Deck 19: Analysis and Interpretation of Financial Statements

Question 1

Which of the following are possible uses of financial analysis?
I) By shareholders to assess future profitability and financial stability
II) By management for planning and control
III) By financial analysts to predict future share price
IV) By the government to estimate taxation payable

A) II, III and IV
B) III and IV
C) I, II and III only
D) I and IV

Answer 1

C

Question 2

Financial stability refers to the ability of an entity to:

A) minimise expenses.
B) increase market share.
C) meet long-term obligations.
D) achieve a high rate of profit.

Answer 2

C

Question 3

Besides the information in annual reports, which of the following are sources of financial information about companies that are useful for analysing their performance and financial position?
I) The Internet
II) The Stock Exchange
III) Financial newspapers and journals
IV) Stock brokers
V) Information on competitors

A) I, II and III only
B) II, III, IV and V only
C) II, IV and V only
D) I, II, III, IV and IV

Answer 3

D

Question 4

The following ratios are measures of aspects of a firm's profitability, except for:

A) return on total assets.
B) earnings yield.
C) dividend yield.
D) current ratio.

Question 5

The debt ratio measures:

A) the proportion of assets financed by borrowing.
B) profits earned in relation to debt.
C) the time taken to collect debts.
D) liquidity.

Question 6

Vertical analysis of a statement of financial position usually:

A) calculates each balance sheet item as a percentage of sales.
B) calculates each balance sheet item as a percentage of share capital.
C) calculates each balance sheet item as a percentage of the bank balance.
D) calculates each balance sheet item as a percentage of total assets (funds).

Question 7

Profit before finance costs and taxation divided by average total assets is the formula for:

A) dividend yield.
B) profit margin.
C) earnings per share.
D) return on total assets.

Question 8

Financial ratios are used for all the following purposes except:

A) by creditors to monitor liquidity.
B) by shareholders to assess profitability.
C) by taxation authorities to determine the amount of tax payable.
D) by management for planning and control.

Question 9

Profit before finance costs is used in calculating return on total assets because:

A) interest rates are hard to predict.
B) it is simpler to calculate than profit after deducting finance costs.
C) the efficient use of resources should be examined independently of the method of financing.
D) interest is a tax deduction for a company.

Question 10

If an entity is able to earn more on borrowings than the cost of those borrowings the return on equity will:

A) vary.
B) increase.
C) decrease.
D) be unchanged.

Question 11

Which of the following ratios measure the adequacy of profits?
I) Profit compared to sales
II) Profit compared to equity
III) Profit compared to total assets
IV) Profit before interest and finance costs/ finance costs

A) II and IV
B) I and II only
C) I, III and IV
D) I, II and III only

Question 12

To be useful for decision making, absolute dollar amounts in financial statements need to be compared with other information. Which of the following are possible comparisons?
I) Prior year results
II) Current year sales, total assets etc.
III) Results of similar businesses or industry averages

A) I and II only
B) I, II and III
C) II and III only
D) None of the above

Question 13

Which of the following statements is incorrect?

A) Dividend yield measures the rate of return on the market price of a share.
B) Dividend yield is an important ratio for an investor who is acquiring shares mainly for income.
C) The dividend payout ratio measures the percentage of profit paid out in dividends to ordinary shareholders.
D) Dividend per share is the ratio to use when comparing income from shares with income from alternative investments.

Question 14

In a trend analysis of Lester Company, which of the following changes appear to be the most significant in requiring further investigation?

A) An increase in revenue of 12%.
B) An increase in total assets of 5%.
C) An increase of 15% in borrowing costs.
D) A decrease of 4% in motor vehicle expenses.

Question 15

The formula for the profit margin ratio is:

A) revenue divided by profit.
B) gross profit divided by net sales.
C) profit after tax divided by revenues.
D) profit after tax divided by total assets.

Question 16

Which of the following are sources of financial information about companies?
I) Published financial statements (annual reports)
II) The Internet
III) The Stock Exchange
IV) Financial newspapers and journals
V) Financial advisory services

A) I, II, III, IV, V
B) I, III, IV, V
C) II, III, IV, V
D) I, II, III, IV

Question 17

Richmond Co performed a trend analysis at the end of the financial period. Which of the following changes appears to be the most significant in requiring further investigation?

A) An increase in revenues of 18%.
B) An increase in total assets of 6%.
C) An increase in 14% for bad debts written off
D) An increase in accounts receivable of 4%.

Question 18

A profit ratio for a retailer of 8.2% in 2019 compared to 7.6% in 2018 indicates:

A) a declining profit margin.
B) no change in the profit margin.
C) an improving profit margin.
D) impending bankruptcy.

Question 19

statements are those financial statements in which each item is stated as a percentage of a specific base item in the same statement.

A) base rate
B) comparative
C) general purpose
D) common size

Question 20

analysis measures an entity's financial structure and its ability to continue to operate into the future and meet its long-term cash obligations.

A) trend
B) liquidity
C) working capital
D) financial stability

Question 21

The profit margin ratio measures:

A) return to shareholders.
B) the rate of return on total assets.
C) the proportion of each sales dollar that represents profit.
D) the difference between the purchase price and the selling price of inventory.

Question 22

is calculated as annual dividend per ordinary share divided by market price per ordinary share.

A) dividend yield.
B) dividend per share.
C) earnings per share.
D) dividend payout ratio.

Question 23

The following ratios are indicators of profitability except for:

A) capitalisation ratio.
B) return on equity.
C) earnings per share.
D) profit margin.

Question 24

When calculating the rate of return on total assets the interest is added back to profit before tax:

A) because it must be paid regardless of profits.
B) because interest rates are variable over time.
C) to indicate to lenders that some risk is involved.
D) to reflect the fact that the efficient use of resources should be examined independently from the method of financing.

Question 25

Which of the following ratios measure the relationship between debt and equity?
I) The debt ratio
II) The current ratio
III) The equity (proprietorship) ratio
IV) The leverage ratio (total assets/total equity)

A) I, II, III and IV
B) III and IV only
C) I and III only
D) I, III and IV only

Question 26

The formula to calculate receivables (debtors) turnover in times per annum is:

A) 365 divided by net sales
B) Net sales revenue divided by total assets
C) Net sales revenue divided by average receivables balance
D) Average receivables balance divided by net sales revenue

Question 27

Calculate the dividend yield for the year ending 30 June 2019 using the following information: interim dividend was 8c per ordinary share; the final dividend 12c per share; and the market price per share on 30 June 2019 was $6.00.

A) 2.18%.
B) 3.33%.
C) 33.33%.
D) 30.00%.

Question 28

Johnson Foods Company had a before-tax profit of $250 000 after deducting interest expenses of $18 000. Johnson Foods' liabilities and equity total $1 875 000. Return on total assets, before finance costs and tax is:

A) 14.29%.
B) 13.33%.
C) 12.37%.
D) unable to be calculated from the information provided.

Question 29

Which P/E ratios and earnings yields do not match?

A) P/E ratio 4; earnings yield 25%
B) P/E ratio 6; earnings yield 15 %
C) P/E ratio 8; earnings yield 12.5%
D) P/E ratio 10; earnings yield 10%

Question 30

The average market price of Lavendar Ltd's ordinary shares is $5.40 and the earnings per ordinary share are 90c. The P/E ratio is:

A) 6.0
B) 4.86
C) 16.67
D) unable to be calculated from the information provided.

Question 31

Using borrowed funds in an attempt to earn a return greater than the cost of borrowing is referred to as:

A) equity funding.
B) capital budgeting.
C) gearing or leverage.
D) overdraft financing.

Question 32

Ratios are normally divided into three general groups, which of these is not one of those groups?

A) Liability ratios
B) Liquidity ratios
C) Profitability ratios
D) Financial stability ratios

Question 33

Profit less income tax, divided by revenue, is the formula for:

A) return on equity.
B) return on assets.
C) profit margin.
D) earnings per share.

Question 34

Trends in ratios that measure the relationship between debt and equity provide information about which (if any) of the following?
I) Long term stability
II) Degree of risk in using debt financing
III) Margin of safety to creditors in the event of liquidation

A) None.
B) I and II only
C) II and III only
D) I, II and III

Question 35

The calculation for dividend yield on ordinary shares is:

A) annual dividend divided by earnings.
B) market price divided by dividend per share.
C) dividend per share divided by market price per share.
D) annual dividend divided by number of ordinary shares.

Question 36

Which of the following businesses is likely to have the highest inventory turnover ratio?

A) jeweller.
B) music shop.
C) fish and chip shop.
D) car dealership.

Question 37

The current (working capital) ratio is calculated by dividing:

A) profit by current assets.
B) revenue by current assets.
C) current liabilities by current assets.
D) current assets by current liabilities.

Question 38

Which statement concerning earnings per share is incorrect?

A) Earnings per share is regarded as one of the least important financial ratios.
B) It represents a conversion of the absolute dollar amount of profit to a per share basis.
C) If profits increase earnings per share could still decrease if share capital increases at a greater rate than profits.
D) In calculating earnings per ordinary share, preference dividends are deducted from profit.

Question 39

In relation to the price-earnings ratio (P/E ratio), which statement is incorrect?

A) Higher P/E ratios tend to be associated with growth companies.
B) As expectations of future profits increase the P/E ratio tends to fall.
C) It measures how much investors are willing to pay for each dollar of earnings.
D) A P/E ratio of 5.2 means that the shares of the company are selling at 5.2 times current profits.

Question 40

Possible explanations for inadequate profitability include all of the following except for:

A) expenses are too high.
B) selling prices are too low.
C) borrowing costs too low.
D) excessive investment in assets in relation to revenues.

Question 41

Which of the following businesses would be expected to have the fastest inventory turnover?

A) Clothing retailer
B) Luxury car showroom
C) Fruit and vegetable store
D) Jewellery store selling custom-made jewellery

Question 42

The proportion of borrowed funds compared to equity is a measure of:

A) borrowings
B) leverage
C) equity
D) liquidity

Question 43

The quick (acid test) ratio reflects:

A) the same information as the debt ratio.
B) the relationship of quick assets to fixed assets.
C) management's reaction time to avoid losses.
D) the belief that not all current assets can be liquidated immediately.

Question 44

Windbreaker Limited has a current ratio of 2.5:1. Which of the following actions will decrease this ratio?

A) Declaration of a dividend
B) Sale of a machine for cash
C) Issue of long-term debentures
D) Collection of an account receivable

Question 45

All of the following are limitations of financial ratio analysis except for:

A) suitable yardsticks may not be available with which to compare results.
B) year-end data is not necessarily typical of the position during the year.
C) excessive information is being disclosed in company annual reports.
D) it is the past performance that is being analysed.

Question 46

Which of the following are limitations of financial analysis?
I The past is an imperfect guide to the future.
II Effects of inflation are not considered.
III Changes in accounting policies are not highlighted.
IV Use of different accounting methods across entities makes comparability difficult.

A) I, III and IV only
B) II, III and IV only
C) I and III only
D) I, II, III and IV

Question 47

Which of the following statements is incorrect?

A) Fundamental analysis is engaged in by many analysts.
B) Fundamental analysis assumes that an analyst can study all the published information in relation to an entity and determine whether its shares are under/over-valued.
C) Fundamental analysis assumes that an analyst should concentrate on studying data about an entity from a primary source and give little weight to secondary sources of information.
D) Fundamental analysis assumes that an analyst can study all the published information in relation to an entity and determine whether its shares are correctly valued.

Question 48

When calculating the quick (acid test) ratio, which of the following is normally deducted from current assets?

A) Current liabilities
B) Cash and prepayments
C) Inventory and prepaid expenses
D) Inventory and accounts receivable

Question 49

Which statement concerning the cash flow adequacy ratio is incorrect?

A) A ratio of 100% or more over several years indicates an inadequate ability to generate sufficient operating cash to cover requirements.
B) The ratio assesses the entity's ability to generate sufficient operating cash flow to cover its main cash requirements.
C) The main requirements for cash from operations is to pay debts, acquire assets and pay dividends.
D) A fall in the ratio indicates a lower ability to generate operating cash to meet requirements.

Question 50

Which of these are limitations of financial analysis?
I) Use of historical data
II) Invalid comparisons
III) Ratio results often contain errors in calculations
IV) Historical cost financial reports are not adjusted for inflation
V) Non-quantitative factors are not considered

A) I, II, III and IV only
B) I, II, III and V only
C) I, II, IV and V only
D) I, II, III, IV and V

Question 51

Financial stability refers to the ability of an entity to:

A) pay its rent.
B) earn a high rate of profit.
C) meet its long-term obligations.
D) pay its current obligations on time.

Question 52

An increase in the inventory turnover ratio is normally considered to be favourable but could be unfavourable if it means:

A) liquidity is greater.
B) storage costs of inventory are lower.
C) inventory is less likely to become obsolete.
D) the firm is not carrying enough inventory to meet its customer's needs.

Question 53

Buyer Co has ordered goods on credit from Seller Co. Before Seller ships the goods it would like to be sure that Buyer will be able to pay for them within the normal credit period. Assuming Seller has access to Buyer's financial statements, which of the following ratios will be of the most interest to Seller Co.?

A) Current ratio
B) Debt ratio
C) Price earnings ratio
D) Dividend yield ratio

Question 54

Aster Limited has a current ratio of 1.75 to 1 and current liabilities of $20 000. If Aster Limited's inventory is $8 000 the quick ratio is:

A) 1.75 to 1
B) 1.35 to 1
C) 1.4 to 1
D) 0.74 to 1

Question 55

Cash flows from operating activities divided by (repayments of long-term borrowings + assets acquired + dividends paid) is the formula for:

A) borrowings ratio.
B) debt coverage ratio.
C) reinvestment ratio.
D) cash flow adequacy ratio.

Question 56

Which of the following statements relating to the debt ratio of a company is incorrect?

A) It is an indicator of a company's long-term solvency.
B) It is a measure of the extent of a company's gearing.
C) It can be calculated by relating liabilities to total funds.
D) A higher level of debt is normally preferable from a creditor's point of view.

Question 57

Which of the following ratios would be the most helpful to an investor who is investing in ordinary shares primarily for dividends rather than for appreciation in market price?

A) dividend yield.
B) current ratio.
C) rate of return on ordinary equity.
D) return on total assets.

Question 58

Which statement about capital market research and financial statement analysis is correct?

A) The evidence of share market research on the efficiency of the market is conclusive.
B) Little research has been carried out to determine the efficiency of share markets.
C) Financial analysis is of little use to investors if share markets are inefficient.
D) Analysts relying on financial statement analysis assume that share markets are inefficient.

Question 59

Which of the following statements concerning the current ratio is incorrect?

A) The current ratio can be manipulated at balance date,e.g. by using cash to pay off short-term debt.
B) A high current ratio may indicate excessive investment in working capital.
C) A low current ratio may indicate difficulty in meeting short-term commitments.
D) A current ratio of 1.5 to 1 should always be maintained.