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G12 Fabm2 Week 8
G12 Fabm2 Week 8
Statements
Week 8 (topic is a Continuation to week 7)
Solvency Ratios
Solvency ratios measure the capability of an entity to pay long term obligations as they
fall due. Creditors of the company’s long term payable and bond payable will be
interested in knowing its solvency ratios.
1. Debt to Total Assets Ratio
This is the proportion between the total liabilities of the company and its
total assets. The debt ratio shows how much of the assets of the company
were given by creditors. As much as possible, current and prospective
creditors want a very low debt to total assets ratio.
Formula: Debt to Total Assets Ratio = Total Liabilities / Total Assets Using the
GSM Company data, we would be able to compute the company’s debt to total
assets ratio for 2018 and 2019.
2018 2019
Total Liabilities 1,600,000.00 1,850,000.00
Divided by: Total Assets 2,300,000.00 2,700,000.00
Debt to Total Assets Ratio .69 .68
Analysis: Comparing the data for the two years involved, it can be seen that there
is a minimal change in the debt ratio of the company. This means that in 2018,
out of the total assets of the company, 69% was being financed by creditors. A
high debt to asset ratio implies a high level of debt.
Analysis: Comparing the times interest earned ratio of the company for two
periods, it can be seen that the company is very solvent in the year 2018
compared to that in 2019. It is 10 times more solvent to pay the interest with its
income before tax.
Profitability Ratios
Profitability ratios measure the ability of the company to generate income from the use
of its assets and invested capital as well as control its cost. The following are the
commonly used profitability ratios:
1. Gross Profit Ratio
This is the proportion of the gross profit of the company with its net sales.
Gross profit is the difference between the net sales of the company and its
cost of goods sold. A company should aim for a bigger gross profit ratio. A
large gross profit ratio shows that a company can generate more sales
from the smaller cost of goods sold that it has.
Formula: Gross Profit Ratio = Gross Profit / Net Sales
Using the GSM Company data, we would be able to compute the company’s gross
profit ratio for 2018 and 2019.
2018 2019
Gross Profit 4,000,000.00 4,500,000.00
Divided by: Net Sales 5,000,000.00 5,800,000.00
Gross Profit Ratio 80% 77.59%
Analysis: This means that for every P 1.00 the company sells, P .80 goes to the
gross profit in the year 2018. The company’s gross profit ratio slightly decreased
in 2019. This should be avoided or at least be minimized. The gross profit ratio
can be improved by continuously finding inventories with lower cost, without
sacrificing quality.
2. Profit Margin Ratio
The profit mentioned here is the Net Income After Tax (NIAT). This ratio
measures the proportion between the NIAT and the Net Sales of the
company. This is a more precise measurement of the company’s
profitability because it has already considered the operating expenses and
other expenses of the entity. Companies want a high profit margin ratio.
Formula: Gross Margin Ratio = Net Income after Tax / Net Sales
Using the GSM Company data, we would be able to compute the company’s gross
margin ratio for 2018 and 2019.
2018 2019
Net Income after Tax 2,350,000.00 2,000,000.00
Divided by: Net Sales 5,000,000.00 5,800,000.00
Gross Margin Ratio 47% 34.48%
Analysis: This means that company earned P .47 for every P 1.00 of sales in the
year 2018. The company’s gross margin ratio shows a decline for the year 2019.
This can be attributed to the lower NIAT coupled by an increase in Net Sales.
4. Return on Assets
Before profits can be realized, certain investments should be made. In this
case, assets will be used for the different projects of the company. The
goal is to generate profit based on the available assets during the year.
Thus, the company aims for a higher return on assets.
Formula: Return on Assets = NIAT / Total Assets
Using the GSM Company data, we would be able to compute the company’s
return on assets for 2018 and 2019.
2018 2019
Net Income After Tax 2,350,000.00 2,000,000.00
Divided by: Total Assets 2,300,000.00 2,700,000.00
Return on Assets 1.02 0.74
Analysis: Comparing the data for the two years involved shows that in the year
2018 the return on assets is very high compared to the year 2019. This can be
attributed to a much higher income compared to the assets of the company.
5. Return on Equity
This is a slight variation of the earlier formula. In this case, it is the average
owner’s/stockholder’s equity that will be used as a denominator. This is a
more specific computation of a company’s profitability because the
denominator being used is the one coming from stockholders/owners
alone.
Formula: Return on Equity = NIAT / Owner’s Equity
Using the GSM Company data, we would be able to compute the company’s
return on equity for 2018 and 2019.
2018 2019
Net Income After Tax 2,350,000.00 2,000,000.00
Divided by: Owner’s Equity 700,000.00 850,000.00
Return on Equity 3.36 2.35
Analysis: In 2019, the return on equity decreased. This could be attributed to a
lower net income after tax and a larger owner’s equity.
Analysis: The assets turnover ratio slightly decreased in 2019. This is something
not good because the company should aim for a higher assets turnover ratio. This
can be attributed to bigger net sales generated for that year.
What’s More
Instruction: Now that you have already finished learning the concepts, let us see what
you have learned so far by supplying the appropriate word(s) on the blank.
Required:
Now, that you are finished accomplishing the module, let us check further what
you have learned. Answer the questions given below by encircling the letter of the correct
answer.
7. This is the entity’s ability to meet long term obligations as they become due.
A. Liquidity
B. Solvency
C. Profitability
D. None of the above
9. Is the quotient of the current assets divided by the current liabilities of the
company?
A. Current ratio
B. Working capital ratio
C. Acid test ratio
D. None of the above
10. This ratio measures the proportion between the net income after tax and the net
sales of the company.
A. Profit margin ratio
B. Gross profit ratio
C. Both A & B
D. None of the above