Question 1

Financial statement analysis is the process of interpreting and evaluating financial statements by using data and disclosures contained in them to produce additional financial measures.

Accepted Answer

Financial statement analysis involves examining financial statements to understand a company's financial position, performance, and changes in financial condition by using various analytical techniques and tools. This process helps in making informed decisions based on the financial data provided in the statements.

Question 2

Financial statement analysis involves comparing financial statements for the current period with those of previous periods and/or other companies, assessing the internal composition of the financial statements, and measuring relations within and among the financial statements.

Accepted Answer

Financial statement analysis indeed encompasses comparing a company's financial statements over different periods and with other companies, examining the structure of the statements, and analyzing the relationships within and between the statements to assess financial health and performance.

Question 3

Financial statement analysis enables managers to see their firm as outsiders see it, to ascertain compliance with credit restrictions, to compare their firm with similar firms, and to identify potential strengths and weaknesses.

Accepted Answer

Managers have three main reasons to analyze their financial statements. Those are to assess overall company performance for strengths and weaknesses, to make sure that borrowing agreements with lenders are honored, and to gain a perspective on how the firm is perceived by outsiders who employ similar financial statement analysis.

Question 4

Because it relates elements from the income statement and balance sheet, the asset turnover ratio is ideal as a single financial indicator.

Accepted Answer

Sales ratios are used to measure various characteristics or conditions of sales. Sales ratios may help evaluate sales, but they do not contribute to the analysis of operating expenses, solvency or performance.

Question 5

Alternative accounting procedures such as methods of depreciation and inventory cost flow methods affect both the income statement and the balance sheet.

Accepted Answer

Alternative accounting procedures affect accumulated depreciation and inventory on the balance sheet and depreciation expense and cost of goods sold on the income statement. Alternative accounting procedures also affect the cash flow statement.

Question 6

Inflation or deflation does not affect comparisons of financial statements between periods because the statements are based on historical dollars.

Accepted Answer

In the case of inflation or deflation, inter-period comparisons are distorted because the statements are not based on dollars of the same value.

Question 7

Because the income statement shows aggregated amounts such as sales, gross profit, and net income, a change in product mix can distort ratios and comparisons of financial statements.

Accepted Answer

Most products have unique profit margins and their mix influences the firm's profit margin. In comparing two years of financial statements for a company with only a few products, high sales of a low profit-margin product can hide the effect of declining sales of a primary, high profit-margin product.

Question 8

In vertical common size analysis, the dollar figure for an account is expressed in terms of that same account figure for a previous year.

Accepted Answer

In vertical analysis, the dollar figure for an account is usually expressed in terms of sales for the income statement and assets for the balance sheet.

Question 9

In order to determine the meaning of common size percentages, some kind of comparison, such as an industry average, trend analysis, or a firm's own history, is helpful.

Accepted Answer

Financial analysis is improved by comparison of financial measures of one firm against industry averages or norms or against comparable measures of competitor firms.

Question 10

Vertical and horizontal analyses are limited in that they involve comparisons of financial measures only for a single firm.

Accepted Answer

Financial analysis is improved by comparison of financial measures of one firm against industry averages or norms or against comparable measures of competitor firms.

Question 11

Vertical analysis helps to identify significant changes that have taken place during the period and to determine whether the changes have favorable or unfavorable impacts on solvency and performance.

Accepted Answer

Vertical analysis is a method of financial statement analysis in which each entry for each of the three major categories of accounts (assets, liabilities, and equity) in a balance sheet is represented as a proportion of the total account. This technique helps in identifying significant changes over the period and assessing their impact on the company's solvency and performance by comparing the relative percentages of account balances year over year or against a benchmark.

Question 12

Horizontal analysis is used to evaluate trends in the financial condition of an organization.

Accepted Answer

This analysis allows current year common size statements to be compared to those of prior years. Comparison over a series of years establishes a trend.

Question 13

Solvency refers to a firm's ability to pay its debts as they come due.

Accepted Answer

Solvency is a measure of a company's ability to meet its long-term financial obligations, indicating whether it can pay its debts as they come due.

Question 14

Primary measures of short term solvency are the debt-to-equity ratio and the times-interest-earned measure.

Accepted Answer

Primary measures of short term solvency are the current ratio, acid test ratio, inventory turnover, and days sales in receivables.

Question 15

Ratios useful in assessing long term solvency are the current ratio, acid test ratio, inventory turnover, and days sales in receivables.

Accepted Answer

Long term solvency is assessed through ratios such as the debt-to-equity and the times-interest-earned measure.

Question 16

Primary measures of performance are asset turnover, return on assets, return on equity, and earnings per share.

Accepted Answer

These ratios measure sales or net income relative to an income producing base such as assets, stockholders' equity, or shares of common stock.

Question 17

If the fixed cost of capital is greater than the return on assets, financial leverage is favorable.

Accepted Answer

Financial leverage is favorable when the fixed cost of capital is less than the return it generates on assets.
Multiple Choice

Question 18

Financial statement analysis is least useful for:
A) Providing creditors with information on the status of their loans
B) Providing investors with useful information for valuing securities
C) Providing managers with relevant information to help achieve organizational goals
D) Providing the Internal Revenue Service with information to determine the amount of taxes owed

Accepted Answer

Financial statement analysis focuses on the information needs of managers internal to the business, and the needs of creditors and investors. The needs of the IRS are addressed through other reports.

Question 19

Which of the following would be users of financial statement analysis?
A) Management
B) Bankers
C) Investment analysts
D) All of the above

Accepted Answer

Financial statement analysis focuses on the information needs of managers internal to the business, and the needs of creditors and investors.

Question 20

With respect to credit analysts and managers, which of the following statements is incorrect?
A) Both credit analysts and managers are concerned about security prices.
B) Credit analysts are concerned with assessing the short-term liquidity of a company.
C) Credit analysts are concerned with assessing the long-term solvency of a company.
D) Managers are concerned about interest, principal, and dividend payments.

Accepted Answer

Stockholders and managers are concerned with security prices. Credit analysts are concerned with the status of client loans.

Quiz 13: Appendix: Managerial Analysis of Financial Statements