Question 1

In general, when a company has greater operating leverage, and its sales increase, profits
A) Increase proportionally with sales
B) Increase proportionately faster than sales
C) Increase proportionately slower than sales

Accepted Answer

When a company has high operating leverage, it means that a larger proportion of its costs is fixed, so when sales increase, those fixed costs do not increase. As a result, any increase in sales leads to a higher increase in profits, which means that profits increase proportionally faster than sales.

Question 2

It would be easiest to see the percentage growth in a company's 2015 accounts receivable by looking at a
A) Common size balance sheet
B) Common size income statement
C) Percentage change balance sheet
D) Percentage change income statement

Accepted Answer

The percentage change balance sheet shows the changes in each account from one period to another, which is useful for calculating the percentage growth in a specific account such as accounts receivable. Common size financial statements express each account as a percentage of a base figure, but do not show changes over time. Common size income statements express each item as a percentage of revenue, which is not relevant for accounts receivable growth. The percentage change income statement is not a common financial statement format and does not exist.

Question 3

In a typical cash flow statement, prepared using the indirect method, which of the following statements about depreciation is correct?
A) Depreciation expense usually appears in the investing section, as a reduction to investing cash flows.
B) Depreciation expense usually appears in the investing section, as an addition to investing cash flows.
C) Depreciation expense usually appears in the operating section, as a reduction to operating cash flows.
D) Depreciation expense usually appears in the operating section, as an addition to operating cash flows.

Accepted Answer

Depreciation expense is a non-cash charge that reduces net income. In the indirect method of preparing a cash flow statement, it is added back to net income in the operating section to adjust for the fact that it does not involve an actual outflow of cash.

Question 4

Assume that during the year, the Cui Company had net income of $100,000. One of the expenses that was included in the computation of net income was depreciation expense of $3,000. The company also had a gain on the sale of investment property of $4,000. Based on this information, net operating cash flows for the year equal
A) 93000
B) 99000
C) 101000
D) 107000

Accepted Answer

Net operating cash flows are calculated by adjusting net income for non-cash expenses and gains/losses on the sale of assets. In this case, we need to add back depreciation expense and subtract the gain on the sale of investment property:

Net operating cash flows = Net income + Depreciation expense - Gain on sale of investment property
= $100,000 + $3,000 - $4,000
= $99,000

Therefore, the best choice is B.

Question 5

Assume that during the year, the Foley Company had net income of $200,000. Its accounts receivable increased by $6,000, and its accrued expenses payable increased by $7,000. Based on this information, net operating cash flows for the year equal
A) 187000
B) 199000
C) 201000
D) 213000

Accepted Answer

To calculate net operating cash flows, we start with net income and adjust for changes in working capital. 
Net income = $200,000 
Increase in accounts receivable = -$6,000 (since this represents cash that is owed to the company but not yet received) 
Increase in accrued expenses payable = $7,000 (since this represents cash that the company owes but has not yet paid out) 
Net operating cash flows = net income + increase in accounts receivable - increase in accrued expenses payable 
= $200,000 - $6,000 + $7,000 
= $201,000

Question 6

Assume that during the year, the Grey Company had net income of $300,000. Its inventory increased by $6,000 and its accounts payable decreased by $7,000. Based on this information, net operating cash flows for the year equal
A) 287000
B) 299000
C) 301000
D) 313000

Accepted Answer

Net operating cash flows are calculated by adjusting net income for changes in working capital. An increase in inventory decreases cash flow by $6,000, and a decrease in accounts payable decreases cash flow by $7,000. Therefore, the net operating cash flow is $300,000 - $6,000 - $7,000 = $287,000.

Question 7

Under the Du Pont framework of analysis, which of the following relationships is true?
A) Return on assets = return on common equity + capital structure leverage
B) Return on common equity = asset turnover ÷ capital structure leverage
C) Return on common equity = asset turnover × profit margin × capital structure leverage
D) Return on assets = asset turnover + return on equity

Accepted Answer

The Du Pont framework of analysis is used to break down return on equity (ROE) into its components in order to better understand the factors driving it. According to the framework:
ROE = Profit Margin × Asset Turnover × Equity Multiplier
where Equity Multiplier = Total Assets/Total Equity

Rearranging the equation, we get:
Profit Margin × Asset Turnover = ROE/Equity Multiplier

Equity Multiplier can be further broken down into:
Equity Multiplier = 1 + Debt/Equity

Substituting the above expression in the first equation, we get:
ROE = Profit Margin × Asset Turnover × (1 + Debt/Equity)

Simplifying the equation, we get:
ROE = (Net Income/Sales) × (Sales/Total Assets) × (Total Assets/Total Equity + 1)

ROE = (Net Income/Total Equity) × (Total Assets/Sales) × (Sales/Total Assets) × (Total Assets/Total Equity + 1)

ROE = (Net Income/Total Equity) × (Total Assets/Total Equity + 1)

ROE = Return on assets × (Total Assets/Total Equity + 1)

Therefore, using the Du Pont approach, we can see that Return on common equity is calculated as Asset turnover × Profit margin × Capital structure leverage. Option C correctly represents this relationship.

Question 8

A commonly used ratio to judge company profitability is
A) The current ratio
B) The debt to equity ratio
C) Times interest earned
D) Return on assets

Accepted Answer

The correct ratio to judge company profitability is the return on assets (ROA), which measures a company's net earnings in relation to its assets. It indicates the company's ability to generate profits from its resources. The other ratios mentioned (current ratio, debt to equity ratio, and times interest earned) are useful for evaluating liquidity, leverage, and debt capacity, respectively, but do not provide a direct measure of profitability.

Question 9

A commonly used ratio to judge the amount a company is earning, not just for its owners, but related to all the resources that managers have to use in the business, is
A) Net income
B) Return on assets
C) Return on common equity
D) Earnings per share

Accepted Answer

Return on assets (ROA) measures how effectively a company is using its assets to generate profits. It is calculated by dividing net income by total assets. This ratio is useful because it takes into account both the profitability and the efficiency of the company in using its assets. Net income (A), earnings per share (D) and return on common equity (C) are also important measures of company performance but do not provide as comprehensive an evaluation of the company's use of its resources.

Question 10

It would be easiest to see the company's 2014 interest expense, as a percentage of revenues for the year, by looking at a
A) Common size balance sheet
B) Common size income statement
C) Percentage change balance sheet
D) Percentage change income statement

Accepted Answer

The common size income statement shows each item as a percentage of total revenue for the year, making it easiest to determine the interest expense as a percentage of revenues. The other options do not provide this specific information.

Question 11

Research indicates that all of the following statements are correct, except:
A) Stock price movements are more closely related to income statement information than cash flow information.
B) Useful (but not perfect) models exist that use financial statement data to predict company bankruptcy.
C) Useful (but not perfect) models exist that use financial statement data to detect improper reporting of financial information.
D) Stock price movements are greater when a change in income is due to one-time items than when the change in income is due to persistent items.

Accepted Answer

Stock price movements are typically more significant when a change in income is due to persistent items rather than one-time items. This is because persistent items are expected to recur in the future, affecting the company's long-term profitability, whereas one-time items are viewed as not indicative of future performance.

Question 12

According to research, movements in stock prices are most closely related to movements in which financial statement?
A) Balance sheet
B) Income statement
C) Statement of owners' equity
D) Cash flow statement

Accepted Answer

The income statement reveals a company's revenue, expenses, and profits over a certain period. This provides investors with insights into the company's current financial performance, which can influence the stock price of the company. As a result, movements in stock prices are most closely related to movements in the income statement.

Question 13

Which of the following is most likely a sign that a company has solvency or liquidity problems?
A) A current ratio is low compared to other companies in the industry.
B) An interest coverage ratio is high compared to other companies in the industry.
C) A ratio of debt to equity that low compared to other companies in the industry.
D) A capital structure leverage ratio is low compared to other companies in the industry.

Accepted Answer

A current ratio that is low compared to other companies in the same industry may indicate that a company is having difficulty meeting its short-term debt obligations and may have liquidity problems. B, C, and D do not necessarily indicate solvency or liquidity problems.

Question 14

Assume a company acquires inventory, using cash. Which of the following statements is correct regarding the effect of this purchase on its ratios?
A) The current ratio will fall.
B) The quick ratio will fall.
C) The inventory turnover ratio increases.
D) The capital structure leverage increases.

Accepted Answer

The quick ratio will fall because it excludes inventory from current assets, so when cash (a quick asset) is used to purchase inventory, the quick ratio decreases.

Question 15

In general, when fixed operating costs become a smaller percentage of a company's operating costs, the operating leverage effect
A) Decreases
B) Stays the same
C) Increases

Accepted Answer

The operating leverage effect refers to the impact of fixed costs on a company's profitability. When fixed costs become a smaller percentage of a company's operating costs, the company becomes less sensitive to changes in sales volume, and therefore, the operating leverage effect decreases. This is because a smaller proportion of costs are fixed and will not change with changes in sales volume, meaning there is less potential for profit to increase rapidly with increased sales.

Question 16

Reasons that a private company might decide to prepare financial statements include all of the following, except:
A) The company's lenders require the company to send them financial statements.
B) The company has several owners, who wish to monitor their ownership interests.
C) All U.S. companies must file annual audited financial statements with the U.S. government each year.
D) The company has profit-sharing plans that require it to base payments on financial statement information.

Accepted Answer

Not all private companies are required to file annual audited financial statements with the U.S. government. However, preparing financial statements can still provide useful information for lenders, owners, and profit-sharing plans.

Question 17

Historical financial statements are meant to help users assess all of the following, except:
A) Likely success of new products
B) Performance of management in earning income
C) Profitability of the business
D) Solvency of the business

Accepted Answer

Historical financial statements are not typically used to assess the likely success of new products, as they reflect past performance rather than future potential. Instead, they are used to evaluate the performance, profitability, and solvency of the business based on past financial results.

Question 18

When a financial statement analyst compares figures for a company's revenues over a five-year period, this can best be describes as an example of
A) Vertical analysis
B) Horizontal analysis
C) Credit analysis
D) Solvency analysis

Accepted Answer

Comparing figures for a company's revenues over a five-year period is an example of horizontal analysis, which is the analysis of financial statements over time to track changes in figures and identify trends. Vertical analysis is the analysis of financial statements for a single time period to compare figures as a percentage of a base figure (usually total assets or total revenues). Credit analysis is the assessment of a borrower's ability to repay debt, while solvency analysis is the assessment of a company's ability to meet its long-term financial obligations.

Question 19

When a financial statement analyst compares various figures on a company's income statement for a single year, and notes that a particular expense is 23% of sales, the analyst is performing
A) Vertical analysis
B) Horizontal analysis
C) Credit analysis
D) Solvency analysis

Accepted Answer

The analyst is performing vertical analysis, which compares each line item on the income statement to a common base, such as revenue/sales. In this case, the particular expense is being compared to sales as a percentage, or ratio, which is a type of vertical analysis. Horizontal analysis, on the other hand, compares financial data over multiple periods (such as years) to analyze changes in performance. Credit analysis and solvency analysis are both different types of financial analysis that focus on a company's ability to meet its financial obligations and manage debt, respectively.

Question 20

Benefits of using ratio analysis include all of the following except:
A) Ratios are usually easy to compute.
B) It is always clear what the optimal ratio is for a company.
C) Ratios allow analysts to look at one figure in the financial statements in relation to a second one.
D) Ratios can be used to compare companies that report results in different currencies.

Accepted Answer

It is not always clear what the optimal ratio is for a company as it can vary based on industry, size, and other factors.

Quiz 4: Managing Your Accounts

In general, when a company has greater operating leverage, and its sales increase, profits

It would be easiest to see the percentage growth in a company's 2015 accounts receivable by looking at a

In a typical cash flow statement, prepared using the indirect method, which of the following statements about depreciation is correct?

Assume that during the year, the Foley Company had net income of $200,000. Its accounts receivable increased by $6,000, and its accrued expenses payable increased by $7,000. Based on this information, net operating cash flows for the year equal

Assume that during the year, the Grey Company had net income of $300,000. Its inventory increased by $6,000 and its accounts payable decreased by $7,000. Based on this information, net operating cash flows for the year equal

Under the Du Pont framework of analysis, which of the following relationships is true?

A commonly used ratio to judge company profitability is

A commonly used ratio to judge the amount a company is earning, not just for its owners, but related to all the resources that managers have to use in the business, is

It would be easiest to see the company's 2014 interest expense, as a percentage of revenues for the year, by looking at a

Research indicates that all of the following statements are correct, except:

According to research, movements in stock prices are most closely related to movements in which financial statement?

Which of the following is most likely a sign that a company has solvency or liquidity problems?

Assume a company acquires inventory, using cash. Which of the following statements is correct regarding the effect of this purchase on its ratios?

In general, when fixed operating costs become a smaller percentage of a company's operating costs, the operating leverage effect

Reasons that a private company might decide to prepare financial statements include all of the following, except:

Historical financial statements are meant to help users assess all of the following, except:

When a financial statement analyst compares figures for a company's revenues over a five-year period, this can best be describes as an example of

When a financial statement analyst compares various figures on a company's income statement for a single year, and notes that a particular expense is 23% of sales, the analyst is performing

Benefits of using ratio analysis include all of the following except: