StuDocu.com FABM2 Module 5 Analysis and Interpretation of FS Fluid Mechanics (University of Makati) ‘StuDcot is not sponsored or endorsed by any college or university Downloaded by Zaya Mich (zeyaazeyaaa@amail com)UNIVERSITY OF MAKATI 4, Rao! Ext, West Remo, Makott City HIGHER SCHOOL NG UMAK ABM AND LANGUAGE DEPARTMENT ‘Course Title Fundamentals of Accountancy, Business & Management 2 1. define the measurement levels, namely, liquidity, solvency, stability, and profitability; Learning Objectives 2. perform vertical and horizontal analyses of financial statements of a single Atthe end of the lesson, the | proprietorship; and students should be able to: | 3. compute and interpret financial ratios such as current ratio, working capital, gross profit ratio, net profit ratio, receivable turnover, inventory turnover, debt-to-equity ratio, and the lke. FINANCIAL STATEMENT (FS) ANALYSIS - Financial statement analysis is a process of evaluating and interpreting an entity’s financial statements to assess its financial health for the purpose of making better economic decisions. Depending on the objective of the analysis, a financial statement analysis may involve analyzing one ot more of the following: 1. Industry and economic trend — This involves the economic environment where the business operates. This is necessary because the ability of a business to thrive is affected by various external forces stich as economic climate. competition, demand and supply. market rates, government regulations, technological changes and the like. Solvency and Capital structure — Solvency refers to the ability of the business to pay its debts and remain as a going concem. Solvency can be a short-term (liquidity) or long term (solvency). On the other hand, Capital structure refers to how a business efficiently finances its operations using different sources of fimds, such as debt or equity. 3. Operational efficiency — It refers 10 how well a business is managing its resources to maximize earnings, 4. Profitability —Refers to the ability of the business to gencrate profit METHODS OF FINANCIAL STATEMENT ANALYSIS. > The two methods used in analyzing financial statements are as follows: a. Horizontal and Vertical Analyses b. Financial ratio analysis a. Horizontal analysis is the comparison of financial information over two or more reporting periods, The purpose is to analyze if changes in amounts are unusually high or low, which may entail investigation of te reason for the unusual change. + Steps in Horizontal Analysis, 1. Compute for the change in the amounts in a baseline year (earlier period) and a later period, 2. Divide the change by the amount in the baseline year. - Examples of Horizontal Analysis ACOs, | (30,000%n 201 - 80, 200) = 50,000 decreaze ~ 80,000 in 20x0 = -62.50%. Moe Asof December31,20c and 200 ASSETS: 20:0 Increase (Decrease) Percent Cashand cash equivalents como) S000) 62500 ‘Accounts receivable-net 1368000 ——150,00% Sales Costofsales| GROSS PROFIT Salaries expenseVertical analysis involves the analysis of the financial statements of one reporting period, It is a proportional analysis whereby each amount in the financial statements is shown as a percentage of another item. Examples of Vertical Analysis (30,000 + 3,030,000 total assets) = 0.99% Balance Sheet As of December 31, 20x1 ASSETS Percent Cash and cash equivalents 30,000 0.99%") Accounts receivable—net 1,672,000 55.18% Inventory 500,000 16.50% Prepaidassets [ 48,000 1.58% Total current assets 250,000 74.26% Property, plant & equipment 780,000 25.74% Total noncurrent assets 780,000 25.74% TOTAL ASSETS 3,030,000 100.00% SUMMARY: Horizontal analysis: Year2 Year 1 Change Percent Cash &cashequivalents 200 100 100 100% —— Vertical analysis: Cash & cash equivalents Total assets FINANCIAL RATIO ANALYSIS Financial ratio analysis involves the computation of percentages, fractions or proportions using certain formulas, Financial ratios are broadly classified into the following: 1. Liquidity ratios 2. Activity ratios (Asset management ratios) 3. Leverage ratios (Debt management ratios) 4. Profitability ratiosT. Liquidity ratios - provide a measure of the ability ofa business o pay its liabilities. Examples include: a. Current ratio — the most commonly used ratio in measuring the ability of a business to pay its, short-term debts. Current assets Current liabilities Current ratio b. Quick ratio (Acid-test ratio) — a much stricter ratio used fo measure the ability of a business to yay its short-term debts. Quick "Quick assets” (Acid-test) = (Cash+ Marketable securities + Accounts receivable, net) ratio Current liabilities ¢. Working capital — similar to current ratio but measures the ability of a business to pay its short- term debis by the excess or deficiency of current assets over current liabilities Workingcapital = Current assets - Current liabilities Activity ratios (Asset management ratios) -provide a measure of how efficient a business is utilizing itsresources. a. Tnventory turnover —is 2 measure of the numberof times inventory is sold and replenished during a period. Inventorytumover = Gest of goods sold _ ‘Average inventory " Where: Inventory, beg. + Inventory, end Averageinvent rage inventory 2 b. Days of inventory (Average sale period) — is a measure of the number Of days inventory is held before itis sold, Days of inventory —__ 365 daysinayear Inventory turnover c. Accounts receivable turnover — is a measure of the number of times accounts receivable have been collected during a period. It is an indication of the efficiency in collection, Credit sales Accounts receivable turnover. =| ——£@————————_ Average accounts receivable Accounts receivable, beg. + Accounts \verage accounts ee receivable, end. receivable 2 d. Days of receivable (Average collection period) — is a measlire of the average time To collect a receivable. 365 days in a year Receivable turnover Days of receivable 3. Leverage ratios (Debt management ratios) - provide a measure of the extent a business uses debt financing or “leverage. a._Debt ratio Debt-to-asset ratio) ~ measures the proportion of assets financed through debt.b._Equity ratio— measures the Equity ratio = woportion of assets financed through equity Total equity Total assets ©. Debt-to-equity ratio — indic: ertaining to the owner(s) Debt-to-equity ratio -ates how much debt is used to finance the assets relative to the amount Total liabilities Total equity 4. Profitability ra os - provide a measure of the performance of a business in terms of its ability to generate profit from its resources. a_Gross profit ratio — shows Gross profit ratio = the relationship between sales and cost of goods sold. Gross profit Net sales b._Net profit ratio —measures ‘Net profit ratio wofitability after considering all income and expeuses. Profit for the year Net sales Return on assets — measure business ¢ Return on assets = 5 the profit generated in relation to the total resources available to the Profit for the year a. Return on equity (Return resources invested by (or att Return on equity = Total assets on net assets) — measures the profit generated in relation 10 the tibutable to) the owner(s) of the business, Profit for the year Total equity QUIZ: ACTIVITY, ‘The comparative statement of financial ‘on December 31, 20x1 are shown below: position and statement of comprehensive income of Entity A Entity A ‘Statement of Financial Position As of December 31, 20x1 ASSETS 20x1 20x0 Cash and cash equivalents 440,000 200,000 Accounts receivable 130,000 120,000Total current assets 730,000 960,000 Property, plant & equipment 760,000 440,000 Total noncurrent assets 760,000 440,000 TOTAL ASSETS 1,490,000 1,400,000 LIABILITIES Trade and other payables 620,000 560,000 EQuiTy ‘Owner's capital 870,000 840,000 TOTAL LIABILITIES & EQUITY 1,490,000 1,400,000 Entity A Statement of Comprehensive Income For the year ended December 31, 20x1 sales 1,000,000 Cost of sales (600,000) GROSS PROFIT 400,000 Rent income 150,000 Depreciation expense (240,000) Insurance expense (120,000) Bad debts expense (30,000) Loss on sale of equipment (40,000) PROFIT FOR THE YEAR 120,000 Other comprehensive income : COMPREHENSIVE INCOME FOR THE YR, _ 120,000 Requirements: Compute for the following financial ratios for the year 20x1: (round-off answers to two decimal places) Current ratio Quick (Acid-test) ratio Working capital Inventory turnover Days of inventory (use 365 days) Accounts receivable turnover (assume all sales are on credit) Days of receivable (use 365 days) Debt ratio Equity ratio Debt-to-equity ratio Gross profit ratio Net profit ratio Return on assets Return on equity Pg rR TT sem pense‘COMPREHENSIVE PROBLEM: Directions: Construct a balance sheet statement using the financial ratios provided. Realeza Corporation has credit sales of 75,000. Given the following ratios, fill in the statement of financial position below: Total Assets Turnover 25 times Inventory Turnover _—15.0 times Accounts Receivable Turnover 10.0 times Debt to Total Sales 45.0 percent Cash to Total Assets 2.0 percent Current Ratio 2.0 times Realeza Corporation Statement of Financial Position As of December 31, 2017 Assets Liabilities and Equity Cash Current Debt Accounts Receivable Long Term Debt Inventory Total Debt Total Current Assets Net worth TOTAL ASSETS TOTAL LIABILITIES AND EQUITY Millan and Ferrer, Fundamentals of Accountancy, Business & Management 2 (2019), Philippine: Bandi Enterprise