Deck 25: Analysis and Interpretation of Financial Statements

Question 1

Besides the information in annual reports, how many of these are sources of financial information about companies that are useful for analysing their performance and financial position?
$\bullet$ The Internet
$\bullet$ The Stock Exchange
$\bullet$ Financial newspapers and journals
$\bullet$ Stock brokers
$\bullet$ Information on competitors

A) 2
B) 3
C) 4
D) 5

Answer 1

5

Question 2

Financial stability refers to the ability of an entity to:

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

Answer 2

D

Question 3

Analysis of an entity's financial structure and its ability to continue to operate into the future and meet its long term cash obligations is known as:

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

Answer 3

D

Question 4

The debt ratio measures:

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

Question 5

Protan Ltd has the following summary balance sheet at year-end.
Current assets $ 700 000
Long-term assets 1 000 000
Current liabilities 100 000
Long-term liabilities 300 000
Share capital 600 000
Retained earnings 700 000
The debt ratio at year-end is:

A) 76.5 %.
B) 23.5 %.
C) 40 %.
D) 17.6%.

Question 6

Which of these 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, III, IV, V
B) II, III, IV, V
C) I, II, III, IV
D) I, II, III, IV, V

Question 7

How many of these are possible uses of financial analysis?
$\bullet$ By shareholders to assess future profitability and financial stability
$\bullet$ By management for planning and control
$\bullet$ By financial analysts to predict future share price
$\bullet$ By the government to estimate taxation payable

A) 1
B) 2
C) 3
D) 4

Question 8

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

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

Question 9

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

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

Question 10

To be useful for decision making, absolute dollar amounts in financial statements need to be compared with other information. How many of these are possible comparisons?
$\bullet$ Prior year results
$\bullet$ Current year sales, total assets etc.
$\bullet$ Results of similar businesses or industry averages

A) 0
B) 1
C) 2
D) 3

Question 11

All of these ratios are measures of aspects of a firm's profitability, except:

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

Question 12

Vertical analysis of a balance sheet usually:

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

Question 13

In a trend analysis of K Company, which of these changes appears to be the most significant in requiring further investigation?

A) An increase of 13% in revenues.
B) An increase of 11% in bad debts written off.
C) An increase of 7% in total assets.
D) An increase of 8% in accounts receivable.

Question 14

Making Moves has the following data available.
Using vertical analysis, express selling expenses as a percentage of the base amount.

A) 60%
B) 50%
C) 20%
D) 15%

Question 15

How many of these ratios measure the adequacy of profits?
$\bullet$ Profit before interest and finance costs/ finance costs
$\bullet$ Profit compared to total assets
$\bullet$ Profit compared to sales
$\bullet$ Profit compared to equity

A) 1
B) 2
C) 3
D) 4

Question 16

Financial ratios are used for all of the following purposes except:

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

Question 17

Which statement is incorrect?

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

Question 18

In a trend analysis of T Company, which of these changes appears to be the most significant in requiring further investigation?

A) An increase of 10% in revenue.
B) An increase of 10% in borrowing costs.
C) An increase of 6% in total assets.
D) A decrease of 4% in motor vehicle expenses.

Question 19

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

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

Question 20

Financial statements in which each item is stated as a percentage of some specific base item in the same statement are known as:

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

Question 21

The formula for the profit margin ratio is:

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

Question 22

What is the formula for receivables (debtors) turnover in times per annum?

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

Question 23

The use of borrowed funds in an attempt to earn a return greater than the cost of borrowing is known as:

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

Question 24

Belfast Water Works had a profit of $300 000 before tax, after deducting $27 000 in interest expense. Belfast's liabilities and equity total $2 725 000. Return on total assets, before finance costs and tax is:

A) 10.4%.
B) 11.0%.
C) 12.0%.
D) unable to be calculated from the information provided.

Question 25

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

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

Question 26

To calculate the current (working capital) ratio it is necessary to:

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

Question 27

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

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

Question 28

All of these ratios are indicators of profitability except:

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

Question 29

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

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

Question 30

The price-earnings ratio of the shares for the current year is:

A) 4.2 to 1.
B) 5 to 1.
C) 8.3 to 1.
D) 10 to 1.

Question 31

Annual dividend per ordinary share divided by market price per ordinary share measures:

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

Question 32

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

A) It measures how much investors are willing to pay for each dollar of earnings.
B) Higher P/E ratios tend to be associated with growth companies.
C) A P/E ratio of 9.1 means that the shares of the company are selling at 9.1 times current profits.
D) As expectations of future profits increase the P/E ratio tends to fall.

Question 33

If the interim dividend was 5c per ordinary share, the final dividend 7c per share and the market price per share on 30 June 2014 $3.20, the dividend yield is:

A) 3.75%.
B) 37.5%.
C) 26.7%.
D) 6%.

Question 34

Of these businesses the one that is likely to have the highest inventory turnover ratio is a:

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

Question 35

How many of these ratios measure the relationship between debt and equity?
$\bullet$ The debt ratio
$\bullet$ The equity (proprietorship) ratio
$\bullet$ The leverage ratio (total assets/total equity)
$\bullet$ The current ratio

A) 1
B) 2
C) 3
D) 4

Question 36

The profit margin ratio measures:

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

Question 37

A profit ratio for a retailer of 4.1% in year 2 compared to 5.5% for the previous year indicates:

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

Question 38

Which statement concerning earnings per share is incorrect?

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

Question 39

All of these are possible explanations of why profitability is inadequate except:

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

Question 40

Trends in ratios that measure the relationship between debt and equity provide information about how many of the following?
$\bullet$ Long term stability
$\bullet$ Degree of risk in using debt financing
$\bullet$ Margin of safety to creditors in the event of liquidation

A) 0
B) 1
C) 2
D) 3

Question 41

Leverage measures:

A) whether the firm can pay its long-term liabilities.
B) the proportion of borrowed funds compared to equity.
C) whether the firm can pay its current liabilities.
D) profit as a portion of equity.

Question 42

Kaplan has a current ratio of 2.5 to 1 and current liabilities of $12 000. If Kaplan has $9000 of inventory what is the quick ratio?

A) 2.25 to 1
B) 2.00 to 1
C) 1.75 to 1
D) 1.50 to 1

Question 43

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

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

Question 44

All of these are limitations of financial ratio analysis except:

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

Question 45

Which statement concerning the current (working capital) ratio is incorrect?

A) A low current ratio may indicate difficulty in meeting short-term commitments.
B) The current ratio can be manipulated at balance date,
C) A high current ratio may indicate excessive investment in working capital.
D) A current ratio of $1.50 of current assets for each $1 of current liabilities should always be maintained.
E)g. by using cash to pay off short-term debt.

Question 46

Which statement relating to the debt ratio of a company is not true?

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

Question 47

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

A) P/E ratio 5; earnings yield 20%
B) P/E ratio 8; earnings yield 12.5%
C) P/E ratio 9; earnings yield 12 %
D) P/E ratio 10; earnings yield 10%

Question 48

A company has a current ratio of 3:1. Which action will decrease this ratio?

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

Question 49

The quick ratio (acid test ratio) reflects:

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

Question 50

A) 1 to 2.
B) 3 to 2.
C) 2 to 1.
D) 2 to 3.

Question 51

A) 40%.
B) 43%.
C) 60%.
D) 66%.

Question 52

Financial stability refers to the ability of an entity to:

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

Question 53

If the average market price of Silver Bling Ltd's shares is $3.50 and earnings per ordinary share are 70c the P/E ratio is:

A) 0.2.
B) 0.5.
C) 5.0.
D) 2.0.

Question 54

Which statement concerning the cash flow adequacy ratio is not correct?

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

Question 55

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

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

Question 56

Of the following firms, would be expected to have the fastest inventory turnover?

A) Sports car showroom
B) Jewellery store
C) Fruit and veg. shop
D) Clothing store

Question 57

Dividend yield on ordinary shares is calculated as:

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

Question 58

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

A) cash flow adequacy ratio.
B) repayment of long-term borrowing ratio.
C) debt coverage ratio.
D) operations index.

Question 59

The ratio which would be most helpful to an investor who is investing in ordinary shares primarily for dividends rather than for appreciation in market price, is:

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

Question 60

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, in which of the following ratios will Seller be most interested?

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

Question 61

Which of these are limitations of financial analysis?
I) The past is an imperfect guide to the future
II) Historical cost financial reports are not adjusted for inflation
III) Non-quantitative factors are not considered
IV) Ratio results often contain errors in calculations
V Comparisons may not be valid

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

Question 62

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

A) If share markets are inefficient financial analysis is of little use to investors.
B) Analysts relying on financial statement analysis assume that share markets are inefficient.
C) The evidence of share market research on the efficiency of the market is conclusive.
D) Little research has been carried out as to whether share markets are efficient or not.

Question 63

How many of these are limitations of financial analysis?
I The past is an imperfect guide to the future
II The effect of inflation is not considered
III Undisclosed changes in accounting policies
IV Inconsistent classification

A) One
B) Two
C) Three
D) Four

Question 64

Which statement is incorrect?

A) 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.
B) 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.
C) Fundamental analysis is engaged in by many analysts.
D) Fundamental analysis assumes that an analyst can study all the published information in relation to an entity and determine whether its shares are ly valued.