Deck 6: Analysis and Interpretation of Financial Statements

Question 1

Because a company's inventory is less liquid than its other current assets, when investors are assessing liquidity they should examine the:

A) debtors turnover ratio.
B) current ratio.
C) acid test ratio.
D) debt-equity ratio.

Answer 1

C

Question 2

The current market price of Fixit Ltd's ordinary shares is $5.00 each. If the latest earnings per share is $0.50, the company's price-earnings ratio is:

A) 20 times.
B) 10 times.
C) 2.0 times.
D) 2.5 times.

Answer 2

B

Question 3

The ratio that helps to measure the risk involved in financing a business with borrowed funds is the:

A) current ratio.
B) profit margin ratio.
C) interest cover ratio.
D) asset turnover ratio.

Answer 3

C

Question 4

The current ratio measures:

A) investments.
B) liquidity.
C) profitability.
D) use of assets.

Question 5

If the turnover period for debtors is 8.1 times per annum, the average number of days it takes to collect cash from debtors is:

A) 45 days.
B) 81 days.
C) 295 days.
D) 60 days.

Question 6

If the price-earnings ratio is 8 times, the earnings yield is:

A) 12.5%.
B) 8%.
C) 80%.
D) 10%.

Question 7

Blue Company reported:

A) $1.80
B) $2.50
C) $1.50
D) $3.00

Question 8

Which of these is not a limitation of ratio analysis?

A) Firms of different size cannot be compared.
B) One ratio is not enough information to make an overall judgement.
C) Different accounting methods used by competitors.
D) All are limitations.

Question 9

Workshafter Ltd has provided the following information from its financial statements for the year ended 30 June 2015. The company trades 365 days per year. The number of times Workshafter Ltd's debtors turned over for 2015 is:

A) 1.8 times.
B) 5.0 times.
C) 2.0 times.
D) 3.8 times.

Question 10

The ratios that are specifically concerned with assessing the returns and performance of shares held for investment purposes are the:

A) investment ratios.
B) efficiency ratios.
C) liquidity ratios.
D) gearing ratios.

Question 11

Which of these is not an efficiency ratio?

A) current ratio
B) asset turnover period
C) average inventory turnover period
D) average settlement period for debtors

Question 12

Solvency refers to the ability of an entity to:

A) improve sales.
B) earn a high rate of profit.
C) meet its long-term obligations.
D) A and B

Question 13

Success Ltd has a price-earnings ratio of 5 and earnings per share of 22 cents. Its issued capital consists of 2,000,000 $1 ordinary shares. The market price per share is:

A) $1.0
B) $1.10
C) $4.40
D) none of the above.

Question 14

A firm has total assets of $800,000 and total liabilities of $300,000. Earnings before interest and taxes are $100,000. Interest is $21,000 and taxes are $34,000. The return on shareholders' funds is:

A) 9.0%.
B) 8.0%.
C) 12.5%.
D) 3.8%.

Question 15

U2 Ltd is considering whether to offer trade credit to A1 Ltd. The ratio from A1's accounts that will be most useful in assessing the firm's ability to repay its trade debts on time is the:

A) gearing.
B) average settlement period for trade payables.
C) interest cover.
D) asset turnover period.

Question 16

A good benchmark to compare business performance during a given period is:

A) competitor's performance.
B) industry averages.
C) past performance.
D) all of the above.

Question 17

Blue Company reported: The price-earnings ratio per ordinary share is:

A) 7.2:1
B) 1.8:1
C) 5.0:1
D) 3.0:1

Question 18

The ratios that measure the degree of risk associated with borrowing money from outsiders to finance the business are the:

A) liquidity ratios.
B) investment ratios.
C) efficiency ratios.
D) gearing ratios.

Question 19

Which user would be interested in examining the results of the profitability and gearing ratios?

A) long-term lenders
B) shareholders
C) potential investors
D) all of the above

Question 20

Solvent Ltd has a quick ratio of 1.2:1 and its current liabilities amount to $200,000. If it purchased $40,000 of inventory on credit, its quick asset ratio would be:

A) higher.
B) unable to be calculated.
C) unaffected by the transaction.
D) lower.

Question 21

The statement concerning the average settlement period for creditors that is correct is:

A) A change in the creditors turnover period of 56 days to 65 days means that creditors are being paid faster.
B) It is always best for the business to make creditors wait for their money for as long as possible.
C) Creditors provide a free source of finance for a business.
D) It is best to pay creditors as quickly as possible.

Question 22

Why is interest added back to profit before tax when calculating return on total assets?

A) because the efficient use of resources should be examined independently from the method of financing
B) to indicate to lenders that some risk is involved
C) because interest rates vary over time
D) A and B

Question 23

Which of these are alternative measures of gearing?

A) total liabilities/total assets
B) long-term liabilities/ total owners' equity
C) total liabilities/total owners' equity
D) All are alternative measures of gearing.

Question 24

Using the formula gearing ratio = long-term liabilities/(shareholders' funds + long-term liabilities) × 100/1, calculate the gearing ratio from the following information. Long-term liabilities are $18m; shareholders' funds are $14m.

A) 44%
B) 128%
C) 78%
D) 56%

Question 25

Which of these is not an advantage of a shorter inventory turnover period?

A) It means that fewer funds are tied up in inventory so more are available for use in the business.
B) It means that inventory is less likely to become obsolete or out of date.
C) It means that less storage space is needed for inventory.
D) It means that management can have the cost advantage of buying in bulk.

Question 26

Which of these is not an advantage of using borrowed funds to finance a business?

A) Lenders do not dilute ownership interest in the business.
B) Interest on borrowing is a legal commitment that must be met.
C) Interest on borrowings is tax-deductible.
D) Borrowing can be used to boost returns to owners as long as the return on the funds exceeds the cost of interest.

Question 27

The ratios that are specifically concerned with assessing the efficiency with which assets have been used by the business are the:

A) liquidity ratios.
B) gearing ratios.
C) efficiency ratios.
D) investment ratios.

Question 28

Operating cash flows ÷ current liabilities is the formula for the:

A) repayment of long-term borrowing ratio.
B) current ratio.
C) cash flow from operations ratio.
D) none of the above

Question 29

Net profit before interest and taxation, divided by sales × 100/1 is the formula for:

A) return on shareholders' funds.
B) asset turnover period.
C) net profit margin.
D) return on total assets.

Question 30

The formula for net profit margin is net profit before interest and tax divided by:

A) total assets.
B) total equity.
C) sales.
D) share capital + long-term loans.

Question 31

Which of these is not considered a limitation of financial ratio analysis?

A) There is no adjustment for the effects of inflation.
B) Ratios are difficult to calculate.
C) It does not consider qualitative factors.
D) All of the above.

Question 32

Dividend yield on ordinary shares is calculated as:

A) dividends per share divided by market price per share.
B) annual dividend divided by earnings.
C) annual dividend divided by issued capital.
D) none of the above.

Question 33

Which of these is a factor that can influence the amount a company is prepared to distribute as dividends to its shareholders?

A) investors' expectations
B) the availability of cash
C) the need to retain funds within the business for future growth
D) all of the above

Question 34

Place the key steps in financial ratio analysis in order of occurrence. i) Select the ratios considered appropriate and carry out the calculations.
Ii) Interpret and evaluate what the ratios reveal.
Iii) Identify the users and their information needs.

A) i, ii, iii
B) iii, i, ii
C) iii, ii, i
D) ii, i, iii

Question 35

If current assets exceed current liabilities, the payment of creditors will:

A) increase the current ratio.
B) decrease the current ratio.
C) increase the level of cash held.
D) do none of the above.

Question 36

Calculate the return on capital employed if net profit before interest and tax is $440,000, shareholders' funds are $4,000,000 and long-term loans are $3,000,000.

A) 12.2%
B) 11.0%
C) 6.2%
D) 3.1%

Question 37

Which of these is a limitation of financial ratio analysis?

A) Year-end data is not necessarily typical of the position during the year.
B) Suitable yardsticks for comparisons are not always available.
C) Ratios have a restricted vision as they only assess the past.
D) All of the above.

Question 38

Use this data to calculate earnings per ordinary share (EPS) for Orange Ltd.

A) $0.19
B) $0.39
C) $0.61
D) $0.43

Question 39

The acid test ratio eliminates from its calculation because it is considered the least liquid of the current assets.

A) debtors
B) government securities
C) inventory
D) bank bills

Question 40

Worshafter Ltd has provided information from its financial statements for the year ended 30 June 2015. The company trades 365 days per year. The number of times Workshafter Ltd's inventory turned over for 2015 is:

A) 5.0 times.
B) 2.2 times.
C) 5.5 times.
D) 2.0 times.

Question 41

Ratios should not be used in isolation because:

A) their behaviour is inter-related.
B) different ratios may give contradictory messages.
C) a decision will often have a number of aspects.
D) all of the above.

Question 42

F Co had a profit of $100,000 before tax, after deducting $16,000 in interest expense. F Co's liabilities and equity total $1,000,000. Return on total assets, before interest and tax, is:

A) 9%.
B) 10%.
C) 11.6%.
D) 13%.

Question 43

The type of analysis being carried out when a company's gross profit ratio for three years is graphed and compared with the average industry gross profit ratio calculated over the same time period is:

A) gearing analysis.
B) vertical analysis.
C) parallel analysis.
D) trend analysis.

Question 44

The statement concerning financial ratios that is not true is:

A) Ratios are easy to interpret but difficult to calculate.
B) A ratio expresses the relationship between two figures appearing in the financial statements.
C) Ratios adjust for scale of operations and allow comparisons between businesses of different sizes.
D) None of the above.

Question 45

If gross profit is $540,000, interest expense is $200,000, sales is $1,800,000 and total assets are $5,400,000, calculate the gross profit margin.

A) 18.9%
B) 30%
C) 10%
D) 6.3%

Question 46

Dividends announced during the period ÷ the number of shares on issue is the formula for:

A) the dividend payout ratio.
B) the dividend yield ratio.
C) the dividend per share ratio.
D) the return on dividends ratio.

Question 47

Sports Ltd reports the following information: If current assets represent 60% of total assets, Sports Ltd's current ratio is:

A) 50%.
B) 150%.
C) 67%.
D) 200%.

Question 48

Which of these ratios measure returns to shareholders?

A) earnings per share
B) return on shareholders' funds
C) dividend yield
D) all of the above

Question 49

If sales for 2015 are $4,000,000 and for 2016 are $6,000,000, and total assets at the end of 2015 are $1,000,000 and at the end of 2016 are $2,000,000, the asset turnover period ratio for 2016 is:

A) 91 days.
B) 146 days.
C) 109 days.
D) 1460 days.

Question 50

The ratio which is considered to be the best measure of overall profitability when judging the performance of internal management is:

A) return on total assets.
B) return on ordinary shareholders' funds.
C) gross profit margin.
D) net profit margin.

Question 51

From the following information calculate Moore Ltd's rate of return on ordinary shareholders' funds. Ordinary share capital $600,000 Retained profits and reserves $200,000
180,000 $2.00 10% Preference shares, each fully paid
Net profit after tax and before preference dividend $276,000

A) 30.0%
B) 26.0%
C) 20.0%
D) 16.0%

Question 52

Which of these ratios is not directly relevant to the evaluation of a company's short-term liquidity position?

A) current ratio
B) net profit ratio
C) quick ratio
D) acid test ratio

Question 53

The statement that is not correct is:

A) A business will prefer a longer average inventory turnover time rather than a shorter turnover time.
B) A business will prefer a shorter settlement time for its accounts receivable rather than a longer settlement period.
C) An asset turnover figure of 1.5 times is preferred to a figure of 1.2 times.
D) None of the statements, i.e. all are correct.

Question 54

The following information was extracted from the financial records of Goss Ltd for the year ended 30 June 2015: If there are 365 trading days per year, calculate for the managing director the number of days that debtors are outstanding at 30 June 2015.

A) 114 days
B) 51 days
C) 86 days
D) 43 days

Question 55

Dollar Ltd has a current ratio of 2:1. This means that:

A) its current assets are insufficient to meet its current liabilities.
B) there is $2 of current assets for every $1 of current liabilities.
C) its current assets are half its current liabilities.
D) its current assets are equal to its current liabilities.

Question 56

Which business would you expect to have the highest current ratio?

A) retailer
B) manufacturer
C) service business that sells for cash
D) service business that sells on credit

Question 57

Trendy Ltd's net profit after tax was $1,200 and its interest expense was $400. Assuming corporate tax is $400, what is the company's interest cover ratio?

A) 5.0
B) 3.0
C) 1.2
D) 1.8

Question 58

If Sharpe Products Ltd has a asset turnover ratio of 2 times and a net profit margin of 6.5%, the return on total assets is:

A) 8.5%.
B) 13.0%.
C) 6.5%.
D) 30.0%.

Question 59

If Line Ltd has a current ratio of 2.5:1 and current assets are $600,000, how much are the company's current liabilities?

A) $200,000
B) $300,000
C) $360,000
D) $240,000

Question 60

The adequacy of the gross profit margin depends on:

A) selling price.
B) buying price.
C) total expenses.
D) both A and B

Question 61

Trendy Traders reported total sales amounting to $1,000,000 in the year 2015, of which 80% were on credit. At 31 December, customers owed $100,000. If the firm operates for 365 days a year, how long, on average, does it take to collect money from its debtors?

A) 46 days
B) 10 days
C) 13 days
D) 29 days

Question 62

The asset turnover period ratio:

A) explains how much the firm's assets could decrease and still leave it able to pay its long-term debts.
B) indicates how efficiently the assets of the firm are being employed to generate sales.
C) measures the liquidity of the firm.
D) measures profitability.

Question 63

A firm has total assets of $800,000 and total liabilities of $200,000. If profit after tax and interest is $120,000, the return on shareholder's funds is:

A) 12.5%.
B) 9%.
C) 20%.
D) 8%.