M8: Introduction to Financial Reports and Analysis (2)

• There are different users of financial statements.

  Financial statement analysis can be used by managers, equity investors, creditors, regulators, labor unions, employees, the public, and potential investors and creditors. Financial statement analysis is used for investment and credit decisions. It is also for regulating companies such as what the Energy Regulatory Commission does for power distribution copanies and other energy companies (Cayanan, 2018).
• Financial statement analysis is definitely used by management for monitoring performance and for identifying strategies to further improve the company’s operations and credibility (Financial ratio analysis, n.d.).

  The following financial ratios will be discussed:

  ● Profitability Ratios

  ● Efficiency Ratios

  ● Liquidity Ratios

  ● Leverage Ratios
• 1. Profitability ratios are used to measure the company’s profitability.

  ● Return on Equity (ROE) measures the amount of net income earned in relation to stockholders’ equity.

  ROE = (Net Income / Stockholders' Equity) x 100

  
  

  ● Return on Assets (ROA) measures the ability of a company to generate income out of its resources.

  ROA = (Net Income / Total Assets) x 100
• EFFICIENCY RATIOS

  
  

  ● Accounts Receivable Turnover Ratio measures the efficiency by which accounts receivable are managed.

  Accounts Receivable Turnover Ratio = Sales / Accounts Receivable

  Average Collection Period = 360 days / Accounts Receivable Turnover Ratio

  
  

  ● Inventory Turnover Ratio measures the company’s efficiency in managing its inventories.

  Inventory Turnover Ratio = Cost of Sales / Inventories

  Days’ Inventories = 360 days / Inventory Turnover Ratio
• EFFICIENCY RATIOS

  ● Accounts Payable Turnover Ratio provides information regarding the rate by which trade payables are

  paid.

  Accounts Payable Turnover Ratio = Cost of Sales / Trade Accounts Payable Days’ Payable = 360 days / Accounts Payable Turnover Ratio
• 2. Efficiency Ratios also known as turnover ratios measure the management’s efficiency in utilizing the assets of the company.

  
  

  ● Total Asset Turnover Ratio measures the company’s ability to generate revenues for every peso of asset invested.

  Asset Turnover Ratio = Sales / Total Assets

  
  

  ● Fixed Asset Turnover Ratio measures the company’s ability to generate revenues for every peso of fixed assets such as property, plang, and equipment.

  Fixed Asset Turnover Ratio = Sales / PPE
• PROFITABILITY RATIOS

  ● Gross Profit Margin measures the ability of a company to cover its cost of goods sold from its sales.

  Gross Profit Margin = (Gross Profit / Sales) x 100

  
  

  ●Operating Profit Margin measures the amount of income generated from the core business of a company.

  Operating Profit Margin = (Operating Income / Sales) x 100

  
  

  ●Net Profit Margin measures how much net profit a company generates for every peso os sales or revenues that it generates.

  Net Profit Margin = (Net Income / Sales) x 100
• 3. Liquidity Ratios measure the ability of a company to pay maturing obligations from its current assets.

  ● Current Ratio measures current assets that can be converted to cash within a year and current liabilities.

  Current Ratio = Current Asset / Current Liabilities

  ● Quick Asset Ratio also measures a company's liquidity less inventories.

  Quick Asset Ratio = (Cash+Current Accounts Receivable+Short-term Marketable Securities) / Current

  Liabilities orQuick Asset Ratio = (Current Assets - Inventories) / Current Liabilities
• 4. Leverage Ratios show the capital structure of a company, that is, how much of the total assets of a company is financed by debt and how much is financed by stockholders’ equity.

  ● Debt Ratio measures how much of the total assets are financed by liabilities.

  Debt Ratio = Total Liabilities / Total Assets

  ● Debt to Equity Ratio is a variation of debt ratio and compares total liabilities to equity.

  Debt to Equity Ratio = Total Liabilities / Total Stockholders’ Equity
• LEVERAGE RATIOS

  ● Interest Coverage Ratio provides information if a company has enough operating income to cover interest expense.

  Interest Coverage Ratio = Earnings Before Interest and Taxes (EBIT) / Interest Expense
• GENERALIZATION:

  Financial ratio analysis is performed by comparing items in the financial statements. The resulting ratio can be interpreted in a way that is more insightful than looking at the items separately. It offers entrepreneurs a way to evaluate their company's performance and compare it to other similar businesses in their industry. Ratios measure the relationship between two or more components of financial statements. They are used most effectively when results over several periods are compared.