Senior High School

Fundamentals of
Accountancy, Business
and Management 2
Module 5: Measurement Levels

AIRs - LM
LU_FABM 2_Module5
ABM-FUNDAMENTALS OF ACCOUNATNCY, BUSINESS AND MANAGEMENT 2
Module 5: Measurement Levels
Second Edition, 2021

Copyright © 2021
La Union Schools Division
Region I

All rights reserved. No part of this module may be reproduced in any form without written
permission from the copyright owners.

Development Team of the Module

Author: Oliver N. Ancheta, T II

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Office Address: Flores St. Catbangen, San Fernando City, La Union
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LU_FABM 2_Module5
 Senior High School

Fundamentals of
Accountancy, Business
and Management 2
Module 5: Measurement Levels

LU_FABM 2_Module5
Introductory Message
This Self-Learning Module (SLM) is prepared so that you, our dear learners,
can continue your studies and learn while at home. Activities, questions, directions,
exercises, and discussions are carefully stated for you to understand each lesson.

Each SLM is composed of different parts. Each part shall guide you step-by-
step as you discover and understand the lesson prepared for you.

Pre-tests are provided to measure your prior knowledge on lessons in each

SLM. This will tell you if you need to proceed on completing this module or if you
need to ask your facilitator or your teacher’s assistance for better understanding of
the lesson. At the end of each module, you need to answer the post-test to self-check
you’re learning. Answer keys are provided for each activity and test. We trust that
you will be honest in using these.

In addition to the material in the main text, Notes to the Teacher are also
provided to our facilitators and parents for strategies and reminders on how they can
best help you on your home-based learning.

Please use this module with care. Do not put unnecessary marks on any part
of this SLM. Use a separate sheet of paper in answering the exercises and tests. And
read the instructions carefully before performing each task.

If you have any questions in using this SLM or any difficulty in answering the
tasks in this module, do not hesitate to consult your teacher or facilitator.

Thank you.

LU_FABM 2_Module5
 Target

Financial Statement (FS) Analysis

Financial Statement (FS) Analysis is the process of evaluating risks,

performance, financial health, and future prospects of a business by subjecting
financial statement data to computational and analytical techniques with the
objective of making economic decisions. There are three kinds of FS analysis
techniques:

- Horizontal analysis

- Vertical analysis

- Financial ratios

In your previous lesson, you have learned about the components and
structure of a Cash-flow Statement and how to prepare it.

In this module, you will be provided with information and activities that will
help you define the different measurement levels. (Liquidity, Solvency and
Profitability ratios) simply called the “Financial Ratios” which are used for financial
statement analysis.

After going through this module, you are expected to:

1. Define the measurement levels, namely, profitability, efficiency and financial

health (liquidity and solvency). (FABM_FABM12-Ig-h12)

Before going on, check how much you know about this topic. Answer the
pretest on the next page in a separate sheet of paper.

Pretest:
Instructions: The following formulas listed below came from the definitions of the
different ratios. Identify the ratio represented in each formula. Write the letter of your
correct answer from the space provided beside the number. Write capital letters only.

Gross Profit
1. Net Sales
A. Acid Test Ratio B. Current Ratio
C. Gross Profit Ratio D. Profit Margin Ratio

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 Net Income
2.
Total Assets
A. Gross profit ratio B. Profit Margin Ratio
C. Return on Asset D. Return on Equity

Total Liabilities
3.
Total Assets
A. Asset Turnover B. Debt to Equity
C. Debt to Total Asset D. Working Capital

Net Credit Sales

4.
Average Accounts Receivable

A. Accounts receivable turnover B. Asset turn over

C. Average collection period D. Working capital

Operating Expense
5. Net Sales
A. Gross profit B. Operating expense to net sales
C. Profit margin D. Return on investment
Total Liabilities
6.
Stock Holder’s Equity

A. Asset Turnover B. Debt to Equity

C. Debt to Total Asset D. Working Capital
Cost of goods sold
7. Average Inventory

A. Accounts Receivable turnover B. Average days in inventory

C. Inventory turnover D. Number of days in inventory

8. Average collection period + Average age of inventory

A. Accounts Receivable Turnover B. Average days in inventory

C. Inventory turnover D. Number of days in operating cycle

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 365
9. Accounts Receivable Turnover

A. Accounts Receivable Turnover B. Average collection period

C. Inventory turnover D. Number of days in inventory

10. 365
Inventory Turnover

A. Accounts Receivable Turnover B. Average days in inventory

C. Inventory turnover D. Average collection period

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 Jumpstart

For you to understand the lesson well, do the following activities. Have fun and good
luck!

Activity 1: Read Me, Understand Me!

Directions: Read and understand the following definition of the different
measurement levels.

1. Horizontal analysis – The company compares their own financial statements for
the current period with their financial statements from the prior period.
2. Vertical Analysis – The company expresses items of a certain financial statement
as a percentage of a given base amount.
3. Ratio analysis – It expresses the relationship among selected items of financial
statement data. The relationship is expressed in terms of a percentage, a rate, or
a simple proportion.

Directions: Choose your answer from the given choices.

1. What is the measurement level that expresses the relationship among selected
items of financial statement data in terms of percentage, rate or a simple
proportion?
A. Horizontal analysis B. Liquidity
C. Ratio analysis D. Solvency

2. What financial ratio is used to measure the ability of the company to generate
income from the use of its assets and invested capital?
A. Liquidity B. Profitability C. Solvency D. Stability

3. Which of the following measures the capability of an entity to pay long term
obligations as they fall due?
A. Liquidity B. Operational efficiency
C. Profitability D. Solvency

4. Which of the following measures the capacity of the company to pay its currently
maturing obligations?
A. Liquidity B. Profitability C. Stability D. Solvency

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 Discover

FINANCIAL RATIOS. A Financial Ratio is composed of a numerator and a

denominator. It expresses the relationship between specific financial statement data.
The resulting ratio may be interpreted as a percentage, a rate or a proportion. Take
for example a company with sales of Php1,000,000 and net income of Php100,000.
If we take the ratio of net income divided by sales, the result is 10%. We can
understand this as “net income is 10% of sales.” We can also look at it as a rate or
proportion. There are many ratios used in business. These ratios are generally
grouped into three categories: (a) profitability, (b) liquidity, and (c) solvency
1. 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. A good
liquidity position would encourage banks or financial institutions to lend while a
bad liquidity position may scare off potential creditors. The following are the
different profitability ratios:
a. Gross Profit Ratio – This is the proportion of the gross profit of the company
with its net sales. It is computed as Gross profit over Net Sales
b. Net Profit Ratio – This ratio measures the proportion between the Net Income
(or Net Income After Tax) and the Net Sales of the Company. In formula form,
we have Net Income as the numerator and the Net Sales as denominator.
c. Operating Income Ratio – This ratio can be computed by dividing the operating
income by the total net sales.
d. Return on Investment
i. Return on Assets – Means how much income is generated by the use of the
total assets. It can be computed by getting the quotient of the Net Income
(or Net Income After Tax) over the total assets.
ii. Return on Equity (Return on Capital) – This is a slight variation of the
Return on Assets. Instead of using the total assets as the denominator the
Stock Holder’s Equity is used (for corporation) or Owner’s Equity (Sole
proprietor).
e. Asset Turnover Ratio – This ratio measures the correlation between the assets
owned by the company and the net sales generated by such properties.

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Consider the Financial statements given below:
Excerpt from the Statement of Financial Position:

P 200,000 Accounts Payable P 300,000

Cash
400,000 Notes Payable 400,000
Accounts Receivable
250,000 Owner, Capital 700,000
Inventory

Equipment 550,000
Total Liabilities and P1,400,000
Total Assets P1,400,000
Equity
Table 1: Sample Statement of Financial Position

Excerpt from the Statement of Comprehensive Income:

Sales P900,000
Note: Operating income is
Cost of Goods Sold 400,000
different from net income.
Gross Profit 500,000 Operating income does not
Operating Expenses 200,000 include interest expense. Interest
Operating Income 300,000 expense is classified as financing
Interest Expense 20,000 expense. To get the net income,
Net Income 280,000 simply decrease the operating
income by the interest expense.

Table 2: Sample Statement of Comprehensive Income

Simple computation of profitability ratios using table 1 and 2.

Name of Ratio Formula Sample Computation

Gross Profit 500,000

Goss profit Ratio = 55.56%
Net Sales 900,000

Net Income 280,000

Net Profit Ratio = 31.11%
Net Sales 900,000

Operating Income 300,000

Operating Income Ratio = 33.33%
Net Sales 900,000

Net Income 280,000

Return on assets = 20%
Average Assets 1,400,000

Net Income 280,000

Return on equity = 40%
Average Equity 700,000

Total Assets 1,400,000

Asset Turnover Ratio = 155%
Net Sales 900,000

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2. Liquidity is the capacity of a company to pay its currently maturing obligations.
The following are the different liquidity ratios:

a. Working Capital- It is obtained by subtracting current liabilities from current

assets. A positive working capital is preferred because it would mean that there
are enough current assets to pay all of the current liabilities at the moment.
On the other hand, a negative working capital is to be avoided because it would
mean that the company will surely default on some of their current obligations.

b. Current Ratio – This is the quotient of Current Assets over Current Liabilities.
As much as possible, a “whole number” current ratio is preferred. For example,
a current ratio of three would mean that the company has Php3 worth of
current assets for every Php1 of current liabilities. It means that there would
be Php2 left after the payment of currently maturing obligations.

c. Acid Test Ratio – Quick Assets (Cash, Receivables and Trading Securities) over
Current Liabilities. It removes inventory and prepaid assets from the
computation. Cash, Receivables and Trading Securities are more liquid than
Inventory and Prepaid Expenses. A whole number is more preferred. It means
that the company has the capability to pay its currently maturing obligations
through its quick assets.

d. Accounts Receivable Turnover Ratio – This ratio measures the frequency of

conversion of the company’s Accounts Receivable back to cash. The ratio could
be obtained by dividing net credit sales over average Accounts Receivable. If
the total net credit sales are not available for most companies, the company
could make use of the total net sales. As much as possible, the goal of the
company is to have a higher Accounts Receivable (A/R) Turnover Ratio. If the
turnover ratio is very low, the company is having trouble in collecting its
receivables. This is not good for the company. It signifies that the company is
running out of current funds. If this will continue, the operating cycle will be
longer than usual and the receivables uncollected may also be declared as
doubtful accounts expense. When this scenario happens, the company will
suffer great loss.
e. Average Collection Period – The average collection period states the usual
number of days that it would take before the company would be able to collect
a certain group of receivables. The shorter the average collection period, the
better. It means that the company is efficient in collecting its Accounts
Receivable. To compute (the numerator could be either 360 or 365) divide 365
days over Accounts Receivable turnover ratio.

f. Inventory Turnover Ratio – This ratio measures the number of times the
company was able to sell its entire inventory to customers during the year. The
numerator for this formula would be the company’s Cost of Goods Sold and
the denominator would be its Average Inventory. As much as possible, the goal
is to have a high inventory turnover ratio. By having such, it will mean that the

LU_FABM 2_Module5
 company is being more effective in selling its inventory to customers. Unsold
goods for a long period of time may lead to the obsolescence of inventory. This
will also tie up the company’s cash resources to its Inventory. This Scenario is
not favorable to the company’s liquidity situation.

g. Average Days in Inventory – This ratio computes the number of days that it will
take before a group of inventories will be entirely sold by the company. The
company can make use of 360 or 365 as their numerator and will make use of
the Inventory turnover ratio for the denominator.

h. Number of Days in Operation Cycle – This is the measure on how long will it
take for the company to transform its inventory back to cash. This is the
combination of the average collection period and the average age of inventory.
It is obtained by adding collection period and average age of inventory. The goal
is to always have a shorter number of days in the operating cycle. A shorter
number will indicate that the company will have additional cash at an earlier
time.

Simple computation of liquidity ratios using table 1 and 2.

Name of Ratio Formula Sample Computation

Working Capital Current Assets 850,000

= 550,000
Current Liabilities 300,000

Current ratio Current Assets 850,000

= 2.83 x
Current Liabilities 300,000

Acid Test ratio Quick Assets 600,000

= 2x
Current Liabilities 300,000

Accounts Receivable Net Credit Sale 900,000

Turnover ratio = 2.25x
Average Accounts Receivable 400,000

Average Collection 365 365

Period = 162.22x
Accounts Receivable turnover 2.25
ratio

Inventory Turnover ratio Cost of Goods Sold 400,000

= 1.6x
Average Inventory 250,000

Average days in 365 365

inventory
= 228.13x
Inventory turnover ratio 1.6

Number of days in Collection period + Ave. days 162.22 + 228.13 = 390.35

operating cycle in inventory

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Note: Observe that acid test ratio, current ratio and turnover ratios are expressed as “number of times”.
For example, Current ratio is “2.83X” which reads as “2 point eighty-three times”. This means that there
are 2 pesos and 83 centavos for every one peso of current liabilities.
3. Solvency ratios measure the capability of an entity to pay long term obligations
as they fall due.

a. Debt to Total Assets Ratio – As the term implies, this is just the proportion
between the total liabilities of the company with its total assets. The debt ratio
show how much of the assets of the company were given by creditors. As much
as possible, current assets of the company were given by creditors. As much
as possible, current and prospective creditors would want a very low debt to
total assets ratio. There is a bigger probability of collection in the future if there
are fewer liabilities to pay.

b. Debt to Equity Ratio – Instead of assets, the debt-to-equity ratio compare the
liabilities of the company with its equity. A small debt to equity ratio would
indicate a healthier solvency position for the company.

c. Times Interest Earned Ratio – Shows the proportion between the Earnings
before Interest and taxes (EBIT) of the Company and its Interest Expense. It is
an indicator on how many times the Earnings Before Interest and Taxes (EBIT}
can cover the finance cost of borrowing.

Simple computation of solvency ratios using table 1 and 2.

Name of Ratio Formula Sample Computation
Debt to total asset Total Liabilities 700,000
ratio = 50%
Total Assets 1,400, 000

Debt to equity ratio Total Liabilities 700,000

= 100%
Owner’s Equity 700,000

Times Interest earned Net Income 280,000

ratio = 14x
Interest Expense 20,000

LU_FABM 2_Module5
 Explore

Here are some enrichment activities for you to work on to master and
strengthen the basic concepts you have learned from this lesson.

Enrichment Activity 1: The Three categories of Financial Ratios.

Instructions: Recall the definition of the three categories of financial ratios
(Profitability, Liquidity and solvency). Classify each of the ratios given below.
Write P for Profitability, L for Liquidity and S for Solvency. Write your answer
on a separate sheet of paper. Use capital letters only.
_____1. Gross profit margin ratio

_____2. Times interest earned ratio

_____3. Number of days in operating cycle
_____4. Return on assets
_____5. Asset turnover ratio
_____6. Acid test ratio
_____7. Average collection period
_____8. Operating income ratio
_____9. Working capital
_____10. Average days in inventory

Enrichment Activity 2: Financial Ratio Formulas

Instructions: The following formulas listed below came from the definitions of
the different ratios. Identify the ratio represented by the formula from the
given choices. Write your answer in a separate sheet of paper. Write capital
letters only.
Gross profit
_____1. Net Sales

A. Acid Test Ratio B. Current Ratio

C. Gross Profit Ratio D. Profit Margin Ratio

Net Income
_____2. Total Assets
A. Gross profit ratio B. Profit Margin Ratio
C. Return on Asset D. Return on Equity
10

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_____3. Total Liabilities
Total Assets

A. Asset Turnover B. Debt to Total Asset

C. Debt to Equity D. Working Capital

Net Credit Sales

_____4.
Average Accounts Receivable
A. Accounts receivable turnover B. Asset turn over
C. Average collection period` D. Working capital

Operating Income
_____5. Net Sales
A. Gross profit B. Operating income ratio
C. Profit margin D. Return on investment

Total Liabilities
_____6. Stock Holder’s Equity
A. Asset Turnover B. Debt to Total Asset
C. Debt to Equity D. Working Capital

Cost of Goods Sold

_____7. Average Inventory

A. Accounts Receivable turnover B. Average days in inventory

C. Inventory turnover D. Number of days in operating
cycle

_____8. Average collection period + Average age of inventory

A. Accounts Receivable Turnover B. Average collection period
C. Inventory turnover D. Number of days in operating cycle

365
_____9. Accounts Receivable Turnover

A. Accounts Receivable Turnover B. Average collection period

C. Inventory turnover D. Number of days in inventory

_____10. 365
Inventory Turnover
A. Accounts Receivable Turnover B. Average days in inventory
C. Inventory turnover D. Number of days in operating cycle

11

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 Deepen

Activity I. Consider the given Financial Statements of C&F Store.

C&F Store
Statement of Financial Position
As of December 31, 2014

2014 2013

110,000 87,400
Cash
90,000 69,920
Accounts Receivable
129,000 218,500
Inventory
12,000 4,370
Prepaid Rent
550,000 493,810
Delivery Van
891,000 874,000
Total Assets
75,000 67,298
Accounts Payable
400,000 393,300
Loans Payable
416,000 413,402
Anistle Cruz, Capital
891,000 874,000
Total Liabilities and Capital

Table 3: Statement of Financial Position of C & F Store

C&F Store
Statement of Comprehensive Income
For the period ending December 31, 2014

2014 2013

810,000 686,000
Sales
348,300 301,750
Cost of Goods Sold
461,700 384,250
Gross Profit
234,900 205,800
Operating Expenses
226,800 178,450
Operating Income
40,500 17,150
Interest Expense
186,300 161,300
Net Income

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Table 4: Statement of Comprehensive Income of C & F Store
Directions: Show the formula and the simple computation using the definition of
each Financial Ratios given below. (Note: Use the Current Year “2014” in computing
the ratios. The preceding year “2013” will only be used to compute for the averages.)
1. Profitability ratios
Name of Ratio Formula Computation
Goss Profit Ratio
Net Profit Ratio
Operating Income Ratio
Return on assets
Return on equity

2. Liquidity ratios
Name of Ratio Formula Sample Computation
Working Capital

Current ratio
Acid Test ratio

Accounts Receivable Turnover ratio

Average Collection Period
Inventory Turnover ratio
Average days in inventory
Number of days in operating cycle

3. Solvency ratios
Name of Ratio Formula Sample Computation
Debt to total asset ratio
Debt to equity ratio

Times Interest earned ratio

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LU_FABM 2_Module5
Rubric for Individual Work
CRITERIA
0 1 2 3 4
No Emergent Developing Capable Strong
Response
Off topic
Response No Limited Basic Complete
UNDERS- does not understand- understanding understanding understand-
TANDING
fit the ding of the of the of the problem- ding of the
given problem problem- Identifies all problem –
problem/t Identifies a few elements of Identifies all
ask elements of the problem and elements of
problem and gives correct problem and
may give answer gives correct
incorrect answer
answer
Computation Computation Computation is All computation
COMPUTATION Did not is incorrect is generally generally is complete and
identify incorrect correct and correct
the and/or complete but
correct incomplete may contain
values minor flaws
Totally Disorganized Organized Organized
ORGANIZATION incorrect thinking with thinking using thinking using
No attempt to unclear or at least one multiple
Attempt represent non-existent representation representations
thinking representation
Totally Unclear or Understandable Thorough and
EXPLANATION incorrect incomplete written/verbal concise
Unable to written/verb written/verbal explanation written/verbal
be read al explanation explanation
explanation
No evidence Inappropriate At least one At least one
STRATEGIES of strategies strategy is appropriate appropriate
No shown shown or strategy is strategy is
Attempt explained shown or completely
explained with shown or
possible minor explained.
flaws

14

LU_FABM 2_Module5
 Gauge

Congratulations! You’ve gone this far. Now let us try your progress.

Posttest:
Directions: Read carefully each item. Write the capital letter of your best answer on
each test item. Use a separate sheet for your answers.
1. What is the ratio that pertains to the capacity of a company to pay its currently
maturing obligations which are very important to short term creditors.?
A. Efficiency B. Liquidity C. Solvency D. Stability

2. What liquidity ratio is represented by quotient of current assets to current

liabilities?
A. Accounts receivable turnover B. Acid Test
C. Current Ratio D. Working capital

3. What is the difference if you will subtract current liabilities from current assets?
A. Accounts receivable turnover B. Acid Test
C. Current D. Working capital

4. Which Financial ratios measure the capability of an entity to pay long term
obligations as they fall due?
A. Efficiency B. Liquidity C. Solvency D. Stability

5. Which ratio compares the liabilities of the company with its equity?
A. Debt to equity ratio B. Debt to total assets ratio
C. Gross profit D. Profit margin ratio

II. Instructions: The following formulas listed below came from the definitions of the
different ratios. Identify the ratio represented in each formula. Write the letter of your
correct answer from the space provided beside the number. Write capital letters only.

Gross Profit
6.
Net Sales
A. Acid Test Ratio B. Current Ratio
C. Gross Profit Ratio D. Profit Margin Ratio

15

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 Net Income
7.
Total Assets
.
A. Gross profit ratio B. Profit Margin Ratio
C. Return on Asset D. Return on Equity

Total Liabilities
8.
Total Assets
A. Asset Turnover B. Debt to Total Asset
C. Debt to Equity D. Working Capital

Net Credit Sales

9.
Average Accounts Receivable

A. Accounts receivable turnover B. Asset turn over

C. Average collection period D. Working capital

Operating Income
10.
Net Sales

A. Gross profit B. Operating income to net sales

C. Profit margin D. Return on investment

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Answer Key

17

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 LU_FABM 2_Module5
18
Post test:
1. B
2. C
3. D
4. C
5. A
6. C
7. C
8. B
9. A
10.B
References:
Printed Materials:

Commission on Higher Education. (2016). Teaching Guide for Senior High School in
Fundamentals of Accountancy, Business and Management (pp. 78-99). Diliman,
Quezon City.
Salazar, Dani Rose C, (2017). Fundamentals of Accountancy, Business and
management 2. Manila Philippines: Rex Bookstore, Inc.
Beticon, Josefina L. (2016). Fundamentals of Accountancy, Business and Management
2. Quezon City Philippines: Vibal Group, Inc.

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 For inquiries or feedback, please write or call:

Department of Education – SDO La Union

Curriculum Implementation Division
Learning Resource Management Section
Flores St. Catbangen, San Fernando City La Union 2500
Telephone: (072) 607 - 8127
Telefax: (072) 205 - 0046
Email Address:
[email protected]
[email protected] 20

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