Deck 12: Financial Statement Analysis

Question 1

Common sized analysis is useful for making comparisons across the various financial statements.

Answer 1

False

Question 2

The auditor's report guarantees the accuracy of the information presented in the financial statements.

Answer 2

False

Question 3

When calculating the EPS, the cumulative preferred dividends must be removed even if the dividends have not been declared and paid.

Answer 3

True

Question 4

Ratio analysis provides a complete picture of the general financial health and wellbeing of a company.

Question 5

Analyzing financial data on the same company over time is called cross sectional analysis.

Question 6

A banker assessing a loan application and an equity analyst making an investment decision would perform the same type of analysis of a company.

Question 7

Times series analysis compares the data from one company with the data from another company.

Question 8

When a company can leverage funds at a rate that is less than the after-tax return on assets, the return on equity will exceed the return on assets.

Question 9

Fully diluted earnings per share is a worst case scenario.

Question 10

The point of leverage where a company's ROE is maximized is referred to as its optimal capital structure.

Question 11

Activity ratios measure how efficiently or effectively a company is managing its short term assets and short term obligations.

Question 12

Retrospective analysis reviews past trends in order to help predict the future.

Question 13

A basic understanding of the range of businesses in which a company is engaged can be obtained by reading the financial statements.

Question 14

The appropriate tax rate to use in the return on assets formula is a company's average tax rate.

Question 15

Return on equity is a measure of performance from management's perspective.

Question 16

The current ratio is an activity ratio.

Question 17

The denominator in the return on equity ratio should only include the equity accounts that belong to the common shareholders.

Question 18

Common size income statement analysis uses net revenues as a base for all percentages.

Question 19

The return on assets ratio can be broken into two elements: the profit margin and the total equity turnover.

Question 20

On a common size income statement, all items are shown as:

A)percentages of net income
B)percentages of total assets
C)percentages of gross revenue
D)percentages of gross profit

Question 21

Lenders would be most concerned with:

A)Debt to equity ratio
B)EPS
C)Inventory turnover
D)price earnings ratio

Question 22

Cross-sectional analysis involves examining a company's financial data:

A)across account classifications.
B)as percentages of net sales or total assets.
C)and comparing it with other companies.
D)across time periods.

Question 23

Use the following information for questions:
Review of the financial statements revealed the following for Sonoma Inc.: Sales $1,250,000, Net income $37,500, Total assets $650,000, Long-term debt $750,000, Interest expense $65,000 and Cost of goods sold $775,000.
When preparing common size financial statements interest expense would be shown as:

A)10.0%
B)9.3%
C)8.4%
D)5.2%

Question 24

The auditor's report confirms that:

A)The financial statements are error free
B)No fraud or intentional misstatements exist in the financial statements
C)The statements present fairly the financial condition of a company
D)The company is in sound financial condition

Question 25

To see if a company's cost of sales is increasing proportionately with sales an analyst would use:

A)raw financial data.
B)common sized analysis.
C)trend analysis.
D)prospective analysis.

Question 26

The return on assets ratio could be used for an):

A)financing decision.
B)liquidity decision.
C)investment decision.
D)debt-to-equity decision.

Question 27

Which of the following is not a general category of ratios?

A)Performance
B)Short-term liquidity
C)Long-term liquidity
D)Financial leverage

Question 28

Ratios are useful in explaining the:

A)relationships between financial data.
B)differences between companies.
C)trends within industries.
D)reasons for financial performance.

Question 29

Which of the following best describes the return on assets ratio?

A)Net income + interest expense) ÷ total assets
B)[Net income + interest expense × 1 - tax rate))] ÷ average total assets
C)[Net income + interest expense × tax rate)] ÷ average total assets
D)Net income + interest expense + income tax expense) ÷ total assets

Question 30

An analytical tool for comparing two companies of different sizes is:

A)Common size statements
B)Short-term liquidity
C)Financial leverage
D)Performance

Question 31

Which of the return on investment ratios would be of most interest to the owners of a company?

A)Return on assets
B)Return on interest
C)Return on debt
D)Return on equity

Question 32

All of the following measure activity except for:

A)Accounts receivable turnover
B)Inventory turnover
C)Equity turnover
D)Accounts payable turnover

Question 33

Place the following steps involved in financial statement analysis in the proper order:
I)Read the auditor's report
II)Perform detailed ratio analysis
III)Read each of the major financial statements
IV)Obtain an overall understanding of a company's range of businesses

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

Question 34

Why is the audit report important in the analysis of a company?

A)It guarantees the accuracy of the information in the financial statements.
B)It guarantees the accuracy of the internal controls of the company
C)The auditors are hired by management to assess the appropriateness of the accounting policies chosen.
D)The auditors are an independent third party expressing an opinion on the fairness of the financial statements.

Question 35

Which of the following companies would be least likely to calculate accounts receivable turnover ratios?

A)A restaurant
B)A construction company
C)A consulting firm
D)An insurance office

Question 36

The analysis of financial statements to assist in predicting future results is an example of:

A)historical analysis.
B)retrospective analysis.
C)retroactive analysis.
D)prospective analysis.

Question 37

Use the following information for questions:
Review of the financial statements revealed the following for Sonoma Inc.: Sales $1,250,000, Net income $37,500, Total assets $650,000, Long-term debt $750,000, Interest expense $65,000 and Cost of goods sold $775,000.
What is the Sonoma's gross profit margin closest to:

A)3%
B)38%
C)52%
D)62%

Question 38

Which of the return on investment ratios would be of most interest to the management of a firm?

A)Return on assets
B)Return on debt
C)Return on equity
D)Return on profits

Question 39

Which of the following is not an example of cross sectional analysis?

A)Determining how the growth in sales from one company differed from that of another company.
B)Comparing growth in sales across different industries
C)Determining the growth in sales for a company over a five-year period.
D)Comparing total sales across companies in the same industry for the past three years.

Question 40

Use the following information for questions:
Review of the financial statements revealed the following for Sonoma Inc.: Sales $1,250,000, Net income $37,500, Total assets $650,000, Long-term debt $750,000, Interest expense $65,000 and Cost of goods sold $775,000.
Assuming a corporate tax rate of 35%, what is the company profit margin ratio closest to?

A)12.3%
B)9.7%
C)6.4%
D)4.8%

Question 41

Use the following information for questions: sales $1,500,000; gross profit $640,000; net income $40,000 and income tax expense $35,000;
What is the common size percentage for the cost of sales?

A)3.0%
B)37.7%
C)42.7%
D)57.3%

Question 42

Financial leverage occurs when the after-tax cost of borrowed funds is:

A)less than the after-tax return on assets.
B)greater than the after-tax return on assets.
C)equal to the after-tax return on assets.
D)greater than the after-tax return on equity.

Question 43

Use the following information for questions:
Consider the following income statement data for Milan Inc.: $\begin{array} { l }&2011&2010\\ \text {Sales revenue }&\$97,000&\$86,200\\ \text { Less: Cost of goods sold}&45,600&53,400\\ \text {Gross profit }&51,700&32,800\\ \text { Less: Selling and administration costs Income before }&22,500&18,300\\ \text {income tax }&29,200&14,500\\\end{array}$


-The common size percentage for selling and administration costs in 2011 was:

A)21.2%
B)23.1%
C)43.5%
D)77.0%

Question 44

Use the following information for questions:
The following data was taken from the accounting records of Darias Corporation: $\begin{array}{lrr}&2011&2010\\\hline\text { Total assets } & \$ 950,000 & \$ 850,000 \\\text { Total liabilities } & 250,000 & 240,000 \\\text { Preferred shares } & 75,000 & 75,000 \\\text { Common shares } & 300,000 & 300,000 \\\text { Retained earnings } & 325,000 & 235,000\\\text { Additional data: } & \\\text { Net income } & 140,000 \\\text { Preferred dividend } & 15,000 \\\text { Interest expense } & 25,000 \\\text { Sales revenue } & 980,000 \\\text { Tax rate } & 32 \%\end{array}$

-The return on assets for 2011 is closest to:

A)15.5%
B)16.5%
C)17.4%
D)18.5%

Question 45

A company has a tax rate of 40%.Leverage would be beneficial for the company for each of the following combinations of interest rates and ROA except:

Question 46

A company's optimal capital structure occurs when:

A)ROA is maximized.
B)the company assets are funded by 50% debt and 50% equity.
C)the company can borrow at a rate lower than its ROA.
D)the ROE is maximized.

Question 47

Use the following information for questions:
Consider the following income statement data for Milan Inc.: $\begin{array} { l }&2011&2010\\ \text {Sales revenue }&\$97,000&\$86,200\\ \text { Less: Cost of goods sold}&45,600&53,400\\ \text {Gross profit }&51,700&32,800\\ \text { Less: Selling and administration costs Income before }&22,500&18,300\\ \text {income tax }&29,200&14,500\\\end{array}$


-Based on common size analysis, which of the following statements is correct?

A)The increase in sales revenue in 2011 was caused by higher selling and administrative expenses.
B)The company's cost to sales ratio improved in 2011.
C)The increase in gross profit in 2011 was due to increased sales.
D)Net income as a percent of sales declined in 2011.

Question 48

Use the following information for questions:
The following data was taken from the accounting records of Darias Corporation: $\begin{array}{lrr}&2011&2010\\\hline\text { Total assets } & \$ 950,000 & \$ 850,000 \\\text { Total liabilities } & 250,000 & 240,000 \\\text { Preferred shares } & 75,000 & 75,000 \\\text { Common shares } & 300,000 & 300,000 \\\text { Retained earnings } & 325,000 & 235,000\\\text { Additional data: } & \\\text { Net income } & 140,000 \\\text { Preferred dividend } & 15,000 \\\text { Interest expense } & 25,000 \\\text { Sales revenue } & 980,000 \\\text { Tax rate } & 32 \%\end{array}$

-The profit margin ratio to be used in calculating ROA for 2011 is closest to:

A)12.7%
B)14.3%
C)16.0%
D)16.8%

Question 49

When a company's ROE is greater than its ROA in a given time period, it could be that:

A)the company was able to borrow at an after tax rate that was less than the rate earned by investing in assets.
B)the company was able to borrow at an after tax rate that was higher than the rate earned by investing in assets.
C)the company has no debt.
D)the level of debt has no impact on the ROA

Question 50

Which of the following statements about ROA is true?

A)ROA is useful for comparing companies in different industries.
B)ROA is the most important ratio for an equity investor.
C)ROA is useful for determining how the company financed its assets.
D)ROA reflects the risk inherent in a company.

Question 51

Changes in the profit margin ratio could indicate changes in any of the following except changes in:

A)sales volume.
B)product profitability.
C)the cost structure.
D)the pricing policy.

Question 52

Use the following information for questions:
The following data was taken from the accounting records of Darias Corporation: $\begin{array}{lrr}&2011&2010\\\hline\text { Total assets } & \$ 950,000 & \$ 850,000 \\\text { Total liabilities } & 250,000 & 240,000 \\\text { Preferred shares } & 75,000 & 75,000 \\\text { Common shares } & 300,000 & 300,000 \\\text { Retained earnings } & 325,000 & 235,000\\\text { Additional data: } & \\\text { Net income } & 140,000 \\\text { Preferred dividend } & 15,000 \\\text { Interest expense } & 25,000 \\\text { Sales revenue } & 980,000 \\\text { Tax rate } & 32 \%\end{array}$

-The total asset turnover for 2011 is closest to:

A).15
B).97
C)1.03
D)1.09

Question 53

It is unattractive to borrow any further funds when:

A)the average borrowing costs start to equal or exceed the ROE.
B)the average borrowing costs start to equal or exceed the ROA.
C)the company's net profit margin falls below the average borrowing costs.
D)the company's debt-to-equity ratio exceeds 50%.

Question 54

Use the following information for questions:
Blue Sea Corporation's books revealed the following for 2011 and 2010: $$\begin{array} { l c r } & 2011 & 2010 \\\text { Cash } & 27,750 & \$ 21,250 \\\text { Accounts receivable }& 42,000 & 37,500 \\\text { Inventory } & 72,250 & 61,600 \\\text { Other prepaid assets } & 12,500 & 12,500 \\\text { Accounts payable } & 41,250 & 38,000 \\\text { Other current payables } & 13,000 & 15,000 \\\text { Sharehol ders' equity }& 100,250 & 79,850 \\\text { Sales } & 525,000 & 450,750 \\\text { Cost of sales }& 300,000 & 240,750 \\\text { Operating expenses } & 70,000 & 65,000 \\\text { Net income } & 155,000 & 145,000\end{array}$$

-The number of days to collect the average receivable in 2011 was closest to:

A)28 days
B)29 days
C)30 days
D)31 days

Question 55

Use the following information for questions:
The following data was taken from the accounting records of Darias Corporation: $\begin{array}{lrr}&2011&2010\\\hline\text { Total assets } & \$ 950,000 & \$ 850,000 \\\text { Total liabilities } & 250,000 & 240,000 \\\text { Preferred shares } & 75,000 & 75,000 \\\text { Common shares } & 300,000 & 300,000 \\\text { Retained earnings } & 325,000 & 235,000\\\text { Additional data: } & \\\text { Net income } & 140,000 \\\text { Preferred dividend } & 15,000 \\\text { Interest expense } & 25,000 \\\text { Sales revenue } & 980,000 \\\text { Tax rate } & 32 \%\end{array}$

-The return on equity for 2011 is closest to:

A)20.0%
B)21.5%
C)26.7%
D)46.7%

Question 56

Which of the following describes the return on equity ratio?

A)[Net income + interest expense × 1 - tax rate))] ÷ average common shareholders' equity
B)[Net income - preferred shares] ÷ average common shareholders' equity
C)[Net income + preferred dividends] ÷ common shareholders' equity
D)[Net income - preferred dividends] ÷ average common shareholders' equity

Question 57

Use the following information for questions:
Consider the following income statement data for Milan Inc.: $\begin{array} { l }&2011&2010\\ \text {Sales revenue }&\$97,000&\$86,200\\ \text { Less: Cost of goods sold}&45,600&53,400\\ \text {Gross profit }&51,700&32,800\\ \text { Less: Selling and administration costs Income before }&22,500&18,300\\ \text {income tax }&29,200&14,500\\\end{array}$


-What was the 2011 net profit margin before income tax closest to?

A)16.8%
B)23.1%
C)30.0%
D)53.1%

Question 58

Changes in the total asset turnover ratio may indicate changes in:

A)financing decisions.
B)cost structure.
C)product profitability.
D)sales volume.

Question 59

Use the following information for questions: sales $1,500,000; gross profit $640,000; net income $40,000 and income tax expense $35,000;
What is the common size percentage for operating expenses?

A)37.7%
B)42.7%
C)95.0%
D)97.3%

Question 60

The return on assets ratio may be expressed as:

A)gross margin × total assets.
B)net income × profit margin ratio.
C)profit margin ratio × total asset turnover.
D)total asset turnover × gross margin ratio.

Question 61

Which of the following represents the debt\equity ratio?

A)Total liabilities ÷ total shareholders' equity
B)Total liabilities ÷ total liabilities + shareholders' equity)
C)Total liabilities ÷ total assets - shareholders' equity)
D)Total long-term liabilities ÷ total long-term liabilities + shareholders' equity)

Question 62

Use the following information for questions:
Blue Sea Corporation's books revealed the following for 2011 and 2010: $$\begin{array} { l c r } & 2011 & 2010 \\\text { Cash } & 27,750 & \$ 21,250 \\\text { Accounts receivable }& 42,000 & 37,500 \\\text { Inventory } & 72,250 & 61,600 \\\text { Other prepaid assets } & 12,500 & 12,500 \\\text { Accounts payable } & 41,250 & 38,000 \\\text { Other current payables } & 13,000 & 15,000 \\\text { Sharehol ders' equity }& 100,250 & 79,850 \\\text { Sales } & 525,000 & 450,750 \\\text { Cost of sales }& 300,000 & 240,750 \\\text { Operating expenses } & 70,000 & 65,000 \\\text { Net income } & 155,000 & 145,000\end{array}$$

-The number of days inventory was held in 2011 was closest to:

A)46 days
B)51 days
C)81 days
D)88 days

Question 63

Use the following information for questions:
Blue Sea Corporation's books revealed the following for 2011 and 2010: $$\begin{array} { l c r } & 2011 & 2010 \\\text { Cash } & 27,750 & \$ 21,250 \\\text { Accounts receivable }& 42,000 & 37,500 \\\text { Inventory } & 72,250 & 61,600 \\\text { Other prepaid assets } & 12,500 & 12,500 \\\text { Accounts payable } & 41,250 & 38,000 \\\text { Other current payables } & 13,000 & 15,000 \\\text { Sharehol ders' equity }& 100,250 & 79,850 \\\text { Sales } & 525,000 & 450,750 \\\text { Cost of sales }& 300,000 & 240,750 \\\text { Operating expenses } & 70,000 & 65,000 \\\text { Net income } & 155,000 & 145,000\end{array}$$

-The current ratio for the 2011 year-end is closest to?

A)2.85
B)2.62
C)1.29
D)1.02

Question 64

All of the following are measures of a company's short-term liquidity except?

A)Quick ratio.
B)Current ratio.
C)Operating cash flow to short-term debt ratio.
D)Operating cash flow to net income ratio.

Question 65

Use the following information for questions:
Dorada Industries' books revealed the following data for 2011: $$\begin{array} { l c c r } \text { Total assets } & \$ 575,000 & \text { Shareholders' equity } & \$ 222,900 \\\text { Current liabilities } & 52,100 & \text { Long-term liabilities } & 300,000 \\\text { Operating Cash flow } & 125,500 &\end{array}$$

-The debt\total assets ratio for 2011 is closest to:

A)23.4%
B)57.3%
C)61.2%
D)67.3%

Question 66

Use the following information for questions:
Dorada Industries' books revealed the following data for 2011: $$\begin{array} { l c c r } \text { Total assets } & \$ 575,000 & \text { Shareholders' equity } & \$ 222,900 \\\text { Current liabilities } & 52,100 & \text { Long-term liabilities } & 300,000 \\\text { Operating Cash flow } & 125,500 &\end{array}$$

-The operating cash flow to total debt ratio for 2011 is closest to:

A)35.6%
B)41.75%
C)56.19%
D)241%

Question 67

Two companies have an identical amount of current assets and current liabilities.Melia Inc.has 40% of its current assets invested in inventory, whereas Tesoro Corp.has 30% of its current assets invested in inventory.Which of the following statements is true?

A)Melia will have the higher quick ratio.
B)Melia will have the higher current ratio.
C)The companies are equally liquid because their current ratios are the same.
D)Melia is less liquid than Tesoro.

Question 68

Which of the following depicts the current ratio?

A)Current assets - inventory) ÷ current liabilities
B)Currents assets ÷ total assets
C)Current assets - inventory) ÷ total assets
D)Current assets ÷ current liabilities

Question 69

Which of the following transactions will increase the current ratio assuming the ratio is initially greater than 1)?

A)Purchasing inventory on credit
B)Selling inventory for more than cost
C)Buying office supplies
D)Collecting accounts receivable

Question 70

Which of the following depicts the quick ratio?

A)Cash + accounts receivable + short-term investments) ÷ current liabilities
B)Cash + accounts receivable) ÷ total assets
C)Current assets - current liabilities) ÷ total assets
D)Cash + inventory) ÷ current liabilities

Question 71

How are prepaid accounts used in each of the following ratios?

Question 72

Use the following information for questions:
Dorada Industries' books revealed the following data for 2011: $$\begin{array} { l c c r } \text { Total assets } & \$ 575,000 & \text { Shareholders' equity } & \$ 222,900 \\\text { Current liabilities } & 52,100 & \text { Long-term liabilities } & 300,000 \\\text { Operating Cash flow } & 125,500 &\end{array}$$

-Which of the following represents the times-interest-earned ratio?

A)Net income ÷ interest
B)[Net income + interest × 1 - tax rate))] ÷ interest
C)Income before interest but after taxes ÷ interest
D)Income before interest and taxes ÷ interest

Question 73

Use the following information for questions:
Dorada Industries' books revealed the following data for 2011: $$\begin{array} { l c c r } \text { Total assets } & \$ 575,000 & \text { Shareholders' equity } & \$ 222,900 \\\text { Current liabilities } & 52,100 & \text { Long-term liabilities } & 300,000 \\\text { Operating Cash flow } & 125,500 &\end{array}$$

-The debt\equity ratio for 2011 is closest to:

A)1.25
B)1.34
C)1.57
D)2.33

Question 74

To best interpret the accounts receivable turnover ratio, the days in accounts receivable should be compared to the company's:

A)inventory turnover.
B)sales revenue.
C)credit terms.
D)accounts receivable balance.

Question 75

Which of the following is a short-term liquidity ratio?

A)Debt\equity ratio
B)Profit margin ratio
C)Quick ratio
D)Return on assets ratio

Question 76

Purchase of inventory for cash will:

A)Increase the current ratio
B)Decrease the current ratio
C)Increase the quick ratio
D)Decrease the quick ratio

Question 77

Use the following information for questions:
Blue Sea Corporation's books revealed the following for 2011 and 2010: $$\begin{array} { l c r } & 2011 & 2010 \\\text { Cash } & 27,750 & \$ 21,250 \\\text { Accounts receivable }& 42,000 & 37,500 \\\text { Inventory } & 72,250 & 61,600 \\\text { Other prepaid assets } & 12,500 & 12,500 \\\text { Accounts payable } & 41,250 & 38,000 \\\text { Other current payables } & 13,000 & 15,000 \\\text { Sharehol ders' equity }& 100,250 & 79,850 \\\text { Sales } & 525,000 & 450,750 \\\text { Cost of sales }& 300,000 & 240,750 \\\text { Operating expenses } & 70,000 & 65,000 \\\text { Net income } & 155,000 & 145,000\end{array}$$

-The average number of days to pay an account during 2011 was closest to:

A)28 days
B)29 days
C)48 days
D)50 days

Question 78

Use the following information for questions:
Blue Sea Corporation's books revealed the following for 2011 and 2010: $$\begin{array} { l c r } & 2011 & 2010 \\\text { Cash } & 27,750 & \$ 21,250 \\\text { Accounts receivable }& 42,000 & 37,500 \\\text { Inventory } & 72,250 & 61,600 \\\text { Other prepaid assets } & 12,500 & 12,500 \\\text { Accounts payable } & 41,250 & 38,000 \\\text { Other current payables } & 13,000 & 15,000 \\\text { Sharehol ders' equity }& 100,250 & 79,850 \\\text { Sales } & 525,000 & 450,750 \\\text { Cost of sales }& 300,000 & 240,750 \\\text { Operating expenses } & 70,000 & 65,000 \\\text { Net income } & 155,000 & 145,000\end{array}$$

-The quick ratio for the 2011 year-end is closest to?

A)1.99
B)1.69
C)1.52
D)1.29

Question 79

Which of the following would indicate a decrease in a company's short-term liquidity?

A)An increase in the current ratio
B)An increase in the quick ratio
C)A decrease in the operating cash flow to short-term debt ratio
D)A decrease in the accounts payable turnover ratio.

Question 80

The quick ratio will be negatively impacted by:

A)tying up cash in inventory
B)increasing accounts receivable
C)decreasing the level of prepaid accounts
D)increasing levels of long term debt