Deck 16: Financial Statement Analysis

Question 1

the two major types of financial statement analysis discussed in this chapter.

Answer 1

The two major type of financial statement analysis discussed in this chapter
• Vertical analysis and
• Horizontal analysis.
Vertical analysis is the analysis in which any of the components (such as sales, cost of goods sold etc.) is taken as base (100%) and the remaining amounts are reported as percent of selected base.
In the horizontal analysis, all the components of a year are taken as base and corresponding components in other years are reported as percentage of selected bases. Any year is taken as base year in horizontal analysis.

Question 2

examining Luke Company's current period income statement, you notice that Research and Development expenses are 62% of sales revenue. Luke has most likely provided

A) a horizontal analysis.
B) a vertical analysis using sales as the base.
C) a horizontal analysis using sales as the base.
D) a vertical analysis using net income as the base.
E) none of the above.

Answer 2

The correct answer of this is Option B.
Vertical analysis of the financial statement is the analysis and comparison of two financial statements and the percentage method is used for the comparison. In this the development expenses are compared with the sales of the same period. Any component of a financial statement is taken as base (100%) and the remaining components are reported as percentage of the base.

Question 3

is horizontal analysis? Vertical analysis? Should both horizontal and vertical analyses be done? Why?

Answer 3

Vertical analysis:
Vertical analysis explains one line item with respect to another line item for same period.
Horizontal analysis:
Horizontal analysis explains one line item with respect of same of last year taking that year as a base.
State the reasons for applying both methods:
These both analyses should be used in order to check how company is performing current and also to compare its result with last year. This will help organization to formulate strategies accordingly and run its operations effectively.

Question 4

advantage of common-size analysis is that

A) the size of dollar amounts impact the analysis.
B) larger companies will have higher common-size percentages.
C) it focuses only on vertical analysis.
D) the effects of size are eliminated.
E) it focuses only on horizontal analysis.

Question 5

Explain how creditors, investors, and managers can use common-size analysis as an aid in decision making.

Question 6

Fractions or percentages computed by dividing one account or line-item amount by another are called

A) returns.
B) industry averages.
C) common-size statements.
D) dividend yields.
E) ratios.

Question 7

are liquidity ratios? Leverage ratios? Profitability ratios?

Question 8

measures of the ability of a company to meet its current obligations are called

A) ratios.
B) liquidity ratios.
C) leverage ratios.
D) profitability ratios.
E) percentage changes.

Question 9

Identify two types of standards used in ratio analysis. Explain why it is desirable to use both types.1. Name the two major types of financial statement analysis discussed in this chapter.

Question 10

Pedee Company's inventory turnover in days is 80 days. Which of the following actions could help to improve that ratio?

A) Increase sales price.
B) Increase manufacturing costs.
C) Reduce cost of goods sold.
D) Reduce average inventory.
E) All of these.

Question 11

information does the quick ratio supply that the current ratio does not?

Question 12

Etchey Company shows that 46% of its assets are financed by creditors. Which of the following shows this result?

A) Current ratio
B) Times-interest-earned ratio
C) Debt ratio
D) Inventory turnover in days
E) Return on sales

Question 13

Suppose that the accounts receivable turnover ratio of a company is low when compared with other firms within its industry. How would this information be useful to the managers of a company?

Question 14

Profitability ratios are used by which of the following groups?

A) Company managers
B) Creditors
C) Lenders
D) Investors
E) All of these.

Question 15

high inventory turnover ratio provides evidence that a company is having problems with stockouts and disgruntled customers. Do you agree? Explain.

Question 16

and Torrie Jones are a retired couple looking for income. They are currently rebalancing their portfolio of stocks to include more with high dividends. Fred and Torrie will be most interested in which of the following?

A) Current ratio
B) Dividend payout ratio
C) Return on assets
D) Price-earnings ratio
E) Dividend yield

Question 17

loan agreement between a bank and a customer specified that the debt ratio could not exceed 60%. Explain the purpose of this restrictive agreement.

Question 18

small pizza restaurant, founded and owned by the Martinelli sisters, would be expected to have which of the following?

A) Low inventory turnover and high gross margin
B) Low accounts receivable turnover and low gross margin
C) High price-earnings ratio
D) High inventory turnover and low gross margin
E) All of these.

Question 19

manager decided to acquire some expensive equipment through the use of an operating lease even though a capital budgeting analysis showed that it was more profitable to buy than to lease. However, the purchase alternative would have required the issuance of some bonds. Offer some reasons that would explain the manager's choice.

Question 20

after-tax cost of interest expense is used in calculating which of the following?

A) Times-interest-earned
B) Return on assets
C) Debt ratio
D) Inventory turnover ratio
E) All of these.

Question 21

Preparing Common-Size Income Statements by Using Base Period Horizontal Analysis
Scherer Company provided the following income statements for its first 3 years of operation:

Refer to the information for Scherer Company on the previous page.

Question 22

Explain why an investor would be interested in a company's debt ratio.

Question 23

Preparing Income Statements by Using Net Sales as the Base: Vertical Analysis
Scherer Company provided the following income statements for its first 3 years of operation:

Refer to the information for Scherer Company on the previous page.

Question 24

Assume that you have been given the responsibility to invest some funds in the stock market to provide an annuity to an individual who has just retired. Explain how you might use the dividend yield and the dividend payout ratio to help you with this investment decision.

Question 25

Explain how an investor might use the price-earnings ratio to value the stock of a company.

Question 26

Calculate the Average Accounts Receivable, the Accounts eceivable Turnover Ratio, and the Accounts Receivable Turnover in Days
Last year, Nikkola Company had net sales of $2,299,500,000 and cost of goods sold of $1,755,000,000. Nikkola had the following balances:

Refer to the information for Nikkola Company above.

Question 27

would investors and creditors be interested in knowing the dilutive effects of convertible securities on earnings per share?

Question 28

Calculating the Average Inventory, the Inventory Turnover Ratio, and the Inventory Turnover in Days
Last year, Nikkola Company had net sales of $2,299,500,000 and cost of goods sold of $1,755,000,000. Nikkola had the following balances:

Refer to the information for Nikkola Company above.

Question 29

Explain the significance of the inventory turnover ratio in a JIT manufacturing environment.

Question 30

Calculating the Times-Interest-Earned Ratio
Paxton Company provided the following income statement for last year:

Question 31

a JIT manufacturing environment, the current ratio and the quick ratio are virtually the same. Do you agree? Why?

Question 32

Calculating the Debt Ratio and the Debt-to-Equity Ratio
Ernst Company's balance sheet shows total liabilities of $32,500,000, total stockholders' equity of $8,125,000, and total assets of $40,625,000.

Question 33

Calculating the Return on Sales
Refer to the information for Somerville Company above.

Question 34

Calculating the Average Total Assets and the Return on Assets
Refer to the information for Somerville Company above. Assume a tax rate of 40%.

Question 35

Calculating the Average Common Stockholders' Equity and the Return on Stockholders' Equity
Refer to the information for Somerville Company above.

Question 36

Computing Earnings per Share
Refer to the information for Somerville Company on the previous page.

Question 37

Computing the Price-Earnings Ratio
Refer to the information for Somerville Company on the previous page. Also, assume that the price per common share for Somerville is $8.10.

Question 38

Computing the Dividend Yield and the Dividend Payout Ratio
Refer to the information for Somerville Company on the previous page. Also, assume that the market price per common share is $8.10.

Question 39

Horizontal Analysis
Sundahl Company's income statements for the past 2 years are as follows:

Refer to the information for Sundahl Company above.

Question 40

Vertical Analysis
Sundahl Company's income statements for the past 2 years are as follows:

Refer to the information for Sundahl Company on the previous page.

Question 41

Horizontal Analysis
Cuneo Company's income statements for the last 3 years are as follows:

Refer to the information for Cuneo Company above.

Question 42

Vertical Analysis
Cuneo Company's income statements for the last 3 years are as follows:

Refer to the information for Cuneo Company above.

Question 43

Current Ratio and Quick (Acid-Test) Ratio
Jordan Company provided the following information:

Question 44

Current Ratio and Quick (Acid-Test) Ratio
Upton Company has current assets equal to $3,600,000. Of these, $1,100,000 is cash, $1,300,000 is accounts receivable, and the remainder is inventories. Current liabilities total $3,000,000.

Question 45

Average Accounts Receivable, Accounts Receivable Turnover Ratio, Accounts Receivable Turnover in Days
Knowlton Company had net sales of $3,906,000. Knowlton had the following balances:

Question 46

Average Accounts Receivable, Accounts Receivable Turnover Ratio, Accounts Receivable Turnover in Days
Whalen Company had net sales of $6,500,300. Whalen had the following balances:

Question 47

Average Inventory, Inventory Turnover Ratio, Inventory Turnover in Days
Belt Company had net sales of $2,225,500,000 and cost of goods sold of $1,557,850,000. Belt had the following balances:

Question 48

Average Inventory, Inventory Turnover Ratio, Inventory Turnover in Days
Delater Company had sales of $3,948,340 and a gross margin of $1,859,260. Delater had beginning inventory of $53,420 and ending inventory of $62,640.

Question 49

Profitability Ratios
Bryce Company manufactures pet supplies. However, Bryce's electronic accounting system recently crashed and, unfortunately, only a partial recovery of the company's year-end accounting records (which included several profitability ratios) was possible. As a result, Bryce's controller, a bright young CMA named Jeanette, must compute various lost financial account balances using the recovered information listed below:
• Long-term liabilities: $1,500,000
• Ending inventory is the same as beginning inventory.
• Gross margin: $3,000,000
• Net sales: $8,000,000
• Accounts receivable turnover: 50
• Ending accounts receivable is the same as beginning accounts receivable.
• Total liabilities: $2,000,000
• Current ratio: 2.5
•. Cash: $600,000
• Quick ratio: 2.0
• Inventory turnover in days: 3.65

Question 50

Times-Interest-Earned
Tsao Company provided the following income statement for last year:

Question 51

Ratio, Debt-to-Equity Ratio
Busch Company's balance sheet shows total liabilities of $510,900, total equity of $126,000, and total assets of $636,900.

Question 52

Times-Interest-Earned Ratio, Debt Ratio, Debt-to-Equity Ratio
Juroe Company provided the following income statement for last year:

Juroe's balance sheet as of December 31 last year showed total liabilities of $10,250,000, total equity of $6,150,000, and total assets of $16,400,000.
Refer to the information for Juroe Company above.

Question 53

Return on Sales
Juroe Company provided the following income statement for last year:

Juroe's balance sheet as of December 31 last year showed total liabilities of $10,250,000, total equity of $6,150,000, and total assets of $16,400,000.
Refer to the information for Juroe Company above.

Question 54

Average Total Assets, Return on Assets
Juroe Company provided the following income statement for last year:

Juroe's balance sheet as of December 31 last year showed total liabilities of $10,250,000, total equity of $6,150,000, and total assets of $16,400,000.
Refer to the information for Juroe Company above. Also, assume that Juroe's total assets at the beginning of last year equaled $17,350,000 and that the tax rate applicable to Juroe is 40%.

Question 55

Average Common Stockholders' Equity, Return on Stockholders' Equity
Rebert Inc. showed the following balances for last year:

Rebert's net income for last year was $3,182,000.
Refer to the information for Rebert Inc. above.

Question 56

Earnings per Share, Price-Earnings Ratio
Rebert Inc. showed the following balances for last year:

Rebert's net income for last year was $3,182,000.
Refer to the information for Rebert Inc. above. Also, assume that the market price per share for Rebert is $51.50.

Question 57

Dividend Yield Ratio, Dividend Payout Ratio
Rebert Inc. showed the following balances for last year:

Rebert's net income for last year was $3,182,000.
Refer to the information for Rebert Inc. above. Also, assume that the dividends paid to common stockholders for last year were $2,600,000 and that the market price per share of common stock is $51.50.

Question 58

Liquidity Analysis
The following selected information is taken from the financial statements of Arnn Company for its most recent year of operations:


During the year, Arnn had net sales of $2.45 million. The cost of goods sold was $1.3 million.

Question 59

Leverage Ratios
Grammatico Company has just completed its third year of operations. The income statement is as follows:

Selected information from the balance sheet is as follows:

Question 60

Profitability Ratios
The following information has been gathered for Malette Manufacturing:

Assume that the firm has no common stock equivalents. The tax rate is 34%.

Question 61

Horizontal Analysis
Mike Sanders is considering the purchase of Kepler Company, a firm specializing in the manufacture of office supplies. To be able to assess the financial capabilities of the company, Mike has been given the company's financial statements for the 2 most recent years.


Refer to the information for Kepler Company above.

Question 62

Vertical Analysis
Mike Sanders is considering the purchase of Kepler Company, a firm specializing in the manufacture of office supplies. To be able to assess the financial capabilities of the company, Mike has been given the company's financial statements for the 2 most recent years.


Refer to the information for Kepler Company above.

Question 63

Liquidity Ratios
Mike Sanders is considering the purchase of Kepler Company, a firm specializing in the manufacture of office supplies. To be able to assess the financial capabilities of the company, Mike has been given the company's financial statements for the 2 most recent years.


Mike Sanders is considering the purchase of Kepler Company, a firm specializing in the manufacture of office supplies. To be able to assess the financial capabilities of the company, Mike has been given the company's financial statements for the 2 most recent years.


Refer to the information for Kepler Company above.

Question 64

Analysis of Accounts Receivable and Credit Policy
Based on customer feedback, Ted Pendleton, manager of Gray Company, which produces photo supplies, decided to grant more liberal credit terms. Ted chose to allow customers to have 60 days before full payment of the account was required. From 2010 through 2012, Gray's credit policy for sales on account was 2/10, n/30. In 2013, the policy of 2/10, n/60 became effective. By the end of 2014, Gray was beginning to experience cash flow problems. Although sales were strong, collections were sluggish, and the company was having a difficult time meeting its shortterm obligations. Ted noted that the cash flow problems materialized after the credit policy was changed and wondered if there was a connection. To help assess the situation, he gathered the following data pertaining to the collection of accounts receivable (balances are end-of-year balances; the 2010 balance was the same as that in 2009):

Question 65

Profitability Analysis for an Investment Decision
Suppose that you are considering investing in one of two companies, each in the same industry. The most recent income statements for each company and other relevant information are as follows:

Question 66

Manipulation of Ratios and Ethical Behavior
Pete Donaldson, president and owner of Donaldson Mining Supplies, was concerned about the firm's liquidity. He had an easy time selling supplies to the local coal mines but had a difficult time collecting the receivables. He had even tried offering discounts for prompt payment. The outcome wasn't as expected. The coal mines still took as long to pay as before but took the discount as well. Although he had complained about the practice, he was told that other suppliers would provide the supplies for the same terms. Collections were so slow that he was unable to pay his own payables on time and was receiving considerable pressure from his own creditors.
The solution was a line of credit that could be used to smooth his payment patterns. Getting the line of credit was another matter, however. One bank had turned him down, indicating that he already had too much debt and that his short-term liquidity ratios were marginal. Pete had begun the business with $5,000 of his own capital and a $30,000 loan from his father-in-law. He was making interest payments of $3,000 per year to his father-in-law with a promise to pay the principal back in 5 years (3 years from now).
While mulling over his problem, Pete suddenly saw the solution. By changing accountants, he could tell the next accountant that the $30,000 had been donated to the business and therefore would be reclassified into the equity section. This would dramatically improve the debt ratio. He would simply not disclose the $3,000 annual payment-or he could call it a dividend. Additionally, he would not tell the next accountant about the $6,000 of safety gear that was now obsolete. That gear could be added back, and the current ratio would also improve. With an improved financial statement, the next bank would be more likely to grant the needed line of credit.

Question 67

Interpreting the Meaning of Ratios from the Financial Statements
Using the Internet, locate the most recent financial statements for two companies from the same industry. Find (or calculate) the ratios listed below, and compare the two companies. (If you cannot calculate a particular ratio, explain why.) Which company do you think is performing better? Why? Ratios:
a. Current ratio
b. Quick ratio
c. Accounts receivable turnover ratio
d. Inventory turnover ratio
e. Turnover in days
f. Times-interest-earned ratio
g. Debt ratio
h. Debt-to-equity ratio
i. Return on sales
j. Return on assets
k. Return on stockholders' equity
l. Earnings per share
m. Price-earnings ratio
n. Dividend yield
o. Dividend payout ratio