SENIOR HIGH SCHOOL

First Semester S.Y. 2020-2021

MODULE 9
BUSINESS FINANCE

Name: _______________________________ Date :__________

Grade/Section: ________________________ Week : 9
Track/Strand: _________________________

SOURCES AND USES OF SHORT-TERM AND

LONG-TERM FUNDS
WHAT IS THIS ALL ABOUT?

Financial statements are tools that managers use to help them in their decision-making
considering financial implications. This module will discuss the different financial statements,
their purposes, and how they are prepared. A detailed discussion of retained earnings and
accumulated profits of a busines is provided so the students will learn to appreciate them.

WHA T DO YOU EXPECT TO LEARN?

Content Standard:
The learners demonstrate understanding of the:
1. concepts of commonly calculated ratios

Performance Standard:
The learners should be able to:
1. distinguish the different type of ratio; and
2. solve exercises and problems in computing for commonly calculated
ratios.

Objectives:
After the lesson, the learners should be able to:
1. define liquidity;
2. distinguish the different type of ratio;
3. list down the formulas used for commonly calculated ratios; and
4. solve the given problems in computing ratios.
PRELIMINARY ACTIVITY

Why do we need to follow the pro-forma of a financial statements? Expound your answer.

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COMMONLY CALCULATED RATIOS

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LIQUIDITY RATIOS

Liquidity is the ability of assets to be converted quickly into cash. Ideally, a company
wants to be liquid to meet current debts, Balance sheet has current liabilities for short-term
debts, payable for a period of less than a year; and long-term debts, payable for more than a
year. It is assumed that the firm's inventory will be converted to cash during the course of a
year so that the receipts from the inventory can be used to service the current debt. Commonly
used ratios to measure liquidity are: current ration and quick or acid test ratio.
Current ratio is the ratio of current assets to current liabilities.

Current assets
Current ratio = Current liabilities
Quick ratio is the ratio of current assets, excluding inventory, divided by current
liabilities.

Current assets - inventory

Quick ratio = Current Liabilities

The current ratio makes the assumption that the company's inventory is being sold at a
steady rate and as a result, being converted to cash. Some companies may have
inventory sold on a seasonal basis. Industry standard for current ratio is 2:1. If the quick ratio is
less than 1.0, the firm must plan on selling inventory in order to cover current liabilities. If
quick ratio is larger than 1.0, the firm must do something for its slowdown in sales.

ACTIVITY RATIOS

Activity ratios are related to operations and operating efficiency because they measure
how quickly the firm is converting assets into cash.

Inventory turnover measures how many times per period (usually a year) the firm sells
through its inventory. To be more accurate, the firm should use an average inventory rather
than the year-ending inventory.

Sales_____
Inventory turnover = Average inventory

Other companies calculate inventory turnover by using cost of goods sold instead of sales
and dividing by average inventory at cost. Another way of looking at inventory turnover is to
calculate how many days of sales are tied up in inventory.
Inventory
Days of sales in inventory = Sales per day
Some businesses may have longer days for stocks to stay before they can be sold out,
others may have quicker or shorter days for inventory turnover.

Accounts receivable turnover is the annual credit sales of the firm divided by the accounts
receivable.
Accounts receivable turnover = Annual Sales
Accounts receivable
Average collection period is also called "days of sales outstanding,"' average
collection period describes the average time it takes to collect accounts,
Average collection period = Receivables
Sales per day
 A 365-day year is usually used; 360-day year can be used, to exclude official
“holydays", Either can be used so long as the financial analyst is consistent and notes the
assumptions.

Inventory conversion cycle combines the days of sales in inventory and days of sales
in accounts receivables. It gives the company an idea as to how long it takes to convert
inventory to accounts receivables, and subsequently, into cash.

Inventory conversion cycle = Days of inventory + Days of Sales outstanding

Asset turnover is concerned with efficient use of assets. The goal is not to sell through
the fixed assets but to maximize the efficiency of those assets. True test of efficiency is not
inventory turnover but how many sales can be generated in the space available, since sales
floor, is a fixed asset. The revenue is derived from the efficient utilization of the space. For
service firms, fixed asset turnover ratios are better indicator of success.

Fixed asset turnover looks at sales in comparison to the long-term assets of the firm,
such as land, equipment, plant.

Fixed asset turnover = Sales

Fixed assets

Total asset turnover combines the effects of current asset management, the conversion
of inventory and accounts receivable into cash; and fixed asset management. It allows the
firm to compare how well it is managing each type of asset. If total assets are turning over more
slowly than fixed asset. If total assets are turning over more slowly than fixed assets, the firm is
not aggressively managing the current assets of cash, accounts receivable, and inventory.

Sales
Total asset turnover = Total Assets

LEVERAGE RATIOS

It is the responsibility of the financial manager to determine the level of debt that is
appropriate for a firm. Debt or loan have, a fixed value, if the company is, making regular
payments. Its principal value decreases over time. If the firm is growing, it value increases
which back to stockholders in the form of dividends, or reinvested capital. If the firm can earn
more that the of loan interest, it may be worth securing additional loan or leveraging the firm.

Debt to equity ratio shows the relationship between debt and equity Where:
Debt
Debt to equity ratio = Equity

The higher the debt of firm in relationship to its equity, the more leverages it is, and the
risk it is, and the more risk it has assumed. Another way of looking at the financing choices of
the company is to compare the debt burden to the value of the total assets. Where:
Debt ratio = Debt
Total assets
Times-interest earned ratio determines if the firm is capable of serving the interest they
have for debts, and gives idea of whether additional interest expense could be added. Debt
obliges the firm to make specified payments of both principal and interest at regular intervals.

Operating income
(earnings before interest and taxes)
Times-interest-earned ratio = Interest
PROFITABILITY RATIOS

Since the goal of most companies is to earn a profit, these ratios are the most important
to financial managers.

Gross profit margin profitability is the broadest measure of the firm's profit level.

Revenues – Cost of goods sold

Gross profit margin = Sales

Gross margin measure profit before operating expenses, interest, and taxes are
subtracted.

Supposing Rose Research Company has this income statement:

Rose Research Company Income Statement

(In Millions of Pesos)
Revenue Php 2.0
Cost of revenue: Research and Development 94.2
Gross profit (loss) ( 92.
2)
Sales, general, administrative expenses 14.7
Gain (loss) from operations
(106.9)
Interest income 2.
6
Interest expense 3.2
Net profit (loss) ( 107.5)

From the data, yearly revenue is Php2,000,000, while research and development costs
were Php94,200,000, resulting in a loss from operations. There is no gross profit margin that can
be computed for Rose Research Company since there is not gross profit.

Operating profit margin examines the income of the company before taking into
account the interest and taxes.

Earnings before interest and taxes

Operating profit margin = Sales

The difference between gross margin and operating margin is that the latter takes into
account overhead costs, not just direct costs of goods sold.

Net profit margin demonstrates a better assessment of a firm’s profitability, particularly

for a company who does owe interest and taxes. This is the bottom line, the net profit margin is
the most often measure of a firm’s profitability.
Net profit (earnings after interest and taxes)
Net profit margin = Sales

Return of assets determines profitability in relation to assets management.

Net profit (earnings after interest and taxes)

Return on assets = Total assets
 Return on equity evaluates whether the use of company assets contributes to the rate of
return for stockholders investment. Whether the profit is returned to the owners in the form of
dividends or reinvested in the company, the financial manager needs to be aware of the fact that
return on equity should compensate shareholders for the level of risk they undertake with their
shares of stocks. Thus, if the firm is unable to meet a risk less rate of return on equi ty, then
shareholders may demand for restructuring, reorganization, or ever liquidation of their
holdings for investment to other offers.
Net profit
Return on equity = Owner’s equity (total assets-total labilities)

MARKET VALUES

A firm's value is related to what an investor will pay for its stock. If demand for the stock
increases, then its price will also increase, wherein its increase share price can be tied to
expectation of increased in future earnings. Some the tools that determine share prices are book
value and earnings per share.

Book value is the basis for fairly determining the worth of the asset' relation to a holders'
share, upon liquidation of the firm.
Total assets
Book value = Number of shares outstanding

Earnings per share aims to identify the valid earnings per share value' looking at trends
overtime or the earnings of other companies in the industry.

Net Income -preferred dividends

Earnings per share = Number of share outstanding

Market Price of the stock

Price-earnings ratio = Earnings per share

The following are financial statements for illustrative problem.

Omega Manufacturing Corporation

Income Statements
20AA and 20BB
20AA 20BB
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Sales Php300,000 Php200,000
Less: Cost of goods sold 120,000 100,000
Gross profit on sales Php 180,000 Php100,000
Less: Operating expenses 125,000
(including depreciation, Php6,000
Income before tax Php 55,000 Php 40,000
Less: Provision for income tax 19,250 14,000
Net income Php 35,750 Php 26,000

OMEGA MANUFACTURING CORPORATION

BALANCE SHEETS
DECEMBER 31 20AA AND 20BB
20AA 20BB
 Assets
Current Assets:
Cash Php 15,000 Ph 12,200
Marketable securities 5,000 16,000
Accounts receivable, net 25,000 15,000
Finished goods 24,000 26,000
Work in process 16,000 13,000
Raw materials 12,000 8,000
Factory supplies 1,200 2,000
Prepaid expenses 1,800 2,300
Total current assets Php 100,000 Php 94,500

Investments 25,000 20,000

Plant, property and equipment, net of depreciation 75,000 60,000
Total assets Php 200,000 Php 174,500

Liabilities and Stockholder’s Equity

Current liabilities:
Accounts payable Php 15,000 Php 22,000
Income taxes payable 19,250 14,000
Accrued expenses 5,000 9,000
Total current liabilities Php 39,250 Php 45,000

Long-term debt:
Mortgage loans payable 60,000 50,000
Total liabilities Php 99,250 Php 95,000

Stockholders’ equity
12% Preferred stock, par Php 10 Php 20,000 Php 20,000
Common stock, par Php 10 30,000 25,000
Premium on preferred stock 5,000 5,000
Premium on common stock 10,000 8,000
Total stockholder’s equity Php 65,000 Php 58,000
Retained earnings 35,750 21,500
Total stockholders’ equity Php 100,750 Php 79,500
Total liabilities and stockholders’ equity Php 200,000 Php 174,500

SUMMARY OF RATIO ANALYSES

Type of Ratio Formula Values in Php Ratio Analysis
20AA
20BB
A. Liquidity Ratios
1. Current Ratio Current Assets 100,000/39,250 2.55:1 Firm's ability to meet short-term
Current Liabilities 94,500/45,000 2.10:1 obligations
 Quick Assets 45,000/39,250 1.15:1 Firm's ability to meet sudden and
Current Liabilities 43,200/45,000 .96:1 immediate demands on current
assets. Quick assets = cash,
marketable securities accounts
receivables, net
B. Activity Ratios
l. Inventory Sales 30,000/25,000 12 times Number of times the merchandise
turnover Average inventory 200,000/25,000 8 times inventory was sold and replenished
during the period.

2. Days of sales in Number of days in a 365/12 30.22 days Number of days inventory is sold,
inventory period/inventory turn- 365/8 45.63 days from date acquired
over

3. Accounts Net sales 200,000/20,000 10 times Number of times receivables have

receivable Average receivables been realized in sales
turnover
4. Average Number of days in year/ 360/10 36 days Average number of days it takes to
collection period Receivable turnover collect receivables

5. Asset turnover
Net sales Net sales Average How effectively fixed assets have
a. Fixed asset Average fixed assets fixed been utilized to generate sales
turnover assets
b. Total assets Net sales 200,000/187,250 1.07 Revenue ability of the firm in
turnover Average total assets generating revenues; a measure of
investment efficiency
C. Leverage Ratios
1. Equity to Owners’ equity 100,750/99,250 1.02 Shows the relationship between
Debt ratio Total liabilities 79,500/95,000 .84 investors' contribution and debt of the
firm
2. Debt ratio Total Liabilities 99,250/200,000 .50 Proportion of assets provided by
Total assets 95,000/174,500 .54 creditors
D. Profitability
Ratios
1. Gross Profit Gross profit 180,000/300,000 60% Gross profit percentage on sales to
margin Sales 100,000/200,000 50% recover operating expenses
2. Debt ratio Earnings (before interest 55,000/300,000 .18 Operating profit percentage per peso
and taxes)/Sales 40,000/200,000 .20 of sales
3. Net profit margin Net profit (earnings after 35,750/300,000 .12 Profit percentage per peso of sales
interest and taxes)/Sales 26,000/200,000 .13
4. Return on assets Net profit (earnings after 26,000/187,250 14% Overall assets productivity
interest and taxes)/
average total assets
5. Return on equity Net profit 26,000/90,125 29% Rate of net income earned based on
Average owners' equity owners' equity

ASSESSMENT

I. TRUE OR FALSE
Write your answers in the space provided before the number.

__________1. The income statement shows the financial condition of the business.
__________2. The balance sheet shows the results of operation of the business.
__________3. If the expenses are more than the revenue, there will be profit.
__________4. Overhead covers the cost of direct materials and direct labor.
__________5. Asset minus liabilities is equal to owner’s equity.

II. IDENTIFICATION
Write your answers in the space provided before the number.

_______________1. Also known as the balance sheet.

_______________2. It refers to a firm’s ability to meet its maturing obligation in the short-run.
_______________3. Examines the income of the company before taking into account the interest
and taxes.
_______________4. Shows the relationship between debt and equity.
_______________5. It is concerned with efficient use of assets

III. PROBLEM SOLVING

Let’s Do it!

BEAUCHE MANUFACTURING CORPORATION

INCOME STATEMENTS
20X AND 20Y
20X 20Y
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Sales Php500,000 Php300,000
Less: Cost of goods sold 150,000 100,000
Gross profit on sales Php 350,000 Php200,000
Less: Operating expenses 125,000 40,000
(including depreciation, Php6,000
Income before tax Php225,000 Php 160,000
Less: Provision for income tax 19,250 20,000
Net income Php 205,750 Php 140,000

BEAUCHE MANUFACTURING CORPORATION

BALANCE SHEET
20X AND 20Y
20X 20Y
Assets
Current Assets:
Cash Php 25,000 Php 20,000
Marketable securities 2,000 5,000
Finished goods 20,000 25,000
Work in process 16,000 10,000
 Raw materials 10,000 8,000
Factory supplies 1,000 2,000
Prepaid expenses 1,500 2,500
Total current assets Php 75,000 Php 72,500

Investments 25,000 20,000

Plant, property and equipment, net of depreciation 75,000 60,000
Total assets Php 175,000 Php 152,500

Liabilities and Stockholder’s Equity

Current liabilities:
Accounts payable Php 18,000 Php 21,000
Income taxes payable 19,250 14,000
Accrued expenses 3,000 6,000
Total current liabilities Php 40,250 Php 41,000

Long-term debt:
Mortgage loans payable 60,000 55,000
Total liabilities Php 100,250 Php 96,000

Stockholders’ equity
12% Preferred stock, par Php 10 Php 25,000 Php 15,000
Common stock, par Php 10 25,000 20,000
Premium on preferred stock 5,000 5,000
Premium on common stock 4,750 6,500
Total stockholder’s equity Php 59,750 Php 46,500
Retained earnings 15,000 10,000
Total stockholders’ equity Php 74,750 Php 56,500
Total liabilities and stockholders’ equity Php 175,000 Php 152,500

Based on the given data above, compute the following:

1. Current ratio

2. Inventory turnover

3. Days of sales in inventory

4. Average collection period

5. fixed asset turnover

 6. Total assets turnover

7. Gross profit margin

8. Net profit margin

9. Return on assets

10. Operating profit margin

FEEDBACK

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 REFERENCE

Dr. Flores, M. (2016). Business Finance for Senior High School. Unlimited Books & Publishing
Inc., Room 215 ICP Bldg., Cabildo ST., Intramuros, Manila, pages 85-94.