Question 1

The net profit margin percentage reflects the amount of income for each dollar of sales.

Accepted Answer

The net profit margin is calculated by dividing net profit by net sales. This gives the percentage of income earned for each dollar of sales.

Question 2

The return on equity ratio measures the profit earned by a company through the use of capital supplied by its bondholders.

Accepted Answer

The return on equity ratio measures the profit earned by a company through the use of capital supplied by its shareholders, not bondholders.

Question 3

Management's Discussion and Analysis is a key part of the 10-K because it provides investors with information management believes necessary to understand the company and forecast future performance.

Accepted Answer

Management's Discussion and Analysis is considered an important section of the 10-K report as it provides insights into the company's operations, financial condition, and potential risks and opportunities that may impact future performance. Its purpose is to help investors make more informed decisions when evaluating the company's prospects.

Question 4

The amount of working capital is more meaningful to users than the current ratio because working capital provides information on the composition of the current accounts.

Accepted Answer

Working capital (the difference between current assets and current liabilities) gives a snapshot of a company's short-term financial health and operational efficiency, but it doesn't provide information on the composition of current accounts. The current ratio (current assets divided by current liabilities) is also a measure of liquidity, indicating a company's ability to pay off its short-term liabilities with its short-term assets. Neither directly informs on the composition of current accounts; for that, detailed analysis of the balance sheet items is required.

Question 5

An example of vertical analysis is that the cost of goods sold for the current year is 129% of the amount from the prior year.

Accepted Answer

Vertical analysis refers to the process of presenting each item in a financial statement as a percentage of a base figure within the same period, not comparing figures across different periods.

Question 6

Time series analysis compares a company's financial data with industry averages.

Accepted Answer

Time series analysis involves examining data points collected or recorded at specific time intervals to identify trends, cycles, or patterns over time, rather than comparing with industry averages.

Question 7

The stock repurchase payout ratio is calculated by adding the dividend payout ratio to the total payout ratio.

Accepted Answer

The stock repurchase payout ratio is calculated by dividing the total amount of funds spent on stock repurchases by the company's net income. It does not involve the dividend payout ratio.

Question 8

Along with its other financial statements, a public corporation must present its most recent two years of income statements within Item I of its Form 10-K.

Accepted Answer

A public corporation is required to present its three most recent fiscal years of income statements within Item 8 of its Form 10-K, not two years within Item 1.

Question 9

Ratios that focus on cash are more useful than those that focus on income in the evaluation of a company's liquidity.

Accepted Answer

Ratios that focus on cash provide a more accurate and immediate reflection of a company's ability to meet its short-term obligations, whereas income may be affected by non-cash items such as depreciation. Therefore, ratios such as cash ratio, quick ratio, and operating cash flow ratio are more useful in assessing a company's liquidity position.

Question 10

An increase in a company's revenue and expense accounts will always cause an increase in net income for the period.

Accepted Answer

An increase in revenue alone would increase net income, but an increase in expenses would decrease net income, so it depends on which account increases more.

Question 11

The analysis of common size financial statements may be included in a horizontal or vertical analysis.

Accepted Answer

The common size financial statements involve expressing each item as a percentage of a specific base figure, thus making it easier to compare them over different periods of time. Common size analysis can be done both horizontally (over time) or vertically (within a single period), making it a versatile tool for financial analysis.

Question 12

When using vertical analysis of the income statement, the base upon which all items are compared is net income.

Accepted Answer

When using vertical analysis of the income statement, the base upon which all items are compared is net sales or total revenue, not net income.

Question 13

Comparing two companies in the same industry should cause no problem since both companies are required to use the same accounting principles.

Accepted Answer

While companies in the same industry may use similar accounting principles, they are not required to use the exact same principles. Differences in accounting methods and estimates can make it difficult to compare companies accurately.

Question 14

The acid test ratio is a stricter measure than the current ratio regarding a company's ability to pay its current obligations as they are due.

Accepted Answer

The acid test ratio (also known as quick ratio) takes into account only the most liquid current assets, such as cash, marketable securities, and accounts receivable. This makes it a more rigorous measure of a company's ability to meet short-term obligations than the current ratio, which includes all current assets in its calculation.

Question 15

The length of the operating cycle is always considered to be a one year period, although that one year doesn't have to begin on January 1.

Accepted Answer

The length of the operating cycle is the time it takes for a company to purchase inventory, sell it, and convert the sale into cash. This cycle can be shorter or longer than one year and does not adhere to a fixed one-year period.

Question 16

Three measures of liquidity include working capital, the acid test ratio, and the current ratio.

Accepted Answer

Working capital, the acid test ratio, and the current ratio are all commonly used measures of liquidity.

Question 17

Inventory is more liquid than accounts receivable because receivables must be collected and some customers may not be willing to pay, while inventory need only be sold in a retail store.

Accepted Answer

Inventory is generally considered less liquid than accounts receivable because it must first be sold to customers, which can take longer and is less certain than collecting on already established receivables from sales.

Question 18

Common size financial statements exclude the dollar amount as a relevant variable in the analysis, which makes comparison of one period with the next more meaningful.

Accepted Answer

Common size financial statements express each line item as a percentage of a base amount, such as total assets or total revenue, making it easier to compare changes over time or between companies. By excluding the dollar amount, the analysis focuses on the relative importance of each item within the financial statement.

Question 19

The least liquid of all assets is cash.

Accepted Answer

Cash is actually the most liquid of all assets because it can easily be used to make purchases or be converted into other forms of currency. Other assets such as real estate or stocks may not be easily sold or converted into cash without a significant amount of time and effort.

Question 20

Return on assets is computed by adding the after-tax interest expense to net income, then dividing by the average total assets.

Accepted Answer

This is the correct formula for calculating return on assets.

Quiz 12: Financial Statement Analysis