Professional Documents
Culture Documents
CHAPTER 5
FINANCIAL STATEMENTS ANALYSIS - II
I.
Questions
1. By looking at trends, an analyst hopes to get some idea of whether a
situation is improving, remaining the same, or deteriorating. Such
analyses can provide insight into what is likely to happen in the future.
Rather than looking at trends, an analyst may compare one company to
another or to industry averages using common-size financial statements.
2. Ratios highlight relationships, movements, and trends that are very
difficult to perceive looking at the raw underlying data standing alone.
Also, ratios make financial data easier to grasp by putting the data into
perspective. As to the limitation in the use of ratios, refer to page 129.
3. Price-earnings ratios are determined by how investors see a firms future
prospects. Current reported earnings are generally considered to be useful
only so far as they can assist investors in judging what will happen in the
future. For this reason, two firms might have the same current earnings,
but one might have a much higher price-earnings ratio if investors view it
to have superior future prospects. In some cases, firms with very small
current earnings enjoy very high price-earnings ratios. This is simply
because investors view these firms as having very favorable prospects for
earnings in future years. By definition, a stock with current earnings of
P4 and a price-earnings ratio of 20 would be selling for P80 per share.
4. A managers financing responsibilities relate to the acquisition of assets
for use in his or her company. The acquisition of assets can be financed
in a number of ways, including through issue of ordinary shares, through
issue of preference shares, through issue of long-term debt, through
leasing, etc. A managers operating responsibilities relate to how these
assets are used once they have been acquired. The return on total assets
ratio is designed to measure how well a manager is discharging his or her
operating responsibilities. It does this by looking at a companys income
before any consideration is given as to how the income will be distributed
among capital resources, i.e., before interest deductions.
5-1
5-2
receivables. As the peak periods end, these short-term borrowings are paid
off, thereby enhancing the current ratio.
11. A 2-to-1 current ratio might not be adequate for several reasons. First,
the composition of the current assets may be heavily weighted toward
slow-turning inventory, or the inventory may consist of large amounts of
obsolete goods. Second, the receivables may be large and of doubtful
collectibility, or the receivables may be turning very slowly due to poor
collection procedures.
12. Expenses (including the cost of goods sold) have been increasing at an
even faster rate than net sales. Thus Sunday is apparently having
difficulty in effectively controlling its expenses.
13. If the companys earnings are very low, they may become almost
insignificant in relation to stock price. While this means that the p/e ratio
becomes very high, it does not necessarily mean that investors are
optimistic. In fact, they may be valuing the company at its liquidation
value rather than a value based upon expected future earnings.
14. From the viewpoint of the companys shareholders, this situation
represents a favorable use of leverage. It is probable that little interest, if
any, is paid for the use of funds supplied by current creditors, and only
11% interest is being paid to long-term bondholders. Together these two
sources supply 40% of the total assets. Since the firm earns an average
return of 16% on all assets, the amount by which the return on 40% of the
assets exceeds the fixed-interest requirements on liabilities will accrue to
the residual equity holders the ordinary shareholders raising the return
on equity.
15. The length of operating cycle of the two companies cannot be determined
from the fact the one companys current ratio is higher. The operating
cycle depends on the relationships between receivables and sales, and
between inventories and cost of goods sold. The company with the higher
current ratio might have either small amounts of receivables and
inventories, or large sales and cost of sales, either of which would tend to
produce a relatively short operating cycle.
16. The investor is calculating the rate of return by dividing the dividend by
the purchase price of the investment (P5 P50 = 10%). A more
5-3
3. True
4. False
5. True
6. True
7. True
8. True
9. False
10. False
III. Problems
Problem 1 (Common Size Income Statements)
Common size income statements for 2005 and 2006:
Sales................................................
Cost of goods sold............................
Gross profit .....................................
Operating expenses ..........................
Net income ......................................
5-4
2006
100%
66
34%
28
6%
2005
100%
67
33%
29
4%
The changes from 2005 to 2006 are all favorable. Sales increased and the
gross profit per peso of sales also increased. These two factors led to a
substantial increase in gross profit. Although operating expenses increased in
peso amount, the operating expenses per peso of sales decreased from 29 cents
to 28 cents. The combination of these three favorable factors caused net
income to rise from 4 cents to 6 cents out of each peso of sales.
Problem 2 (Measures of Liquidity)
Requirement (a)
Current assets:
Cash
Marketable securities
Accounts receivable
Inventory
Unexpired insurance
Total current assets
Current liabilities:
Notes payable
Accounts payable
Salaries payable
Income taxes payable
Unearned revenue
Total current liabilities
P 47,600
175,040
230,540
179,600
4,500
P637,280
P 70,000
125,430
7,570
14,600
10,000
P227,600
Requirement (b)
The current ratio is 2.8 to 1. It is computed by dividing the current assets of
P637,280 by the current liabilities of P227,600. The amount of working
capital is P409,680, computed by subtracting the current liabilities of
P227,600 from the current assets of P637,280.
The company appears to be in a strong position as to short-run debt-paying
ability. It has almost three pesos of current assets for each peso of current
liabilities. Even if some losses should be sustained in the sale of the
merchandise on hand or in the collection of the accounts receivable, it appears
probable that the company would still be able to pay its debts as they fall due
in the near future. Of course, additional information, such as the credit terms
5-5
2005
100.0 %
60.0
40.0
17.5
14.6
32.1
7.9
1.0
6.9 %
Requirement 2
The companys major problem seems to be the increase in cost of goods sold,
which increased from 60.0% of sales in 2005 to 63.2% of sales in 2006. This
suggests that the company is not passing the increases in costs of its products
on to its customers. As a result, cost of goods sold as a percentage of sales
has increased and gross margin has decreased. Selling expenses and interest
expense have both increased slightly during the year, which suggests that costs
generally are going up in the company. The only exception is the
administrative expenses, which have decreased from 14.6% of sales in 2005 to
13.6% of sales in 2006. This probably is a result of the companys efforts to
reduce administrative expenses during the year.
Problem 4 (Comparing Operating Results with Average Performance in
the Industry)
Requirement (a)
Ms. Freeze,Inc.
100%
49
51%
Sales (net)
Cost of goods sold
Gross profit on sales
Operating expenses:
Selling
General and administrative
21%
17
5-6
Industry Average
100%
57
43%
16%
20
38%
13%
6
7%
36%
7%
3
4%
Requirement (b)
Ms. Freezes operating results are significantly better than the average
performance within the industry. As a percentage of sales revenue, Ms.
Freezes operating income and net income after nearly twice the average for
the industry. As a percentage of total assets, Ms. Freezes profits amount to
an impressive 23% as compared to 14% for the industry.
The key to Ms. Freezes success seems to be its ability to earn a relatively
high rate of gross profit. Ms. Freezes exceptional gross profit rate (51%)
probably results from a combination of factors, such as an ability to command
a premium price for the companys products and production efficiencies which
lead to lower manufacturing costs.
As a percentage of sales, Ms. Freezes selling expenses are five points higher
than the industry average (21% compared to 16%). However, these higher
expenses may explain Ms. Freezes ability to command a premium price for
its products. Since the companys gross profit rate exceeds the industry
average by 8 percentage points, the higher-than-average selling costs may be
part of a successful marketing strategy. The companys general and
administrative expenses are significantly lower than the industry average,
which indicates that Ms. Freezes management is able to control expenses
effectively.
Problem 5 (Common-Size Statements)
Requirement 1
The income statement in common-size form would be:
Sales.......................................................
Less cost of goods sold............................
Gross margin ..........................................
Less operating expenses ..........................
Net operating income ..............................
Less interest expense ...............................
5-7
2006
100.0%
65.0
35.0
26.3
8.7
1.2
2005
100.0%
60.0
40.0
30.4
9.6
1.6
7.5
2.3
5.3%
8.0
2.4
5.6%
2006
2005
2.0%
15.0
30.1
1.0
48.1
51.9
100.0%
5.1%
10.1
15.2
1.3
31.6
68.4
100.0%
25.1%
20.1
45.1
12.7%
25.3
38.0
15.0
10.0
29.8
54.9
100.0%
19.0
12.7
30.4
62.0
100.0%
Note: Columns do not total down in all cases due to rounding differences.
Requirement 2
The companys cost of goods sold has increased from 60 percent of sales in
2005 to 65 percent of sales in 2006. This appears to be the major reason the
companys profits showed so little increase between the two years. Some
benefits were realized from the companys cost-cutting efforts, as evidenced
by the fact that operating expenses were only 26.3 percent of sales in 2006 as
compared to 30.4 percent in 2005. Unfortunately, this reduction in operating
expenses was not enough to offset the increase in cost of goods sold. As a
5-8
result, the companys net income declined from 5.6 percent of sales in 2005 to
5.3 percent of sales in 2006.
74.8
152.7
1,191.8
95.5
P1,514.8
Quick assets:
Cash
Receivables
Total quick assets
74.8
152.7
P 227.5
Requirement (b)
(1) Current ratio:
Current assets (Req. a)
Current liabilities
Current ratio (P1,514.8 P1,939.0)
P1,514.8
P1,939.0
0.8 to 1
P 227.5
P1,939.0
0.1 to 1
P1,514.8
P1,939.0
P(424.2)
5-9
Requirement (c)
No. It is difficult to draw conclusions from the above ratios. Alabang
Supermarkets current ratio and quick ratio are well below safe levels,
according to traditional rules of thumb. On the other hand, some large
companies with steady ash flows are able to operate successfully with current
ratios lower than Alabang Supermarkets.
Requirement (d)
Due to characteristics of the industry, supermarkets tend to have smaller
amounts of current assets and quick assets than other types of merchandising
companies. An inventory of food has a short shelf life. Therefore, the
inventory of a supermarket usually represents only a few weeks sales. Other
merchandising companies may stock inventories representing several months
sales. Also, supermarkets sell primarily for cash. Thus, they have relatively
few receivables. Although supermarkets may generate large amounts of cash,
it is not profitable for them to hold assets in this form. Therefore, they are
likely to reinvest their cash flows in business operations as quickly as
possible.
Requirement (e)
In evaluating Alabang Supermarkets liquidity, it would be useful to review
the companys financial position in prior years, statements of cash flows, and
the financial ratios of other supermarket chains. One might also ascertain the
companys credit rating from an agency such as Dun & Bradstreet.
Note to Instructor: Prior to the year in which the data for this problem was
collected, Alabang Supermarket had reported a negative retained earnings
balance in its balance sheet for several consecutive periods. The fact that
Alabang Supermarket has only recently removed the deficit from its financial
statements is also worrisome.
Problem 7 (Balance Sheet Measures of Liquidity and Credit Risk)
Requirement (a)
(1) Quick assets:
Cash
P 47,524
5-10
55,926
23,553
P127,003
P 47,524
55,926
23,553
32,210
5,736
P164,949
P 20,000
5,912
1,424
21,532
6,438
P 55,306
Requirement (b)
(1) Quick ratio:
Quick assets (Req. a)
Current liabilities (Req. a)
Quick ratio (P127,003 P55,306)
P127,003
P 55,306
2.3 to 1
P164,949
P 55,306
3.0 to 1
P164,949
55,306
5-11
Working capital
P109,643
P 81,630
P353,816
23.1%
Requirement (c)
(1) From the viewpoint of short-term creditors, Bonbon Sweets appear
highly liquid. Its quick and current ratios are well above normal rules of
thumb, and the companys cash and marketable securities alone are
almost twice its current liabilities.
(2) Long-term creditors also have little to worry about. Not only is the
company highly liquid, but creditors claims amount to only 23.1% of
total assets. If Bonbon Sweets were to go out of business and liquidate
its assets, it would have to raise only 23 cents from every peso of assets
for creditors to emerge intact.
(3) From the viewpoint of shareholders, Bonbon Sweets appears overly
liquid. Current assets generally do not generate high rates of return.
Thus, the companys relatively large holdings of current assets dilutes its
return on total assets. This should be of concern to shareholders. If
Bonbon Sweets is unable to invest its highly liquid assets more
productively in its business, shareholders probably would like to see the
money distributed as dividends.
Problem 8 (Selected Financial Measures for Short-term Creditors)
Requirement 1
Current assets (P80,000 + P460,000 + P750,000 +
P10,000) .............................................................................. P1,300,000
Current liabilities (P1,300,000 2.5) .......................................
520,000
Working capital ....................................................................... P 780,000
5-12
Requirement 2
Acid-test ratio =
Acid-test ratio =
P80,000 + P0 + P460,000
P520,000
= 1.04 to 1 (rounded)
Requirement 3
a. Working capital would not be affected:
Current assets (P1,300,000 P100,000) ............................... P1,200,000
Current liabilities (P520,000 P100,000) .............................
420,000
Working capital .................................................................... P 780,000
b. The current ratio would rise:
Current ratio
Current rate
Current assets
Current liabilities
P1,200,000
= 2.9 to 1 (rounded)
P420,000
P840,000
P2,100,000
= 40%
2. Current ratio:
Current assets
Current liabilities
P490,000
P200,000
= 2.45 to 1
P181,000
P200,000
= 0.91 to 1 (rounded)
3. Acid-test ratio:
Quick assets
Current liabilities
5-13
365 days
14 times
P2,100,000
P150,000
= 14 times
5. Inventory turnover:
Cost of goods sold
Average inventory
365 days
4.5 times
P1,260,000
P280,000
= 4.5 times
6. Debt-to-equity ratio:
Total liabilities
Total equity
P500,000
P800,000
= 0.63 to 1 (rounded)
P180,000
P30,000
= 6.0 times
P800,000
20,000 shares*
* P100,000 total par value P5 par value per share = 20,000 shares
P105,000
20,000 shares
P3.15
P5.25
= 60%
P3.15
P63.00
= 5%
P63.00
P5.25
= 12.0
P126,000
P1,200,000
= 10.5%
=
=
=
5-15
= 13.8% (rounded)
3. Financial leverage was positive, since the rate of return to the ordinary
shareholders (13.8%) was greater than the rate of return on total assets
(10.5%). This positive leverage is traceable in part to the companys
current liabilities, which may carry no interest cost, and to the bonds
payable, which have an after-tax interest cost of only 7%.
10% interest rate (1 0.30) = 7% after-tax cost.
Acid-test
ratio
=
=
= 1.04 (rounded)
Requirement (3)
a. Working capital would not be affected by a P100,000 payment on
accounts payable:
Current assets (P1,300,000 P100,000) ........................... P1,200,000
Current liabilities (P520,000 P100,000) .........................
420,000
Working capital ................................................................ P 780,000
b. The current ratio would increase if the company makes a P100,000
5-16
Current assets
Current liabilities
P1,200,000
P420,000
= 2.9 (rounded)
2. No effect
3. Increase
4. No effect
5. Decrease
6. Decrease
5-17
7. Increase
8. No effect
9. Decrease
10. Increase
11. Increase
12. Increase
13. No effect
14. Decrease
15. No effect
16. Decrease
18. Decrease
Customers are paying their bills more slowly in Year 3 than in Year 1.
This is evidenced by the decline in accounts receivable turnover.
5-19
Last Year
P1,470,000
600,000
P 870,000
P1,470,000
P600,000
2.45 to 1
P650,000
P600,000
1.08 to 1
P6,000,000
P375,000
16.0 times
27.4 days
22.8 days
P4,800,000
5-20
P760,000
6.3 times
57.9 days
P1,350,000
P1,950,000
0.69 to 1
P630,000
P90,000
7.0 times
P490,000
P90,000
5.4 times
Last Year
Current assets:
Cash ........................................................
2.3 %
Marketable securities ...............................
0.0
Accounts receivable, net........................... 16.3
Inventory ................................................. 32.5
Prepaid expenses .....................................
0.5
Total current assets ...................................... 51.5
Plant and equipment, net .............................. 48.5
Total assets ................................................. 100.0 %
6.1 %
1.5
12.1
24.2
0.6
44.5
55.5
100.0 %
Liabilities:
Current liabilities .....................................
Bonds payable, 12% ................................
Total liabilities.............................................
27.5 %
18.8
46.3
18.2 %
22.7
40.9
Equity:
Preference shares, P50 par, 8% ................
5.0
Ordinary shares, P10 par ......................... 12.5
Retained earnings..................................... 36.3
Total equity ................................................. 53.8
Total liabilities and equity ............................ 100.0 %
6.1
15.2
37.9
59.1
100.0 %
5-21
Last Year
100.0 %
80.0
20.0
11.8
8.2
1.5
6.7
2.7
4.0 %
Requirement 3
The following points can be made from the analytical work in parts (1) and (2)
above:
The company has improved its profit margin from last year. This is
attributable to an increase in gross margin, which is offset somewhat by an
increase in operating expenses. In both years the companys net income as a
percentage of sales equals or exceeds the industry average of 4%.
Although the companys working capital has increased, its current position
actually has deteriorated significantly since last year. Both the current ratio
and the acid-test ratio are well below the industry average, and both are
trending downward. (This shows the importance of not just looking at the
working capital in assessing the financial strength of a company.) Given the
present trend, it soon will be impossible for the company to pay its bills as
they come due.
The drain on the cash account seems to be a result mostly of a large buildup in
accounts receivable and inventory. This is evident both from the common-size
balance sheet and from the financial ratios. Notice that the average age of the
receivables has increased by 5 days since last year, and that it is now 9 days
5-22
over the industry average. Many of the companys customers are not taking
their discounts, since the average collection period is 27 days and collection
terms are 2/10, n/30. This suggests financial weakness on the part of these
customers, or sales to customers who are poor credit risks. Perhaps the
company has been too aggressive in expanding its sales.
The inventory turned only 5 times this year as compared to over 6 times last
year. It takes three weeks longer for the company to turn its inventory than the
average for the industry (71 days as compared to 50 days for the industry).
This suggests that inventory stocks are higher than they need to be.
In the authors opinion, the loan should be approved on the condition that the
company take immediate steps to get its accounts receivable and inventory
back under control.
This would mean more rigorous checks of
creditworthiness before sales are made and perhaps paring out of slow paying
customers. It would also mean a sharp reduction of inventory levels to a more
manageable size. If these steps are taken, it appears that sufficient funds
could be generated to repay the loan in a reasonable period of time.
Case 2 (Financial Ratios for Ordinary Shareholders)
Requirement 1
a.
Net income..................................................
Less preference dividends ............................
Net income remaining for ordinary (a) .........
Average number of ordinary shares (b) ........
Earnings per share (a) (b) .........................
This Year
P324,000
16,000
P308,000
50,000
P6.16
Last Year
P240,000
16,000
P224,000
50,000
P4.48
P2.16
P45.00
4.8%
P1.20
P36.00
3.33%
P2.16
P6.16
P1.20
P4.48
35.1%
26.8%
P45.00
P6.16
7.3
P36.00
P4.48
8.0
Investors regard Metro Building Supply less favorably than other firms in
the industry. This is evidenced by the fact that they are willing to pay only
7.3 times current earnings for a share of the companys stock, as
compared to 9 times current earnings for the average of all stocks in the
industry. If investors were willing to pay 9 times current earnings for
Metro Building Supplys stock, then it would be selling for about P55 per
share (9 P6.16), rather than for only P45 per share.
e.
This Year
Last Year
Equity ........................................................ P2,150,000
P1,950,000
Less preference shares ................................
200,000
200,000
Ordinary equity (a) ..................................... P1,950,000
P1,750,000
Number of ordinary shares (b) ....................
Book value per share (a) (b) ....................
50,000
P39.00
50,000
P35.00
A market price in excess of book value does not mean that the price of a
stock is too high. Market value is an indication of investors perceptions
of future earnings and/or dividends, whereas book value is a result of
already completed transactions and is geared to the past.
Requirement 2
a.
This Year
Net income ................................................. P 324,000
Add after-tax cost of interest paid:
[P90,000 (1 0.40)] ............................
54,000
Total (a) ..................................................... P 378,000
Last Year
P 240,000
54,000
P 294,000
P3,650,000
10.4%
P3,000,000
9.8%
This Year
P 324,000
Last Year
P 240,000
b.
5-24
16,000
16,000
P 308,000
P 224,000
P2,050,000
200,000
P1,850,000
P1,868,000
200,000
P1,668,000
16.6%
13.4%
Requirement 1
This Year
a. Net income ................................................. P 280,000
Add after-tax cost of interest:
P120,000 (1 0.30) ............................
84,000
P100,000 (1 0.30) ............................
Total (a) ..................................................... P 364,000
Average total assets (b)...............................
Return on total assets (a) (b)....................
Last Year
P 168,000
70,000
P 238,000
P5,330,000
6.8%
P4,640,000
5.1%
P 168,000
48,000
P 120,000
P3,120,000
600,000
P2,520,000
P3,028,000
600,000
P2,428,000
9.2%
4.9%
c. Leverage is positive for this year, since the return on ordinary equity
(9.2%) is greater than the return on total assets (6.8%). For last year,
leverage is negative since the return on the ordinary equity (4.9%) is less
than the return on total assets (5.1%).
Requirement 2
This Year
P 232,000
50,000
P4.64
Last Year
P 120,000
50,000
P2.40
P1.44
P36.00
4.0%
P0.72
P20.00
3.6%
5-26
P1.44
P4.64
31.0%
P0.72
P2.40
30.0%
P36.00
P4.64
7.8
P20.00
P2.40
8.3
Notice from the data given in the problem that the average P/E ratio for
companies in Helixs industry is 10. Since Helix Company presently has
a P/E ratio of only 7.8, investors appear to regard it less well than they do
other companies in the industry. That is, investors are willing to pay only
7.8 times current earnings for a share of Helix Companys stock, as
compared to 10 times current earnings for a share of stock for the average
company in the industry.
e. Equity .......................................................
Less preference shares ...............................
Ordinary equity (a) ....................................
P3,200,000
600,000
P2,600,000
P3,040,000
600,000
P2,440,000
50,000
P52.00
50,000
P48.80
Note that the book value of Helix Companys stock is greater than the
market value for both years. This does not necessarily indicate that the
stock is selling at a bargain price. Market value is an indication of
investors perceptions of future earnings and/or dividends, whereas book
value is a result of already completed transactions and is geared to the
past.
f.
P1,050,000
P5,250,000
20.0%
P860,000
P4,160,000
20.7%
This Year
P2,600,000
1,300,000
Last Year
P1,980,000
920,000
Requirement 3
a. Current assets ...........................................
Current liabilities.......................................
5-27
P1,300,000
P1,060,000
P2,600,000
P1,300,000
2.0 to 1
P1,980,000
P920,000
2.15 to 1
P1,220,000
P1,300,000
0.94 to 1
P1,120,000
P920,000
1.22 to 1
P5,250,000
P750,000
7.0 times
P4,160,000
P560,000
7.4 times
52 days
P4,200,000
P1,050,000
4.0 times
49 days
P3,300,000
P720,000
4.6 times
91 days
79 days
f.
P2,500,000
P3,200,000
0.78 to 1
P1,920,000
P3,040,000
0.63 to 1
P520,000
P120,000
4.3 times
P340,000
P100,000
3.4 times
Requirement 4
As stated by Meri Ramos, both net income and sales are up from last year.
The return on total assets has improved from 5.1% last year to 6.8% this year,
and the return on ordinary equity is up to 9.2% from 4.9% the year before.
But this appears to be the only bright spot in the companys operating picture.
Virtually all other ratios are below the industry average, and, more important,
they are trending downward. The deterioration in the gross margin
percentage, while not large, is worrisome. Sales and inventories have
increased substantially, which should ordinarily result in an improvement in
5-28
the gross margin percentage as fixed costs are spread over more units.
However, the gross margin percentage has declined.
Notice particularly that the average age of receivables has lengthened to 52
daysabout three weeks over the industry averageand that the inventory
turnover is 50% longer than the industry average. One wonders if the increase
in sales was obtained at least in part by extending credit to high-risk
customers. Also notice that the debt-to-equity ratio is rising rapidly. If the
P1,000,000 loan is granted, the ratio will rise further to 1.09 to 1.
In the authors opinion, what the company needs is more equitynot more
debt. Therefore, the loan should not be approved. The company should be
encouraged to make another issue of ordinary stock in order to provide a
broader equity base on which to operate.
Case 4 (Statement Reconstruction Using Ratios)
Bulacan Company
Income Statement
For the Year Ended December 31, 2005
Sales
Less: Cost of Sales (4)
Gross Profit
Less: Expenses
Net Income (1)
P140,800
84,480
P 56,320
46,320
P 10,000
Bulacan Company
Balance Sheet
December 31, 2005
Assets
Current Assets:
Cash
Accounts Receivable (5)
Merchandise Inventory (3)
Total Current Assets (2)
Fixed Assets (8)
Total Assets
P 27,720
28,160
21,120
P 77,000
55,000
P132,000
5-29
P 44,000
P40,000
48,000
88,000
P132,000
Supporting Computations:
(1) Earnings Per Share
Net Income
Ordinary Shares Outstanding
P0.50
X
20,000
X (Net Income)
P10,000
1.75
1
0.75
=
P33,000 0.75
P44,000
Current Assets
Current Liabilities
1.27
X
44,000
X (Current Assets)
P77,000
5-30
Quick Assets
Current Liabilities
1.27
X
44,000
X (Current Assets)
P55,880
Quick Ratio
Current Assets
Quick Assets
Inventory
P77,000
55,800
P21,120
X (Cost of Sales)
Cost of Sales
Ave. Inventory
X
P21,120
P84,480
Quick Assets
Current Liabilities
P140,800
X
X (Receivables)
P28,160
Net Sales
Average Receivables
Another Method:
5-31
P140,800
365
73 days
25%
Share Capital
P40,000
Fixed
Assets
Current Liabilities +
Equity
P77,000 + 0.625X
P44,000 + X
0.375X
P33,000
X
(8) Fixed Assets to Equity
P88,000 Equity
(7) Current
Assets
Fixed Assets
Equity
X
P140,800
X (Fixed Assets)
0.625
0.625
P55,000
Current rate
Current assets
Current liabilities
P290,000
= 1.8 (rounded)
P164,000
5-32
Acid-test ratio =
P70,000 + P0 + P50,000
= 0.70 (rounded)
P164,000
Net operating income
P20,000
=
= 5.0
P80,000
x 0.10 x (6/12)
Interest on the loan
Acid-test ratio =
The company would fail to qualify for the loan because both its current ratio
and its acid-test ratio are too low.
Requirement 2
By reclassifying the P45 thousand net book value of the old machine as
inventory, the current ratio would improve, but there would be no effect on the
acid-test ratio. This happens because inventory is considered to be a current
asset but is not included in the numerator when computing the acid-test ratio.
Current ratio
Current rate
Acid-test ratio =
Acid-test ratio =
Current assets
Current liabilities
P290,000 + P45,000
= 2.0 (rounded)
P164,000
Even if this tactic had succeeded in qualifying the company for the loan, we
strongly advise against it. Inventories are assets the company has acquired for
the sole purpose of selling them to outsiders in the normal course of business.
Used production equipment is not considered to be inventoryeven if there is
a clear intention to sell it in the near future. Since the loan officer would not
expect used equipment to be included in inventories, doing so would be
intentionally misleading.
Nevertheless, the old equipment is an asset that could be turned into cash. If
this were done, the company would immediately qualify for the loan since the
P45 thousand in cash would be included in the numerator in both the current
ratio and in the acid-test ratio.
5-33
Current ratio
Current rate
Acid-test ratio =
Acid-test ratio =
Current assets
Current liabilities
P290,000 + P45,000
= 2.0 (rounded)
P164,000
= 1.00 (rounded)
However, other options may be available. After all, the old machine is being
used to relieve bottlenecks in the plastic injection molding process and it
would be desirable to keep this standby capacity. We would advise Rome to
fully and honestly explain the situation to the loan officer. The loan officer
might insist that the machine be sold before any loan is approved, but he might
instead grant a waiver of the current ratio and acid-test ratio requirements on
the basis that they could be satisfied by selling the old machine. Or he may
approve the loan on the condition that the equipment is pledged as collateral.
In that case, Rome would only have to sell the machine if he would otherwise
be unable to pay back the loan.
Case 6 (Financial Ratios for Ordinary Shareholders)
[pesos in thousands]
Requirement (1)
Calculation of the gross margin percentage:
Gross margin
Sales
P23,000
P66,000
= 34.8%
Requirement (2)
Calculation of the earnings per share:
Earnings per share =
=
Requirement (3)
Calculation of the price-earnings ratio:
Market price per share
Price-earnings ratio =
Earnings per share
P26
P3.20
= 8.1
Requirement (4)
Calculation of the dividend payout ratio:
Dividends per share
Earnings per share
P0.75
P3.20
= 23.4%
Requirement (5)
Calculation of the dividend yield ratio:
Dividend yield ratio =
=
= 2.9%
Requirement (6)
Calculation of the return on total assets:
Return on total assets =
=
Requirement (7)
5-35
= 3.7%
=
=
P39,610
41,080
40,345
1,000
P39,345
P1,980 P60
P39,345
= 4.9%
Requirement (8)
Calculation of the book value per share:
Book value
per share
P41,080 P1,000
=
= P66.80 per share
600 shares Creditors)
Case 7 (Financial Ratios for Short-Term
Requirement (1)
Calculation of working capital:
Working capital
Requirement (2)
Calculation of the current ratio:
Current ratio =
=
Current assets
Current liabilities
P22,680
P19,400
Requirement (3)
5-36
= 1.17
Acid-test ratio =
P1,080 + P0 + P9,000 + P0
P19,400
Acid-test ratio =
= 0.52
Requirement (4)
Calculation of accounts receivable turnover:
Accounts receivable
turnover
Sales on account
Average accounts receivable balance
P66,000
(P6,500 + P9,000) / 2
Acid-test ratio =
= 8.5
Requirement (5)
Calculation of the average collection period:
Average collection
period
365 days
Accounts receivable turnover
365 days
8.5
Acid-test ratio =
= 42.9 days
Requirement (6)
Calculation of inventory turnover:
Inventory
turnover
Acid-test ratio =
= 3.8
Requirement (7)
Calculation of the average sale period:
Average sale
period
365 days
Inventory turnover
365 days
3.8
Acid-test ratio =
= 96.1 days
Acid-test ratio =
Requirement (2)
Calculation of the debt-to-equity ratio:
Debt-to-equity
ratio
Acid-test ratio =
Total liabilities
Shareholders equity
P27,400
P41,080
= 0.67
A
C
D
B
A
D
11.
12.
13.
14.
15.
16.
C
A
C
B
D
B
21.
22.
23.
24.
25.
26.
B
D
A
C
A
C
31.
32.
33.
34.
35.
36.
5-38
C
D
C
A
A
C
41. C
7.
8.
9.
10.
C
D
A
B
17.
18.
19.
20.
A
C
A
C
27.
28.
29.
30.
D
A
D
A
37.
38.
39.
40.
5-39
A
A
C
C