R AT I O A N A LY S I S

LEARNING OUTCOMES
At the end of this topic, you shall be able to:
• Identify the four traditional financial ratio analysis.
• Describe liquidity ratios
• Identify the commonly used liquidity ratios
• Enumerate the different solvency ratios
• Identify profitability ratios
• Discuss the qualitative factors in financial statement analysis
F I N A N C I A L R AT I O A N A LY S I S
➢It is an analytical tool employing ratio or
proportion of certain item in the financial
statement in relation to other related item in the
same financial statement or other statements to
judge comparative performance.
T H E F O U R B A S I C C L A S S I F I C AT I O N S
O F F I N A N C I A L R AT I O S A R E :
[Link] ratios
[Link] ratios
[Link] ratios
[Link] ratios
L I Q U I D I T Y R AT I O S
This is the most fundamentally important set of
ratios, because they measure the ability of a
company to remain in business.
L I Q U I D I T Y R AT I O S
➢Current Ratio
➢Quick or Acid-Test Ratio
➢Receivable Turnover
➢Average Collection Period
➢Inventory Turnover
➢Average Sales Period
C U R R E N T R AT I O
➢Shows a firm’s ability to cover its current liabilities
with its current assets.

The formula to compute the current ratio is:

Current Ratio = Current Assets/Current Liabilities
C U R R E N T R AT I O
Year 2 Year 1
Current assets:
Cash and marketable P 140 P 140
securities
Accounts receivable, net 190 180 Current Ratio = Current
Inventory 150 150 assets ÷ Current liabilities
Prepaid expenses 70 70 = P550 ÷ P440
Total current assets 550 540 = 1.25:1

Current liabilities:
Accounts payable P 160 P 160
Accrued liabilities 50 60
Notes payable, short term 230 250
Total current liabilities 440 470
Q U I C K O R A C I D -T E S T R AT I O
➢Shows a firm’s ability to meet current liabilities with its
most liquid assets.

The formula to compute the quick or acid-test ratio is:

Quick Ratio = Quick Assets/Current Liabilities
Q U I C K R AT I O
Year 2 Year 1
Current assets:
Cash and marketable P 140 P 140
securities
Accounts receivable, net 190 180 Quick Ratio = Quick assets ÷
Inventory 150 150 Current liabilities
Prepaid expenses 70 70 = P330 ÷ P440
Total current assets 550
330 540 = 0.75:1

Current liabilities:
Accounts payable P 160 P 160
Accrued liabilities 50 60
Notes payable, short term 230 250
Total current liabilities 440 470
RECEIVABLE TURNOVER
➢Measures a company's ability to collect accounts
receivable.

The formula to compute the receivable turnover is:

Receivable Turnover = Net Credit Sales/Average
Trade Receivables
 Year 2 Year 1
Current assets:
Cash and marketable P 140 P 140
securities
Accounts receivable, net 190 180
Inventory 150 150 Accounts receivable turnover
Prepaid expenses 70 70 = Sales on account ÷
Total current assets 550 540 Average accounts
receivable* = P2,000 ÷ P185
Sales (all on account) P2,000 = 10.81 times
Cost of goods sold 1,400
Gross margin 600 *Average accounts
Selling and administrative
expense
240 receivable = (P190 + P180) ÷
Net operating income 360
2 = P185
Interest expense 30
Net income before taxes 330
Income taxes (30%) 99
Net income P 231

RECEIVABLE TURNOVER
AVERAGE COLLECTION PERIOD
➢Also called the days sales outstanding, measures the
speed of collecting trade receivables.

Average Collection Period = 360 days/Receivable

Turnover
or
Average Collection Period = Average
receivables/Average daily sales
AVERAGE COLLECTION PERIOD

Average collection period = 360 days ÷ Accounts

receivable turnover*
= 360 ÷ 10.81
= 34 days
INVENTORY TURNOVER
➢Measures the amount of inventory needed to support
a given level of sales.

The formula to compute the inventory turnover is:

Inventory Turnover = Cost of Goods Sold/Average
Inventory
 Year 2 Year 1
Current assets:
Cash and marketable P 140 P 140
securities
Accounts receivable, net 190 180
Inventory 150 150 Inventory turnover = Cost of
Prepaid expenses 70 70 goods sold ÷ Average
Total current assets 550 540 inventory* = P1,400 ÷ P150
= 9.33 times
Sales (all on account) P2,000
Cost of goods sold 1,400 *Average inventory = (P150 +
Gross margin 600 P150) ÷ 2 = P150
Selling and administrative 240
expense
Net operating income 360
Interest expense 30
Net income before taxes 330
Income taxes (30%) 99
Net income P 231

INVENTORY TURNOVER
AVERAGE SALES PERIOD
➢Also called the conversion period, measures the
length of time the company sell the inventory to
customers.

Average Sales Period = 360 days/Inventory

Turnover
AVERAGE SALES PERIOD

Average sale period = 360 days ÷ Inventory turnover*

= 360 ÷9.33
= 39 days
L E V E R A G E R AT I O S
➢These ratios reveal the extent to which a company is
relying upon debt to fund its operations, and its ability
to pay back the debt. The different ratios under this
category also reflect the extent to which a firm utilizes
debt financing.
F I N A N C I A L L E V E R A G E R AT I O S
➢Debt Ratio
➢Equity Ratio
➢Debt to Equity Ratio
➢Times Interest Earned
D E B T R AT I O
➢Measures the portion of funds provided by creditors.

The debt ratio is computed as follows:

Debt Ratio = Total Liabilities/Total Assets
 Year 2 Year 1
Current assets:
Cash and marketable securities P 140 P 140
Accounts receivable, net 190 180
Inventory 150 150
Prepaid expenses 70 70 Debt Ratio = Total Liabilities ÷
Total current assets 550 540 Total Assets
Noncurrent assets: = P740 ÷ P2,040
Plant & equipment, net 1,490 1,420
= 0.36:1
Total assets P2,040 P1,960

Current liabilities:
Accounts payable P 160 P 160
Accrued liabilities 50 60
Notes payable, short term 230 250
Total current liabilities 440 470
Noncurrent liabilities:
Bonds payable 300 300
Total liabilities 740 770

D E B T R AT I O
E Q U I T Y R AT I O
➢Measures the portion of resources provided by owners of
the business.

The equity ratio is computed as follows:

Equity Ratio = Total Equity/Total Assets
or
Equity Ratio = 1 - Debt Ratio
 Year 2 Year 1
Current assets:
Cash and marketable securities P 140 P 140
Accounts receivable, net 190 180
Inventory 150 150
Prepaid expenses 70 70 Equity Ratio = Total SHE ÷ Total
Total current assets 550 540 Assets
Noncurrent assets: = P1,300 ÷ P2,040
Plant & equipment, net 1,490 1,420
= 0.64:1
Total assets P2,040 P1,960

Stockholders’ equity:
Preferred stock, $5 par, 10% 120 120
Common stock, $5 par 180 180
Additional paid-in capital–common 210 210
stock
Retained earnings 790 680
Total stockholders’ equity 1,300 1,190

E Q U I TY R AT I O
D E B T TO E Q U I T Y R AT I O
➢Measures the proportion of debt and equity in the
capital structure of the company. It shows the extent
to which the firm is financed by debt.

The formula to compute debt to equity ratio is as follows:

Debt to Equity Ratio = Total Liabilities/Total Equity
Current liabilities:
Accounts payable P 160 P 160
Accrued liabilities 50 60
Notes payable, short term 230 250
Total current liabilities 440 470
Debt-to-equity ratio = Liabilities
Noncurrent liabilities: ÷ Stockholders' equity
Bonds payable 300 300 = P740 ÷ P1,300
Total liabilities 740 770 = 0.57
Stockholders’ equity:
Preferred stock, $5 par, 10% 120 120
Common stock, $5 par 180 180
Additional paid-in capital–common 210 210
stock
Retained earnings 790 680
Total stockholders’ equity 1,300 1,190

D E B T TO E Q U I TY R AT I O
TIMES INTEREST EARNED
➢Indicates a firm’s ability to cover interest charges.

The formula to compute times interest earned is as follows:

TIE = Earnings Before Interest and Taxes

(EBIT)/Interest Expense
TIMES INTEREST EARNED

Sales (all on account) P2,000

Cost of goods sold 1,400
Times interest earned = Net
Gross margin 600
Selling and administrative 240
operating income ÷ Interest expense
expense = P360 ÷ P30
Net operating income 360 = 12.00
Interest expense 30
Net income before taxes 330
Income taxes (30%) 99
Net income P 231
P R O F I TA B I L I T Y R AT I O S
➢These ratios measure how well a company performs
in generating a profit.
P R O F I TA B I L I T Y R AT I O S
➢Gross Profit Margin
➢Net Profit Margin
➢Return on Investment
➢Return on Assets
➢Return on Equity
GROSS PROFIT MARGIN
➢Shows revenues minus the cost of goods sold, as a
proportion of sales.

The formula to compute gross profit margin is as follows:

Gross Profit Margin = Gross Profit/Net Sales
GROSS PROFIT MARGIN

Sales (all on account) P2,000

Cost of goods sold 1,400
Gross Profit Margin = Gross Profit ÷
Gross margin 600
Selling and administrative 240
Net Sales
expense = P600 ÷ P2,000
Net operating income 360 = 30%
Interest expense 30
Net income before taxes 330
Income taxes (30%) 99
Net income P 231
NET PROFIT MARGIN
➢Also known as return of sales. This measures the
overall operating results of a business. The measure
considers all income recognized and all expenses
incurred during the period.

The formula to compute net profit margin is as follows:

Net Profit Margin = Net Income/Net Sales
NET PROFIT MARGIN

Sales (all on account) P2,000

Cost of goods sold 1,400
Net Profit Margin = Gross Profit ÷ Net
Gross margin 600
Selling and administrative 240
Sales
expense = P231 ÷ P2,000
Net operating income 360 = 11.55%
Interest expense 30
Net income before taxes 330
Income taxes (30%) 99
Net income P 231
RETURN ON ASSETS
➢It indicates how efficiently your company generates income using its
assets.

The formula to compute return on assets is as follows:

ROA = Net Income/Average Total Assets

However, if the business entity has interest-bearing liabilities, ROA is

computed as follows:
ROA = {Net Income + [interest (1 - tax rate)]} /Average Total Assets
 Year 2 Year 1
Current assets:
Cash and marketable securities P 140 P 140
Accounts receivable, net 190 180
Inventory 150 150
Prepaid expenses 70 70
Return on total assets = Adjusted net
Total current assets 550 540 income* ÷ Average total assets**
Noncurrent assets: = P252 ÷ P2,000
Plant & equipment, net 1,490 1,420 = 12.60%
Total assets P2,040 P1,960

Sales (all on account) P2,000 *Adjusted net income = Net income +

Cost of goods sold 1,400 [Interest expense × (1−Tax rate)]
Gross margin 600 = P231 + 30 × (1 − 0.30) = P252
Selling and administrative expense 240
Net operating income 360
**Average total assets = (P2,040 + P1,960)
Interest expense 30
Net income before taxes 330
÷ 2 = P2,000
Income taxes (30%) 99
Net income P 231

RETURN ON ASSETS
RETURN ON EQUITY
➢It measures the rate of return on ordinary shareholders'
investment. The measure is applicable only to ordinary shares,
since preference shares normally have fixed rate of return.

The formula to compute return on equity is as follows:

ROE = Net Income/Average Total Shareholders' Equity
Stockholders’ equity:
Preferred stock, $5 par, 10% 120 120
Common stock, $5 par 180 180
Additional paid-in capital–common 210 210
stock
Retained earnings 790 680
Total stockholders’ equity 1,300 1,190
Return on Equity = Net Income ÷
Average Total Shareholders’
Equity
Sales (all on account) P2,000
Cost of goods sold 1,400
= P231 ÷ P2,490
Gross margin 600 = 9.27%
Selling and administrative expense 240
Net operating income 360 Average total SHE = (P1,300 +
Interest expense 30 P1,190) ÷ 2 = P2,490
Net income before taxes 330
Income taxes (30%) 99
Net income P 231

RETURN ON EQUITY
G R O W T H R AT I O S
➢These are the group of ratios that reflect the value of
the shares to its earnings, book value per share and
cash flow.
G R O W T H R AT I O S
➢Earnings Per Share
➢Price-Earnings Ratio
➢Dividend-Yield Ratio
➢Dividend-Payout Ratio
➢Book Value Per Share
EARNINGS PER SHARE
➢It measures the value of ordinary shares relative to earnings of the
business. Only the net income attributable to ordinary shares shall be
included in the computation; hence, dividends applicable to preference
shares shall be deducted from net income. We will only discuss the
basic earnings per share in this lecture.

The formula to compute basic earnings per share is as follows:

EPS = Net income applicable to ordinary shares/Average number of
shares outstanding
Stockholders’ equity:
Preferred stock, $5 par, 10% 120 120
Earnings per share = (Net Income −
Common stock, $5 par 180 180
Additional paid-in capital–common 210 210
Preferred Dividends) ÷Average
stock number of common shares
Retained earnings 790 680 outstanding*
Total stockholders’ equity 1,300 1,190
= (P231 − P12) ÷ 36
= P6.08
Sales (all on account) P2,000
Cost of goods sold 1,400
*Number of common shares
Gross margin 600
Selling and administrative expense 240
outstanding = Common stock ÷ Par
Net operating income 360
value
Interest expense 30 = P180 ÷ P5 = 36
Net income before taxes 330
Income taxes (30%) 99 Dividends during Year 2 totaled P121 thousand, of which P12 thousand were
Net income P 231 preferred dividends. The market price of a share of common stock on
December 31, Year 2 was P80.

EARNINGS PER SHARE

P R I C E - E A R N I N G S R AT I O
• It measures price per share in relation to the earnings of the
company. This measure also reflects the amount investor is
willing to pay for every 1 peso of current earnings.

The formula to compute price-earnings ratio is as follows:

Price-earnings ratio = Market price per share/Earnings per
share
Stockholders’ equity:
EPS = P6.08
Preferred stock, $5 par, 10% 120 120
Common stock, $5 par 180 180
Additional paid-in capital–common 210 210
stock
Retained earnings 790 680 Price-earnings ratio = Market
Total stockholders’ equity 1,300 1,190 price per share ÷ Earnings per
share = P80 ÷ P6.08
Sales (all on account) P2,000 = 13.2
Cost of goods sold 1,400
Gross margin 600
Selling and administrative expense 240
Net operating income 360
Interest expense 30
Net income before taxes 330
Income taxes (30%) 99 Dividends during Year 2 totaled P121 thousand, of which P12 thousand were
Net income P 231 preferred dividends. The market price of a share of common stock on
December 31, Year 2 was P80.

P R I C E - E A R N I N G S R AT I O
D I V I D E N D -Y I E L D R AT I O
➢Dividends represent earnings of the company distributed to
the shareholders in proportion to their investments. The
dividend-yield ratio measures the amount of dividends in
relation to market.

The formula to compute dividend-yield ratio is as follows:

Dividend-yield ratio = Dividend per share/Market price per
share
Stockholders’ equity:
Preferred stock, $5 par, 10% 120 120
Common stock, $5 par 180 180
Additional paid-in capital–common 210 210 Dividend yield ratio = Dividends per
stock
share* ÷ Market price per share
Retained earnings 790 680
= P3.03 ÷ P80.00
Total stockholders’ equity 1,300 1,190
= 3.78%

Dividends per share = Common

dividends ÷ Common shares**
= P109 ÷ 36 = P3.03

Dividends during Year 2 totaled P121 thousand, of which P12 thousand were
preferred dividends. The market price of a share of common stock on
December 31, Year 2 was P80.

D I V I D E N D -Y I E L D R AT I O
D I V I D E N D - PAYO U T R AT I O
➢Measures the percentage of dividend payments in
relation to earnings.

The formula to compute dividend-payout ratio is as follows:

Dividend-payout ratio = Dividend per

share/Earnings per share
Stockholders’ equity:
Preferred stock, $5 par, 10% 120 120
Common stock, $5 par 180 180
Additional paid-in capital–common
stock
210 210
Dividend payout ratio =
Retained earnings 790 680 Dividends per share* ÷
Total stockholders’ equity 1,300 1,190 Earnings per share
= P3.03 ÷ P6.08
= 49.8%
Dividends per share = Common dividends ÷ Common
shares
= P109 ÷ 36 = P3.03

EPS = P6.08

Dividends during Year 2 totaled P121 thousand, of which P12 thousand were
preferred dividends. The market price of a share of common stock on
December 31, Year 2 was P80.

D I V I D E N D - PAYO U T R AT I O
BOOK VALUE PER SHARE
➢It measures the amount payable to each share based on
realizable amount of assets in the event of liquidation.

The formula to compute book value per share is as follows:

Book value per share = Stockholders' equity/Average
number of shares outstanding
Stockholders’ equity:
Book value per share (common) = Common
Preferred stock, $5 par, 10% 120 120 stockholders' equity ÷ Number of common shares
Common stock, $5 par 180 180 outstanding*
= P1,180 ÷ 36
Additional paid-in capital–common 210 210 = P32.78
stock
Retained earnings 790 680 Book value per share (preferred) = Preferred
stockholders' equity ÷ Number of preferred shares
Total stockholders’ equity 1,300 1,19 outstanding
0 = P910 ÷ 24
= P37.92

*Number of common shares outstanding = Common

stock ÷ Par value
= P180 ÷ P5 = 36
*Number of preferred shares outstanding = Preferred
stock ÷ Par value
= P120 ÷ P5 = 24

BOOK VALUE PER SHARE

Q U A L I TAT I V E FA C T O R S I N A N A LY S I S
O F F I N A N C I A L S TAT E M E N T S
➢Sound financial statement analysis is not mere calculating numbers but looking
beyond the absolute results of mathematical computations. The analyst should
likewise consider seriously the qualitative factors:

1. The presence of one major customer.

2. The presence of one major product.
3. The competitors in the market.
4. Reliance on a single supplier.
5. The goals of the company.
 Data derived from financial statements
analysis are not absolute measures of
entity's operating performance. They are
only indicators of liquidity, solvency,
management efficiency and
profitability.
END OF
DISCUSSION