Deck 9: Analysis of Financial Statements

Question 1

With straight‑line depreciation, the book value of the asset is reduced by the same amount each year.​

Answer 1

True

Question 2

Additional paid‑in capital is a current asset.​

Answer 2

False

Question 3

An increase in retained earnings is a cash inflow. /span>​

Answer 3

True

Question 4

Accountants suggest that assets should always be valued at their market value.​

Question 5

Since depreciation is a non-cash expense, it has no impact on a firm's income taxes.​

Question 6

Interest and dividends are paid before income taxes. /span>​

Question 7

Depreciation expense produces a cash outflow of funds, because it reduces the firm's earnings.​

Question 8

Accounts receivable are adjusted for doubtful accounts (i.e., accounts that may not be paid).​

Question 9

If a firm sells inventory at cost for cash, its total assets rise.​

Question 10

An income statement shows how much the firm earned and the cash generated during a period of time.​

Question 11

Issuing new stock or borrowing from a bank is a cash inflow.​

Question 12

An increase in a current asset or long-term liability produces a cash inflow.​

Question 13

Retained earnings are part of the stockholders' equity in a corporation.​

Question 14

Retained earnings represents the earnings accumulated by the firm over its life.​

Question 15

An increase in accounts payable is a cash outflow.​

Question 16

If liabilities are decreased or assets increased, that generates a cash inflow.​

Question 17

If a firm uses accelerated depreciation, its earnings are initially increased.​

Question 18

If a firm's current assets and current liabilities decline, the firm had a cash inflow.​

Question 19

If a firm has retained earnings, it has an equal amount of cash.​

Question 20

The sum of a firm's liabilities and equity equals the sum of its assets.​

Question 21

Liabilities equal​

A) ​assets
B) ​equity
C) ​equity minus assets
D) ​assets minus equity

Question 22

The return on equity represents what the firm is earning on stockholders' investment in the firm.​

Question 23

Current liabilities include​

A) ​stock
B) ​bonds
C) ​accounts receivable
D) ​accrued interest payable

Question 24

The higher the ratio of debt to total assets, the smaller is the use of financial leverage.​

Question 25

The more rapidly receivables turn over, the more funds the firm has tied up in accounts receivable.​

Question 26

Accountants suggest that assets​

A) ​should be valued at market
B) ​should be valued at cost
C) ​should be valued at the lower of market or cost
D) ​should be valued at the higher of market or cost

Question 27

The more rapidly inventory turns over, the more finance the firm needs. /span>​

Question 28

If the "times‑interest‑earned" were 1.5, that implies the interest payments will not be made.​

Question 29

If a firm issues long‑term debt and uses the proceeds to retire short‑term debt, the current ratio is unaffected.​

Question 30

Selling short‑term government securities and using the funds to purchase inventory reduces the current ratio.​

Question 31

An under‑capitalized firm has excessive debt relative to equity.​

Question 32

Cross‑section analysis refers to comparing a firm to other firms in its industry.​

Question 33

If accounts receivable are collected, the quick ratio increases.​

Question 34

The higher the "times‑interest‑earned," the safer (i.e., more assured) should be interest payments.​

Question 35

The numerical value of the quick ratio can never exceed the numerical value of the current ratio.​

Question 36

Increases in income taxes reduce a firm's operating income.

Question 37

The DuPont system combines liquidity and earnings.​

Question 38

The use of financial leverage may permit the firm to increase the return on equity.​

Question 39

If inventory is sold on credit, the quick ratio declines.​

Question 40

Leverage ratios indicate the extent to which the firm uses debt financing.​

Question 41

Operating income does not consider​

A) ​depreciation
B) ​cost of goods sold
C) ​taxes paid
D) ​salaries

Question 42

Equity includes​

A) ​cash
B) ​investments
C) ​retained earnings
D) ​assets

Question 43

When an asset is depreciated,​

A) ​its cost is allocated over a period of time
B) ​the firm's earnings and taxes are increased
C) ​the cash flow from an investment is reduced
D) ​the cost of the asset is increased to reflect appreciation in its value

Question 44

The current ratio excludes​

A) ​accrued interest
B) ​inventory
C) ​cash equivalents
D) ​retained earnings

Question 45

Leverage ratios measure​

A) ​extent to which the firm uses debt financing
B) ​the speed with which the firm sells inventory
C) ​sales relative to some base such as equity
D) ​capacity of the firm to meet current obligations

Question 46

Current liabilities do not include​

A) ​short‑term bank loans
B) ​accrued interest
C) ​accounts payable
D) ​additional paid‑in capital (capital surplus)

Question 47

An increase in the days sales outstanding implies​

A) ​an increase in inventory
B) ​receivables turn into cash more rapidly
C) ​receivables turn into cash more slowly
D) ​the price of the product has been reduced

Question 48

A high current ratio suggests that the firm​

A) ​has a small amount of long‑term debt
B) ​is carrying little inventory
C) ​is able to meet its current obligations
D) ​is profitable

Question 49

​No matter which method of depreciation is used,

A) ​the firm's earnings are unaffected
B) ​the cash flow from an investment is reduced
C) ​the maximum amount that may be depreciated is the cost of the investment
D) ​only short‑term assets may be depreciated

Question 50

The use of accelerated depreciation​

A) ​initially increases the firm's profits
B) ​initially decreases the firm's taxes
C) ​discourages investment in plant and equipment
D) ​increases expenses and decreases cash flow

Question 51

Which of the following is a cash outflow?​

A) ​a new issue of bonds
B) ​a decrease in accounts receivable
C) ​an increase in plant
D) ​an increase in accounts payable

Question 52

Current assets include​

A) plant​
B) ​inventory
C) ​equipment
D) ​additional paid‑in capital (capital surplus)

Question 53

Which of the following is a cash outflow?​

A) ​a stock repurchase
B) ​a decrease in inventory
C) ​an increase in accounts payable
D) ​a stock dividend

Question 54

Performance is measured by​

A) ​liquidity ratios
B) ​leverage ratios
C) ​profitability ratios
D) ​turnover ratios

Question 55

Which of the following is a cash inflow?​

A) ​an increase in accounts receivable
B) ​a decrease in inventory
C) ​distributing cash dividends
D) ​a decrease in long‑term debt

Question 56

According to accountants, assets should be recorded at​

A) ​the selling price
B) ​the market value
C) ​the lower of market value or cost
D) ​the cost of the asset

Question 57

Assets equal​

A) ​liabilities
B) ​equity
C) ​liabilities plus equity
D) ​liabilities minus equity

Question 58

​A new issue of bonds is
1) a cash outflow
2) a cash inflow
3) a long-term asset
4) a long-term liability

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

Question 59

Determination of earnings (profits) requires knowing​

A) ​paid-in capital (capital surplus)
B) ​cash
C) ​retained earnings
D) ​depreciation

Question 60

​Owners of long-term debt instruments such as bonds would prefer
1) a debt ratio of 50% to a debt ratio of 30%
2) a debt ratio of 30% to a debt ratio of 50%
3) a times interest earned of 3.0 to a times-interest-earned ratio of 5.0
4) a times interest earned of 5.0 to a times-interest-earned ratio of 5.0​

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

Question 61

Profitability ratios measure​

A) ​liquidity
B) ​leverage
C) ​performance
D) ​turnover

Question 62

The larger the debt ratio​

A)
​the more equity the firm is using
B)
​the riskier the firm becomes
C)
​the larger are the firm's total assets
D)
​the smaller is the firm's use of financial leverage

Question 63

​What is the debt/net worth ratio and the debt to total assets ratio for a firm with total debt of $600,000 and equity of $400,000?

Question 64

Determine a firm's earnings per share from the following information. Corporate income tax rate $25 \%$
Number of shares outstanding 10,000
Cost of goods sold $\$ 60,000$
Interest earned $\quad 2,400$
Selling and administrative expense 15,000
Interest expense $\quad 5,000$
Sales $\quad 100,000$
Annual credit sales 90,000

Question 65

The inventory turnover for an industry is 6 (every two months) but Slow Corp. turns over its inventory 4 times a years (every three months). If annual sales are $1,000,000 and the interest cost to carry inventory is 12 percent, what is the potential savings in interest expense if the firm achieves the industry for the turnover of its inventory?​

Question 66

If the industry days sales outstanding is 65 days and a firm with sales of $1,034,550 has receivables of $268,700, how much in interest expense could the firm save if the receivables turn over as quickly as the industry average and the cost of carrying the receivables is 9%?

Question 67

The DuPont system of financial analysis combines​

A) ​profitability and turnover
B) ​liquidity and turnover
C) ​profitability and liquidity
D) ​turnover and coverage

Question 68

​If a firm collects its accounts receivable,

A) ​the current ratio increases
B) ​inventory turnover increases
C) ​the average collection period (days sales outstanding) is reduced
D) ​inventory is reduced

Question 69

Given the following information, construct the statement of cash flow. What happened to the firm's liquidity position during the year? Net income $\$ 16.7$
Decrease in accounts receivable $6.1$
Increase in accounts payable $13.6$
Sale of bonds $55.1$
Dividends $\quad 14.8$
Retirement of bonds $10.8$
Increase in inventory $15.2$
Depreciation expense $56.0$
Cost of goods sold $72.1$
Reduction in income taxes payable $5.0$
Sale of stock $\quad 0.4$
Purchase of plant and equipment $91.0$
Beginning cash $1.1$
Repurchase of stock $5.6$ ​
The firm's cash position has increased, but that does not mean the firm is more liquid since inventory and accounts payable increased while accounts receivable declined. You should also note that the firm increased its investment in plant by using the cash generated through depreciation and the issuing of new long-term debt. The earnings and sale of stock did not cover dividends and stock repurchases. This indicates that the firm is more financially leveraged.

Question 70

Using the income statement and balance sheet constructed in (1) and (2), compute the following ratios. Compare the results with the industry averages. What strengths and weaknesses are apparent?
​ $\begin{array}{l}\text { RATIO INDUSTRY AVERAGE } \\\text { Current ratio } \quad 2: 1 \\\text { Acid test (quick ratio) } \quad 1: 1 \\\text { Inventory turnover } \\\text { a. annual sales } \quad 2.5 \\\text { b. cost of goods sold } \quad 1.2 \\\text { Receivables turnover } \\\text { a. annual credit sales } \quad 5.0 \mathrm{x} \\\text { b. annual sales } \quad 6.0 \mathrm{x} \\\text { Average collection period } \quad 75 \text { days } \\\text { (days sales outstanding) } \\\text { Operating profit margin } \quad 26 \% \\\text { Net profit margin } \quad 19 \% \\\text { Return on assets } \quad 10 \% \\\text { Return on equity } \quad 15 \% \\\text { Debt/equity } \quad 33 \% \\\text { Debt ratio (debt/total assets) } \quad 25 \% \\\text { limes-interest-earned } \quad 7.1 \mathrm{x} \\\text { ADDITIONAL INFORMATION: } \\\text { last year's inventory } \quad \$ 40,000 \\\text { credit sales } \quad \$ 90,000\end{array}$

Question 71

​Times-interest-earned uses

A) ​gross earnings
B) ​operating earnings
C) ​net earnings
D) ​per share earnings

Question 72

The more rapidly receivables turn over​

A) ​the more rapidly the firm is receiving cash
B) ​the larger are the firm's sales
C) ​the smaller is the firm's inventory
D) ​the larger are the firm's accounts payable