Deck 5: Essentials of Financial Statement Analysis

Question 1

Common size income statements recast each statement item as a percent of total assets.

Answer 1

False

Question 2

Cross-sectional analysis helps identify similarities and differences across companies over time.

Answer 2

False

Question 3

Analysts use financial statement information to assess the economic activities of a company and its condition.

Answer 3

True

Question 4

Return on assets is defined as EBI divided by total year-end assets.

Question 5

Because GAAP specifies what must be contained in financial reports,management is precluded from disclosing financial and nonfinancial operating details that GAAP does not require-thus promoting comparability among companies' financial reports.

Question 6

A benchmark comparison is an analytic tool similar in approach to time-series analysis.

Question 7

An analyst desiring to determine the degree to which a company's earnings have fluctuated historically in relation to changes in economic growth would employ cross-sectional analysis.

Question 8

Managers' ability to freely choose among several alternative reporting methods makes it more difficult for a financial analyst to evaluate the activities and condition of a company.

Question 9

Operating and administrative efficiencies that result in lower expenses per dollar of sales possibly explain a trend where income grows faster than sales.

Question 10

Informed financial statement analysis begins with knowledge of the company and its industry.

Question 11

The first step to informed financial statement analysis is a careful examination of the auditor's opinion.

Question 12

GAAP filters the data needed for a complete and faithful picture in the financial reports.

Question 13

Analysts must always be vigilant about the possibility that accounting distortions are present and complicate the interpretation of financial ratios,percentage relations,and trend indices.

Question 14

Companies are not required to disclose business transactions that involve potential conflicts of interest if the transactions are with affiliated companies.

Question 15

Analysts need to understand what accounting data do and do not reveal about a company's economic activities and condition.

Question 16

Asset turnover is defined as sales divided by total assets.

Question 17

Trend statements often provide a clearer indication of growth and decline than do common size statements.

Question 18

Common size income statements show you how much of each sales dollar hits the bottom line as profit.

Question 19

Time-series analysis helps identify financial trends over time for a single company.

Question 20

Trend income statements recast each statement item as a percent of sales.

Question 21

EBI refers to the company's earnings before interest.

Question 22

Both common and preferred stock dividends are subtracted in arriving at net income available to common stockholders.

Question 23

The only way a company can increase its operating profits per asset dollar is to expand the amount of sales generated from each asset dollar.

Question 24

Profit margin can be decomposed into its individual factors including COGS/Sales and Taxes/Sales.

Question 25

When return on assets is high at a highly levered firm,return on common equity will be low.

Question 26

The long-term asset turnover ratio captures information about property,plant,and equipment utilization.

Question 27

Companies that consistently earn rates of return above the industry's competitive floor are said to have a competitive advantage.

Question 28

A company can increase its return on assets by either increasing the profit margin or decreasing the intensity of asset utilization.

Question 29

According to most observers,there are numerous strategies for achieving superior performance in any business.

Question 30

Competition in an industry continually works to drive up the rate of return on assets towards the competitive ceiling.

Question 31

The financial structure leverage ratio measures the degree to which the company uses long-term debt to finance assets.

Question 32

Financial leverage is beneficial when the company earns more than the incremental after-tax cost of debt.

Question 33

Most companies try to develop customer loyalty while controlling costs.

Question 34

Before computing ROA,analysts isolate a company's sustainable operating profits by removing nonoperating or nonrecurring items from reported income.

Question 35

Return on assets will generally equal return on common equity except when the company has no long-term debt.

Question 36

The current asset turnover ratio helps the analyst spot efficiency gains from improved accounts receivable and inventory management.

Question 37

ROCE measures a company's performance in using capital provided by common shareholders to generate earnings.

Question 38

Differences in the business strategies companies adopt give rise to economic differences that are reflected as differences in asset utilization only.

Question 39

Analysts typically eliminate after-tax interest expense from EBI when calculating ROA.

Question 40

Companies that are able to get people to pay premium prices for their products have successfully enacted a differentiation strategy.

Question 41

Using total sales instead of credit sales in the accounts receivable turnover calculation can produce misleading results and is a problem primarily for companies that have a material amount of cash sales.

Question 42

The accounts receivable turnover ratio can be used by the analyst to spot changing customer payment patterns.

Question 43

There is more than one commonly used debt ratio.

Question 44

The quick ratio measures the most immediate liquidity of a company.

Question 45

The interest coverage ratio reflects the cushion between operating profit inflows and required interest payments.

Question 46

Disparate operating and cash conversion cycles can spell a dangerous mismatch between cash outflows and inflows.

Question 47

Lenders have several courses of action available when a borrower is in default.

Question 48

The quick ratio does not include inventory in the denominator because few businesses can instantaneously convert their inventories into cash.

Question 49

Activity ratios describe the profitability of a company.

Question 50

Solvency refers to the long-term ability to generate sufficient cash to satisfy plant capacity needs,fuel growth,and to repay debt when due.

Question 51

The statement of cash flows is an important source of information when analyzing a company's credit risk.

Question 52

Credit risk analysis using financial ratios typically involves an assessment of profitability and solvency.

Question 53

Lenders typically petition to have a borrower judged insolvent by a court when the borrower is in default.

Question 54

Credit risk refers to the risk of payment default by the borrower,and the resulting loss to the lender of interest and loan principal payments.

Question 55

A low-credit-risk company generates operating cash flows substantially in excess of what are required to sustain its business activities.

Question 56

Although a company's earnings are important,an analysis of its cash flows is central to all credit evaluations and lending decisions.

Question 57

The more a company relies on long-term borrowing to finance its business activities,the lower its debt ratio and long-term solvency risk.

Question 58

The long-term asset turnover ratio helps the analyst identify efficiency gains from improved accounts receivable and inventory management.

Question 59

The Z-score model combines five financial ratios in a precise way to estimate a company's default risk.

Question 60

Days payable outstanding helps analysts understand the company's pattern of cash receipts from customers.

Question 61

Financial ratios help lenders quantify a potential borrower's default risk before a loan decision is finalized.

Question 62

An analytical tool that measures a company's performance against a predetermined standard is a/an

A)benchmark comparison analysis.
B)profitability analysis.
C)time-series analysis.
D)common size statement.

Question 63

A type of analysis that helps identify similarities and differences across companies or business units at a single moment in time is

A)trend analysis.
B)common size statements' analysis.
C)time-series analysis.
D)cross-sectional analysis.

Question 64

Lower profitability means higher default risk.

Question 65

The disadvantage of debt financing is that interest on debt is tax-deductible.

Question 66

All companies should be expected to produce positive operating cash flows every year.

Question 67

Mature companies' capital expenditures are limited to the amount needed to sustain current levels of operation.

Question 68

Time-series analysis helps identify financial trends

A)across companies at a single point in time.
B)across business units at a single point in time.
C)over time for a single company or business unit.
D)among the companies that comprise an industry group.

Question 69

Predicting loan default and bankruptcy are relatively easy tasks if financial ratios are carefully analyzed.

Question 70

Negative operating cash flows are often attributable to increasing receivables and inventories.

Question 71

Credit risk analysis uses financial ratios that focus on an assessment of liquidity and solvency.

Question 72

Established growth companies require substantial investments in property,plant,and equipment at a stage when operating cash flows are typically negative.

Question 73

All of the following are used as financial analysis tools except

A)managements' discussion and analysis.
B)common size statements.
C)trend statements.
D)financial ratios.

Question 74

When analyzing a company's risk of bankruptcy using Altman's Z-score,a high Z-score indicates low risk of default.

Question 75

Common-size financial statements recast each statement item as

A)a percentage using industry averages for the "base number."
B)a percentage using a base year number for each line item.
C)a percentage of some "base number" on the financial statement in question.
D)a percentage of the "bottom line."

Question 76

An unexplained increase in fixed asset sales may indicate that management needs to raise cash quickly.

Question 77

Most financial ratios can only be calculated in one way.

Question 78

In the highest risk S&P category of CCC/C,about 60% of the firms default within a year.

Question 79

Companies assigned a Moody's "Aaa" credit rating have a 2-4% default rate.

Question 80

Companies that spend more cash on operating activities than they generate must find ways to finance these operating cash shortfalls.