Financial Statement Analysis - Ratio

FINANCIAL STATEMENT ANALYSIS – FINANCIAL RATIO
Financial Statement (FS) Analysis is the process of evaluating risks, performance,

financial health, and prospects of a business by subjecting financial statement data to
computational and analytical techniques with the objective of making economic
decisions(White et.al 1998).There are three kinds of FS analysis techniques:
- Horizontal analysis
- Vertical analysis
- Financial ratios
(Note: this lesson will focus on ratio analysis.)
Ratio analysis expresses the relationship among selected items of financial statement
data. The relationship is expressed in terms of a percentage, a rate, or a simple proportion
(Weygandtet.al. 2013). A financial ratio is composed of a numerator and a denominator. For
example, a ratio that divides sales by assets will find the peso amount of sales generated by
every peso of asset invested. This is an important ratio because it tells us the efficiency of
invested asset to create revenue. This ratio is called asset turnover. There are many ratios
used in business. These ratios are generally grouped into three categories:
(a) profitability,
(b) efficiency, and (c) financial health.
a. Profitability ratios measure the ability of the company to generate income from the use of
its assets and invested capital as well as control its cost.
The following are the commonly used profitability ratios:

- Gross profit ratio reports the peso value of the gross profit earned for every peso of
sales. We can infer the average pricing policy from the gross profit margin.
- Operating income ratio expresses operating income as a percentage of sales. It
measures the percentage of profit earned from each peso of sales in the company’s
core business operations (Horngren et.al. 2013). A company with a high operating
income ratio may imply a lean operation and have low operating expenses.
Maximizing operating income depends on keeping operating costs as low as possible
(Horngren et.al. 2013).
- Net profit ratio relates the peso value of the net income earned to every peso of sales.
This shows how much profit will go to the owner for every peso of sales made.
- Return on asset(ROA) measures the peso value of income generated by employing
the company’s assets. It is viewed as an interest rate or a form of yield on asset
investment. The numerator of ROA is net income. However, net income is profit for
the shareholders. On the other hand, asset is allocated to both creditors and
shareholders. Some analyst prefers to use earnings before interest and taxes instead of
net income. There are also two acceptable denominators for ROA – ending balance of
total assets or average of total assets. Average assets is computed as beginning
balance + ending balance divided by 2.
- Return on equity(ROE) measures the return (net income) generated by the owner’s
capital invested in the business. Similar to ROA, the denominator of ROE may also be
total equity or average equity.
Sample Financial Statements to be used for the computations:

Cash ₱ 200,000
Accounts Receivable 400,000
Inventory 250,000
Equipment 550,000
Total Assets 1,400,000
Accounts Payable 300,000

Notes Payable 400,000
Owner, Capital 700,000
Total Liabilities and equity ₱ 1,400,000
Sales ₱ 900,000.00
Cost of Goods Sold 400,000.00
Gross Profit 500,000.00
Operating Expenses 200,000.00
Operating income 300,000.00
Interest Expense 20,000.00
Net Income ₱ 280,000.00
Name of Ratio Formula Sample Computation

𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡
Gross profit margin 𝑥 100
𝑥 100 = 55.56%
𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠
𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐼𝑛𝑐𝑜𝑚𝑒
Operating income Margin 𝑥 100
𝑥100 = 33.33%
𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒
Net Profit margin 𝑥 100
𝑥100 = 31.11%
Return on Assets 𝑥 100
𝑥 100 = 20%
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐴𝑠𝑠𝑒𝑡𝑠
Return on Equity 𝑥 100
𝑥 100 = 40%
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐸𝑞𝑢𝑖𝑡𝑦
b) Operational efficiency ratio measures the ability of the company to utilize its assets.
Operational efficiency is measured based on the company’s ability to generate sales from the
utilization of its assets, as a whole or individually. The turnover ratios are primarily used to
measure operational efficiency.
- Asset turnover measures the peso value of sales generated for every peso of the
company’s assets. The higher the turnover rate, the more efficient the company is in
using its assets.
- Fixed asset turnover is indicator of the efficiency of fixed assets in generating sales.
- Inventory turnover is measured based on cost of goods sold and not sales. As such
both the numerator and denominator of this ratio are measured at cost. It is an
indicator of how fast the company can sell inventory. An alternative to inventory
turnover is
“days in inventory”. This measures the number of days from acquisition to sale.
- Accounts receivables turnover the measures the number of times the company was
able to collect on its average accounts receivable during the year. An alternative to
accounts receivable turnover is “days in accounts receivable”. This measures the
company’s collection period which is the number of days from sale to collection.
Financial Health Ratios investigate the company’s solvency and liquidity ratios.
Solvency refers to the company’s capacity to pay their long-term liabilities. On the other
hand, liquidity ratio intends to measure the company’s ability to pay debts that are coming
due (short term debt).
- Debt ratio indicates the percentage of the company’s assets that are financed by debt.
A high debt to asset ratio implies a high level of debt.
- Equity ratio indicates the percentage of the company’s assets that are financed by
capital. A high equity to asset ratio implies a high level of capital.
- Debt to equity ratio indicates the company’s reliance to debt or liability as a source
of financing relative to equity. A high ratio suggests a high level of debt that may
result in high interest expense.
- Interest coverage ratio measures the company’s ability to cover the interest expense
on its liability with its operating income. Creditors prefer a high coverage ratio to give
them protection that interest due to them can be paid.
- Current ratio is used to evaluate the company’s liquidity. It seeks to measure
whether there are sufficient current assets to pay for current liabilities. Creditors
normally prefer a current ratio of 2.
- Quick ratio is a stricter measure of liquidity. It does not consider all the current
assets, only those that are easier to liquidate such as cash and accounts receivable that
are referred to as quick assets.
ACTIVITY: FINANCIAL RATIOS

Directions: Prepare Profitability ratios, Efficiency ratios, and Financial Health ratios in your
activity notebook. Use the following data statements given below.
C&F Store
Statement of Financial Position
As of December 31
2019 2020
Cash ₱ 110,000 ₱ 87,400

Accounts Receivable 90,000 69,920
Inventory 129,000 218,500
Prepaid Rent 12,000 4,370
Delivery Van 550,000 493,810
Total Assets ₱ 891,000 ₱ 874,000
Accounts Payable ₱ 75,000 ₱ 67,298

Loan Payable 400,000 393,300
Anistle Cruz, Capital 416,000 413,402
Total Liabilities and Equity ₱ 891,000 ₱ 874,000
C&F Store
Statement of Comprehensive Income
For the period ending December 31
2019 2020
Sales ₱ 810,000.00 ₱ 686,000.00
Cost of Goods Sold 348,300.00 301,750.00
Gross Profit 461,700.00 384,250.00
Operating Expenses 234,900.00 205,800.00
Interest Expense 40,500.00 17,150.00
Net Income ₱ 186,300.00 ₱ 161,300.00
Reference: DepEd SDO NegOr_Region VII

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FINANCIAL STATEMENT ANALYSIS – FINANCIAL RATIO

Financial Statement (FS) Analysis is the process of evaluating risks, performance,

The following are the commonly used profitability ratios:

Sample Financial Statements to be used for the computations:

Accounts Payable 300,000

Name of Ratio Formula Sample Computation

ACTIVITY: FINANCIAL RATIOS

Cash ₱ 110,000 ₱ 87,400

Accounts Payable ₱ 75,000 ₱ 67,298

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