Deck 4: Analysing Financial Statements

Question 1

Liquidity ratios are concerned with the company's ability to pay its current bills without putting the company in financial difficulty.

Answer 1

True

Question 2

Turnover ratios are used by managers to identify operational inefficiencies.

Answer 2

True

Question 3

Shareholders focus on the value of their shares but not on how much cash they can expect to receive from dividends and/or capital appreciation.

Answer 3

False

Question 4

A company can improve its liquidity by increasing its accounts payable, while holding all else constant.

Question 5

Managers' decisions regarding financing, investment, and working capital are reflected in the financial statements.

Question 6

The most frequent method of adjusting balance sheets to a common-size basis is to divide each of the accounts by total assets, expressing each account as a percentage of total assets.

Question 7

Financial statement analysis can help us determine why a company's cash flows are increasing or decreasing

Question 8

A company increased its days' sales outstanding from 35 days to 43 days. This implies the company is more efficient.

Question 9

A benchmark for a financial statement analysis is the performance of a multinational company in the same industry from another country.

Question 10

Total asset turnover is more relevant for service industry companies, while the fixed asset turnover ratio is more relevant for manufacturing industry companies.

Question 11

A typical way common size income statement is constructed is by dividing all expense items in an income statement by profit.

Question 12

For a company's given share price, the lower the EPS the lower the price-earnings ratio.

Question 13

For a given level of after-tax income, the lower the level of equity a company has, the higher the return on equity its shareholders will earn.

Question 14

The higher the times interest earned ratio, the more comfortable are a company's creditors in the ability of the company to meet its interest obligations.

Question 15

Financial leverage refers to the use of preference shares in a company's capital structure.

Question 16

The purchase of additional inventory by a company should decrease a company's quick ratio.

Question 17

The equity multiplier is calculated by dividing equity by total assets.

Question 18

A company that has no debt will have its ROA equal to its ROE.

Question 19

A financial statement analysis conducted over a three- to five-year period is called trend analysis.

Question 20

A company's current ratio changed from 1.4 times in the previous year to 1.6 times this year. Concluding that the company's liquidity improved is ___________.

Question 21

Which one of the following statements is correct?

A) The lower the level of a company's debt, the higher the company's leverage.
B) The lower the level of a company's debt, the lower the company's equity multiplier.
C) The lower the level of a company's debt, the higher the company's equity multiplier.
D) The tax benefit from using debt financing reduces a company's risk.

Question 22

Which one of the following statements is NOT true?

A) The accounts receivables turnover ratio measures how quickly the company collects on its credit sales.
B) One ratio that measures the efficiency of a company's collection policy is days' sales outstanding (DSO).
C) The more days that it takes the company to collect on its receivables, the more efficient the company is.
D) DSO measures in days, the time the company takes to convert its receivables into cash.

Question 23

The creditors of a company analyse financial statements so that they can focus on

A) the company's amount of debt.
B) the company's ability to generate sufficient cash flows to meet all legal obligations first and still have sufficient cash flows to meet debt repayment and interest payments.
C) the company's ability to meet its short-term obligations.
D) All of the above.

Question 24

Which of the following is NOT true of common-size income statements?

A) Each income statement item is standardised by dividing it by total assets.
B) Income statement accounts are represented as percentages of sales.
C) Each income statement item is standardised by dividing it by sales.
D) Common-size financial statement analysis is a specialised application of ratio analysis.

Question 25

Which of the following is NOT true of liquidity ratios?

A) They measure the ability of the company to meet short-term obligations with short-term assets without putting the company in financial trouble.
B) There are two commonly used ratios to measure liquidity-current ratio and quick ratio.
C) For manufacturing companies, quick ratios will tend to be much larger than current ratios.
D) The higher the number, the more liquid the company and the better its ability to pay its short-term bills.

Question 26

Which one of the following statements about the inventory turnover ratio is NOT correct?

A) It is calculated by dividing inventory by cost of sales.
B) It measures how many times the inventory is turned over into saleable products.
C) The more times a company can turn over the inventory, the better.
D) Too high a turnover or too low a turnover could be a warning sign.

Question 27

The Global Industry Classification Standard (GICS) system is a joint Standard and Poor's/ Morgan Stanley Capital International product which indicates the business or industry in which the company is engaged.

Question 28

In doing an industry group analysis, you form the comparison group by choosing companies that are larger than the company being compared.

Question 29

The DuPont equation relates a company's net profit margin, total asset turnover ratio, and equity multiplier to determine its return on equity.

Question 30

Which one of the following statements is NOT true of asset turnover ratios?

A) Asset turnover ratios measure the level of sales per dollar of assets that the company has.
B) The fixed assets turnover ratio is less significant for equipment-intensive manufacturing industry companies than the total assets turnover ratio.
C) The higher the total asset turnover, the more efficiently management is using total assets.
D) All of the above are true.

Question 31

Shareholders analyse financial statements in order to:

A) assess the cash flows that the company will generate from operations
B) determine the company's profitability, their return for that period, and the dividend they are likely to receive.
C) focus on the value of the shares they hold.
D) All of the above.

Question 32

Common-size financial statements:

A) are a specialised application of ratio analysis.
B) allow us to make meaningful comparisons between the financial statements of two companies that are different in size.
C) are prepared by having each financial statement item expressed as a percentage of some base number, such as total assets or total revenues.
D) All of the above are true.

Question 33

Which one of the following is NOT true of common-size balance sheets?

A) Each asset and liability item on the balance sheet is standardised by dividing it by total assets.
B) Balance sheet accounts are represented as percentages of total assets.
C) Each asset and liability item on the balance sheet is standardised by dividing it by sales.
D) Common-size financial statements allow us to make meaningful comparisons between the financial statements of two companies that are different in size.

Question 34

Companies with a lower ROA and higher leverage will have a lower ROE than companies with a higher ROA and lower leverage.

Question 35

Which one of the following does NOT change a company's current ratio?

A) The company collects on its accounts receivables.
B) The company purchases inventory by taking a short-term loan.
C) The company pays down its accounts payables.
D) None of the above.

Question 36

All else being equal, which one of the following will decrease a company's current ratio?

A) a decrease in the net fixed assets
B) a decrease in depreciation
C) an increase in accounts payable
D) None of the above

Question 37

If company A has a higher equity ratio than company B, then

A) company A has a lower equity multiplier than company B.
B) company B has a lower equity multiplier than company A.
C) company B has lower financial leverage than company A.
D) None of the above.

Question 38

All but one of the following is true about quick ratios.

A) The quick ratio is calculated by dividing the most liquid of current assets by current liabilities.
B) Service companies that tend not to carry too much inventory will see significantly higher quick ratios than current ratios.
C) Inventory, being not very liquid, is subtracted from total current assets to determine the most liquid assets.
D) Quick ratios will tend to be much smaller than current ratio for manufacturing companies or other industries that have a lot of inventory.

Question 39

The use of inflation-adjusted balance sheets serves to correct a weakness of ratio analysis.

Question 40

A company's management analyses financial statements so that:

A) they can get feedback on their investing, financing, and working capital decisions by identifying trends in the various accounts that are reported in the financial statements.
B) similar to shareholders, they can focus on profitability, dividend, capital appreciation, and return on investment.
C) they can get more share options.
D) a and b.

Question 41

Leverage ratio: What will be a company's equity multiplier given a debt ratio of 0.45?

A) 1.82
B) 1.28
C) 2.22
D) None of the above

Question 42

Leverage ratio: Your company has an equity multiplier of 2.47. What is its debt-to-equity ratio?

A) 0.60
B) 1.47
C) 1.74
D) 0

Question 43

Efficiency ratio: If Viera Ltd has an accounts receivable turnover of 3.9 times and net sales of $3,436,812, what is its level of receivables?

A) $881,234
B) $13,403,567
C) $1,340,357
D) $81,234

Question 44

Liquidity ratio: Lionel Ltd has current assets of $623,122, including inventory of $241,990, and current liabilities of 378,454. What is the quick ratio?

A) 1.65
B) 0.64
C) 1.01
D) None of the above

Question 45

Liquidity ratio: Zidane Enterprises has a current ratio of 1.92, current liabilities of $272,934, and inventory of 197,333. What is the company's quick ratio?

A) 0.72
B) 1.20
C) 1.92
D) None of the above

Question 46

Efficiency ratio: If Randolph Company has accounts receivables of $654,803 and net sales of $1,932,349, what is its accounts receivable turnover?

A) 0.34 times
B) 1.78 times
C) 2.95 times
D) None of the above

Question 47

Which one of the following is a criticism of equating the goals of maximising the ROE of a company and maximising the company's shareholder wealth?

A) ROE is based on after-tax earnings, not cash flows.
B) ROE does not consider risk.
C) ROE ignores the size of the initial investment as well as future cash flows.
D) All of the above are criticisms of ROE as a goal.

Question 48

Which one of the following statements is NOT correct?

A) A leveraged company is more sensitive to changes in its revenue income than a company that is not leveraged.
B) A leveraged company is more risky than a company that is not leveraged.
C) A company that uses debt magnifies the return to its shareholders.
D) An all-equity company has no risk.

Question 49

Coverage ratios, like times interest earned and cash coverage ratio, allow

A) a company's management to assess how well they meet short-term liabilities.
B) a company's shareholders to assess how well the company will meet its short-term liabilities.
C) a company's creditors to assess how well the company will meet its interest obligations.
D) a company's creditors to assess how well the company will meet its short-term liabilities other than interest expense.

Question 50

For a company that has both debt and equity,

A) ROE > ROA.
B) ROE < ROA.
C) ROE = ROA
D) None of the above.

Question 51

Efficiency ratio: Deutsche Bearings has total sales of $9,745,923, inventories of $2,237,435, cash and equivalents of $755,071, and days' sales outstanding of 49 days. If the company's management wanted its DSO to be 35 days, by how much will the accounts receivable have to change?

A) $373,816.23
B) -$373,816.23
C) -$379,008.12
D) $379,008.12

Question 52

Liquidity ratio: Ronaldinho Ltd is required by its bank to maintain a current ratio of at least 1.75, and its current ratio now is 2.1. The company plans to acquire additional inventory to meet an unexpected surge in the demand for its products and will pay for the inventory with short-term debt. How much inventory can the company purchase without violating its debt agreement if their total current assets equal $3.5 million?

A) $0
B) $777,777
C) $1 million
D) None of the above

Question 53

Liquidity ratio: Bathez Company has receivables of $334,227, inventory of $451,000, cash of $73,913, and accounts payables of $469,553. What is the company's current ratio?

A) 1.83
B) 0.73
C) 1.67
D) None of the above

Question 54

Coverage ratios: Fahr Company had depreciation expenses of $630,715, interest expenses of $112,078, and an EBIT of $1,542,833 for the year ended June 30, 2006. What are the times interest earned and cash coverage ratios for this company?

A) 19.4 times; 12.7 times
B) 17.3 time; 11.4 times
C) 13.8 times; 19.4 times
D) None of the above

Question 55

Coverage ratio: Trident Company has debt of $3.35 million with an interest rate of 6.875 percent. The company has an EBIT of $2,766,009. What is its times interest earned?

A) 13 times
B) 12 times
C) 11 times
D) None of the above

Question 56

Efficiency ratio: Ellicott City Manufacturers Ltd has sales of $6,344,210, and a gross profit margin of 67.3 percent. What is the company's cost of sales?

A) $2,074,557
B) $2,745,640
C) $274,560
D) None of the above

Question 57

Coverage ratios: Sectors Ltd has an EBIT of $7,221,643 and interest expense of $611,800. Its depreciation for the year is $1,434,500. What is its cash coverage ratio?

A) 15.42 times
B) 18.34 times
C) 14.15 times
D) None of the above

Question 58

Efficiency ratio: Gateway Company has an inventory turnover ratio of 5.6. What is the company's days' sales in inventory?

A) 65.2 days
B) 64.3 days
C) 61.7 days
D) 57.9 days

Question 59

Efficiency ratio: Jason Traders has sales of $833,587, a gross profit margin of 32.4 percent, and inventory of $178,435. What is the company's inventory turnover ratio?

A) 4.67 times
B) 3.16 times
C) 4.1 times
D) None of the above

Question 60

Efficiency ratio: Jet Ltd has net sales of $712,478 and accounts receivables of $167,435. What are the company's accounts receivables turnover and days' sales outstanding?

A) 0.24 times; 78.5 days
B) 4.26 times; 85.7 days
C) 5.2 times; 61.3 days
D) None of the above

Question 61

Market-value ratio: RTR Company has reported a profit of $812,425 for the year. The company's share price is $13.45, and the company has 312,490 shares outstanding. Calculate the company's price-earnings ratio.

A) 4.87 times
B) 8.12 times
C) 5.17 times
D) None of the above

Question 62

Which one of the following is NOT an advantage of using ROE as a goal?

A) ROE is highly correlated with shareholder wealth maximisation.
B) ROE and the DuPont analysis allow management to break down the performance and identify areas of strengths and weaknesses.
C) ROE does not consider risk.
D) All of the above are advantages of using ROE as a goal.

Question 63

Explain the different ways that a company's ratios can be benchmarked.

Question 64

DuPont equation: GenTech Pharma has reported the following information: Sales/Total assets = 2.89; ROA = 10.74%; ROE = 20.36%.
What are the company's profit margin and equity multiplier?

A) 7.1%; 0.53
B) 7.1%; 1.90
C) 3.7%; 0.53
D) 3.7%; 1.90

Question 65

Peer group analysis can be performed by

A) management choosing a set of companies that are similar in size or sales, or who compete in the same market.
B) using the average ratios of this peer group, which would then be used as the benchmark.
C) identifying companies in the same industry that are grouped by size, sales, and product lines in order to establish benchmark ratios.
D) Only a and b relate to peer group analysis.

Question 66

DuPont equation: Sorenstam Corp has an equity multiplier of 2.34 times, total assets of $4,512,895, a ROE of 17.5 percent, and a total assets turnover of 3.1 times. Calculate the company's ROA.

A) 6.23%
B) 4.53%
C) 7.48%
D) 5.79%

Question 67

Which one of the following statements is NOT correct?

A) The DuPont system is based on two equations that relate a company's ROA and ROE.
B) The DuPont system is a set of related ratios that links the balance sheet and the income statement.
C) Both management and shareholders can use this tool to understand the factors that drive a company's ROE.
D) All of the above are correct.

Question 68

Leverage ratio: Dreisen Traders has total debt of $1,233,837 and total assets of $2,178,990. What are the company's equity multiplier and debt-to-equity ratio?

A) 2.31; 1.31
B) 1.75; 0.75
C) 0.75; 1.75
D) 1.31; 2.31

Question 69

What are some of the main limitations of ratio analysis?

Question 70

Compare how a company's creditor would analyse a company's financial statements relative to those of a company's shareholders.

Question 71

DuPont equation: Saunders Ltd has a ROE of 18.7 percent, an equity multiplier of 2.53, sales of $2.75 million, and a total assets turnover of 2.7 times. What is the company's profit?

A) $75,281.80
B) $514,250.00
C) $51,425.00
D) $7,528.10

Question 72

Market-value ratios: Perez Electronics Company has reported that its profit for 2006 is $1,276,351. The company has 420,000 shares outstanding and a P-E ratio of 11.2 times. What is the company's share price?

A) $34.05
B) $3.68
C) $11.20
D) $36.80

Question 73

The DuPont equation shows that a company's ROE is determined by three factors:

A) net profit margin, total asset turnover, and the equity multiplier
B) operating profit margin, ROA, and the ROE
C) net profit margin, total asset turnover, the ROA
D) ROA, total assets turnover, and the equity multiplier

Question 74

Which one of the following statements about trend analysis is NOT correct?

A) This benchmark is based on a company's historical performance.
B) It allows management to examine each ratio over time and determine whether the trend is good or bad for the company.
C) The Global Industry Classification Standard (GICS) uses trend analysis to classify companies.
D) All of the above are true statements.

Question 75

Profitability ratio: Juventus Corp has total assets of $4,744,288, total debt of $2,912,000, and net sales of $7,212,465. Their profit margin for the year is 18 percent. What is Juventus's ROA?

A) 25.6%
B) 18%
C) 27.4%
D) None of the above

Question 76

Limitations of ratio analysis include all but

A) Ratios depend on accounting data based on historical costs.
B) Differences in accounting practices like FIFO versus weighted average cost make comparison difficult.
C) Trend analysis could be distorted by financial statements affected by inflation.
D) All of the above are limitations of ratio analysis.

Question 77

DuPont equation: Andrade Corp has debt of $2,834,950, total assets of $5,178,235, sales of $8,234,121, and profit of $812,355. What is the company's return on equity?

A) 7.1%t
B) 34.7%
C) 28.1%
D) 43.2%

Question 78

Profitability ratios: Tigger Company has reported the financial results for year-end 2006. Based on the information given, calculate the company's gross profit margin and operating profit margin. Net sales = $4,156,700
Profit = $778,321
Cost of sales = $2,715,334
EBIT = $1,356,098

A) 34.7%; 32.6%
B) 32.6%; 18.72%
C) 34.7%; 18.72%
D) None of the above