-Size Form. Two basic methodologies are often used
to match financial statements between companies or between different years for the same
company: horizontal (trend) analysis and vertical (common-size) analysis.
a. Horizontal Analysis – involves comparing figures shown in the financial statements of two
or more successive periods.
Percentage Change (∆%) = Most Recent Value – Base Period Value
Base Period Value
Relationships can be made between an actual amount compared against a budgeted
amount, with the ‘budget’ serving as the basis or pattern of performance.

LIMITATION: if a negative or a zero amount appears in the base year, percentage change
cannot be figured.

b. Vertical Analysis – is the process of comparing figures in the FS of a single period. It

involves the transformation of amounts in the FS to a common base. This is accomplished
by expressing all figures in the FS as percentages of an important item such as total assets
(in the balance sheet) or net sales (in the income statement). These converted statements
are called common-size statements or percentage composition statements.

Percentage composition statements are used for matching:

1. Numerous years of data from the same firm
2. Companies that are dissimilar in size
3. Company to industry averages

LO2: Compute and infer financial ratios that managers use to assess for different users.
Ratio Analysis – involves the growth of mathematical relationships between accounts in the financial
statements.

DIFFERENT RATIOS FOR DIFFERENT USERS:

3
FLM 1.0
 FIN 004 Financial Management I
Module #4

Name: _________________________________________ Class number: _________________

Section: _________ Schedule: ______________________ Date: _________________________

A. TESTS OF LIQUIDITY – affect the capability of the business to quicken its operating cycle to
meet operating obligations and payments.
 The liquidity of a business is determined by balancing its operating cycle days and payable
days. Operating cycle days measure the length of the time to convert the cash back to
cash again. Payable days relate to the time period the average trade payables are paid.

Turnover Liquidity Days

Trade Receivables Net Credit Sales / Trade 365 / Receivable Turnover
Receivables
Inventory Cost of goods sold / Inventory 365 / Inventory
Trade Payables Net Credit Purchases / Trade 365 / Payable Turnover
Payables

The liquidity of a business is based on its operating cycle days

Inventory days x
+ Collection period x
Operating cycle x
-Payment period x
Net cash cycle x

The other liquidity ratios are as follows:

Current ratio Current assets / Current liabilities

Quick assets ratio Quick assets / Current liabilities
Quick assets Cash + Marketable securities + Trade
receivables
Net working capital Current assets – Current liabilities
Fixed-asset turnover Net sales / Average net fixed assets
Total asset turnover Net sales / Average total assets

B. TESTS OF SOLVENCY – refers to the ability of the company to pay its debts.
These ratios involve leverage ratios. ‘Leverage’ refers to how much of company’s resources are
financed by debt and/or preferred equity, both of which require fixed payment of interests and
dividends.

Time Interest Earned 𝐸𝐵𝐼𝑇 It defines the extent to which

Debt-Equity Ratio
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝐸𝑥𝑝𝑒𝑛𝑠𝑒
𝑇𝑜𝑡𝑎𝑙 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
𝑇𝑜𝑡𝑎𝑙 𝐸𝑞𝑢𝑖𝑡𝑦
operations cover interest
expense.
Proportion of assets provided
by creditors compared to that
provided by owners.

4
FLM 1.0
 FIN 004 Financial Management I
Module #4

Name: _________________________________________ Class number: _________________

Section: _________ Schedule: ______________________ Date: _________________________

Debt Ratio 𝑇𝑜𝑡𝑎𝑙 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 Proportion of total assets

𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 provided by creditors.
Equity Ratio 𝑇𝑜𝑡𝑎𝑙 𝐸𝑞𝑢𝑖𝑡𝑦 Proportion of total assets
𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 provided by owners.
Book value per share on 𝐶𝑜𝑚𝑚𝑜𝑛 𝑠𝑡𝑜𝑐𝑘 𝑒𝑞𝑢𝑖𝑡𝑦 Measures recoverable amount
common stock # 𝑜𝑓 𝑜𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔 𝑐𝑜𝑚𝑚𝑜𝑛 𝑠𝑡𝑜𝑐𝑘 in the event of liquidation if
assets are realized at their
book values.

C. TESTS OF PROFITABILITY – is a measure of operating effectiveness. It measures the ability of

the business to recover long-term investment from money produced by its normal operating
activities.

Gross profit margin 𝐺𝑟𝑜𝑠𝑠 𝑝𝑟𝑜𝑓𝑖𝑡

𝑁𝑒𝑡 𝑠𝑎𝑙𝑒𝑠
Profit margin 𝑁𝑒𝑡 𝑖𝑛𝑐𝑜𝑚𝑒
𝑁𝑒𝑡 𝑠𝑎𝑙𝑒𝑠
Return on sales 𝐼𝑛𝑐𝑜𝑚𝑒
𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠
Return on total assets 𝑁𝑒𝑡 𝑖𝑛𝑐𝑜𝑚𝑒
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑡𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠
Return on common stock equity 𝑁𝑒𝑡 𝑖𝑛𝑐𝑜𝑚𝑒
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑐𝑜𝑚𝑚𝑜𝑛 𝑠𝑡𝑜𝑐𝑘ℎ𝑜𝑙𝑑𝑒𝑟 ′ 𝑠 𝑒𝑞𝑢𝑖𝑡𝑦
Earnings per share 𝑁𝑒𝑡 𝑖𝑛𝑐𝑜𝑚𝑒 − 𝑃𝑟𝑒𝑓𝑒𝑟𝑟𝑒𝑑 𝑠𝑡𝑜𝑐𝑘 𝑑𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑟𝑒𝑞𝑢𝑖𝑟𝑒𝑚𝑒𝑛𝑡𝑠
𝐶𝑜𝑚𝑚𝑜𝑛 𝑠𝑡𝑜𝑐𝑘 𝑜𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔

D. MARKET TESTS – summarizes ratios that common stockholders use to evaluate a company’s
performance. Given that common stockholders are the ones who own the company, it
reasonably follows that managers should have a detailed understanding of the measures that
their owners will use to judge their performance.

Price/earnings 𝑀𝑎𝑟𝑘𝑒𝑡 𝑝𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 It indicates the number of

Market-to-book value
Dividend yield
𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 pesos required to buy P1 of
earnings.
𝑀𝑎𝑟𝑘𝑒𝑡 𝑝𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 It proposes how much
𝐵𝑜𝑜𝑘 𝑣𝑎𝑙𝑢𝑒 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 investors are paying against
each dollar of book value in
the balance sheet.
𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 Measures the rate of return
𝑀𝑎𝑟𝑘𝑒𝑡 𝑝𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 in the investor’s common
stock investments.

5
FLM 1.0
 FIN 004 Financial Management I
Module #4

Name: _________________________________________ Class number: _________________

Section: _________ Schedule: ______________________ Date: _________________________

Dividend payout 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 It indicates the proportion of

𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 earnings distributed as
dividends.

2) Activity 3: Skill-building Activities (with answer key) (18 mins + 2 mins checking)
Let’s use the multiple formulas to keep those in your mind!

Exercise 1. CONSTRUCTION OF FINANCIAL STATEMENTS

The following information is available concerning Savage Love Company’s expected results in
2020. Turnovers are based on year-end values.

REQUIRED: Fill in the blanks.

1. Return on sales 6%
2. Gross profit percentage 40%
3. Receivables turnover 5 times
4. Inventory turnover 4 times
5. Current ratio 3:1
6. Ratio of total debt to total assets 40%

Condensed Income Statement

Sales P 900
Cost of sales (A) _____
Gross profit (B) _____
Operating expenses (C) _____
Net income (D) _____

Condensed Balance Sheet

Cash P 30 Current liabilities (H) P _____
Receivables (E) ____ Long-term debt (I) _____
Inventory (F) ____ Shareholder’s equity (J) _____
Plant and equipment 670
Total (G) ____ Total (K) _____

3) Activity 4: What I Know Chart, part 2 (2 mins)

It’s time to answer the questions in the What I Know chart in Activity 1. Log in your answers in
the table.

4) Activity 5: Check for Understanding (5 mins)

Applying horizontal analysis, show the percentage change from 2019 to 2020 with 2019 as the
base year.

6
FLM 1.0
 FIN 004 Financial Management I
Module #4

Name: _________________________________________ Class number: _________________

Section: _________ Schedule: ______________________ Date: _________________________

Comparative data for Why Is Everything Chrome’s corporation for the two-year period 2019-
2020 are given as follows:

Income Statement Data

2019 2020
Net sales P 1,400,000.00 P 800,000.00
Cost of goods sold 840,000.00 440,000.00
Gross profit 560,000.00 360,000.00
Selling, general, and other expenses 400,000.00 130,000.00
Income tax expense 40,000.00 30,000.00
Net income P 120,000.00 P 200,000.00
Dividends paid 80,000.00 80,000.00
Net increase in retained earnings P 40,000.00 P 120,000.00

Balance Sheet Data

2019 2020
Assets
Current assets P 540,000.00 P 440,000.00
Land, buildings, and equipments 800,000.00 720,000.00
Total assets P 1,340,000.00 P 1,160,000.00

Liabilities and stockholder’s equity

Current liabilities P 300,000.00 P 240,000.00
Bonds payable (8%) 320,000.00 320,000.00
Common stock (P5 par) 480,000.00 400,000.00
Retained earnings 240,000.00 200,000.00
Total liabilities and stockholder’s equity P 1,340,000.000 P 1,160,000.00

Answer:

Percentage (%)
a. Net sales i. Current assets
b. Cost of goods sold j. Land, buildings, and equipment
c. Gross profit on sales k. Total assets
d. Selling, general, and other l. Current liabilities
expenses
e. Income tax expense m. Bonds payable
f. Net income n. Common stock

7
FLM 1.0
 FIN 004 Financial Management I
Module #4

Name: _________________________________________ Class number: _________________

Section: _________ Schedule: ______________________ Date: _________________________

g. Dividends paid o. Retained earnings

h. Net increase in retained p. Total liabilities and
earnings stockholder’s equity

C. LESSON WRAP-UP
1) Activity 6: Thinking about Learning (5 mins)
Congratulations for finishing this module! Shade the number of the module that you finished.

Are you having difficulty in learning the concepts in this module? If none, which parts of the module
helped you learn the concepts?
__________________________________________________________________________________
__________________________________________________________________________________

Some question/s I want to ask my teacher about this module is/are:

__________________________________________________________________________________
__________________________________________________________________________________

Learning Scores Action Plan

Date
Target/Topic
What module# did
What contributed to the quality of your
you do? What were What were your
What’s the performance today? What will you do next
the learning targets? scores in the
date today? session to maintain your performance or
What activities did activities?
improve it?
you do?

FAQ
In a test of profitability, what INCOME figure should be used?
 If the purpose is to measure operational performance, income is expressed as before
interest and tax; otherwise, income before ‘after-tax’ interest may be used to ignore the
effect of capital structure.
 If the purpose is to evaluate total managerial effort, income is expressed after interest and
tax.
 The practice of expressing income after interest but before tax is now seldom applied in
business practice.

8
FLM 1.0