FINANCIAL PERFORMANCE METRICS provide a relative basis for comparing a company with itself over

time or with a company versus competitors within its industry; literature of business
METRICS provide a comparative basis for evaluating suppliers and customers and is used for historical
analysis as well as projected performance
Financial analysis:
a. quantitative relations to diagnose strengths and weakness in a firms performance
b. consideration of strategic and economic developments for the firms long run success
c. provide actionable feedback to improve operations of the firm
Purpose of financial performance metrics:
1. basis for long term incentive compensation (for management)
2. basis for success/failure of the firm (for stakeholders)
FS ANALYSIS

involves the evaluation of the firms past performance, present condition, and business
potentials.
The analysis provides information about the following, among others:
Profitability of the business firm
Ability to meet company obligations
Safety of investment in the business
Effectiveness of management in running the firm

FINANCIAL STATEMENT (FS) ANALSIS TOOLS AND TECHNIQUES

1. Horizontal analysis (trend or index analysis)
2. Vertical analysis
3. Financial ratios
4. Gross profit variation analysis
5. Cash flow analysis

HORIZONTAL ANALYSIS
Horizontal or index analysis involves comparison of figures shown in the financial statements of two or
more consecutive periods. The difference of the amount between two periods is calculated, and the percentage
change from one period to the next is computed using the earlier period as the base.
Percentage Change ( %)

Most Recent Value Base Period Value

Base Period Value

Comparisons can be made between an actual amount compared against a budgeted amount, with the `budget
serving as the base or pattern of performance.
LIMITATION: if a negative or zero amount appears in the base year, percentage change cannot be computed.

VERTICAL ANALYSIS
Vertical analysis is the process of comparing figures in the financial statements of a single period. It
involves conversion of figures in the statements to a common base. This is accomplished by expressing all figures
in the statements as percentages of an important item such as total assets (in the BS) or net sales (in the IS). These
converted statements are called common-size statements or percentage composition statements.
Percentage composition statements are used for comparing:
1. Multiple years of data from the same firm
2. Companies that are different in size
3. Company to industry averages
RATIO ANALYSIS

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Ratio analysis involves development of mathematical relationships among accounts in the financial
statements. Ratios calculated from these statements provide users and analysts with relevant information about the
firms liquidity, solvency, and profitability.
BASIC RULES ON RATIO CALCULATIONS
When calculating a ratio using balance sheet numbers only, the numerator and denominator
should be from the same balance sheet date. The same is true for ratios using only income
statement numbers. Exception: calculation of growth ratios.
If an income statement account and a balance sheet account are both used to calculate a ratio, the
balance sheet account should be expressed as an average for the period represented by the
income statement account.
If the beginning balance of a balance sheet account is not available, the ending balance is
normally used to represent the average balance of the account
If sales and/or purchases are given without making distinction as to whether made in cash or on
credit, assumptions are made depending on the ratio being calculated:
Turnover ratios: Sales and purchases are made on credit.
Cash flow ratios: Sales and purchases are made in cash.
Generally, the number of days in a month or year is not critical to the analysis: a year may have
360 days, 52 weeks, or 12 months; alternatively, a year may be comprised of 365 calendar days,
300 working days or any appropriate number of days.
FINANCIAL RATIOS
TESTS OF LIQUIDITY (Liquidity refers to the companys ability to pay its current liabilities as they fall
due.)
It is a measure of adequacy of
Current/Bankers/Working
Current Assets
working capital. It is the primary
Capital Ratio
Current Liabilities
test of solvency to meet current
obligations from current assets.
It measures the number of times
that the current liabilities could
Quick Assets
be paid with the available cash
Quick/Acid Test Ratio
Current Liabilities
and near-cash assets (i.e., cash,
current
receivables
and
marketable securities).
Working Capital Activity Ratios (Efficiency Ratios)
It is the time required to
complete one collection cycle
Net (Credit) Sales
from the time receivables are
Receivable Turnover
Average Receivables
recorded, then collected, to the
time new receivables are
recorded again
It indicates the average number
Average Age of Receivables
360
of days during which the
(Average Collection Period)
Receivable Turnover
company must wait before
(Days Sales in Receivables)
receivable are collected.
It measures the number of times
Cost of goods sold
Inventory Turnover
that the inventory is replaced
Ave. Merchandise Inventory
during the period
It indicates the average number
Average Age of Inventory*
360
of days during which the
(Inventory Conversion Period)
Inventory Turnover
company must wait before the
(Days Sales in Inventory)
inventories are sold.
Cost of Materials Used
Raw materials Turnover
Average Raw Materials Inventory
Cost of Goods Manufactured
Work in Process Turnover
Average Work in Process Inventory

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Finished Goods Turnover

Cost of Goods Sold

Average Finished Goods Inventory

Normal Operating Cycle

Average Age of Inventory + Average Age of Receivalbes

Net Credit Purchases

Ave. Trade Payables
Average Age of Trade Payables
It indicates the length of time
360
(Payable Deferral Period)
during
which
payables
Payables Turnover
(Days Purchases in Payables)
remain unpaid.
It indicates the movement
Cost of Sales + Operating
and utilization of current
Current Assets Turnover
Expenses**
assets to meet operating
Ave. Current Assets
requirements.
Average Age of Inventory + Average Age of Receivables Age of
Cash Conversion Cycle
Payable
*In some accounting and finance texts, average inventory age is also called as the average sales period.
** These exclude depreciation, amortization and other expense related to long-term assets.
Trade Payables Turnover

TESTS OF SOLVENCY (Solvency refers to the ability of company to pay its debts)
These ratios involve leverage ratios. `Leverage refers to how much of companys resources are financed by debt
and/or preferred equity, both of which require fixed payment of interest and dividends.
It determines the extent to
Earnings Before Interest and Taxes (EBIT)
Times Interest Earned
which operations cover
Interest Expense
interest expense.
Proportion
of
assets
Total Liabilities
provided by creditors
Debt-Equity Ratio
Total Shareholders Equity
compared to that provided
by owners.
Total Liabilities
Proportion of total assets
Debt Ratio
Total Assets
provided by creditors
Total Shareholders Equity
Proportion of total assets
Equity Ratio
Total Assets
provided by owners.

TEST OF PROFITABILITY
Return on Sales

Income
Net Sales

Return on Assets

Income
Average Assets

Determines the portion of sales

that went into companys
earnings
Efficiency with which assets are
used to operate the business.

What INCOME figure should be used?

If the intention is to measure operational performance, income is expressed as before interest and tax;
alternatively, income before `after-tax interest may be used to exclude the effect of capital structure.
If the intention is to evaluate total managerial effort, income is expressed after interest and tax.
The practice of expressing income after interest but before tax is now being discouraged.
Income should include dividends and interest earned if the said investments are included in asset base.
If used in the DuPont technique, income must be after interests, taxes and preferred stock dividends.
Return on Equity = Return on Sales X Assets Turnover X Equity Multiplier

Return on Equity
Earnings Per Share

Income
Average Equity
Net Income Preferred Dividends
Weighted. Ave. Common Shares

Strategic Financial Management: Financial Performance Metrics

Measures the amount earned on

the owners or stockholders
investment
Measures the amount of net
income earned by each common

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Outstanding

share

Price-Earnings (P/E) Ratio

Price Per Share

Earnings Per Share

Dividend Yield

Dividend Per Share

Price Per Share

Dividend Pay-out

Dividend Per Share

Earnings Per Share

It indicates the number of pesos

required to buy P1 of earnings
Measures the rate of return in the
investors
common
stock
investments.
It indicates the proportion of
earnings distributed as dividends

MARKET TESTS

OTHER MEANINGFUL RATIOS

RATIOS USED TO EVALUATE LONG-TERM FINANCIAL POSITION OR STABILITY
Measures the proportion of
owners equity to fixed assets.
Fixed Assets to Total
Fixed Assets
Indicative of over or under
Equity
Total Equity
investment by owners and
weakness in trading on the
equity*
Indicates
possible
overFixed Assets to Total
Fixed Assets (Net)
expansion
of
plant
and
Assets
Total Assets
equipment
Test roughly the efficiency of
Sales to Fixed Assets
Net Sales
management in keeping plant
(Plant Turnover)
Fixed Assets (Net)
properties employed.
Measures recoverable amount by
Book Value Per Share
Common Stockholders Equity
common stockholders in the
Common Stock
Common Shares Outstanding
event of liquidation if assets are
realized at their book values
It indicates ability to provide
Times Preferred
Net Income After Taxes
dividends
to
preferred
Dividend Earned
Preferred Dividends
stockholders.
Measures efficiency of the firm
Total Assets
Capital Intensity Ratio
to generate sales through
Net Sales
employment of its resources.
Net Income before taxes & fixed charges
Times Fixed Charges
Measures ability to meet fixed
(Fixed charges + sinking fund
Earned
charges.
payment)**
* `Trading on the equity is another name for leverage
** Fixed charges shall include rent, interest and other relevant fixed expenses; sinking fund payment must be
expressed before tax.

TESTS OF OVER-ALL SHORT-TERM SOLVENCY OR SHORT-TERM FINANCIAL POSITION

Indicates adequacy of working
Net Sales
Working Capital Turnover
capital to support operation
Average working capital
(sales)
Current Liabilities
Measures coverage of current
Defensive Interval Ratio
Cash & Cash Equivalent
liabilities
Measures efficiency of the
Net Purchases
Payable Turnover
company in meeting the accounts
Average Accounts Payable
payable
Reflects extent of the utilization
Fixed Assets to Long-Term
Fixed Assets
of resources from long-term debt.
Liabilities
Long Term Liabilities
Indicative
of
sources
of
additional funds.

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 RATIOS INDICATIVE OF INCOME POSITION

Rate of Return on Average
Income
Current Asset
Average Current Assets
Operating Profit
Operating Profit Margin
Net Sales
Operating Cash Flow
Cash Flow Margin
Net Sales

Measures the profitability of

current assets invested.
Measures profit generated after
consideration of operating costs.
Measures the ability of the firm
to translate sales to cash

EXERCISES: FINANCIAL STATEMENT ANALYSIS

1. VERTICAL AND HORIZONTAL ANALYSIS
Following are the financial statements of Getbackers Company:
GETBACKERS COMPANY
Condensed Statement of Financial Position
December 31, 2010 (In Thousands)
ASSETS
Cash
Non-Cash Current
Fixed Assets
TOTAL ASSETS

P 750
1,250
3,000
_
P5,000

LIABILITIES AND SHE

Current Liabilities
P 500
Long-term Debts
1,000
Capital Stock
1,500
Retained Earnings
_2,000
TOTAL LIAB. & SHE
P 5,000

For 2009: Net Sales, P1,600; CGS, P1,000; Operating Expenses, P300; Interests and tax charges, P200.
For 2010: Net Sales, P2,000; CGS, P1,300; Operating Expenses, P300; Interests and tax charges, P220.
REQUIRED:
1. Prepare 2010 common-size balance sheet and determine:
a. Current ratio
b. Debt ratio
c. Equity ratio
2. Prepare 2010 common size-income statement and determine:
a. Gross profit margin
b. Operating profit margin
c. Net profit margin
3. Compute trend percentages or prepare index analysis for the following
a. Net sales
b. EBIT
c. Net income
2. LIQUIDITY ANALYSIS
Indicate the effects of each of the following transactions on the companys (A) current ratio and (B) acidtest ratio. There are three possible answers: (+) increase, (-) decrease, and (0) no effect. Before each
transaction takes place, both ratios are greater than 1 to 1.
Effects on
Transactions:
(A) Current Ratio
(B) Acid-test Ratio
Example: Sell merchandise for cash
+
+
1. Buy inventory on account.
2. Pay an account payable.
3. Borrow cash on a short-term loan.
4. Issue long-term bonds payable.
5. Collect an account receivable.
6. Record accrued expenses payable.
7. Sell a plant assets for cash at a profit
8. Sell a plant asset for cash at a loss
9. Buy marketable securities, for cash
10. Sell merchandise on credit
3. FINANCIAL RATIOS
Midou Ban has 1,000,000 common shares outstanding. The price of the stock is P8. Midou Ban
declared dividends per share of P0.10. the balance sheet at the end of 2009 showed approximately the
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same amounts as that at the end of 2010. The financial statements for Midou Ban Company are as
follows:

Midou Ban Company, Income Statement for 2010 (in thousands)

Sales
4,700
Cost of goods sold
2,300
Gross Profit
2,400
Operating Expenses:
Depreciation
320
Other
1,230 1,550
Income before interest and taxes
850
Interest expense
150
Income before taxes
700
Income taxes
280
Net Income
420
Midou Ban Company, Balance Sheet at December 31, 2010 (in thousands)
Assets
Liabilities and SHE
Cash
220
Accounts payable
190
Accounts Receivable
440
Accrued expenses
180
Inventory
410
Total current liabilities
370
Total current assets
1,070
Long-term debt
1,960
Plant and equipment
5,600
Common stock
1,810
Accumulated Depreciation
(2,100)
Retained earnings
430
Total Assets
4,570
Total Liab. And SHE
4,570
REQUIRED: (round-off answers to two decimal places)
1. Current ratio (2.89:1)
11. EPS (0.42)
2. Acid-test ratio (1.78:1)
12. P/E Ratio (19.05)
3. Accounts Receivable turnover (10.68 times)
13. Dividend Yield *1.25%)
4. Inventory turnover (5.61 times)
14. Payout ratio (23.81%)
5. Gross profit margin (51.06%)
15. Debt ratio (50.98%)
6. Operating profti margin (18.09%)
16. Debt-equity ratio (1.04:1)
7. Return on Sales (RoS) (8.94%)
17. Times interest earned (5.67 times)
8. RoA operational perfomance (18.60%)
18. Defensive interval ratio (1.68:1)
9. RoA total management effort (9.19%)
19. Cash flow to total debt (31.76%)
10. Return on Equity (RoE) (18.75%)
20. Cash flow margin (15.74%)

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