Deck 10: Understanding a Firms Financial Statements

Question 1

Accounts payable consist of payments due from a firm's customers.

Answer 1

False

Question 2

The income statement answers the question: "How profitable is the business?"

Answer 2

True

Question 3

The income statement shows the profit or loss from a firm's operations over a given period of time.

Answer 3

True

Question 4

A new business needs to manage cash flows carefully because if a firm runs out of cash, it is out of business.

Question 5

Depreciation is the cost of a firm's equipment and building allocated over their useful life.

Question 6

The income statement shows a firm's financial position on a specific date.

Question 7

The balance sheet shows a firm's assets, liabilities, and owners' equity at a specific point in time.

Question 8

The money that owners invest in the business is called owners' equity.

Question 9

Ownership equity represents the owner's investment in the company, which can be either his/her cash invested in the company or money borrowed from a bank to purchase fixed assets.

Question 10

Total assets less outstanding debt must always equal ownership equity.

Question 11

Assets that can be converted to cash relatively quickly are said to be liquid.

Question 12

In the text the authors state that the terms earnings and profits will be used interchangeably, but not income.

Question 13

A profitable company does not necessarily have positive cash flows.

Question 14

Profits reward owners for investing in a company, but they do little to promote future growth.

Question 15

Jan Woodring is considering investing in a business. To see the firm's financial position over a period of time, she should look at its balance sheet.

Question 16

The cash flow statement answers the questions "where did the cash come from?' and "where did it go?"

Question 17

The income statement reports a firm's results over a given period of time, but to determine a firm's complete financial position the cash flow statement is required.

Question 18

Cash flows that investors either provide to or receive from the business are called cash flows from owners' equity.

Question 19

Accounts payable, accrued expenses, 5-year notes payable, and 90-day notes are short-term liabilities.

Question 20

The major difference between cash-basis accounting and accrual-basis accounting lies in when the firm recognizes revenue and profits.

Question 21

Other assets include

A) land.
B) machinery.
C) contingency funds.
D) goodwill.

Question 22

The best financial ratio to determine a company's ability to pay debt as it comes due is the debt ratio.

Question 23

As Krista explained to her daughters Ashley and Cameron, the report that provides a picture of the firm's assets and its sources of financing at a point in time is the

A) balance sheet.
B) income statement.
C) cash flow statement.
D) asset list.

Question 24

A conventional measure of a firm's liquidity is a comparison of current assets to current liabilities.

Question 25

Liquidity represents the degree to which a firm can meet maturing short-term debt obligations with available working capital.

Question 26

Fixed assets include

A) land.
B) copyrights.
C) contingency funds.
D) goodwill.

Question 27

In order to determine the cash flows from day-to-day operations the firm must convert the company's income statement from an accrual basis to a cash basis.

Question 28

To determine the debt ratio, the total debt is divided by the total assets.

Question 29

Assets that are relatively liquid are classified as

A) current assets.
B) fixed assets.
C) short-term assets.
D) other assets.

Question 30

Other assets would include all of the following except

A) startup costs.
B) patents.
C) copyrights.
D) inventories.

Question 31

The ____ shows the results of a firm's operations over a period of time, usually one year.

A) income statement
B) balance sheet
C) statement of cash flow
D) statement of financial position

Question 32

The three activities that explain the cash inflows and outflows of a business are the selling, investment and financing activities.

Question 33

An example of a fixed asset is

A) a delivery truck for sale by an automotive dealer.
B) inventory.
C) a delivery truck used by a grocer to deliver merchandise to customers.
D) short-term investments in stock.

Question 34

Earnings before taxes are computed by deducting the firm's interest expense from its ____ income.

A) total
B) projected
C) net
D) operating

Question 35

An example of a current asset is

A) equipment.
B) land.
C) leased property.
D) accounts receivable.

Question 36

Ownership equity is derived only from sources external to the firm.

Question 37

Dividends to a firm's owners are not considered an expense in the income statement.

Question 38

An example of a current asset is

A) land.
B) inventories.
C) equipment.
D) buildings.

Question 39

Using more debt can increase the owner's return on equity but it also increases risk.

Question 40

The net income does not measure the return on the firm's total assets.

Question 41

Which of the following is not used in determining a company's profitability on assets?

A) return on assets
B) debt ratio
C) operating profit margin
D) total asset turnover

Question 42

The amount of the business owners' initial investment, owners' later investment in the business, and retained earnings comprise

A) debt capital.
B) accrued expenses.
C) owners' long-term debt.
D) owners' equity capital.

Question 43

Cumulative depreciation expense is shown on the

A) balance sheet.
B) cash-flow statement.
C) income statement.
D) all of these.

Question 44

The income statement reports financial information related to the following broad areas of business except

A) sales
B) operating expenses
C) accumulated depreciation
D) interest expense

Question 45

Raw materials and products held by the firm for sale constitute _____.

A) accounts payable.
B) accounts receivable.
C) cost of goods.
D) inventories.

Question 46

The debt ratio is determined by dividing the firm's total debt by the total _____.

A) income
B) operating profits
C) assets
D) liabilities

Question 47

The cash flow statement reflects cash flows from

A) operating activities.
B) investment activities.
C) financing activities.
D) operating, investment, and financing activities.

Question 48

A two year-old asset has a depreciable life of 10 years. Its initial purchase cost was $450,000 and it is depreciated by 10 percent annually. What is the remaining depreciable value of the asset?

A) $ 0.00
B) $90,000
C) $200,000
D) $360,000

Question 49

Current debt represents amounts borrowed from banks or other lending sources for _____ or less.

A) 2 years
B) 6 months
C) 1 quarter
D) 12 months

Question 50

For their opening day, Ashley and Cameron bought $40 of "premium pink lemonade mix" and paper cups, which constituted their

A) cash balance.
B) fixed assets.
C) inventories.
D) cost of goods sold.

Question 51

The cash flow statement measures cash flows on

A) an annual basis.
B) an accrual basis.
C) a cash-basis.
D) a normalized basis.

Question 52

On the balance sheet, for every dollar of assets there must be a dollar of financing in the form of debt or _____.

A) owner's equity
B) accounts receivable
C) accumulated depreciation
D) net profit

Question 53

The value of a depreciable asset

A) is constant over time.
B) increases with each use of the asset.
C) decreases over time.
D) increases over time.

Question 54

The "bottom line" of the income statement is affected by all of the following EXCEPT:

A) cost of good sold
B) dividends paid to owners
C) general and administrative costs
D) marketing expenses

Question 55

The _____ shows all cash receipts and payments involved in operating the business and managing its financial activities.

A) income statement
B) balance sheet
C) cash flow statement
D) statement of financial position

Question 56

After their first day Ashley and Cameron's profits were $45, but their cash increased by only $30 because their _____ also increased.

A) debt
B) inventory
C) accounts payable
D) accounts receivable.

Question 57

In order to derive a cash flow statement, starting with the income statement the owner must add back in _____.

A) depreciation expense
B) increase in accounts receivable
C) increases in inventory
D) decrease in accounts payable

Question 58

The major distinction between cash-basis and accrual-basis accounting is that the

A) cash method is easier to use.
B) cash method matches revenue and expenses better.
C) point of recognition of revenue and expenses is different.
D) cash method involves less record keeping.

Question 59

Current assets include all of the following EXCEPT

A) accounts payable.
B) accounts receivable.
C) cash.
D) inventories.

Question 60

Interest expense is deducted from the _____ to arrive at the company's profits before taxes.

A) operating profits
B) gross profits
C) net profits
D) cost of goods sold

Question 61

You Make the Call-Situation 2
At the beginning of 2005, Mary Abrahams purchased a small business, the Turpen Company, whose income statement and balance sheets are shown below.
The firm has been profitable, but Abrahams has been disappointed by the lack of cash flows. She had hoped to have about $10,000 a year available for personal living expenses. However, there never seems to be much cash available for purposes other than business needs. Abrahams has asked you to examine the financial statements and explain why, although they show profits, she does not have any discretionary cash for personal needs. She observed, "I thought that I could take the profits and add depreciation to find out how much cash I was generating. However, that doesn't seem to be the case. What's happening?"

Question 62

Describe the main reasons why profits based on an accrual accounting system will differ from those based on a cash-based system?

Question 63

The number resulting when taxes are subtracted from earnings is the _____ income

A) total
B) projected
C) net
D) operating

Question 64

A company's net income depends on all of the following except

A) amount of sales.
B) cost of goods sold.
C) interest expenses and taxes.
D) inventory estimates.

Question 65

List the four primary ways an entrepreneur's decisions play out when it comes to evaluating a firm's financial performance.

Question 66

Name and define three categories of assets.

Question 67

The computation of cost of goods sold and operating expenses is based on all of the following except

A) the cost of goods sold.
B) general and administrative expenses.
C) the firm's interest expense.
D) depreciation expenses.

Question 68

You Make the Call-Situation 1
The Donahoo Furniture Sales Company was formed on December 31, 2004, with $1,000,000 in equity plus $500,000 in long-term debt. On January 1, 2005, all of the firm's capital was held in cash. The following transactions occurred during January 2005.

Question 69

Briefly explain the difference between accrual-basis accounting and cash-basis accounting.

Question 70

The textbook identifies a number of sources of current debt. Name these sources and describe the nature of each.

Question 71

If a firm's current ratio improves from 1.5 to 2.0, what has likely happened?

A) Current liabilities have decreased
B) Fixed assets have increased
C) Ownership equity has increased
D) Long-term debt has decreased

Question 72

The liquidity of a firm is

A) often measured by a ratio of current assets to current liabilities.
B) not important to a company's financial health.
C) the ability of the firm to sell its products quickly.
D) a measurement of spontaneous financing.

Question 73

You Make the Call-Situation 3
Cameron Products, Inc., used as an example in chapter 10, is an actual firm (although some of the facts were changed to maintain confidentiality). Kate Lynn bought the firm from its founding owners and moved its operations to her hometown. Although she estimated the firm's asset needs and financing requirements, she cannot be certain that these projections will be realized. The figures merely represent the most likely case. Lynn also made some projections that she considers to be the worst-case and best-case sales and profit figures. If things do not go well, the firm might have sales of only $200,000 in its first year. However, if the potential of the business is realized, Lynn believes that sales could be as high as $325,000. If she needs any additional financing beyond the existing line of credit, she could conceivably borrow another $5,000 in short-term debt from the bank by pledging some personal investments. Any additional financing would need to come from Lynn herself, thereby increasing her equity stake in the business.
[Source: Personal conversation with Kate Lynn. (Numbers are hypothetical.)]

Question 74

The equation "Sales-Expenses = Profits" would represent which financial statement?

A) Cash flow
B) Income
C) Retained earnings
D) Balance sheet

Question 75

If a firm's current ratio _____, its liquidity _____.

A) increases. increases
B) increases, decreases
C) decreases, increases
D) increases, remains the same

Question 76

Operating expenses include

A) marketing-related expenses.
B) the cost for independent dealers to prepare for the distribution of the product.
C) interest on all loans.
D) income taxes.

Question 77

A business loan for 9 months would be best described as a(n)

A) account payable.
B) accrued expense.
C) short-term note.
D) long-tern debt.

Question 78

What four variables drive the amount of profit a company earns?