Learning Competencies

The learners shall be able

to prepare financial
statements
(ABM_BF12-III-6)
 MOTIVATION (20 MINS)
Match the letter with the
definition that corresponds
to the following terms:
(Modified from Basic
Accounting, Valencia &
Roxas)
Accounting
is the systematic and comprehensive
recording of financial transactions pertaining
to a business. (Investopedia - Sharper Insight.
Smarter Investing. | Investopedia. (2016).
Investopedia. Retrieved 8 May 2016, from
http://investopedia.com)
1. The Accounting Equation
The basic accounting equation is:

ASSETS = LIABILITIES + OWNER’S EQUITY

This means that the whole assets of the company
comes from the liability, or debt of the company, and
from the capital of the owner of the business, and the
income it generated from the business operations.
This reflects the double-entry bookkeeping, and
shown in the balance sheet.
Double entry bookkeeping tells
us that if we add something from
the one side, which is asset, we
must add the same amount to
the other side to keep them in
balance.
For example, if we were to increase cash (an asset)
we might have to increase note payable (a liability
account) so that the basic accounting equation
remains in balance
In double-entry bookkeeping,
there is the concept of debit
(dr) and credit (cr). Debit is
the left, and credit is the right
.
There is also a concept of normal
balances. A normal balance,
either a debit normal balance or
a credit normal balance, is the
side where a specific account
increases.
In the accounting equation, asset is
on the left side, while liabilities and
equity is on the right side.
Therefore, asset has a debit normal
balance, meaning that cash as an
asset is debited to increase, while
credited to decrease.
On the other hand, liabilities and
owners’ equity have a credit normal
balance. This means that a liability
account is credited to increase, while
debited to decrease. The accounting
equation provides the foundation for
what eventually becomes the balance
sheet.
2. T-Account Analysis
In double-entry bookkeeping, the terms
debit and credit are used to identify which
side of the ledger account an entry is to be
made. Debits are on the left side of the
ledger and Credits are on the right side of the
ledger. It does not matter what type of
account is involved.
The debit to cash increases
the Cash Account by PHP500
while the credit to Accounts
Payable increases this liability
account by the same PHP500.
In contrast, there are accounts that
reflect activities for a specific
accounting period. These are called
Nominal or Temporary Accounts. After
the end of the specific period and the
start of a new period, the balance of
the nominal accounts are zero.
Using the accounting equation, we can
now expand the analysis that will
include both real and nominal
accounts. All nominal accounts will be
then closed to a Retained Earnings
account at the end of the period,
which is an owner’s equity account.
Illustrative Example:
Calvo Delivery Service is owned and operated by Noel
Calvo. The following selected transactions were completed
by Calvo Delivery Service during February:
A.Received cash from owner as additional investment, P35,000.
B.Paid creditors on account, P1,800.
C.Billed customers for delivery services on account, P11,250.
D.Received cash from customers on account, P6,740.
 ASSETS = LIABILITIES + OWNER’S EQUITY

CASH ACCOUNTS ACCOUNTS CALVO, SERVICE

RECEIVABLE PAYABLE CAPITAL REVENUE

A PHP35,000 PHP35,000

B PHP1,800 PHP1,800

C PHP11,250 PHP11,250

D PHP6,740 PHP6,740
3. Nominal Accounts
There are two major categories of nominal accounts: Expense and
Revenue accounts.
Expense Accounts
A resource, when not yet used up for the current period, is
considered an Asset and will provide benefits at a future time.
On the other hand, a resource that has been used for the current
period is called an Expense. At the end of each accounting period,
expenses are closed out to the Retained Earnings Account which
decreases the Owners’ Equity. Since expenses decrease the owners’
equity, those expense accounts carry a normal debit balance.
Revenue Accounts
 Revenue Accounts reflect the accumulation of potential
additions to retained earnings during the current
accounting period.
• At the end of the accounting period accumulation of
revenues during the period are closed to the Retained
Earnings Account which increases Owners’ Equity.
 Therefore revenue accounts carry a normal credit balance
meaning the same balance as the Retained Earnings
Account.
 ASSETS = LIABILITIES + OWNER’S EQUITY
MAR CASH ACCOUNTS OFFICE ACCOUNTS SERVICE EXPENSES
RECEIVABLE EQUIPMENT PAYABLE REVENUE
1 PHP35,000 PHP35,000
2 PHP3,000 PHP3,000
2 PHP1,800 PHP1,800
6 PHP12,300 PHP12,300
15 PHP1,200 PHP1,200
27 PHP500 PHP500
30 PHP180 PHP180
31 PHP315 PHP315
If journalized
March 1 Debit Cash for PHP35,000; Credit Service Revenue for PHP35,000

2 Debit Rent Expense for PHP3,000; credit Cash for PHP3,000

2 Debit Advertising Expense for PHP1,800; Credit Cash for PHP1,800

6 Debit Office Equipment for PHP12,300; Credit Accounts Payable for PHP12,300

15 Debit Accounts Payable for PHP1,200; Credit Cash for PHP1,200

27 Debit Repairs Expense for PHP500; credit Cash for PHP500

30 Debit Utilities Expense (or telephone) for PHP180; Credit Cash for PHP180

31 Debit Utilities Expense (or energy) for PHP315; credit Cash for PHP315
4. The Accounting Cycle
Because accounting is all about getting data and
putting them into the accounting equation, the end
products are financial statements such as a balance
sheet and income statements, the process of
accounting follows a cycle called the Accounting Cycle.
It starts with the identification of whether a
transaction is accountable or can be quantified, and
ends with a post-closing trial balance.
The Process:
Step 1: Analyze Business Transactions.
 In this step, a transaction is analyzed to find out if it affects
the company and if it needs to be recorded.
 Personal transactions of the owners and managers that do
not affect the company should not be recorded.
 In this step, a decision may have to be made to identify if a
transaction needs to be recorded in special journals such
as a sales or purchases journal.
Therefore, what you should do is:
o Carefully read the description of the transaction to
determine whether an asset, a liability, an owner’s equity,
a revenue, an expense, or a drawing account is affected.
o For each account affected by the transaction, determine
whether the account increases or decreases.
o Determine whether each increase or decrease should be
recorded as a debit or a credit, following the rules of debit
and credit.
Illustrative Example:
 N. Juna resigned from Company X.
This does not affect any asset, liability, or
the owner’s equity account.
 B. Cano purchased PHP500 cash worth of
supplies at Ace Hardware.
This affects cash and supplies, both asset
accounts.
Step 2: Record This in the Journal.
•Using the rules of debit and credit, transactions are
initially entered in a record called a Journal and the
entry made is called a Journal Entry.
•The journal serves as a record of when transactions
occurred and were recorded.
•For repetitive transactions or high volume
transactions (e.g. one thousand sales transactions in
one day), Special Journals are made. These special
journals include sales journal, purchases journal, cash
receipts journal, and cash disbursements journal.
The Source Document is the file or
document (i.e. official receipt, purchase
order, contract) that will provide a basis or
reason for a journal entry. For example,
an official receipt issued by the business
will tell you that a sale transaction
occurred and will be reflected by the
journal entry.
Illustrative Example:
•M. Jaya resigned from Company X.
No journal entry.
•C. Danto purchased PHP500 cash
worth of supplies to Ace Hardware.
Debit Supplies PHP500, Credit
Cash PHP500 .
Step 3: Post the Transactions on a Ledger.
•A transaction is first recorded in a journal. Periodically, the journal
entries are transferred to the accounts in the ledger.
•The process of transferring the debits and credits from the journal
entries to the accounts is called Posting.
•Ledgers provide chronological details as to how transactions affect
individual accounts. There are two types of ledgers: the General
Ledger
and Subsidiary Ledger. The general ledger is a summary of the
different Subsidiary Ledgers and can serve as a control account.
•For example, a general ledger for accounts receivable summarizes
the balances found in the different subsidiary ledgers for different
customers.
Illustrative Example:
J. Gaya, a CPA, is an independent auditor with only
two clients. The Accounts Receivable ledger account
has a balance of PHP100,000. His two clients are A.
Rania, and X. Campos. The subsidiary ledger of A.
Rania has a balance of PHP25,000. X. Campos’s ledger
balance is PHP75,000. The sum of subsidiary ledgers
must total the general ledger or else there must be an
investigation to identify the source of discrepancies
 ACCOUNTS RECEIVABLE

DATE

December 31, 2015 Bal. Php 100,000

Subsidiary Ledgers
A. RANIA
DATE
December 31, 2015 Bal. Php 25,000
X. CAMPOS
DATE
December 31, 2015 Bal. Php 75,000
Step 4: Prepare an Unadjusted Trial Balance.
•Errors may occur in posting debits and credits from the journal
to the ledger. One way to detect such errors is by preparing a
trial balance.
•Double-entry accounting requires that debits must always
equal credits. The trial balance verifies this equality.
•The steps in preparing a trial balance are as follows:
1.List the name of the company, the title of the trial balance, and
the date the trial balance is prepared.
2.List the accounts from the ledger and enter their debit or credit
balance in the Debit or Credit column of the trial balance.
3.Total the Debit and Credit columns of the trial balance.
4.Verify that the total of the Debit column equals the total of the
Credit column.
Step 5: Make adjustments. Journalize
adjusting entries.
•At the end of the accounting period, many of the
account balances in the ledger can be reported in
the financial statements without change.
•For example, the balances of the cash and land
accounts are normally the amount reported on
the balance sheet. However, some accounts in
the ledger require updating
•This updating is required for the following reasons:
1.Some expenses are not recorded daily. For example, the daily use of
supplies would require many entries with small amounts. Also, managers
usually do not need to know the amount of supplies on hand on a day-to-day
basis.
2.Some revenues and expenses are earned as time passes rather than as
separate transactions. For example, rent received in advance (unearned rent)
expires and becomes revenue with the passage of time. Likewise, prepaid
insurance expires and becomes an expense with the passage of time.
3.Some revenues and expenses may be unrecorded. For example, a company
may have provided services to customers that are has not billed or recorded at
the end of the accounting period. Likewise, a company may not pay its
employees until the next accounting period even though the employees have
earned their wages in the current period.
•The analysis and updating of accounts at the end of the period
before the financial statements are prepared is called the Adjusting
Process. The journal entries that bring the accounts up to date at
the end of the accounting period are called Adjusting Entries.
•The following are normally adjusted at the end of a period:
-Accruals. These include unpaid salaries for the accounting period,
unpaid interest expense, or unpaid utility expenses.
-Prepayments. If a company has prepaid expenses such as prepaid
rent or prepaid insurance then the correct balances for these
accounts have to be established at the end of each accounting
period to reflect their correct balances.
• Depreciation and amortization expenses. Depreciation
expenses are recognized at the end of each accounting
period through adjusting entries. If there are intangible
assets such as franchise, the allocation of their costs
which is called amortization expense, is also recognized
at the end of each accounting period through adjusting
entries.
• Allowance for uncollectible accounts. Bad debt expense
from accounts receivable is also recognized through
adjusting entries.
Step 6: Prepare an Adjusted Trial
Balance.
An adjusted trial balance is prepared
after taking into consideration the effects
of the adjusting entries. Again, this is to
ensure that the total debit balances
equal the credit balances after posting
and journalizing adjusting entries made.
Step 7: Prepare the financial
statements.
From the adjusted trial balance, the
financial statements can then be
prepared. These are the statement of
financial position, statement of profit or
loss, and the statement of cash flows.
Step 8: Make the closing entries.
In the discussion about accounts, it was
discussed that nominal accounts (revenue and
expense accounts) are closed to retained
earnings, or an owner’s capital account
because these accounts refer only to a specific
accounting period. Actually, these accounts to
be closed are accounts that can be seen in the
income statement.
Upon closing:
 If the revenues exceed expenses during an
accounting period, retained earnings will
increase.
 The reverse is true which means that if the
expenses exceed revenues, the retained
earnings will decrease.
In closing temporary accounts:
 Revenue account balances are transferred to an account
called Income Summary Account (sometimes profit or
loss summary).
 Expense account balances are also transferred to the
Income Summary Account.
 The balance of the Income Summary (net income or net
loss) is transferred to the owner’s capital account.
 The balance of the owner’s drawing account is
transferred to the owner’s capital account.
Step 9: Make a Post-Closing Trial
Balance.
A Post-Closing Trial Balance shows the
accounts that are permanent or real. These
are the accounts that can be seen in your
balance sheet. The post-closing trial
balance is prepared to test if the debit
balances equal the credit balances after
closing entries are considered.
Basic Financial Statements
A financial statement is basically a summary of all
transactions that are carefully recorded and
transformed into meaningful information. It also
shows the company’s permanent and temporary
accounts. Basically, financial statements are
comprised of the following:
Income Statement
These are also known as the Profit/Loss
Statement, Statement of Comprehensive
Income, or Statement of Income.
This is a summary of the revenue and
expenses of a business entity for a specific
period of time, such as a month or a year.
 CESNI COMPANY
Income Statement
For the Year Ended April 30, 2018

Fees earned P263,200

Expenses:
Wages expense ………………………………………… P131,700
Office expense…………………………………………. 63,000
Miscellaneous expense……………………………. 12,950
Total expenses……………………………….. 207,650
Net Income…………………………………………………… P 55,550

Figure 1: Sample Income Statement

 CESNI COMPANY
Income Statement
For the Year Ended April 30, 2018

Fees earned P263,200

Expenses:
Wages expense ………………………………………… P131,700
Office expense…………………………………………. 63,000
Miscellaneous expense……………………………. 12,950
Total expenses……………………………….. 207,650
Net Income…………………………………………………… P 55,550

Figure 1: Sample Income Statement

b.Statement of Owner’s Equity
•These are also known as the Statement of Changes in Equity.
•This reports the changes in the owner’s equity over a period of time.
•It is prepared after the income statement because the net income or
net loss for the period must be reported in this statement.
•Similarly, it is prepared before the balance sheet since the amount
of owner’s equity at the end of the period must be reported on the
balance sheet.
•Because of this, the statement of owner’s equity is often viewed as
the connecting link between the income statement and balance
sheet.
c.Balance Sheet
•Formerly known as the Statement of Financial
Position.
•This provides information regarding the liquidity
position and capital structure of a company as of a
given date.
•It must be noted that the information found in this
report are only true as of a given date.
•It shows a list of the assets, liabilities, and owner’s
equity of a business entity as of a specific date, usually
at the close of the last day of a month or a year.
 CESNI COMPANY
Balance Sheet
April 30, 2018
ASSETS LIABILITIES

Cash P 53,050 Accounts Payable P 12,200

Accounts receivable 31,350

Supplies 3,350 Owner’s Equity

Land 80,000 Markus Davira, capital P155,550

Total Assets P167,750 Total liabilities & owners equity P167,750

Figure 3: Sample Balance Sheet

d.Statement of Cash Flows
•The statement of cash flows reports a company’s
cash inflows and outflows for a period.
•This is used by managers in evaluating past
operations and in planning future investing and
financing activities.
•It is also used by external users such as investors
and creditors to assess a company’s profit potential
and ability to pay its debt and pay dividends.
 CESNI COMPANY
Statement of Cash Flows
For the Year Ended April 30, 2018

Cash flows from operating activities:

Cash received from costumers………………………………………P 251,000
Deduct cash payment from expenses………………………….. 210,000
Net cash flows from operating activities…………………………………………….. P 41,000
Cash flows from operating activities:
Cash payments for purchased of lands……………………………………………….. (80,000)
Cash flows from financing activities:
Cash received from owner as investment…………………….P50,000
Deduct cash withdrawal from owner ………………………... 30,000
Net cash flows from financing activities…………………………………………… 20,000
Net decrease during year………………………………………………………………………….. P(19,000)
Cash as of May 1, 2017……………………………………………………………………………… 72,050
Cash as of April 30, 2018…………………………………………………………………………… P 53,050

Figure 4: Sample Statement of Cash Flows

PRACTICE (20 MINS)
1. Using the following (scrambled) accounts, prepare a balance sheet for ABC, a retail company, for the year ending in December
31, 2016. Assume that these are the only Balance Sheet Accounts.

Accounts Payable 39,000

Accrued Expenses 8,000
Accumulated Depreciation 51,000
Additional Paid-In Capital 86,000
Allowance for Doubtful Accounts 2,000
Cash 23,000
Common Stock (PHP0.20 par) 45,000
Current Portion of L.T. Debt 6,000
Gross Accounts Receivable 40,000
Gross Fixed Assets 486,000
Inventories 54,000
Long-Term Debt 210,000
Net Accounts Receivable 38,000
Net Fixed Assets 435,000
Retained Earnings 138,000
Short-Term Bank Loan (Notes Payable) 18,000
Answer Key Balance Sheet
ABC, Incorporated
December 31, 2016

Cash 23,000
Gross accounts receivable 40,000
Allowance for doubtful accounts (2,000)
Net accounts receivable 38,000
Inventories 54,000
Current assets 115,000
Gross fixed assets 486,000
Accumulated depreciation (51,000)
Net fixed assets 435,000
Total assets 550,000
Short-term bank loan (notes payable) 18,000
Accounts payable 39,000
Accrued expenses 8,000
Current portion of L.T. Debt 6,000
Current liabilities 71,000
Long term debt 210,000
Total liabilities 281,000
Common stock (P0.20 par) 45,000
Additional paid-in capital 86,000
Retained earnings 138,000
Total liabilities and equity 550,000
2. Prepare a multi-step income statement for the retail company, ABC, for the year ending
December 31, 2016 given the information below:

Advertising expenditures 68,000

Beginning inventory 256,000
Depreciation 78,000
Ending inventory 248,000
Gross Sales 3,210,000
Interest expense 64,000
Lease payments 52,000
Management salaries 240,000
Materials purchases 2,425,000
R&D expenditures 35,000
Repairs and maintenance costs 22,000
Returns and allowances 48,000
Taxes 51,000
 Income Statement The ABC Company
For the 12 month period Ending December 31, 2016

Net sales 3,162,000

Cost of goods sold 2,433,000
Gross profit 729,000
Operating expenses (excluding depreciation) 417,000

Depreciation 78,000
Operating profit 234,000
Interest expense 64,000
Earnings before taxes 170,000
Taxes 51,000
Net income 119,000
1.Indicate whether the following items would appear on the
income statement (IS), or balance sheet (BS).
A. Office Supplies
B. Accounts Payable
C. Computer Equipment
D. Commission Fees Earned
E. Salaries Expense
F. B. So, Capital
G. Accounts Receivable
2. Using the following accounts from the retail store, A-Mart Incorporated’s income
statement for the year ending in December 31, 2018, answer the questions below.
Note that all figures are in millions.

Cost of goods sold PHP600

Lease payments 30
Advertising 20 A.A-Mart’s gross profit is PHP .
B.A-Mart’s operating profit is PHP .
Taxes 35 C.A-Mart’s net profit is PHP .
Repairs and 40
maintenance expenses
Management salaries 100
Net sales 1,000
Depreciation 60
3. Using the following accounts from the A-Mart, Incorporated’s balance sheet for
the year ending December 31, 2016, answer the questions below. Use cash as a
plug figure. Note that all figures are in millions.
Current portion of L.T. Debt PHP 60
Leasehold improvements 300
Accrued expenses 40 A.A-Mart’s current assets are PHP
.
Accumulated depreciation 200
B.A-Mart’s current liabilities are PHP
Gross fixed assets 900 .
Accounts payable 90 C.A-Mart’s total assets are PHP .
Inventories 190 D.A-Mart’s total liabilities are PHP
Common stock (PHP1.00 par) .
400
Short-term bank loan 20
E.A-Mart’s total stockholder’s equity is
PHP .
Net accounts receivable 100
Long-term bank loan 600
Retained earnings 200
Cash ???
Learning Competencies
The learners shall be able to:
•Define the measurement levels namely, liquidity,
solvency, stability, and profitability (ABM_BF12-
IIIb-7)
•Compute, analyze, and interpret financial ratios
such as current ratio, Review of Financial
Statement Preparation, Analysis, and
Interpretation
Specific Learning Outcomes
At the end of the lesson, the learners
will be able to:
•Define liquidity
•Solve liquidity ratios (current and
quick)
•Analyze, interpret, and compare the
liquidity ratios of sample companies.
Below is the business case. You may look for or make another business case as long
as it highlights the same topics.
Zapatoes, Inc

Anthony Cruz owns Zapatoes, Inc., a home-grown Filipino shoe company.

His company has experienced tremendous growth since it has started its
operations in 2009. With a growing demand for his products, Anthony
Cruz is considering expanding his operations by opening his first
production facility. Currently, he pays another company to manufacture
the shoes he designs. He is contemplating to produce the shoes
Zapatoes, Inc. facility, with the hope of lowering the cost of production.

The company needs PHP10 million to finance this expansion and is at a

tight cash position. Anthony Cruz is now wondering where to get the
funds needed – invite an investor or personally borrow from a bank?
PRE-WORK
Provide copies of the financial
statement of the subject company to
the learners a day before the class.
Ask them to compute for liquidity
and efficiency ratios.
INTRODUCTION/REVIEW (20 MINS)
1. Communicate learning objectives
•Introduce the following learning objectives using any of the
suggested protocols (verbatim, own word, read-aloud):
• Introduce financial ratios
• Define liquidity
• Solve for liquidity ratios (current and quick)
• Analyze, interpret, and compare the liquidity
ratios of sample Philippine companies
2. Review
•What the contents are of the financial
statements.
•How the contents of the financial statements
are classified.
•What did you remember about current and
non-current classifications for assets and
liabilities.
•What accounts are considered current assets
and liabilities.
MOTIVATION (10 MINS)
1.Ask them if they have tried buying from sari-sari stores on
credit.
2.Ask them what the implications are if you or your household
don’t pay your obligations to your neighbor’s sari-sari store.
3.Write their answers on the board.
4.Ask them, if a business does not pay its obligations on
time, will it also have the same experiences like the
household not paying its obligations? What could
possibly happen to the business? Short-run? Long-
run?
1. The four main categories of
financial ratios:
•Liquidity
•Profitability
•Efficiency
•Leverage
What the uses of
financial ratios
are?
2. Define liquidity.
•Liquidity refers to the company’s
ability to satisfy its short-term
obligations as they come due. Refer
back to the household example to
emphasize the meaning of liquidity.
LIQUIDITY
What it is:
Liquidity is the ability to sell an
investment at or near its
value.
How it works/Example:
Let’s say you take an old painting from the attic to the
local filming of Antiques Roadshow. The expert says
your painting is worth P50,000. Surprise!
That’s great news, except that it could take months to
find a buyer, and the buyer may only want to pay
P35,000 or P40,000. Your painting, while valuable, isn’t
very liquid. That is, you can’t convert it to P50,000 very
quickly or easily. Houses aren’t very liquid, either. They
too can take months to sell, and buyers often don’t pay
the sticker price.
THE FOLLOWING ARE COMMON EXAMPLE
OF LIQUIDITY.
CASH
Cash of a major currency
is considered completely
liquid.
RESTRICTED CASH
Legally restricted cash deposits
such as compensating balances
against loans are considered
illiquid.
MARKETABLE SECURITIES
Financial instruments
that can be bought and
sold on public market.
CASH EQUIVALENTS
Cash equivalents include
marketable securities and other
cash-convertible instruments
such as treasury bills and
commercial paper.
CREDIT
Unused credit such as line of credit
may help an entity to achieve
liquidity. Such facilities may be
subject to terms that make them
far less reliable than cash in
liquidity crunch.
ASSETS
Assets such as inventory, receivables,
equipment, vehicles and real estate
are not considered liquid as they can
take many month to convert to cash.
3. Define the types of liquidity ratios and Current ratio and
quick ratio formula.

Current Assets
Current Ratio =
Current Liabilities
Liquidity ratios are the ratios that
measure the ability of a company to
meet its short term debt obligations.
Most common examples of liquidity
ratios include current ratio, acid
test ratio (also known as
quick ratio), cash ratio and working
capital ratio.
LIQUIDITY RATIOS:
The first classification of ratios are known
as Liquidity Ratios. As mentioned earlier,
Liquidity Ratios measure a company's
ability to provide sufficient cash to cover
its short term obligations (debt). The
most common liquidity ratios include;
the current ratio and the quick ratio.
Lets look at each type of liquidity ratio,
beginning with the current ratio.
CURRENT RATIO:
The current ratio indicates the extent to which the
claims of short-term creditors are covered by assets
that are expected to be converted to cash in a
period roughly corresponding to the maturity of the
liabilities. Here's how the current ratio is calculated.

Current Ratio = Current Assets

Current Liabilities
As mentioned under the balance sheet
section, a current liability represents money
a company owes and is due in the near
future- less than one year. A current asset,
on the other hand, is cash or others short-
term assets that can be converted into cash
in the near future (IE less than a
year). Inventory, for example, is a current
asset that is purchased and sold by a
company to obtain cash.
By dividing the current assets by the current liabilities, we can determine whether or
not a company has the ability to pay off its short-term debt (current liabilities). Below
shows the current assets and current liabilities for The Cesni Company.

ASSETS: LIABILITIES:

Current Assets: Current Liabilities:

Cash P 2,550 Accounts P 9,500

Payable
Marketable P 2,000 Short-term P11,375
securities Bank Loan
Account P16,675 Total Current P20,875
Receivable Liabilities
(Net)
Inventories P26,470

Total Current P47,695

Assets
Using the values shown in the total current
assets account and total current liabilities
account we can calculate the company's
current ratio as follows:
Current = Current Assets = P47,695
Ratio Current Liabilities P20,875
= 2.28
As you can see, The Cesni Company has a
current ratio of 2.28. That is, for every P1.00
the company owes in current liabilities, it has
P2.28 worth of current assets. Therefore, if the
Cesni Company's short-term debt was due
tomorrow, they would NOT have any difficulty in
paying their creditors. Moreover, they would
simply use the cash in their bank account ,
redeem their marketable securities, collect cash
from customers who owe them (Accounts
Receivable) and sell more products to
customers.
Banks like to see a current ratio
of at least 2 to 1 ; that is, for
every P1.00 a company owes in
short-term debt, it has P2.00 in
current assets. Note: the higher
the current ratio, the stronger
the company is thought to be.
SOURCE ACKNOWLEDGEMENT:

https://www.businessplanhut.com/liquidit
y-ratios-explained-examples-and-
calculations
 4. A sample financial statement and ask the learners to compute for the
ratios :

Sample Company Statement of Financial Position as of December 31, 2018

Assets Liabilities and Stockholders’ Equity

Cash Accounts Payable P 70,000.00
P 120,000.00
Marketable P 35,000.00 Short-term notes P 55,000.00
Securities
Accounts receivable P 45,000.00 Current liabilities P 125,000.00
Inventories P 130,000.00 Long-term debt P 2,700,000.00
Current assets P 330,000.00 Total liabilities P 2,825,000.00
Equipment P 2,970,000.00 Common stock P 500,000.00
Buildings P 1,600,000.00 Retained earnings P 1,575,000.00
Fixed Assets P 4,570,000.00 Stockholders’ equityP 2,075,000.00
Total Assets P 4,900,000.00 Total liabilities and equity P 4,900,000.00
SEAT WORK: (10 MINUTES)
Questions:
•Current assets is PHP2,000, current liabilities is PHP3,500. What is
current ratio?
•Inventory is PHP150. Accounts payable is PHP450. Cash and accounts
receivable total PHP800. What is the current ratio? Quick ratio?
•If current ratio is 1.7, what is the total accounts receivable if cash is
PHP20,000, inventory is PHP7,500, and accounts payable is
PHP30,000.
•Cash is 30% of total current assets. If current ratio is 2.3, what is the
new current ratio if total non-cash current assets grow by 50%?
Answer Key:
•Current ratio: 2,000/3,500 = 0.57
•Current ratio: (800 + 150)/450 = 2.11 Quick ratio: 800/450 = 1.78
•Total receivables: 1.7= (X+20,000+7500)/ 30,000 = 23,500
•Current ratio: 2.3 = (6,900 + 16,100)/ 10,000
Assuming an increase in noncurrent assets of 50%
New current ratio:(6,900 + 24,150)/ 10,000 = 3.105
Use hypothetical numbers to compute. .
QUICK RATIO:
Some conservative minded investors don't like to use
the current ratio as a indicator of whether or not a
company has the ability to pay its short term
obligations (debt). Instead, the quick ratio is used.
The quick ratio is similar to the current ratio with one
exception; that is, the quick ratio measures a
company's ability to pay its short-term debt, without
relying on the sale of its inventory. Therefore, in
calculating a quick ratio, business owners must
subtract the inventory from the current assets. The
formula used to calculate the quick ratio is as follows;
Quick Ratio = Current Assets - Inventories
Current Liabilities
The three items required in calculating the quick ratio can be obtained from a company's
balance sheet. Below shows the values of Cesni Company's current assets and current
liabilities on December 31, 200Y.
ASSETS: LIABILITIES:

Current Assets: Current Liabilities:

Cash P 2,550 Accounts Payable P 9,500

Marketable P 2,000 Short-term Bank Loan P11,375

securities
Account P16,675 Total Current P20,875
Receivable Liabilities
(Net)
Inventories P26,470

Total Current P47,695

Assets
As you can see, as of December 31, 200Y, the company's total
current assets are valued at P47,695, inventory valued at
P26,470, and current liabilities are valued at P20,875. Using
these amounts, the Cesni Company would calculate its quick
ratio as follows:

Quick = Current Assets - Inventories = P47,695 -

Ratio Current Liaibilities P26,470
P20,875
= 1.02
As shown above, the Cesni Company has a
quick ratio of 1.02. This means; for every P1.00
owed by the company in short-term debt, it has
P1.02 of current assets (excluding inventory).
In theory, if the Cesni Company did not sell any
more products, then it would have the ability to
pay all of its short-term debt using its current
assets; other than inventory. Note: the higher
the quick ratio, the stronger the company is
perceived to be. For further detail, please refer
to our detailed article on the Quick Ratio.
Liquidity Ratio Summary:
In summary, the liquidity ratios consist of the
Current Ratio and the Quick Ratio. The current
ratio is calculated by dividing the current assets
by the current liabilities. The quick ratio is
calculated by dividing the current assets
(excluding inventory) by the current liabilities.
Below summarizes the current ratio and the
quick ratio for the Cesni Company as of
December 31, 200Y.
Current = Current Assets = P47,695
Ratio Current Liabilities P20,875

= 2.28

Quick Ratio = Current Assets - Inventories = P47,695 -

Current Liabilities
P26,470
P20,875

= 1.02
Teacher Tip:
Emphasize the accounts needed in solving the ratios.
Note that accounts receivable can have a non-current
portion. Make sure it is removed from the current portion
in computing the liquidity ratios. Marketable securities
are short-term investments. Add that for receivables to be
considered current, they should be collected within a
year. Cite that property developers can be examples of
companies which can have accounts receivable-trade
beyond one year.
Define profitability.
Profitability refers to the
company’s ability to generate
earnings. It is one of the most
important goals of businesses.
Define the profitability ratios and
write the formulas in the board.
•These are the return on equity,
return on assets, gross profit
margin, operating profit margin,
net profit margin.
•Return on equity measures the
amount of net income earned in
relation to stockholders’ equity.
•ROE (return on equity) = Net
income ÷ Stockholders’ equity
•Return on assets measures the
ability of a company to generate
income out of its
resources/assets.
•ROA (return on asset) =
Operating income ÷ Total assets
•Gross profit margin shows how many pesos
of gross profit is earned for every peso of
sale. It provides information regarding the
ability of a company to cover its
manufacturing cost from its sales.
Remember that gross profit is just sales less
cost of goods or cost of services.
•Gross profit margin = Gross profit ÷ Sales
•Operating profit margin shows how many
pesos of operating profit is earned for
every peso of sale. It measures the
amount of income generated from the
core business of a company.
•Operating profit margin =Operating
income ÷ Sales
•Net profit margin measures how
much net profit a company
generates for every peso of sales
or revenues that it generates.
•Net profit margin = Net income ÷
Sales
Show a sample financial statement and compute for the financial ratios.
Answer Key:
Return on equity = 16.98% = 352,240/2,075,000
Return on assets = 7.19% = 352,240/4,900,000
Gross profit margin = 35% = 700,000/2,000,000
Operating profit margin = 25.05% = 501,000/2,000,000
Net profit margin = 17.61% = 352,240/2,000,000
The ROE of 16.98% means that for every PHP1 of stockholders’ equity, PHP0.1698 or
16.98 centavos was earned in 2014. To be more meaningful, this rate of return is
compared with the returns on alternative investments such as the returns on time
deposits and other fixed income instruments. For example, if the interest on time
deposits is only 2%, then the 16.98% ROE seems better. However, before a conclusion
is made that the 16.98% ROE is better than the time deposit rate of 2%, the risks
associated with this company earning 16.98% has to be assessed. Generally, the 2%
time deposit rate is guaranteed while the 16.98% ROE is not. In 2014, ROE of Sample
Company was high, but what if in the future, it will earn a negative ROE. Is this
possible for a company? Yes! No manager in his/or sound mind will guarantee a
specific rate of return, especially when that rate is relatively high. Why? Because in
business, there are always risks. A company which is doing so well this year may find
itself with too many competitors in the future and these competitors may eat its share
of the business in the market and can make a profitable company today a losing
company in the future.
 . The learners will compute the ratios of the sample companies and ask them to
compare the three companies using the ratios computed.

5. Summarize the discussion for today. Focus on how to interpret the profitability ratios.
5. Summarize the discussion for today. Focus on how to interpret the profitability ratios.
Teacher Tip:
Ask whether the high net income would mean
high net cash inflows to the business. This is not
necessarily the case. High net income might not
result to high cash flows for the company.
Remember that we use accrual method and not
cash method in accounting for net income. This
concept (quality of earnings) will be discussed in
detail in the following modules
..
EVALUATION (20 MINUTES)
•Provide a written true-or-false or multiple-choice quiz about solving and interpreting
profitability ratios.

1.Which of the following statements is true?

A.Gross profit margin is always less than net profit margin
B.Gross profit margin is always greater than net profit margin
C.Gross profit margin is can be less than or greater than net profit
margin

2.A business has a decreasing gross profit however, gross margin

percentage is constant. What could be the possible reason?
A.Sales is increasing, but cost of sales is decreasing
B.Sales and cost of sales increase by the same percentage
C.Sales and cost of sales decrease by the same percentage
Specific Learning Outcomes
At the end of the lesson, the learners will be able to :

•Define efficiency.
•Solve efficiency/activity ratios (accounts receivable turnover,
average collection period, average age of AR, or days sales
outstanding, inventory
turnover, average age of inventory or days in inventory,
accounts payable turnover, average age of payables, average
payment period, or days in accounts payable, total asset
turnover, operating cycle, and cash conversion cycle.
•Analyze,
interpret, and compare the efficiency ratios of sample
companies.
 Define efficiency.
Solve for efficiency/activity/turnover ratios (accounts
receivable turnover, average collection period, average age
of AR, or days sales outstanding, inventory turnover, average
age of inventory or days in inventory, accounts payable
turnover, average age of payables, average payment period,
or days in accounts payable total asset turnover, operating
cycle, and cash conversion cycle)
• Analyze, interpret, and compare the efficiency ratios of sample
Philippine companies
MOTIVATION (5 minutes)
1.Ask the learners if they have tried buying from sari-sari stores on
credit. How many days were given to them as the “credit period” or
the period within which they needed to pay? Do they strictly follow
this credit period? When do they actually pay?
2.This time, ask them about the consequences of paying much later than
the credit period on the operations of the sari-sari stores with respect
to their obligations. Will it create problems for the sari-sari store if,
for example, it has a due obligation tomorrow but none of its
customers have paid their obligations yet?
Now ask them if a shorter credit period, by itself, is always better than a
longer credit period or does the length depend on other factors.
4. Write their answers on the board
The following table summarizes the possible effects of changes in credit terms (tenor).

Short Credit Long Credit

Period Period

Effect on sales Decrease Increase

Effect on AR Decrease Increase

Effect on Bad Debt Decrease Increase

Expense*
Define efficiency.
•Efficiency refers to a company’s ability to be efficient
in its operations. Specifically, it refers to the speed
with which various current accounts are converted
into sales, and ultimately, cash.
•You may refer back to the sari-sari store example to
illustrate the meaning of efficiency (in that example,
the credit period is the target speed with which the
store goals to collect their receivables).
. Define the efficiency ratios and write the formulas.
•Accounts receivable turnover
•Average collection period, otherwise known as average age
of AR, days’ receivable or days sales outstanding
•Inventory turnover
•Average age of inventory or days’ inventory
•Accounts payable turnover
•Average age of payables, average payment period, or days’
payable
•Total asset turnover
•Operating cycle
•Cash conversion cycle
Sample Company Statement of Financial Position as of December 31, 2018

ASSETS LIABILITIES AND STOCKHOLDERS’

EQUITY
Cash P 120,000.00 Accounts Payable P 70,000.00

Marketable Securities P 35,000.00 Short-term notes P 55,000.00

Accounts Receivable P 45,000.00 Current Liabilities P 125,000.00

Inventories P 130,000.00 Long-term debt P 2,700,000.00

Current Assets P 330,000.00 Total Liabilities P 2,825,000.00

Equipment P 2,970,000.00 Common stock P 500,000.00

Buildings P 1,600,000.00 Retained earnings P 1,575,000.00

Fixed Assets P 4,570,000.00 Stockholders’ equity P 2,075,000.00

Total Assets P 4,900,000.00 Total liabilities and equity P 4,900,000.00

Sample Company Statement of Financial Performance for the Year Ended December 31, 2018
Answer Key:
(provide that the beginning inventory is P 247,000):
•Accounts receivable turnover: 44.4x
•Average collection period: 8.2 days
•Inventory turnover: 10x
•Average age of inventory: 36.5 days
•Accounts payable turnover: 18.57x
•Average payment period: 19.65 days
•Total asset turnover: 0.41x
•Operating cycle: 44.7 days
•Cash conversion cycle: 25.05 days
FIND OUT THE ANSWER OF THE FOLLOWING USING THE GIVEN FORMULA:

(provide that the beginning inventory is P 247,000):

•Accounts receivable turnover:
•Average collection period:
•Inventory turnover:
•Average age of inventory:
•Accounts payable turnover:
•Average payment period:
•Total asset turnover:
•Operating cycle:
•Cash conversion cycle:
PRACTICE (20 MINUTES)

(Easy)
•Total asset is PHP750,000. Sales is PHP1,500,000. What is the
total asset turnover?
•Accounts receivable turnover is 4. What is the average
collection period assuming annual data are used? What is the
average collection period assuming quarterly data are used?
•Sales for the year amount to PHP100,000. Accounts
receivable amount to PHP12,000. What is the average
collection period assuming annual data are used? What is the
average collection period assuming quarterly data are used?
Average/Difficult)
A.The quick ratio is 1.7 while the current ratio is 2.5. The current liabilities
amount to PHP5,000. Cost of goods sold is PHP52,500. What is the inventory
turnover? Average age of inventory?
B.Beginning inventory is PHP2,000 while ending inventory is PHP5,000. Cost of
goods sold is double the ending inventory and accounts payable is PHP4,000.
What is accounts payable turnover? Average payment period?
C.Ending inventory is PHP13,000 while accounts payable is PHP2,500.
Purchases were half the ending inventory. What is accounts payable turnover?
Average age of payables?
D.Current assets amount to PHP30,000 while noncurrent assets are
PHP50,000. Sales amount to PHP200,000. What is the total asset turnover?
E.Based on your answers from letters c, d, and e, what is the operating cycle of
the company? Cash conversion cycle?
Answer Key:
•Total asset turnover = 1.5M/750K = 2
•Average collection period: 365/4 = 91.25
•Average collection period = 43.8 days, Accounts receivable turnover = 8.3x
•Inventory turnover = 13.1x, Average age of inventory = 27.8 days
•Accounts payable turnover = 3.25x, Average payment period = 112.3 days
•Accounts payable turnover = 2.6x, Average age of payables = 140.4 days
•Total asset turnover = 2.5x
•Operating cycle = 71.6 days, Cash conversion cycle = (40.7) days