Deck 14: Financial Statement Analysis

Question 1

A company's liquidity refers to its ability to remain profitable.

Answer 1

False

Question 2

The quality of earnings tends to be higher for a company that uses straight-line depreciation and defers costs whenever possible than for a company which uses accelerated depreciation and defers costs only when necessary.

Answer 2

False

Question 3

When an income statement does not show gross profit or operating profit it is called a consolidated statement.

Answer 3

False

Question 4

Working capital is the excess of current assets over current liabilities.

Question 5

Vertical analysis compares the results of financial information with a business in the same industry for a number of consecutive periods of time.

Question 6

The gross profit rate usually is lowest on fast moving merchandise and highest on specialty and novelty products

Question 7

The trend in ratios is usually more useful than looking at a single year's ratio.

Question 8

Inventory is an example of a quick asset.

Question 9

The quick ratio is especially useful in evaluating the liquidity of a company with fast moving inventories.

Question 10

Current assets are those assets that can be converted into cash within a year and never longer.

Question 11

The owners of a corporation are not personally responsible for the debts of the business.

Question 12

ROE - return on equity - is measured by dividing profit by average number of shares outstanding.

Question 13

The gross profit rate is gross profit expressed as a percentage of net sales.

Question 14

If total current assets are $140,000 at the end of Year 1, increase by $50,000 by the end of Year 2, and increase by $50,000 in Year 3, the percentage increase over the preceding year is less in Year 3 than in Year 2.

Question 15

Comparative financial statements show side-by-side financial data for two or more companies.

Question 16

The yield rate on shares is measured by dividing dividends per share by market price per share.

Question 17

The acid test ratio includes marketable securities but does not include accounts receivable.

Question 18

Deducting the cost of goods sold from profit gives us operating profit.

Question 19

The debt ratio is computed by dividing total liabilities by current assets.

Question 20

The lower the current ratio, the more liquid the company appears.

Question 21

A company should carry the amount of working capital necessary to conduct operations not necessarily maximize its working capital.

Question 22

One number expressed as a percentage of another is called:

A) Money changes
B) Trend percentages
C) Component percentages
D) Ratios

Question 23

The inventory turnover rate indicates how quickly inventory sells.

Question 24

The more pessimistic investors' expectations regarding a company's future performance the lower the price/earnings ratio is likely to be.

Question 25

The price/earnings ratio is calculated by dividing earnings per share by the current market price of an ordinary share of the company.

Question 26

From a creditor's point of view, the lower the debt ratio; the safer the creditors' position.

Question 27

A company whose future earnings are expected to rise substantially is likely to have a higher price/earnings ratio than a company whose future earnings are expected to decline.

Question 28

A comparative financial statement

A) Places the balance sheet, the income statement and the statement of cash flows side by side in order to compare the results.
B) Places two or more years of a financial statement side by side in order to compare results.
C) Places the financial statements of two or more companies side by side in order to compare results.
D) Places the dollar amounts next to the percentage amounts of a given year for the income statement.

Question 29

A single-step and multiple-step income statement are different in form and in the amount of profit reported.

Question 30

In a single-step income statement, all revenue items are listed then all expense items are combined and deducted from total revenue.

Question 31

The return on equity ratio may be either higher or lower than the return on assets ratio.

Question 32

The current ratio may be less than, equal to, or greater than the quick ratio.

Question 33

In a classified balance sheet, assets are subdivided into current assets, plant and equipment and other assets, while liabilities are all classified as current.

Question 34

The measurement of the relative size of each item included in a total is called:

A) Money changes
B) Trend percentages
C) Component percentages
D) Ratios

Question 35

The changes in financial statement items from a base year to following years are called:

A) Money changes
B) Trend percentages
C) Component percentages
D) Ratios

Question 36

If the return on total assets ratio is substantially below the cost of borrowing, ordinary shareholders will benefit from a high debt ratio.

Question 37

A company whose sales are growing at less than the rate of inflation may actually be selling less merchandise every year.

Question 38

Profit stated as a percentage of sales is one means of evaluating a company's ability to control its expenses.

Question 39

In order for investors and creditors to decide whether to invest in a company or loan a company funds they may

A) Analyze financial statements.
B) Focus on corporate governance.
C) Both of the above.
D) Neither of the above.

Question 40

A company cannot be increasing its market share if its net sales are declining.

Question 41

The price/earnings ratio is measured by dividing

A) Book value by earnings per share.
B) Par value by earnings per share.
C) Market value by earnings per share.
D) Market value by total profit.

Question 42

Quick assets include which of the following?

A) Cash, investments in securities and receivables.
B) Cash, investments in securities and inventories.
C) Cash, inventories and receivables.
D) Investments in securities, receivables and inventories.

Question 43

Component percentages indicate the relative size of each item included in a total. Which of the following statements is true?

A) Income statement items are expressed as a percentage of profit and balance sheet items as a percentage of total assets.
B) Income statement items are expressed as a percentage of sales and balance sheet items as a percentage of total assets.
C) Income statement items are expressed as a percentage of profit and balance sheet items as a percentage of net worth.
D) Both income statement and balance sheet items are expressed as a percentage of net worth.

Question 44

The current ratio:

A) Is computed by dividing current assets by current liabilities.
B) Is computed by subtracting current liabilities from current assets.
C) Remains unchanged throughout the operating cycle.
D) Is a measure of short-term profitability.

Question 45

Current assets are those assets that can be converted into cash within:

A) One year and never longer.
B) One year or the operating cycle, whichever is longer.
C) One year or the operating cycle, whichever is shorter.
D) Management's discretion.

Question 46

Which American industry would tend to have the greatest debt ratio?

A) Auto.
B) Retail clothing.
C) Manufacturing.
D) Banking.

Question 47

The measures most often used in evaluating solvency--the current ratio, quick ratio, and amount of working capital are developed from amounts appearing in the:

A) Balance sheet.
B) Income statement.
C) Statement of changes in equity.
D) Statement of cash flows.

Question 48

In evaluating the quality of a company's earnings, which of the following factors is least important?

A) The accounting methods used by management.
B) The trend of the company's earnings over a period of years.
C) The dollar amount of earnings per share.
D) The stability and sources of the company's earnings.

Question 49

The excess of current assets over current liabilities is called:

A) Current ratio
B) Working capital
C) Debt ratio
D) Quick ratio

Question 50

Which of the following is not a measure of long-term credit risk?

A) Quick ratio.
B) Debt ratio.
C) Interest coverage ratio.
D) Trend in net cash provided by operating activities.

Question 51

How would a company's working capital be affected if a substantial amount of accounts payable were paid in cash?

A) It would be unaffected.
B) It would fall.
C) It would increase.
D) The change would depend on the relationship between the payables liquidated and current liabilities.

Question 52

Comparative financial statements compare the company's current statements with:

A) Those of prior periods.
B) Those of other companies in the same industry.
C) Those of the company's principal competitor.
D) The budgeted level of performance for the period.

Question 53

All of the following ratios are considered measures of liquidity except:

A) Quick ratio
B) Debt ratio
C) Current ratio
D) Receivables turnover rate

Question 54

The ratio which measures total liabilities as a percentage of total assets is called:

A) Current ratio
B) Working capital
C) Debt ratio
D) Quick ratio

Question 55

A high quality of earnings is indicated by:

A) Earnings derived largely from newly introduced products.
B) Declaration of both cash and stock dividends.
C) Use of the FIFO method of inventory during sustained inflation.
D) A history of increasing earnings and conservative accounting methods.

Question 56

The term classified financial statements refers:

A) To the financial statements of all companies working on government projects.
B) Only to the financial statements of defense contractors working on secret projects.
C) To financial statements prepared for use by management, but not for distribution outside of the organization.
D) To financial statements in which items with certain characteristics are placed together in a group in an effort to develop useful subtotals.

Question 57

Which of the following is not a measure of profitability?

A) EPS.
B) ROI.
C) ROE.
D) NLR.

Question 58

The current ratio will be _______________ the quick ratio.

A) Less than.
B) Greater than or equal to.
C) The same as.
D) Always different than.

Question 59

All of the following ratios are considered measures of profitability except:

A) Earnings per share
B) Gross profit rate
C) Price earnings ratio
D) Return on assets

Question 60

Which of the following is not a measure of short-term liquidity?

A) Quick ratio.
B) Working capital.
C) Current ratio.
D) Debt ratio.

Question 61

Operating profit excludes each of the following, except:

A) Interest expense.
B) Income taxes.
C) Depreciation.
D) Prepaid expenses.

Question 62

Short-term creditors are most likely to use the quick ratio instead of the current ratio in evaluating the solvency of a company with large, slow-moving:

A) Plant and equipment.
B) Receivables.
C) Inventories.
D) Employees.

Question 63

In calculating earnings per share, the denominator of the equation includes:

A) Only ordinary shares outstanding.
B) Ordinary shares plus preference shares.
C) Ordinary shares less preference shares.
D) The total shares of authorized ordinary shares.

Question 64

Assume that sales are increasing faster than the rate of inflation, and that the company's gross profit rate is rising. Of the following, the most logical conclusion is that:

A) The company's cost of purchasing merchandise is rising rapidly.
B) Operating expenses are falling.
C) Demand for the company's products is very strong.
D) The company has achieved an increase in sales volume by reducing its sales prices.

Question 65

All of the following captions or subtotals are typical of a multiple-step income statement except for:

A) Net sales.
B) Gross profit.
C) Total costs and expenses.
D) Operating profit.

Question 66

The quick ratio:

A) Is computed by dividing current assets by current liabilities.
B) Is always higher than the current ratio.
C) Cannot be higher than the current ratio.
D) May be higher or lower than the current ratio.

Question 67

In a multiple-step income statement, interest expense usually is not classified as an operating expense because interest charges:

A) Do not contribute to the production of revenue.
B) Stem from the manner in which assets are financed, not the manner in which they are used in business operations.
C) Relate directly to the cost of goods sold.
D) The statement is incorrect. Interest usually is classified as an operating expense.

Question 68

Which of the following transactions would cause a change in the amount of a company's working capital?

A) Collection of an account receivable.
B) Payment of an account payable.
C) Borrowing cash over a 60-day period.
D) Selling merchandise at a price above its cost.

Question 69

In a multiple-step income statement, income taxes are not classified as operating expenses because:

A) Income taxes do not contribute to the production of revenue.
B) Income taxes stem from the manner in which assets are financed, not the manner in which they are used in business operations.
C) Not all forms of business organization are subject to income taxes.
D) The statement is incorrect; income taxes are classified as operating expenses.

Question 70

Traditionally, shares of financially sound companies with stable earnings usually have a price/earnings ratio of:

A) 90.
B) 12.
C) 1/4.
D) 3.

Question 71

The gross profit rate represents:

A) Total sales revenue.
B) The percentage change in net sales from the prior period.
C) The percentage of sales revenue remaining after providing for the cost of the merchandise sold.
D) Profit stated as a percentage of total sales revenue.

Question 72

The debt ratio indicates the percentage of:

A) Total assets financed by long-term mortgages.
B) Revenue consumed by interest expense.
C) Total assets financed by creditors.
D) Total liabilities classified as current.

Question 73

When comparing the current ratio to the quick ratio:

A) The current ratio will always be greater
B) The quick ratio will always be greater
C) The quick ratio is sometimes greater and sometimes less than the current ratio
D) They always will be the same

Question 74

Return on equity computations are used in evaluating:

A) Liquidity.
B) Profitability.
C) Gross profit.
D) Whether a ratio is improving or deteriorating over time.

Question 75

Which of the following is considered a quick asset?

A) Accounts receivable.
B) Inventory.
C) Automobiles.
D) Prepaid expenses.

Question 76

A rising gross profit rate most strongly suggests:

A) An increase in physical sales volume.
B) Strong consumer demand for the company's products.
C) Intense competition.
D) Increased short-term solvency.

Question 77

The current ratio is calculated by:

A) Dividing current assets by total assets.
B) Dividing current assets by total liabilities.
C) Dividing current assets by shareholders' equity.
D) Dividing current assets by current liabilities.

Question 78

The debt ratio is used primarily as a measure of:

A) Short-term liquidity.
B) Creditors' long-term risk.
C) Profitability.
D) Return on Investment.

Question 79

Generally speaking, which appears to be a desirable current ratio?

A) 20 to 1.
B) 1 to 20.
C) 2 to 1.
D) 1 to 2.

Question 80

On common size income statements, each component in the income statement is represented as a percentage of:

A) Profit.
B) Sales.
C) Total assets.
D) Profit.