BA23

Analysis of Financial Statement:

Financial Mix Ratio Approach

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 Learning Objectives
• LO1: Apply the various analytical methods in order to
make the financial statements “tell a story
• LO2: Measures the capability of firm to meet current
obligation
• LO3 : Apply the ratio and formula to Test if the business
is near bankruptcy
• LO4 • Apply the various ratios and formula to measure
the performance of the business in terms of generating
profit
• LO5 • Measure the “market worth” of a company
 What are the items from
financial statements
needed for analyzation?

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What is Financial Mix Ratio Analysis?

-is an analytical tool employing the ratio or proportion of a certain item in the
financial statement vis-à-vis other related items in the same financial statement or
other statement to determine comparative performance.
In a financial ratio analysis, the item in the statement of financial position or
statement of comprehensive income being evaluated or compared is assume to
have direct relationship with other items in the statement.

The broad classification of financial ratios are as follows:

1. Liquidity ratios
2. Solvency or Stability ratios
3. Profitability ratios
 YVONE Merchandising
Comparative Statement of Financial Position
December 31, 2017 and 2018

2021 2020
Current Assets
Cash and cash equivalents 7,500 10,000
Trade and other receivables 113,500 138,000
Inventory 302,000 238,000
Prepaid expense 10,000 7,500
Total current
assets 433,000 393,500
Non-current Assets
Property, Plant and Equipment 1,500,000 1,112,500
Investment in stocks 500,000 500,000
Total non-current assets 2,000,000 1,612,500
TOTAL ASSETS 2,433,000 2,006,000

Current Liabilities
Trade and other payables 118,500 104,500
Other current liabilities 50,000 42,500
Total current Liabilities 168,500 147,000
Non-current Liabilitites
Bonds payable - 10% 500,000 500,000
Total Liabilities 668,500 647,000
Owner's equity
Yvone, Capital 1,764,500 1,359,000
TOTAL LIABILITIES AND OWNER'S
EQUITY 2,433,000 2,006,000
 YVONE Merchandising

Comparative Statement of Comprehensive Income

December 31, 2017 and 2018

2021 2020

Sales 1,635,000 1,457,500

Expenses

Cost of Sales 1,050,000 950,000

Selling Expense 185,000 170,000

Administrative Expense 100,000 107,500

Total 1,355,000 1,227,500

Operating Income 300,000 230,000

Interest Expense 50,000 50,000

Income before tax 250,000 180,000

Income tax - 30% 75,000 54,000

Income after tax 175,000 126,000

Liquidity ratios
Liquidity ratios are group of ratios that measures the ability of the firm
to pay off short-term obligations as they mature. These ratios shows
the relationship of current assets to current liabilities.
Liquidity ratios are as follows:
1. Current ratio

2. Quick or acid test ratio

3. Receivable turnover

4. Inventory turnover
1. Current Ratio
The current ratio indicates the extent to which the current liabilities
are covered by the current assets. This is the most commonly used
measure of short-term solvency because it serve as a single indicator
of the extent to which the claims of short-term creditors are covered
by the current assets.
The formula to compute the current ratio is as follows:

Current ratio = current assets

current liabilities
[Link] Ratio or Acid-test Ratio
The quick ratio or acid-test ratio is a more stringent measure of the liquidity status
of a business firm since some current assets are not included in the computation. By
reducing the amount of current assets, the quick asset test ratio, in all instances, will be
lower than the current ratio.
Quick assets include only the following: cash, trading securities, and trade
receivables. Trading securities and trade receivables are convertible easily into cash
without reducing much the value of the assets.

Quick Assets = Cash + Trading Securities + Trade Receivables

The formula to compute a quick ratio or acid-test ratio is as follows:
Quick Ratio or Acid-test Ratio = Quick Assets
Current Liabilities
3. Receivable Turnover
The receivable turnover measure the velocity of conversion of trade receivables into cash during the year. It
answer the question: how many times during the year has a receivable been converted into cash?
The receivable turnover is considered an asset management ratio since it measure the effectiveness
of the management in handling its resources. It also measures the efficiency of the collection effort and credit
policy of the business.
Generally, it is favorable for the business to have a high receivable turnover. However, a very high or
a low receivable turnover may not be a favorable indicator of the liquidity status.

The formula to compute the receivable turnover is as follows:

Receivable Turnover = Net Credit Sales

Average Trade Receivable

The average trade receivable is computed as follows:

Average Trade Receivable = Receivable beginning + Receivable end
2
4. Inventory Turnover
The inventory turnover ratio measures the number of times
inventories are acquired and sold during the year. In a typical situation,
profits are realized from sale of inventories; hence, the faster the sale of
goods, the higher is the profit. This indicates that a high inventory turnover
is favorable to the business.
The inventory turnover is computed using this formula:
Inventory Turnover = Cost of Good Sold
Average Inventory
The average inventory is computed as follows:
Average Inventory = Inventory beginning + Inventory end
2
Solvency Ratios
The solvency ratios, otherwise known as the stability ratio, are a group of
financial ratios that measure the ability of a business to settle its financial
obligation when they mature and to remain still financially stable.
A business with favorable solvency ratios appears to have most of the funds
provided by the owner or owners instead of the creditors.
The different ratios under this category also reflect the extent to which a
firm utilizes debt financing; hence, they are also called financial leverage ratios.
The concept of leverage or an act of increasing from current status is divided into
two:
a) Operating leverage
b) financial leverage
 Operating leverage affects the short-term investment and non-current
assets of an entity or the left-hand side of the statement of financial position. It
is also concerned with how fixed cost influences the operations of the company.
Financial leverage, on the other hand, primarily affects the right-hand side
of the statement of financial position or the short-term debt, long term debt,
and owner’s equity. It reflects the amount of debts utilized in the capital
structure of the business firm.

The commonly used financial leverage ratios are the following:

1. Debt ratio

2. Equity ratio
3. Debt-to-equity ratio
4. Times interest earned
1. Debt Ratio
The debt ratio measures the proportion of funds provided by creditors
on the total resources of the business. In other words, this ratio
reflects the percentage of total assets that are financed with debts or
by the creditors.

The debt ratio is computed as follows:

Debt Ratio = Total Liabilities

Total Assets
2. Equity Ratio
The equity ratio determines the proportion of resources
provided by the owner or the owners of the business. It presents the
financial strengths of the business as it provides the margin of safety
that the company affords to creditors.
The equity ratio is computed as follows:
Equity ratio = Total equity
Total assets
The equity ratio may also be computed as follows:
Equity Ratio = 1- Debt ratio
3. Debt-to-Equity Ratio
The debt-to-equity ratio measures the proportion of debt and
equity in the capital structure of the business. This measure also
indicates whether the company favor risk in its capital structure or
not.

The formula to compute the debt-to-equity ratio is as follows:

Debt-to-equity ratio = Total liabilities
Total equity
4. Times Interest Earned
The times interest earned (TIE) is a tool that measures the debt
paying ability of the business. It reflects the degree of protection provided
by an entity to its long-term creditors. Similarity, it is favorable to investors
if the business firm has higher ratio of times interest earned.
The computation of times interest earned is applicable only once the
business has an interest-bearing obligations. The interest usually arises
when the obligation is considered long-term in nature. This measure will
test the ability of the operating activities of the business to cover the
amount of interest expense.
The formula to compute the TIE is as follows:
TIE = Income before interest and taxes
Interest expense
Profitability Ratios
Profitability ratios are a group of ratios that reflect the combines
effects of liquidity and management efficiency in handling the assets
and liabilities relative to the operations of the business. In short, the
ratios show the effectiveness of business operations.
The measures of profitability are as follows:
1. Gross profit rate

2. Operating profit margin

3. Net profit margin
4. Return on investments
1. Gross Profit Rate
The gross profit rate measures the percentage of gross profit sales. It
also measures the percentage of gross profit margin available to cover the
operating expenses for the period. The gross profit rate also reveals the
percentage of cost of sales to sales.
The gross profit or gross margin is the difference between sales and
the cost of sales. Since profit may grow by increasing the selling price or
quantity, or by reducing the cost of selling the product, the gross margin
may also indicate the measures adopted by the business to control the
elements affecting sales and cost of sales.
The formula to compute gross profit rate is as follows.:
Gross Profit Rate = Gross profit
Net sales
2. Operating Profit Margin
The operating profit margin measures the percentage of profit
available after deducting the cost of sales and operating expenses
from the sales. the operating profit margin is the difference between
the gross profit and the operating expenses.
This measure reflects the overall efficiency of the management
in handling the production, selling, and administrative costs of the
business.
The formula to compute the operating profit margin is as follows:
Operating Profit Margin = Operating profit
Net sales
3. Net Profit Margin
The net profit margin, also called return of sales, measures the
overall operating results of an entity. The measure considers all
income recognized and all expenses incurred during the period.
In computing the net profit margin, gains or losses from
transaction not directly related to the normal operations of the
business such as sale of property, plant, and equipment or sale or of
investments in stocks or bonds are included.
The formula to compute the net profit margin is as follows:
Net Profit Margin = Net income
Net sales
4. Return on Investments
The return on investments (ROI), also called return on assets, measures the amount of net
income per peso of investment in a business. The ratio reflects the profitability of the every peso
invested by the owner.
Higher ROI is generally favorable to the business. However, the industry average serves as
a good benchmark to compare the profitability performance of the business.
The formula to compute the return on investment is as follows:
Return on Investment = Net income
Average total assets
However, if the business entity has interest-bearing liabilities the return on investment is
computed as follows:
Return on Investment = Net income + [Interest(1-Tax rate)]
Average total assets
In the second formula, if the business firm has an interest-bearing debt, the amount of
interest net of tax is added back to the net income.
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