MAC 302 – MANAGEMENT REPORTING

2nd Semester, AY 2024 – 2025

BS Management Accounting

Module 6
FINANCIAL STATEMENT ANALYSIS

Financial Statement Analysis

General purpose financial statements contain historical information about the firm’s financial condition, operating results
and other business activities. When one reads a company’s financial statements, he gets an over-all picture of the firm’s
profitability and financial conditions. Merely reading such statements, however, is not enough when one wants to make
informed judgments or decisions. For decision-making purposes, a thorough analysis and interpretation of such
statements is required.

As these users read the financial statements, they try to find answers to the following questions:
1. Profitability of the business firms
2. The firm’s ability to meet its obligations
3. Safety of the investment in the business
4. Effectiveness of management in running the firm

Techniques in Analyzing and Interpreting Financial Statements

1. Horizontal analysis
2. Vertical analysis
3. Ratio analysis
4. Analysis of variation in gross profit and net income
5. Statement of changes in financial position
6. Cash flow statement

Horizontal Analysis
- Involves comparing figures shown in the financial statements of two or more consecutive periods. The difference
between the figures of the two periods is calculated and the percentage change from one period to the next is computed,
using the earlier period as the base.

Vertical Analysis
- Involves converting the figures in the statements to a common base
- This is accomplished by expressing all the figures in the statements as a percentage of an important item, such as total
assets (in the balance sheet) and net sales (in the income statement)
- All the figures in the statements would be expressed not in peso but in percentage terms
- These converted statements are called common-size statements, 100% statements or component statements

Ratio Analysis
- The most widely known and most commonly used tool for financial statements analysis
- Meaningful ratios may be computed for items found in the balance sheet, income statement or both
- Ratios calculated from these financial statements provide users of the statements with relevant information about the
business firm’s liquidity, solvency and profitability

Ratio
- A mathematical relationship between two numbers

Categories of Ratios
A. Tests of Liquidity
1. Current ratio
2. Acid test ratio
3. Turnovers

B. Tests of Solvency
1. Times interest earned ratio
2. Debt-equity ratio
3. Debt ratio
4. Equity ratio

C. Tests of profitability
1. Return on sales
2. Return on total assets
3. Return on owners’ equity
4. Earnings per share

Reference: Management Services (2021 Edition )by: Franklin T. Agamata

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MAC 302 – MANAGEMENT REPORTING
2nd Semester, AY 2024 – 2025
BS Management Accounting

D. Market Tests
1. Price-earnings ratio
2. Dividend yield
3. Dividend payout

Liquidity
- The company’s ability to pay its short-term liabilities as they fall due

Current Ratio
- Working capital ratio or banker’s ratio
- Measures the number of times that the current liabilities could be paid with the available current assets

Current Ratio = Current Assets

Current Liabilities

Acid Test Ratio or Quick Ratio

- The current ratio is further refined by including in the formula only the quick or liquid current assets
- Inventories and prepayments are excluded
- Only those assets that are cash or near cash are included so that the resulting ratio can indicate the firm’s paying ability
in the very near term

Acid Test Ratio = Quick Assets

Current Liabilities

= Cash + Marketable Securities + Receivables

Current Liabilities

Receivables Turnover
- The time required to complete one collection cycle, from the time receivables are recorded, then collected, to the time
new receivables are recorded again

- The faster the cycle is completed, the more quickly receivables are converted into cash

Receivables Turnover = Net Credit Sales or Net Sales

Average Receivables

Average Receivables = (Beginning Balance + Ending Balance) / 2

Since receivables arise from credit sales, it is but proper to use net credit sales as the numerator. However, analysts may
not have access to information about the composition of total sales (breakdown into cash and credit sales), particularly
those who do not belong to the firm. For lack of better information, the net sales figure may be used.

Average Age of Receivables

- Days’ sales in receivables or average collection period
- Indicates the average number of days during which the company must wait before receivables are collected
- The faster the customers pay, the better
- This is reflected in an increase in turnover or decrease in average age of receivables, an indication of the firm’s
efficiency in collecting its receivables

Average Age of Receivables = No. of Working Days in a Year

Receivables Turnover

Inventory Turnover
- Measures the number of times that inventory is replaced during the period
- A high turnover and short average age of inventories is desirable

Inventory Turnover = Cost of Goods Sold

Average Inventory
Average Inventory = (Beginning Balance + Ending Balance) / 2

Average Age of Inventory = No. of Working Days in a Year

Inventory Turnover

Reference: Management Services (2021 Edition )by: Franklin T. Agamata

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MAC 302 – MANAGEMENT REPORTING
2nd Semester, AY 2024 – 2025
BS Management Accounting

Raw Materials Turnover= Cost of Raw Materials Used

Average Raw Materials Inventory

Goods in Process Turnover = Cost of Goods Manufactured

Average Goods in Process Inventory

Finished Goods Turnover = Cost of Goods Sold

Average Finished Goods Inventory
Operating Cycle
- An operating cycle for a manufacturing firm begins from the time raw materials are acquired, through production, sale of
finished goods, until the time when receivables are collected or converted into cash which may in turn be used again to
acquire raw materials
- The sum of average age of receivables and average age of inventory

Payables Turnover = Net Credit Purchases

Average Trade Payables

Average Age of Trade Payables

- Indicates the length of time or the number of days during which trade payables remain unpaid
- The time which elapses from the purchase of materials up to the payment of accounts or notes payable arising from
such purchase

Average Age of Trade Payables = No. of Working Days in a Year

Payables Turnover

Current Assets = Cost of Sales + Operating Expenses (excluding depreciation and amortization)
Turnover Average Current Assets

Solvency
- The company’s ability to pay all its debts, whether such liabilities are current or noncurrent
- It is similar to liquidity except that solvency involves a longer time horizon

Times Interest Earned

- Determines the extent to which operations cover interest expense

Times Interest Earned = Income Before Tax + Interest Expense

Interest Expense

Debt-Equity Ratio
- To determine the amount provided by creditors relative to that provided by the owners
- If the ratio is equal to 1, this means that the creditors and owners provided an equal amount of capital

Debt-Equity Ratio = Total Liabilities

Shareholders’ Equity

Debt Ratio
- Indicates the percentage of total assets provided by creditors

Debt Ratio = Total Liabilities

Total Assets

Equity Ratio
- Indicates the percentage of total assets provided by the owners or shareholders

Equity Ratio = Shareholders’ Equity

Total Assets

Rate of Return or = Income

Return on Investment Investment

Return on Sales
- Determines the portion of sales that went into company’s earnings

Reference: Management Services (2021 Edition )by: Franklin T. Agamata

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MAC 302 – MANAGEMENT REPORTING
2nd Semester, AY 2024 – 2025
BS Management Accounting

Return on Sales = Income

Net Sales

Gross Profit Ratio = Gross Profit

Net Sales

Net Profit Ratio = Net Profit

Net Sales

Return on Assets
- Efficiency with which assets are used to operate the business

Return on Assets = Income Before Interest and Taxes

Average Total Assets
= Net Income + Interest Expense + Income Tax
Average Total Assets

Return on Shareholders’ Equity

- Measures the amount earned on the owners’ or shareholders’ investment

Return on Shareholders’ Equity = Net Income

Average Shareholders’ Equity
Return on = Net Income – Preferred Dividends
Common Equity Average Common Equity

Earnings Per Share

- Measures the amount of net income earned by each common share

Earnings Per Share = Net Income – Preferred Dividends

Weighted Average No. of Common Shares

Price-Earnings Ratio
- Indicates the number of pesos required to buy P1 of earnings

Price-Earnings Ratio = Price Per Share

Earnings Per Share

Dividend Yield
- Measures the rate of return in the investor’s common stock investments

Dividend Yield = Dividend Per Share

Price Per Share

Dividend Payout
- Indicates the proportion of earnings distributed as dividends

Dividend Payout = Common Dividend Per Share

Earnings Per Share

Reference: Management Services (2021 Edition )by: Franklin T. Agamata

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MAC 302 – MANAGEMENT REPORTING
2nd Semester, AY 2024 – 2025
BS Management Accounting

EXERCISES
1. The annual sales revenue of an enterprise is P3,000,000. Half of the sales are on credit terms, half are cash
sales. Accounts receivable at the balance sheet date are P165,000. What is the average collection period using a
365 days.?

2. Shown below are the selected data from Fortune Company’s most recent financial statements.
Marketable securities P10,000
Accounts Receivable 60,000
Inventory 25,000
Supplies 5,000
Accounts Payable 40,000
Short term debt payable 10,000
Accruals 5,000

What is the Fortune’s net working capital?

3. Black Two Enterprises had the following account information.

Accounts Receivable P200,000
Accounts Payable 80,000
Bonds Payable, due in 10years 10,000
Cash 100,000
Interest Payable, due in3months 10,000
Inventory 400,000
Land 250,000
Notes Payable, due in 6months 50,000
Prepaid Expenses 40,000

The company has operating cycle of 5 months. What is the company’s acid test/quick ratio?

4. Total sales for the year were P85,900 of which 61,400 were credit sales. The cost of good sold was P24,500. Lara
inventory turnover ratio for the year was?

5. On January 1, Pharma had a balance of 10,000 shares of the common stock outstanding. On June 1, the
company issued an additional 2,000 shares of the common stock for cash. A total of 5,000 shares of 6%, P100
par, nonconvertible preferred stock was outstanding all year. Pharma net income was P120,000 for the year. What
is the earnings per share for the year?

Reference: Management Services (2021 Edition )by: Franklin T. Agamata

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