ECC229+Module+5 (1)

Financial Management Overview

• The Financial Management course focuses on understanding and applying financial ratios for business analysis.

• Key Objectives:

  • Define financial ratios and their importance.

  • Perform financial ratio analysis, interpretation, and implications.

• Essential question for analysis: What factors determine if a business is growing and profitable?

Debt-Utilization (Leverage) Ratios

• Help analyze how effectively a company manages its financial obligations.

• Compare liabilities and owners’ equity against total assets or total liabilities.

Key Ratios:

1. Debt to Equity Ratio (2015)

   • Formula: Total Liabilities / Total Stockholders' Equity

   • Calculation: P598,930 / P415,152 = 1.44 or 144%

   • Indicates usage of borrowed funds and the risk involved in leveraging.

   • Trade on equity: Borrowing money to increase operations and profits, increasing risk if not managed well.

2. Debt Ratio (2015)

   • Formula: Total Liabilities / Total Assets

   • Calculation: P598,930 / P1,014,082 = 0.59 or 59%

   • Shows proportion of assets financed through debt, indicating higher risk during possible bankruptcies.

3. Number of Times Interest Earned (2015)

   • Formula: Net Income before interest and taxes / Annual Interest Expense

   • Calculation: P220,367 / P41,860 = 5.26 times

   • Measures a company's ability to meet its interest obligations based on operating income.

Profitability Ratios

1. Gross Profit Ratio (2015)

   • Formula: Gross Profit / Net Sales

   • Calculation: P799,367 / P3,007,887 = 0.26 or 26%

   • Assesses cost control effectiveness against sales revenue.

   • Riel's management should focus on reducing the 74% cost ratio to enhance profitability.

2. Net Profit Ratio or Profit Margin (2015)

   • Formula: Net Profit / Net Sales

   • Calculation: P116,030 / P3,007,887 = 0.039 or 3.9%

   • Indicates net income generated per sales revenue, prompting management to boost income and reduce costs.

3. Return on Assets (ROA) (2015)

   • Formula: Net Income / Average Total Assets

   • Calculation: P116,030 / ((P1,014,082 + P966,290)/2) = 0.12 or 12%

   • Determines how effectively assets are utilized to generate earnings.

4. Return on Equity (ROE) (2015)

   • Formula: Net Income / Average Stockholders' Equity

   • Calculation: P116,030 / ((P415,142 + P376,631)/2) = 0.29 or 29%

   • Measures profitability relative to shareholders' equity, showcasing management efficiency.

Du Pont Analysis

• Combines ROA and profit margin to offer insight on how profits are generated through asset efficiency.

• Recommended ratios:

  • Return on Assets = Profit Margin x Asset Turnover.

  • Analyze by isolating factors contributing to ROE.

Liquidity Ratios

• Common ratios for assessing short-term solvency include:

  1. Current Ratio

     • Formula: Current Assets / Current Liabilities

     • Assesses a firm's ability to cover short-term obligations.

  2. Quick Ratio

     • Formula: (Cash + Trading Securities + Trade Receivables) / Current Liabilities

     • Stricter test of liquidity, evaluating immediate cash availability.

  3. Cash Flow Liquidity Ratio

     • Formula: (Cash + Cash Equivalents + Cash Flow from Operations) / Current Liabilities

     • Indicates firm's cash-based ability to meet obligations.

Asset Management Ratios

• Evaluate efficiency in asset use:

  1. Receivable Turnover

  2. Inventory Turnover

  3. Working Capital Turnover

  4. Fixed Assets Turnover

Summary of Financial Ratios

• Debt ratios measure capital structure risk.

• Profitability ratios gauge earnings effectiveness and management efficiency.

• Liquidity ratios classify a firm's ability to meet short-term needs.

• Asset management efficiency ratios reflect how well assets convert to sales.

Concept Application and Evaluation

• Fill in blanks with the correct financial terms based on learned concepts.

• Participate in assessments evaluating understanding of the above ratios and their applications.