FINANCIAL RATIO

- is a relative magnitude of two selected numerical values taken

from an enterprise’s financial statement

- are useful indicators of a firm’s performance and financial

situation
4 main categories of financial ratios:

1. Liquidity
2. Profitability
3. Efficiency
4. Leverage
 LIQUIDITY

Liquidity refers to the company’s ability to satisfy its short- term

obligations as they come due.
TYPES OF LIQUIDITY RATIOS

1. Current Ratio

2. Quick Ratio
1. Current Ratio – (also known as working capital)
is popular tool to evaluate short- term solvency position of the
business.

Formula:

Current Assets
Current Ratio = ----------------------------
Current Liabilities
2. Quick Ratio – is a measure of how well a company
can meet its short-term financial liabilities

Formula:

Cash + Marketable Securities + Accounts Receivable

Quick Ratio = --------------------------------------------------------
Current Liabilities
Sample Company Statement of Financial Position as of December 31, 2014.

Assets Liabilities and

Owner’s Equity
Cash P120,000 Accounts Pay. P70,000
Marketable Securities 35,000 Short-term notes P55,000
Accounts Rec. 45,000 Long-term debt P2,700,000
Inventories 130,000
Current Assets 330,000 Total Liabilities P2,825,000

Equipment P 2,970,000 Common Stock P500,000

Buildings P1,600,000 Retained Earnings P1,575000

Fixed Assets P4,570,000 Owner’s equity P2,075,000

Total Assets P 4,900,000 Total Liabilities & Equity P4,900,000

*Compute the Current Ratio & the Quick Ratio of

the given Financial Position
Solution:

Current Assets
Current Ratio = ---------------------------
Current Liabilities

P330,000
Current Ratio = --------------------
P125,000

Current Ratio = 2.64 / 2:64

Cash + Marketable Securities + Accounts Rec.

Quick Ratio = ---------------------------------------------------
Current Liabilities

P120,000 = P35,000 = P45,000

Quick Ratio = -------------------------------------
P125,000

Quick Ratio = 1.60 / 1:60

Sample questions:

1. Current assets is P2,000, current liabilities is P3,500. What is the

current ratio?

2. Inventory is P150. Accounts payable is P450.Cash and accounts

receivable total P800.What is the current ratio? Quick ratio?

3. If current ratio is 1.7, what is the total accounts receivable if cash is

P20,000, inventory is P7,500, and accounts payable is P30,000?
Solution:
Current Assets
1. Current Ratio = ---------------------------
Current Liabilities

2,000
Current Ratio = ---------------
3,500

Current Ratio = 0.57

Solution:

Current Assets
1. Current Ratio = ---------------------------
Current Liabilities
( 800 + 150 )
Current Ratio = ----------------------
450
Current Ratio = 2.11

Cash +Marketable Securities +Accounts Receivable

2. Quick Ratio = ---------------------------------------------------
Current Liabilities
800
Quick Ratio = -------------------
450
Quick Ratio = 1.78
Sample Problem:

1. On December 31, 2016, the balance sheet of Marshal Co. shows the total current
assets of P1,000,000 and the total current liabilities of P400,000. Compute the
current ratio of the company.

2. The T & D company’s current ratio is 2.5 for the most recent period. If the total
current assets of the company are P 7,500,000, what are the total current liabilities?

3. If current ratio is 1.5 and total current liabilities are P500,000, what are the total
current assets?

4. According to Charlie’s balance sheet he reported $100,000 of current liabilities

and only $25,000 of current assets. Charlie’s current ratio would be?
Examples of Current Assets:

Cash
Accounts Receivable
Inventories/Stock
Prepaid Expenses

Examples of Current Liabilities:

Accounts Payable
Accrued Payable
Short term bonds payable
 PROFITABILITY

- Refers to the company’s ability to generate earnings.

- These are the return on equity, return on assets, gross profit margin,
operating profit margin, net profit margin.
RETURN ON EQUITY – measures the amount of net income earned
in relation to stockholder’s equity.

RETURN ON ASSETS – measures the ability of a company to

generate income out of its resources/assets.

GROSS PROFIT MARGIN - shows how many pesos of gross profit is

earned for every peso of sale. It provides information
regarding the ability of a company to cover its
manufacturing cost from its sales.

OPERATING PROFIT MARGIN – shows how many pesos of operating

profit is earned for every peso sale. It measure the
amount of income generated from the core business of
a company.

NET PROFIT – measures how much net profit a company generates for
every peso of sales or revenues that it generates
 EFFICIENCY

- Refers to a company’s ability to be efficient in its operations.

- it refers to the speed with which various accounts are converted into
sales, and ultimately, cash.

- Efficiency ratios measure the ability of a business to use its assets

and liabilities to generate sales. A highly efficient organization has
minimized its net investment in assets, and so requires less capital and
debt in order to remain in operation.
The following are considered to be efficiency ratios:

◘ Accounts receivable turnover

◘ Inventory turnover

◘ Fixed asset turnover

◘ Accounts payable turnover

Accounts Receivable Turnover
Calculated as credit sales divided by average
accounts receivable.
Sales
Accounts Receivable Turnover = ---------------------
Accounts Rec.

Inventory Turnover
Calculated as the cost of goods sold divided by
average inventory.

Cost of Goods Sold

Inventory Turnover = ----------------------
Inventory
Fixed Assets Turnover
Calculated as sales divided by fixed assets.

Sales
Fixed Assets Turnover = ----------------
Fixed Assets

Accounts Payable Turnover

Calculated as total purchases from supplier divided
by inventory.

Purchases
Accounts Payable Turnover = ----------------------
Inventory
 FINANCIAL LEVERAGE

- Refers to the company’s use of debt.

- It defines the company’s capital structure which indicates
how much of the total assets are financed by debt
and equity.
 Types of Leverage Ratio

1. DEBT RATIO – this ratio measures the portion of total

assets finance by total liabilities or money provided by
creditors ( not by the business owners ).

2. DEBT-TO-EQUITY RATIO – a variation of debt ratio,

shows the proportion of debt to equity.

3. INTEREST COVERAGE RATIO – this ratio shows the

company’s ability to pay its fixed interest charges in
relation to its operating income or earnings before
interest and taxes.
Formulas;

Total Liabilities
Debt Ratio = --------------------------
Total Assets

Total Liabilities
Deb-to-Equity Ratio = -------------------------
Total Equity

Earnings before interest and taxes (EBIT)

Interest Coverage Ratio = -----------------------------------------------------
Interest Expense