Ateneo de Zamboanga University

School of Management and Accountancy

Accountancy Department

LEARNING PACKET
FINMAN2 –FINANCIAL MANAGEMENT
Session 1, First Semester, SY 2020-21

LEARNING PACKET NO. 2 DATE: August 17 – 21,

TOPIC: FINANCIAL STATEMENT ANALYSIS 2020
Week No.: 2
Session: 1

INTENDED LEARNING OUTCOME:

At the end of this learning units, the learners shall:

1. Develop analysis of financial statements using various techniques to analyze financial

statement, and interpret these analyses in the light of the relevant environmental conditions.
2. Re-design financial information using limited data through the aid of financial ratios.

I. CONCEPT NOTES
Five Contents of Financial Statements

1. Income Statement
 Provides the firm’s operating results during a particular period
 Components usually include:
o Revenues-amount collected or collectible during the period for the
goods/services provided
o Cost of Goods Sold- total costs of the goods/services given/provided to customers
o Gross profit- profit from production itself and excess from revenues used to pay
other operating expenses
o Operating expenses-costs not related to manufacturing but are incurred by the
firm during its operations
o Operating Income-profit after the operating expenses but before other incomes
and expenses
o Earnings before Interest and Taxes (EBIT)-earnings after the other sources of
income and expenses, but before the financial charges (interest) and taxes
o Interest Expenses- finance cost from borrowing funds
o Taxes- contributions to the government
o Net Profit/Income – the earnings after all expenses are considered
 Other points to consider:
o Earnings per Share (EPS) – net income generated for each ordinary share, may be
basic or diluted EPS depending on existence of options and convertible
instruments
o Earnings before Interest, Taxes, Depreciation, and Amortization (EBITDA) – cash
earnings by the company from their operations

2. Balance Sheet
 Provides for the financial position in a given period
 Assets are everything that is owned by the company, components include ( in order of
liquidity):
o Current Assets:
 Cash and cash equivalents (including marketable securities)
 Receivables
 Inventory
o Noncurrent Assets
 Fixed Assets
 Noncurrent financial assets
 Intangibles
 Liabilities are obligations from other parties in acquiring these assets, and include:
 o Current Liabilities
 Accounts payable
 Accruals
o Noncurrent Liabilities
 Notes and Bonds Payable
 Finance Leases
 Other Long-term debt
 Equity are the owners’ or shareholders’ claims over the assets, and include:
o Paid-in-capital
o Additional paid in capital
o Retained Earnings
o OCI items
 Other points to consider:
o Book Value – value of the equity based on the books of the company, may be
inaccurate
o Market Value – value of the equity based on the market (stock price)

3. Statement of Owners’/Stockholders’ Equity

 Transactions that affected your equity as a whole, like issuances of stock, treasury shares,
net income, dividends
4. Statement of Cash Flows
 Summary of inflows and outflows of cash over a period of time and is divided into operating,
financing and investing activities
5. Notes to Financial Statement
 Provide detailed information about the accounting policies, procedures, calculations and
disclosure that supports the information presented in the other financial statements

Ratio Analysis
 methods of calculating and interpreting financial ratios to analyze and monitor firm’s
performance. Context is that, using balances in the financial statements and derive ratios
from them generates meaningful information about the firm that is not provide by the
face of the financial statements

Uses:
1. Performance evaluation
2. Comparison and benchmarking
3. Control

Classification of financial ratios

1. Liquidity Ratios – ability to satisfy its short-term obligations as they come due, being liquid, do
you have available liquid assets to pay your obligations when they become due

a. Current Ratio
i. Current Assets/ Current Liabilities
ii. Assesses how much current assets do you have (available) for every peso
of current liability
iii. Preferably more than one, implying that there are more assets to cover
each peso/dollar of current liability

b. Quick (Acid Test) Ratio

i. (Cash + Marketable Securities + Receivables)/Current Liabilities
ii. Similar with current ratio but using the more liquid assets, since inventory
might be hard to convert to cash right away
c. Cash ratio
i. Cash/Current Liabilities
ii. Most conservative of the three, considering only the most liquid asset to
pay off the short-term obligations

2. Asset Efficiency Ratios – ratios related to the activities of the firm and is related to operations,
measures how efficient does the firm operate along a variety of dimensions
 a. Inventory Turnover
i. COGS/Inventory
ii. Measures how many times is inventory converted and sold to customers
iii. High Inventory Turnover for perishable, minute goods, but low for high-
value goods
iv. Average age of inventory=365/Inventory Turnover (how many days
before an average inventory is sold)

b. Receivables Turnover
i. Net Credit Revenues/ Accounts Receivables
ii. Measures how many times receivables have been turned into cash
(Collection)
iii. Average age of receivable=365/Receivable Turnover (how many days
before a receivable is converted to cash), compare it with the discount period (it
can assess the discounting policy)
c. Payable Turnover
i. Net Credit Purchases/ Accounts Payable
ii. Measures how many times you purchase on account in a year
iii. Average payment period=365/Payable turnover (how many days on
average before a payable is paid), compare it with credit period

d. Total Asset Turnover

i. Revenues/Total assets
ii. Measures how much Revenues are generated by every peso/dollar of asset
owned
iii. Assesses efficiency in using its assets

e. Capital Intensity Ratio

i. Total Assets/Revenue
ii. Measures how much capital is needed to generate one peso/dollar of
revenue
iii. Reverse of Total Asset Turnover, assesses the amount of capital needed for
the operations

3. Leverage Ratio- assesses the firm’s financial leverage of the company (magnification of risk and
return through the use of fixed cost financing)

a. Debt to assets ratio

i. Total liabilities/total assets
ii. Assesses how much of its assets are owned by creditor, for every peso of
asset, how much of that is owned by creditors

b. Debt to Equity Ratio

i. Total liabilities/SHE
ii. Assesses for every peso of owners, how much pesos are borrowed

c. Equity Multiplier
i. Total Assets/Total Equity
ii. Measures the amount of a firm’s assets that are financed by its
shareholders
iii. High equity multiplier means the company is heavily dependent on the
debt

d. Times interest earned Ratio

i. EBIT/Interest Payment
ii. Measures the ability of the firm to make contractual interest payments

e. EBITDA Interest Coverage Ratio

i. EBITDA/Interest Payment
ii. Considered the cash earnings available to pay off the interests
 f. Fixed Payment Coverage Ratio
i. (EBIT + Lease Payment)/(Interest + Principal Payments + Lease Payments +
Preference Stock Dividends)
ii. Measures the ability of the company to pay all its fixed payments

4. Profitability Ratio – assess the ability to generate profits after spending expenses

a. Gross Profit Margin

i. GP/Revenues
ii. Percentage of revenues left after paying the inventoriable/product costs in
the form of COGS

b. Operating Profit Margin

i. Operating Income (before financial charges and taxes)/Revenues

c. Net Profit Margin

i. NI/Revenues
ii. Percentage of revenues left after paying all expenses by the company

d. Earnings per Share (EPS)

i. Earnings available for common stockholders/Number of common stock
ii. Amount of pesos earned by each share of common stock
iii. Could vary when potential stocks (in the form of options of convertible
instruments) are considered, called diluted EPS

e. Dividend Payout Ratio

i. Dividends/Net Income
ii. The amount paid to shareholders for every peso/dollar of profit earned

f. Return on Assets (ROA) or Return on Investment (ROI)

i. Earnings available for common stockholder/Total assets
ii. How much was earned by every peso of asset

g. Return on Equity (ROE)

i. Earnings available for common stockholders/Common stock equity
ii. Measures the amount of pesos earned by every peso of investment of
common stockholders

h. Return on Capital Employed (ROCE)

i. EBIT/Capital Employed (Equity)
ii. Determines the efficiency of using the capital to generating earnings before
any financing/ taxes

5. Market Ratio- How investors (market) view the value of the firm
a. Price Earnings Ratio
i. Market Price per common stock/Earning per share
ii. Amount that investors are willing to pay for each dollar of a firm’s earnings
iii. Degree of confidence that investors have in future performance of firm
b. Market/Book Ratio
i. Market Price per common stock /Book Value per common stock
ii. How much are investors willing to pay for every peso of book value of the
share

Dupont Identity
 The return on equity is believed to be driven by three factors, including:
o Operating Efficiency, evidenced by the Net Profit Margin
o Asset Management, evidenced by Total Asset Turnover
o Financial Leverage, evidenced by Equity Multiplier

Formula:
 ROE = NP Margin X Total Asset Turnover X Equity Multiplier

Trend Analysis
 It is the comparison of different financial statement line items and/or financial ratios in order to
evaluate the performance of the operations in a given period.
 When different financial statements line items are compared, two analyses can be made:
o Common-size Analysis
 We get the percentage of the certain line items to the total (for Income Statement this
would be the revenue, and for Balance Sheet this would be the Total Assets)
 This helps us compare the line items to each other (one revenue stream vs the other, or
marketing expense vs salaries expense, current assets vs fixed assets, etc)
o Index Analysis
 We get the percentage of the certain line items to the index period (like the
depreciation in year 3 over in year 1, or the cash from quarter 4 over the quarter 1).
Clearly, the identification of an index year is crucial in order to perform this analysis.
 This helps us understand the changes that happened to a particular line item over the
course of the period.
 Financial ratios, on the other hand, can be compared to:
o Other periods
o Other companies/industry benchmarking

Cautions and Limitations:

1. Overall vs Specific performance- Single ratio does not evaluate overall performance, but rather
specific areas only
2. Timing of comparisons- Comparisons of ratios should be done for ratios computed using data
computed at same time, not seasonal
3. Causation- Possibility, but not necessarily the cause
4. Inflation
5. Accuracy of data- as much as possible, use audited FS

Sources:
 Fundamentals of Financial Management by Van Horne, 13th edition
 Fundamentals of Financial Management by Brigham and Houston, 11th Edition
 Fundamentals of Corporate Finance by Berk, DeMarzo, and Harford, 4th Edition

II. CHECKING FOR UNDERSTANDING

EXERCISE 1. Provide the listed ratios of Kakayanin Manufacturing Company based on their operations
for the calendar year ending December 31, 2020.

KAKAYANIN Manufacturing Company

Income Statement
for the Year Ended December 31, 2020

Revenues P600,000
Less: Cost of goods sold 460,000
Gross profits P140,000
Less: Operating expenses
General and administrative expenses P30,000
Depreciation expense 30,000 60,000
Operating profits P 80,000
Less: Interest expense 10,000
Net profits before taxes P 70,000
Less: Taxes 27,100
Net profits after taxes (earnings available for common stockholders) P 42,900
Earnings per share (EPS) P2.15

KAKAYANIN Manufacturing Company

Balance Sheet
December 31, 2020
Assets
Cash P 15,000
Marketable securities 7,200
Accounts receivable 34,100
Inventories 82,000
Net fixed assets 270,000
Total assets P408,300

Liabilities and Stockholders’ Equity

Accounts payable P 57,000
Notes payable 13,000
Accruals 5,000
Long-term debt 150,000
Common stock equity (20,000 shares outstanding) P110,200
Retained earnings 73,100
Total liabilities and stockholders’ equity P408,300

Industry Ave KAKAYANIN

Current ratio 2.35
Quick ratio 0.87
Inventory turnover a 4.55
Average collection period a 35.8 days
Total asset turnover 1.09
Debt ratio 0.300
Times interest earned ratio 12.3
Gross profit margin 0.202
Operating profit margin 0.135
Net profit margin 0.091
Return on total assets (ROA) 0.099
Return on common equity (ROE) 0.167
Earnings per share (EPS) P3.10

a
Based on a 365-day year and on end-of-year figures.

EXERCISE 2. Provided is an incomplete balance sheet for Dracarys Aviation, Inc. based on the following
financial data.

Balance Sheet
Dracarys Aviation, Inc.
December 31, 2020

Assets Liabilities and Stockholders’ Equity

Cash $ Accounts Payable $ 28,800
8,005
Marketable Securities ? Notes Payable ?
Accounts Receivable ? Accruals 18,800
Inventories ? Long-term Debt ?
Gross Fixed Assets ? Preferred Stock 2,451
Accumulated Depreciation 50,000 Common Stock at par 30,000
Net Fixed Assets ? Paid in capital in excess of par ?
Total Assets ? Retained Earnings 90,800
Total Liabilities and Stockholders’ ?
Equity

Key Financial Data (2020)

1. Sales totaled $720,000. 6. The current ratio was 2.35.

2. The gross profit margin was 38.7 percent. 7. The total asset turnover was 2.81.
3. Inventory turned 6 times. 8. The debt ratio was 49.4 percent.
4. There are 360 days in a year. 9. Total current assets equal $159,565.
5. The average collection period was 31 days.
REQUIRED: Provide for the missing amounts in its balance sheet.

EXERCISE 3. Robert Arias recently inherited a stock portfolio from his uncle. Wishing to learn more
about the companies in which he is now invested, Robert performs a ratio analysis on each one and
decides to compare them to each other. Some of his ratios are listed below.

Island Burger Fink Roland

Ratio Electric Utility Heaven Software Motors
Current ratio 1.10 1.3 6.8 4.5
Quick ratio 0.90 0.82 5.2 3.7
Debt ratio 0.68 0.46 0.0 0.35
Net profit margin 6.2% 14.3% 28.5% 8.4%

Assuming that his uncle was a wise investor who assembled the portfolio with care, Robert finds the wide
differences in these ratios confusing. Help him out.

a. What problems might Robert encounter in comparing these companies to one another on the basis of
their ratios?
b. Why might the current and quick ratios for the electric utility and the fast-food stock be so much lower
than the same ratios for the other companies?
c. Why might it be all right for the electric utility to carry a large amount of debt, but not the software
company?
d. Why wouldn’t investors invest all of their money in software companies instead of in less profitable
companies? (Focus on risk and return.)

EXERCISE 4. The new owners of Bluegrass Natural Foods, Inc., have hired you to help them diagnose and
cure problems that the company has had in maintaining adequate liquidity. As a first step, you perform a
liquidity analysis. You then do an analysis of the company’s short-term activity ratios. Your calculations
and appropriate industry norms are listed.

Ratio Bluegrass Industry norm

Current ratio 4.5 4.0
Quick ratio 2.0 3.1
Inventory turnover 6.0 10.4
Average collection period 73 days 52 days
Average payment period 31 days 40 days

a. What recommendations relative to the amount and the handling of inventory could you make to the
new owners?
b. What recommendations relative to the amount and the handling of accounts receivable could you make
to the new owners?
c. What recommendations relative to the amount and the handling of accounts payable could you make to
the new owners?
d. What results, overall, would you hope your recommendations would achieve? Why might your
recommendations not be effective?

III. ANALYSIS

1. Why is there a need to understand the different components of the financial statements?
2. How are each classification of financial ratios useful to the management/other stakeholders?
3. As a financial analyst, what ratio do you think companies should always check on? Why?
4. What is the value in studying the trend in the financial statement line items and financial ratios?

IV. INTEGRATION

1. What ratio do you think would be useful to you in your student life?
V. INDEPENDENT LEARNING

The whole class will be grouped into 6 groups, which will be communicated by the instructor. The task is
as follows:

1. Each group is assigned one company, as provided below:

a. GROUP 1 – Ford (F)
b. GROUP 2 – Microsoft (MSFT)
c. GROUP 3 – Johnson & Johnson (JNJ)
d. GROUP 4 – Chevron (CVX)
e. GROUP 5 – Walmart (WMT)
f. GROUP 6 – Nike (NKE)
2. Search the most recent financial statements (Income Statement and Balance Sheet) by checking
finance.yahoo.com and looking up the company name (or symbol). Get the last two whole fiscal
year operations of the company. Double click then drag the cursor to select the contents of the 2
financial statements and copy them to a spreadsheet (preferably an Excel spreadsheet).
3. In one tab, do a trend analysis (both common size and index analyses) of the company for the two
years.
4. In another tab, determine all the ratios you can provide with all the information given. Each
classification should have at least one ratio. For market/stock price, provide the date when you
extracted the stock price and select the closing rate.
5. During the synchronous meeting, provide a 10-minute presentation on the company and provide
the following:
a. Short background (what does the company do) -2 minutes
b. High-level salient points on the common-size and index analysis (any significant findings
that should be brought up) – 3 minutes
c. High-level discussion on the ratio analysis (each member shall discuss ratio (s) for one
classification and provide an insight on the probable cause of movement in the ratio and/or
its impact to related shareholders) – 1 minute each classification

PREPARED BY:

MR. JOHN CARLOS S. WEE, CPA MBA CMITAP

MR. ROMEL W. DELOSA, CPA CMA
MR. ROMMEL REGOR D. ONG, CPA
FINMAN2 Instructors