Deck 8: Analysis and Interpretation of Financial Statements

Question 1

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

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

Answer 1

C

Question 2

Which of these is not an efficiency ratio?

A)Current ratio.
B)Average settlement period for accounts receivable.
C)Asset turnover period.
D)Average inventory turnover period.

Answer 2

A

Question 3

R Co had a profit of $100,000 before tax, after deducting $18,000 in interest expense. R Co's non-current liabilities and equity total $1,000,000. Return on capital employed, before interest and tax is:

A)13%.
B)11.8%.
C)10%.
D)9%.

Answer 3

B

Question 4

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

A)return on capital employed.
B)asset turnover period.
C)return on shareholders' funds.
D)operating profit margin.

Question 5

A firm has total assets of $800,000 and total liabilities of $200,000. If profit after tax and interest is $150,000, the return on shareholders' funds is:

A)25%.
B)8%.
C)12.5%.
D)9%.

Question 6

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

Question 7

A firm has total assets of $900,000 and total liabilities of $400,000. There are no preference shareholders. Earnings before interest and taxes are $100,000. Interest is $21,000 and taxes are $34,000. The return on ordinary shareholders' funds is:

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

Question 8

Which ratios measure the degree of risk associated with borrowing money from outsiders to finance the business?

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

Question 9

The formula for gross profit margin is gross profit divided by:

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

Question 10

The incorrect statement concerning financial ratios is:

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

Question 11

Calculate the return on capital employed if net profit before interest and tax is $440,000, shareholders' funds are $5,000,000 and long-term loans are $4,000,000.

A)4.9%.
B)11.0%.
C)6.2%.
D)12.2%.

Question 12

What is a good benchmark to compare business performance during a given period?

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

Question 13

Which ratio is considered to be the primary measure of overall profitability as it assesses how effectively the business has used its funds?

A)return on ordinary shareholders' funds.
B)gross profit margin.
C)return on capital employed.
D)operating profit margin.

Question 14

Which ratios are specifically concerned with assessing the returns and performance of shares held for investment purposes?

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

Question 15

SSS Ltd has provided the following information from its financial statements for the year ended 30 June 2018. $$\begin{array} { l r } \text { Sales (all on credit) } & \$ 2,000,000 \\\text { Gross profit on sales } & 1,000,000 \\\text { Net profit } & 150,000 \\\text { Cost of sales } & 1,000,000 \\\text { Inventory at end of year } & 200,000 \\\text { Accounts receivable at end of year } & 500,000\end{array}$$

-The company trades 365 days per year. The number of times SSS's accounts receivable turned over for 2018 is:

A)5.0 times.
B)1.8 times.
C)3.8 times.
D)4.0 times.

Question 16

If gross profit is $500,000, interest expense is $200,000, sales is $1,900,000 and total assets are $5,400,000, calculate the gross profit margin.

A)6.3%.
B)18.9%.
C)26.3%.
D)10%.

Question 17

Ratios should not be used in isolation because:

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

Question 18

SSS Ltd has provided information from its financial statements for the year ended 30 June 2018. $$\begin{array} { l r } \text { Sales (all on credit) } & \$ 2,000,000 \\\text { Gross profit on sales } & 1,000,000 \\\text { Net profit } & 150,000 \\\text { Cost of sales } & 1,000,000 \\\text { Inventory at end of year } & 200,000 \\\text { Accounts receivable at end of year } & 500,000\end{array}$$

-The company trades 365 days per year. The number of times SSS's inventory turned over for 2018 is:

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

Question 19

From the following information, calculate Todd Ltd's rate of return on ordinary shareholders' funds.

Ordinary share capital $600,000.
Retained profits and reserves $200,000.
180,000 fully paid $2.00 10% Preference shares.
Net profit after tax and before preference dividend $276,000.

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

Question 20

On what does the adequacy of the gross profit margin depend?

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

Question 21

Trendy Traders reported total sales amounting to $1,800,000 in the year 2018, of which 80% were on credit. At 31 December, customers owed $200,000. If the firm operates for 365 days a year, how long, on average, does it take to collect money from its debtors?

A)29 days.
B)13 days.
C)10 days.
D)51 days.

Question 22

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)asset turnover period.
C)interest cover.
D)average settlement period for accounts payable.

Question 23

Which of the following businesses would you expect to have the highest current ratio?

A)Service business that sells on credit.
B)Manufacturer.
C)Retailer.
D)Service business that sells for cash.

Question 24

Sports Ltd reports the following information: $$\begin{array} { l l } \text { Net profit } & \$ 30,000 \\\text { Total assets } & 950,000 \\\text { Current liabilities } & 285,000 \\\text { Deferred liabilities } & 405,000\end{array}$$ If current assets represent 60% of total assets, Sports Ltd's current ratio is:

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

Question 25

The following information was extracted from the financial records of Ross Ltd for the year ended 30 June 2018: $$\begin{array} { l r } \text { Cash Sales } & \$ 50,000 \\\text { Credit Sales } & 200,000 \\\text { Accounts receivable } & 25,000 \\\text { Cost of Sales } & 130,000\end{array}$$ If there are 365 trading days per year, calculate for the managing director the number of days that accounts receivable are outstanding at 30 June 2018.

A)86 days.
B)51 days.
C)114 days.
D)46 days.

Question 26

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

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

Question 27

If the turnover period for accounts receivable is 8.1 times per annum, what is the average number of days it takes to collect cash from accounts receivable?

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

Question 28

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

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

Question 29

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

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

Question 30

Which ratios are specifically concerned with assessing the efficiency with which assets have been used by the business?

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

Question 31

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

Question 32

Which statement concerning the average settlement period for accounts payable is correct?

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

Question 33

Using the information below find the average inventory turnover for Vox Ltd in days. $$\begin{array} { l r } \text { Sales } & \$ 1,800,000 \\\text { Cost of sales } & 1,200,000 \\\text { Stock on hand start } & 360,000 \\\text { Stock on hand end } & 312,000\end{array}$$

A)102.2 days.
B)63.26 days.
C)94.8 days.
D)68 days.

Question 34

Which statement is not correct?

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

Question 35

What does the inventory turnover period ratio measure?

A)the liquidity of the firm.
B)how much the firm's current assets could decrease and still leave it able to pay its current liabilities.
C)profitability.
D)the average time an organisation holds inventory.

Question 36

If current assets exceed current liabilities, the payment of accounts payable will:

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

Question 37

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 new quick ratio would be:

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

Question 38

What does the current ratio measure?

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

Question 39

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

A)Operating profit ratio.
B)Current ratio.
C)Quick ratio.
D)Acid test ratio.

Question 40

What does the acid test ratio eliminate from its calculation, because it is considered the least liquid of the current assets?

A)bank bills
B)accounts receivable
C)government securities
D)inventory

Question 41

Blue Company reported: $$\begin{array} { l l } \text { Share price } & \$ 18 \\\text { Net profit } & \$ 3,000 \\\text { Preference dividend } & \$ 500 \\\text { Ordinary dividend } & \$ 1,000 \\\text { Issued ordinary shares } & 1,000 \text { shares }\end{array}$$ The price-earnings ratio per ordinary share is:

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

Question 42

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

A)The availability of cash.
B)Investors expectations.
C)The need to retain funds within the business for future growth.
D)All of the above.

Question 43

What ratio helps to measure the risk involved in financing a business with borrowed funds?

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

Question 44

A company with a higher level of gearing will have:

A)a high liabilities/total assets ratio.
B)a lower owners' equity/total assets ratio.
C)a higher owners' equity/total assets ratio.
D)Both A and B.

Question 45

Which of these ratios measure returns to shareholders?

A)Earnings per share.
B)Dividend yield.
C)Return on ordinary shareholders' funds.
D)All of the above.

Question 46

Use this data to calculate earnings per ordinary share (EPS)for Orange Ltd. $$\begin{array} { l r } \text { Market price for each Orange Ltd share } & \$ 7,80 \\\text { Net Profit (after interest, tax) } & \$ 6,400 \\\text { Number of ordinary shares issued } & 15,000\end{array}$$

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

Question 47

If earnings per share is 30c and the market price of each share is $6, the price-earnings ratio is:

A)20:1.
B)10:1.
C)5:1.
D)25:1.

Question 48

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

A)Shareholders.
B)Long-term lenders.
C)Potential investors.
D)All of the above.

Question 49

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

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

Question 50

Blue Company reported: $$\begin{array} { l l } \text { Share price } & \$ 18 \\\text { Net profit } & \$ 3,000 \\\text { Preference dividend } & \$ 500 \\\text { Ordinary dividend } & \$ 1,000 \\\text { Issued ordinary shares } & 1,000 \text { shares }\end{array}$$ Earnings per ordinary share is:

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

Question 51

Dividend yield on ordinary shares is calculated as:

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

Question 52

Which of these are alternative measures of gearing?

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

Question 53

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

Question 54

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

Question 55

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

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

Question 56

Dividend yield is calculated as:

A)market price per share/dividend per share.
B)dividend per share/market price per share.
C)dividend/ number of issued shares.
D)net profit/market price per share.

Question 57

What does financial solvency refer to the ability of an entity to do?

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

Question 58

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)$1.10.
B)$1.00.
C)$4.40.
D)none of the above.

Question 59

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 $18m, Shareholders' funds $14m.

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

Question 60

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

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

Question 61

Which of these is not a limitation of ratio analysis?

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

Question 62

Which of these is a limitation of financial ratio analysis?

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

Question 63

If the earnings yield is 6.67%, the price-earnings ratio is:

A)12:1.
B)15:1.
C)6:1.
D)6.7:1.

Question 64

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

Question 65

If earnings per share is 85c, dividend per share is 50c, and the market price of each share is $9.35, the price-earnings ratio is:

A)18.7:1.
B)11:1.
C)9:1.
D)5:1.

Question 66

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

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