PALAWAN STATE UNIVERSITY

College of Business and Accountancy

Department of Human Resource Development Management, Financial
Management and Business Economics
Puerto Princesa City

CHAPTER 3 - Lesson 2:
Financial Statements: Tools for Decision
Making
COURSE TITLE: Business Finance
COURSE CODE: Fin 2001
2nd Semester | SY: 2022-2023
BSBA
Financial Statements: Tools for Decision-making

Overview
In this chapter, we will discuss the different kinds of analysis done by financial analysts and
decision makers. This chapter will show illustrative examples of comparative income statements and
balance sheets using the horizontal analysis and the vertical analysis. For a theoretical corporation.
These same analyses can be done for sole proprietorship and partnership by just substituting owners’
equity for the former and partners’ equity for the latter for “stockholders’ equity”.

Intended Learning Outcomes:

 Explain the steps in analyzing financial statements;
 Analyze the computed ratios; and
 Apply financial ratios in financial decision making.

INTRODUCTION
The information in the financial statements are used by managers and other external users,
like investors and creditors, in making financial decisions. Most of these decisions have financial
implications that are utmost importance to these decision makers. For managers, the decision to
acquire an asset, build bigger plant, expand operations, acquire computers to update the company’s
information system, liquidate liabilities, obtain a loan, and grant salary and benefit increases to
employees have financial implications. For suppliers and creditors, the decision to grant additional
credit, collect receivables, or continue to supply a company with all its needs for products they sell
have financial implications. For current and future stockholder’s, decisions to buy more shares of the
company or to sell their current holdings have financial implications.
Financial statement are indispensable tools in making financial decisions. They shed light on
the performance of the company (income statements) and the financial condition of company
(balance sheet). The cash flow statement shows where cash came from and where it was spent. The
statement of changes in owners’ equity shows investments by owners (additional sale) withdrawals
by owners (dividends declared by the board of directors), and any profit earned or loss incurred by
the company. As such, financial. Statements help not only manager’s users of the statements but
also the external users of the financial statements including the government (relevant to taxes to be
collected and adherence to government laws, rules, and regulations) as well. Financial statements
analysis highlights the connection, relation and importance of accounting to financial management in
particular and to finance in general. It is, however, important to bear in mind that financial analysis is
not an end in itself but rather an effort to understand and judge the characteristic and performance of
a highly interrelated system of financial relationships.
Business analysis and financial statement analysis are important in a number of other contexts.
 Managers. Analysis of financial statements can provide managers with clues to strategic changes
in operating, investing, and financing activities. Managers also analyze the businesses and
financial statements of competing companies to evaluate a competitor’s profitability and risk.
Such analysis allows for inter-firm comparisons, both to evaluate relative strengths and
weaknesses and to benchmark performance.
 Mergers, acquisitions, and divestitures. Business analysis is performed whenever a company
restructures its operations, through mergers, acquisitions, divestitures, and spin-offs. Investment

2
 bankers need to identify potential targets and determine their values, and security analysts need
to determine whether and how much additional value is created by the merger for both the
acquiring and the target companies.
 Financial management. Managers must evaluate the impact of financing decisions and dividend
policy on company value. Business analysis helps assess the impact of financing decisions on
both future profitability and risk.
 Directors. As elected representatives of the shareholders, directors are responsible for protecting
the shareholders’ interests by vigilantly overseeing the company’s activities. Both business
analysis and financial statement analysis aid directors in fulfilling their oversight responsibilities.
 Regulators. The Internal Revenue Service applies tools of financial statement analysis to audit
tax returns and check the reasonableness of reported amounts.
 Labor unions. Techniques of financial statement analysis are useful to labor unions in collective
bargaining negotiations.
 Customers. Analysis techniques are used to determine the profitability (or staying power) of
suppliers along with estimating the suppliers’ profits from their mutual transactions.

BASES OF ANALYSIS: BUSINESS ACTIVITIES

1. Planning Activities - A company exists to implement specific goals and objectives. For example,
Colgate aspires to remain a powerful force in oral, personal, and home care products. A company’s
goals and objectives are captured in a business plan that describes the company’s purpose, strategy,
and tactics for its activities. A business plan assists managers in focusing their efforts and identifying
expected opportunities and obstacles. Insight into the business plan considerably aids our analysis of
a company’s current and future prospects and is part of the analysis of business environment and
strategy. We look for information on company objectives and tactics, market demands, competitive
analysis, sales strategies (pricing, promotion, and distribution), management performance, and
financial projections. Information of this type, in varying forms, is often revealed in financial
statements.
2. Financing Activities - A company requires financing to carry out its business plan. Colgate needs
financing for purchasing raw materials for production, paying its employees, acquiring complementary
companies and technologies, and for research and
development. Financing activities refer to methods that
companies use to raise the money to pay for these needs.
Because of their magnitude and their potential for determining
the success or failure of a venture, companies take care in
acquiring and managing financial resources. There are two
main sources of external financing—equity investors (also
called owners or shareholders) and creditors (lenders).
Decisions concerning the composition of financing activities
depend on conditions existing in financial markets. Financial
markets are potential sources of financing. In looking to
financial markets, a company considers several issues,
including the amount of financing necessary, sources of financing (owners or creditors), timing of
repayment, and structure of financing agreements. Decisions on these issues determine a company’s
organizational structure, affect its growth, influence its exposure to risk, and determine the power of
outsiders in business decisions. The chart on the left shows the makeup of total financing for selected
companies.

3
3. Investing Activities - refer to a company’s acquisition and maintenance of investments for
purposes of selling products and providing services, and for the purpose of investing excess cash.
Investments in land, buildings, equipment, legal rights (patents, licenses, and copyrights), inventories,
human capital (managers and employees), information systems, and similar assets are for the
purpose of conducting the company’s business operations. Such assets are called operating assets.
4. Operating Activities - represent the “carrying out” of the business plan given its financing and
investing activities. Operating activities involve at least five possible components: research and
development, procurement, production, marketing, and administration. A proper mix of the
components of operating activities depends on the type of business, its plans, and its input and output
markets. Management decides on the most efficient and effective mix for the company’s competitive
advantage.
Operating activities are a company’s primary
source of earnings. Earnings reflect a company’s success
in buying from input markets and selling in output
markets. How well a company does in devising business
plans and strategies, and deciding the mix of operating
activities, determines its success or failure. Analysis of
earnings figures, and their component parts, reflects a
company’s success in efficiently and effectively managing
business activities.
Colgate earned $1.383 billion in 2006. This number by itself is not very meaningful. Instead, it
must be compared with the level of investment used to generate these earnings. Colgate’s return on
beginning-of-year total assets of $8.51 billion is 15.9% ($1.353 billion/$8.510 billion)—a superior
return by any standard, and especially so when considering the highly competitive nature of the
consumer products industry.

FINANCIAL STATEMENT ANALYSIS

Financial statement analysis (or financial analysis) is the process of reviewing and analyzing a
company's financial statements to make better economic decisions to earn income in future.
Objectives of Financial Statement Analysis
1. Assessment of Past Performance and Current Position:
Past performance is often a good indicator of future performance. Therefore, an investor or
creditor is interested in the trend of past sales, expenses, net income, cast flow and return on
investment. These trends offer a means for judging management’s past performance and are
possible indicators of future performance.
Similarly, the analysis of current position indicates where the business stands today. For
instance, the current position analysis will show the types of assets owned by a business enterprise
and the different liabilities due against the enterprise. It will tell what the cash position is, how much
debt the company has in relation to equity and how reasonable the inventories and receivables are.
2. Prediction of Net Income and Growth Prospects:
Investors also consider the risk or uncertainty associated with the expected return.

4
 The decision makers are futuristic and are always concerned with the future. Financial
statements which contain information on past performances are analyzed and interpreted as a basis
for forecasting future rates of return and for assessing risk.
3. Prediction of Bankruptcy and Failure:
After being aware about probable failure, both managers and investors can take preventive
measures to avoid/minimize losses. Corporate managements can effect changes in operating policy,
reorganize financial structure or even go for voluntary liquidation to shorten the length of time losses.
4. Loan Decision by Financial Institutions and Banks:
Financial statement analysis is used by financial institutions, loaning agencies, banks and
others to make sound loan or credit decision. In this way, they can make proper allocation of credit
among the different borrowers. Financial statement analysis helps in determining credit risk, deciding
terms and conditions of loan if sanctioned, interest rate, maturity date etc.
LIMITATIONS OF FINANCIAL STATEMENT ANALYSIS
The primary purpose of financial statement analysis is to examine the present as well as past
statement financial position (SFP) and results of operations (Income Statement) of the firm in order to
determine the best suitable estimate and predict the future state and performance of the company. In
addition to this, the main object (the financial statement) used for the analysis is also subject to
limitations. These limitations, if not carefully considered, can ultimately bring about wrong decisions.
The inherent limitations of the financial statements, among other things, may stem from:
1. Its failure to consider changes in the purchasing power, inconsistencies, as well as dissimilarities
in the accounting principles, policies, and procedures used by the firms in the industry.
2. Its failure to consider changes in the purchasing power of currencies.
3. The age of the financial statements. The older it gets, the less reliable it becomes, thus,
considered as a risk management tool.
4. Its failure to read and understand the information in the notes to the financial statements. It may
obscure managers in evaluating the degree of risk.
5. Financial statements that have not undergone external auditing procedures. It may or may not
conform’ with the Generally Accepted Accounting Principles (GAAP) and Standards, thus, usage
of these statements may lead to erroneous analysis, and ultimately erroneous decisions.
6. Financial statements that have not undergone external auditing procedures. It may be inaccurate
or worse, fraudulent; hence, do not fairly present the company’s financial condition. Financial
measurements from the analysis of these companies are not dependable and not conclusive.
7. Audited statements that do not guarantee accuracy.
Lastly, the reality that a firm is trading in the stock exchange and that its financial statements are
readily available does not guarantee that the company in question is financially stable and credit-
worthy.
PRACTICAL STEPS IN ANALYZING FINANCIAL STATEMENTS

5
 There are various ways by which the analysis of financial statements can be done. The
following proposed steps in carrying’ out the analysis may be used:
1) Determine which of the following objectives previously discussed would be the coverage
of the analysis. Is it to evaluate profitability, liquidity, asset activity, or debt-utilization? Or are you
going to evaluate all of them?
2) As mentioned earlier, the analysis may cover not only the subject firm but could involve other
firms belonging to the same Industry. It will be wise to learn about the retrospective, current,
as well as the prospective conditions of the industry. Other external variables that may have
a bearing or significant effect on the industry may also be considered. This may include
socioeconomic and political variables. New laws or mandates, financial in nature, and changing
or modifying the industry requirements may also be considered. Knowledge of average prices, or
market values of commodities, shares of stocks, and debt instruments in the industry may be
considered.
3) Get to know the firm you are analyzing. Know their mission and vision. Review their strategic
plans and their current status in the industry and be familiar with their financial projections. Know
all things about the firm which you consider relevant and may have a bearing on your analysis.
4) Assess and analyze the financial statements. The analysis should cover salient areas like the
profitability, liquidity or solvency, stability and operational efficiency of the firm. One may employ
the following methods in analyzing financial statements:
a) Horizontal Analysis. Also known as Comparative Financial Statement Analysis, dynamic
measure or trend ratios.
b) Vertical Analysis. Also known as Common Size Financial Statement Analysis, static
measure or structural ratios.
5) After finishing the work of computing the trends and ratios comes a more important task:
interpreting the results of the computations and ratios.
6) Draw conclusions from the interpretations made in step five. The conclusions must take into
consideration the objectives set up in step number 1.

HORIZONTAL ANALYSIS OR COMPARATIVE FINANCIAL STATEMENT ANALYSIS

The percentage analysis of increases and decreases in corresponding items in comparative
financial statements is called Comparative Financial Statement Analysis or horizontal analysis.
This involves the computation of amount changes and percentage changes from the previous to the
current year. The amount of each item on the most recent statement is compared with the
corresponding item on one or more earlier statements.
When the comparison is made between two statements, the earlier statement is used as the
base. If the horizontal analysis includes three or more statements, there are two alternatives in the
selection of the base. First, the earliest date or period may be used as the basis for comparing all
later dates or periods: or second, each statement may be compared with the immediately preceding
statement.
The most important information often revealed from comparative financial statement analysis is
trend. A trend analysis is a more longitudinal and a modification of the horizontal and vertical
analysis. A comparison of statements over several periods can reveal the direction, speed, and extent
of a trend.
The percent change is computed as:

6
 Percentage change = Amount of change/Previous year amount x 100
Exhibit 1.10 shows a year-to-year comparative analysis using Colgate’s income statements. This
analysis reveals several items of note.
 First, net sales increased by 7.38 but cost of goods sold increased by only 6.63 , therefore
increasing Colgate’s gross profit by 8.01, which is higher than its revenue increase. Overall, this
suggests that Colgate has been able to control its production costs and therefore increase its
profit margin on sale. Selling, general, and administrative expenses increased by 11.07%.
Colgate attributes this increase to higher levels of advertising, charges related to the company’s
restructuring program. Pretax income decreased by 3.70%, but tax expense decreased by
10.99%, thereby increasing net income by 0.22 . In sum, Colgate is performing well in a tough
competitive environment.

Another example of Comparative Financial Statement Analysis:

7
8
9
10
Financial Statement Analyses, Interpretations, and Conclusions - Riel Corporation
The following analyses, interpretations, and conclusions are made in terms of:

Liquidity and Solvency

To measure liquidity, you can focus more closely on the working capital items of the
statements of financial position (SFP). In doing the analysis, salient changes must be given with due
consideration and must be accounted for. One must be able to explain to management the cause(s)
of such change. Part of being thorough with the analysis is by establishing links between related
accounts across financial statements. For instance, the increase or decrease in accounts receivable
may have a bearing on the sales, or the increase/ decrease in inventory may have a bearing on the
cost of sales.
In the given example, it can be noted that there is an increase in the current assets (9.91%)
and current liabilities (16.17%). However, it can be seen that the increase in the current assets is less
than the increase in the current liabilities. The increase in the current assets is mainly due to the
increase in the trade and other receivables (18.07%) and inventory (12.5%). This could be related to
the increase in sales (10.07%). Note that the increase in accounts receivable and inventory is much
higher than the increase in sales. This can be interpreted to mean that the inventory and receivables
had a slow conversion into cash.
It is also worth noting that the increase in inventory could be related to the marked increase in
the cost of goods sold (12.40%). It implies that the purchase cost of inventories has increased, which
must be investigated. Along with this, you may want to consider accounting for the notable increase
of unearned revenues by 30.38%. The increase in trade and other payables (14.04%) can also be
accounted for by considering its bearing on the cost of goods sold. You may want to relate this to
Riel’s purchases.
Based on the surface findings and analysis, you can infer that there is a drop in the liquidity
status of Riel Corporation as of period ending 2025 vis-â-vis 2024.

Stability or Long-term Financial Position

11
 Under this position, you can focus your analysis by considering Riel’s capital structure. It can
be noted that the growth in total liabilities (1.57%) is much lower than the growth of the firm’s total
shareholders’ equity (10.23%).This can be accounted for by the marked increase in the firm’s
retained earnings, which caused the notable growth of the total shareholders’ equity. The growth in
the retained earnings could be attributed to the firm’s net income growth of 7.57%.
Riel’s property, plant, and equipment carry a value diminished by 18.46%. This could be
accounted for by considering depreciation of the fixed assets.
Based on the results of the analysis, it could be inferred that Riel Corporation has stabilized its
long-term financial position.

Operating Efficiency and Profitability

In analyzing the firm’s profitability, the income statement is used. There is a marked favorable
increase in sales (10.07%); however, this is negated by the greater increa5e in the cost of goods sold
(COGS) (12.40%). This occurrence could be accounted for by looking at elements that made up the
sales revenue and the cost of goods sold. The sales revenue consists of selling price and sales
volume while cost of goods sold is made up mainly of current purchases and inventories. The
relatively lower sales growth vis-â-vis COGS growth may mean that the company is failing to
adequately adjust their selling price to cover the COGS. The higher growth rate of the COGS may be
interpreted that the company may have acquired inventories at higher prices and may have failed to
consider other suppliers who may offer much lower or more reasonable prices.
The decrease in administrative expenses (-2.82%) is noteworthy; this may mean that the
company has efficiently and successfully controlled its expenses. In presenting your report to
management, disclose the reason for this marked decrease in administrative expenses. Management
may need it to further improve their cost controlling systems and use the same system to lower selling
expenses for the succeeding periods. The decrease in the notes payable (17.78%) may indicate early
payment of the debt, which resulted in a decrease interest expense (-4.66%).
In general, it can be inferred that the operating performance of Riel Corporation has’ proven to
be favorable as supported by the increase in net income of 7.57%.

VERTICAL ANALYSIS OR COMMON SIZE FINANCIAL STATEMENT ANALYSIS

Vertical Analysis is a financial analysis tool that expresses each line item as a percentage of the
base amount for a given period

Income Statement Common Size Analysis

The total sales or total revenues is used as the base item. Common size analysis is used
to calculate net profit margin, as well as gross and operating margins. The ratios tell investors and
finance managers how the company is doing in terms of revenues, and they can make predictions of
the future revenues. Companies can also use this tool to analyze competitors to know the proportion
of revenues that goes to advertising, research and development and other essential expenses.

12
13
Financial Statement Analysis – Riel Corporation
Vertical Analysis
The assessment of the statement of financial position using vertical analysis reveals the following:
Statement of Financial Position
The common-size statement reveals that for both periods, the company’s current assets
represent a great bulk of the firm’s assets. This is good because it indicates liquidity.
However, deeper analysis of the statement shows that majority of the current assets is made up of
inventory (33.02%) and seconded by receivables (32.31%). Inventory is one of the least liquid of all
assets under the current assets category. Again, the analyst must be able to account for this
proportion. Why are inventory and receivables so high? The growth in percentage can be accounted
for by the sales revenue increase. Another item worth accounting for is the decrease in the
percentage of cash. What caused such decrease?

14
 The decrease in the percentage allocation for property, plant, and equipment must also be
noted. Although this can be caused by depreciation, it is worth mentioning to the management, if the
circumstances call for it.
The total liability percentage (59.06%) is higher than the total shareholders’ equity percentage
(40.94%), which means that most assets were financed by borrowings. The decrease of liabilities in
2024 (61.02%) to 2025 (59.06 A) indicates that the firm is shifting its dependence of financing from
borrowing to using more of the owners’ investment. If this continues, this would be a good indication
of long-term financial position.
The owners’ equity is considered as the margin of safety by the creditors. Creditors are happy
when the owners’ equity is high. This is because the owners’ equity is the amount that can absorb
any decline in the assets. In other words, in case the assets of the company decline, the owners’
equity is the amount that can be used to pay the creditors.

Income Statement
The noticeable high percentage of the COGS (73.42%) to sales is not favorable. This indicates
that most of the sales revenue is used to cover the cost of selling. As mentioned in the horizontal
analysis, management must determine what caused this and establish measures to remedy this. The

15
gross profit ratio (26.58%) in 2025 has decreased comparing it with the gross profit ratio (28.10%) in
2024. This is due to the marked increase of the cost of goods sold ratio.
The decreases in the operating expense ratios are favorable for the firm. This indicates the
firm‘s efficiency in controlling operating expenses. The net income ratio (3.86%) is favorable as this
indicates that the company earned during the year. However, deeper analysis would indicate that
there was a decrease in the net income ratio. Again this could be accounted for by the unfavorable
increase in the CGS ratio, which was too high to be offset by the favorable results from the decrease
in the operating expense ratio.

Implication to Financial Management

Based from the analyses, interpretations, and conclusions, the following implications may be culled:
 The slow movement of the company operating cycle due to the slow conversion of inventory and
receivable needs to be addressed. New policies that would speed up the operating cycle must be
designed. Improved cash discount policies to encourage quick and prompt payment of receivable
s must be put in place. Strict and assertive measures for receivable collection must also be
established. New marketing strategies to increase sales of inventories are also needed.
 The firm’s capital structure leaning toward equity due to company’s favorable results of
operations is to be maintained. However, it would still be wise to strike a balance between
liabilities and owners’ equity, as this would favor both potential creditors and owners.
 Consistent measures to lower the cost of goods sold and/or to increase sales revenue to cover
CGS issues must be drawn as soon as possible. This would help improve the 7.57% growth of
net income for the succeeding periods. Control measures on cost and expense reduction must be
improved and make sure that the measures are strictly implemented.
 There is a need to consistently monitor implementation if measures and policies to assure
continuous improvements of said measures and implementation procedures.

FINANCIAL RATIOS
Financial ratio is a financial tool that involves methods of calculating and interpreting financial
statements to assess the firm’s performance and status. The firm needs to make an in-depth review
and evaluation of its financial statements thru the use of financial tools called ratios.
Interested Parties
a. Present and prospective stockholders are interested in the firm’s current and future level of risk
and return
b. Creditors are interested in the firm’s ability to pay short-term and long-term obligations promptly.
c. Management is the most concerned with all aspects related to financial situation. Allows the
management to closely monitor the firm’s performance from time to time and to determine what
changes took place, what caused such changes and what should be done in the light of such
changes
Limitations of Ratio Analysis
a. Historical Information: Information used in the analysis is based on real past results that are
released by the company. Therefore, ratio analysis metrics do not necessarily represent future
company performance.

16
b. Inflationary effects: Financial statements are released periodically and, therefore, there are time
differences between each release. If inflation has occurred in between periods, then real prices are
not reflected in the financial statements. Thus, the numbers across different periods are not
comparable until they are adjusted for inflation.
c. Changes in accounting policies: If the company has changed its accounting policies and
procedures, this may significantly affect the financial reporting. In this case, the key financial metrics
utilized in ratio analysis are altered and the financial results recorded after the change are not
comparable to the results recorded prior to the change. It is up to the analyst to be up to date with
changes to accounting policies. Changes made are generally found in the notes to financial
statements section.
d. Operational changes: A company may significantly change its operational structure, anything
from their supply chain strategy to the product that they are selling. When significant operational
changes occur, the comparison of financial metrics before and after the operational change may lead
to misleading conclusions about the company’s performance and future prospects.
e. Manipulation of financial statements: Ratio analysis is based on information that is reported by
the company in their financial statements. This information may be manipulated by the company’s
management to report a better result than its actual performance. Hence, ratio analysis may not
accurately reflect the true nature of the business, as the misrepresentation of information is not
detected by simple analysis. It is important that an analyst is aware of these possible manipulations
and always complete extensive due diligence before reaching any conclusions.
Categories of Financial Ratios
1. Liquidity Ratios - used to measure the firm’s ability to pay its short term debts as they fall due and
the value of current ratio is considered acceptable depends on the industry in which the firm operates.
Types of Liquidity Ratios
 The Current Ratio measures a company's ability to pay off its current liabilities (payable within
one year) with its total current assets such as cash, accounts receivable, and inventories. The
higher the ratio, the better the company's liquidity position:

 The quick ratio measures a company's ability to meet its short-

term obligations with its most liquid assets and therefore
excludes inventories from its current assets. It is also known as the
acid-test ratio:
Example:
Liquids, Inc.
Current ratio = $30 / $10 = 3.0 Quick ratio = ($30 – $10) / $10 = 2.0
Solvents, Co.

17
Current ratio = $10 / $25 = 0.40 Quick ratio = ($10 – $5) / $25 = 0.20

We can draw several conclusions about the financial condition of these two companies from these
ratios.
 Liquids, Inc. has a high degree of liquidity. Based on its current ratio, it has $3 of current assets
for every dollar of current liabilities. Its quick ratio points to adequate liquidity even after excluding
inventories, with $2 in assets that can be converted rapidly to cash for every dollar of current
liabilities.
 Solvents, Co. is in a different position. The company's current ratio of 0.4 indicates an inadequate
degree of liquidity, with only $0.40 of current assets available to cover every $1 of current
liabilities. The quick ratio suggests an even more dire liquidity position, with only $0.20 of liquid
assets for every $1 of current liabilities.
2. Profitability Ratios - used to show the combined effects of liquidity, asset management, and debt
management on operating results. The firm’s earnings is evaluated in relation to assets, sales,
owner’s investment or share value.
 Gross Profit Margin Ratio - The gross profit is calculated by deducting all the direct expenses
called cost of goods sold from the sales revenue. The cost of goods sold primarily includes raw
materials and the labor expense incurred for production. Finally, the gross profit margin is
calculated by dividing the gross profit by the sales revenue and expressed in percentages.

18
 Net Profit Margin Ratio - The net profit, called Profit After Tax (PAT) is calculated by deducting
all the direct and indirect expenses from the sales revenue. Then the net profit margin is
calculated by dividing the net profit by the sales revenue and is expressed in percentages.

3. Debt Ratios - used to measure the degree of

indebtedness of the firm and its ability to service its debts
A ratio greater than 1 shows that a considerable
amount of a company's assets are funded by debt, which means the company has more liabilities
than assets. A high ratio indicates that a company may be at risk of default on its loans if interest
rates suddenly rise. A ratio below 1 means that a greater portion of a company's assets is funded by
equity.

19