Chapter F12: Financial Statement Analysis
Multiple Choice
1.
The following statement is true regarding users of financial statements:
For short-term borrowing, lending institutions seldom charge interest
while trade creditors do charge interest.
Long-term creditors are primarily interested in whether the company
will be able to pay the periodic interest payments and repay the loan
upon maturity.
*
Equity investors (stockholders) are considered internal decision
makers.
Management should focus on the short-term profitability of the firm.
Hint for question 1
The focus of Chapter 12 is on three groups of economic decision makers:
creditors (short term and long term), equity investors (present and potential),
and company management. There are also other economic decision makers.
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2.
Background information helps put the company financial statements into
the proper context. The background check into a company's external
environment should include all except -
the health of the business economy as reported in Business Week
and Forbes and other business periodicals.
government regulation, income taxes, and other actions taken by
Congress and the President.
research about the industry in which the company operates such as
is reported in Moody's Industry Review, and Standard and Poor's
Industry Surveys.
*
all of the above.
Hint for question 2
The background check into a company's external environment should include
information about general economic conditions, political events and political
climate, and industry outlook.
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3.
All of the following statements are true regarding ratios except -
ratios need to be compared to other information such as industry
averages to be useful.
ratios need to be compared to other information such as company
ratios from prior years to be useful.
the amounts may be from two different financial statements or from
the same financial statement.
ratios have a set formula so there is consistency in calculations
among analysts and financial publications.
*
Hint for question 3
Ratios highlight the relationship between two financial statement amounts. To
be useful, ratios need to be compared to other information such as industry
averages or ratios from prior years.
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4.
The following statement is true regarding profitability ratios:
The current ratio is a profitability ratio that measures a company's
ability to meet short-term obligations.
*
A total asset turnover ratio of 2 indicates for every dollar invested in
assets the company is generating $2 in sales revenue.
The industry average for profit margin after income tax ratio is 10%.
A company ratio of 5% would be considered favorable.
A decreasing trend for the return on equity ratio is considered
favorable.
Hint for question 4
Profitability ratios include profit margin before income tax, profit margin after
income tax, return on assets (ROA), total asset turnover, return on equity
(ROE), and return before interest on equity.
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5.
The following statement is true regarding liquidity ratios:
The debt ratio measures the proportion of assets financed by debt--a
liquidity ratio.
The current ratio measures the ability to meet all obligations--both
short term and long term.
The industry average for inventory turnover is 4 times. A company
ratio of 6 times would indicate a company is turning over inventory faster
than the industry average. This would be considered favorable.
*
A decreasing trend for the receivables turnover ratio indicates
receivables are being collected in fewer days and is considered
favorable.
Hint for question 5
Liquidity ratios include the current ratio, quick ratio, net sales to working capital,
receivables turnover, and inventory turnover.
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6.
The following statement is true regarding solvency ratios:
Return on equity is a solvency ratio.
A 1.5 ratio for liabilities to net worth ratio indicates a greater portion
of company assets are being financed with equity rather than with debt.
*
The industry average for the debt ratio is 60%. A company ratio of
90% indicates more assets are financed by debt than average for the
industry.
A decreasing trend for the coverage ratio (also referred to as the
times interest earned ratio) indicates a better ability to pay periodic
interest payments.
Hint for question 6
Solvency ratios include the debt ratio, total liabilities to net worth, and the
coverage ratio.
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7.
Compute return on equity from the following information:
Accounts payable $10,000; bonds payable $90,000; common stock
$30,000; retained earnings $70,000; and net income after taxes
$20,000.
10%.
*
20%.
67%.
none of the above.
Hint for question 7
Return on equity = net income after taxes / equity.
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8.
Given the following information, the following statement is true regarding
the current and quick ratios:
Cash 10,000; accounts receivable 15,000; inventory 25,000; equipment,
net 150,000; accounts payable $20,000; bonds payable $80,000;
common stock $30,000; and retained earnings $70,000.
The quick ratio equals .25 to 1.
The quick ratio equals .50 to 1.
The current ratio equals 1.25 to 1.
*
The current ratio is 2.5 to 1.
Hint for question 8
Current ratio = current assets / current liabilities. Quick ratio = (cash +
receivables + marketable trading securities) / current liabilities.
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9.
Compute the debt ratio from the following information:
Cash 10,000; accounts receivable 15,000; inventory 25,000; equipment,
net 150,000; accounts payable $20,000; bonds payable $80,000;
common stock $30,000; and retained earnings $70,000.
25%.
*
50%.
200%.
none of the above.
Hint for question 9
Debt ratio = total liabilities / total assets.
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10.
Two companies are identical except for the fact that Company D uses
the double-declining-balance method of depreciation and Company S
uses the straight-line method of depreciation. Assume this is the first
year of business. For Company D, the ratio that will be greater is --
the current ratio.
profit margin after income tax.
*
the total asset turnover ratio.
none of the above.
Hint for question 10
Double-declining-balance is an accelerated method of depreciation. Accelerated
methods allocate more depreciation expense to the earlier years of the asset's
useful life.
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11.
Lucy Company and Fred Company are identical except for the fact that
Lucy Company uses the LIFO inventory costing method and Fred
Company uses the FIFO inventory costing method. In a period of rising
prices, the ratio that will be lower for Lucy Company is --
the current ratio.
the inventory turnover ratio.
*
profit margin after income tax.
none of the above.
Hint for question 11
LIFO allocates the higher, more recent costs to cost of goods sold. Cost of
goods sold is an expense. Higher expenses lead to lower net income.
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12.
The following are limitations to ratio analysis except --
information to calculate the ratios may come from two different
financial statements.
*
ratios are based on historical cost.
companies choose different accounting methods for depreciation
and inventory costing.
lack of uniformity in the formulas used to calculate the various ratios.
Hint for question 12
Ratio analysis is an excellent tool for financial statement analysis, but it
does have its limitations.
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Submit for Grade
Chapter F12: Financial Statement Analysis
True or False
1.
A sole ratio value can be extremely meaningful.
TRUE
*
FALSE
Hint for question 1
No conclusion should be based on a single ratio nor should any single ratio
value be ignored.
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2.
*
The North American Industrial Classification System (NAICS) uses a six
digit code to specify the industry in which the company operates.
TRUE
FALSE
Hint for question 2
NAICS is used by industries in all of North America.
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3.
The profit margin after income tax ratio for Wal-Mart, a discount store, is
approximately 3%. This is low compared to Microsoft's 25% profit margin
ratio and therefore indicates Wal-Mart is a poor investment.
TRUE
*
FALSE
Hint for question 3
The average profit margin after income tax ratio differs between industries.
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4.
In general, a grocery store would be expected to have a greater inventory
turnover ratio than a retailer such as Sears.
*
TRUE
FALSE
Hint for question 4
The inventory turnover ratio indicates how quickly inventory is sold--the number
of times the company sells its average inventory level during a year.
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5.
In general, a debt ratio of 90% indicates lower financial risk than a debt
ratio of 60%.
TRUE
*
FALSE
Hint for question 5
The debt ratio indicates the percentage of assets financed with debt.
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Submit for Grade
Chapter F12: Financial Statement Analysis
Fill In The Blanks
1.
__________ are financial statement users interested in the likelihood of a
dividend distribution and whether the stock of the company will increase
in market value.
Short-term creditors
Long-term creditors
*
Equity investors
Managers
Hint for question 1
Who benefits from dividend distributions and a market value increase?
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2.
A thorough financial analysis should include researching about general
economic conditions, political events and political climate, and
__________ outlook.
employment
environmental
*
industry
political
Hint for question 2
Employment, environmental, industry, or political?
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3.
The coverage ratio is a(n) __________ ratio used to examine a
company's ability to meet long-term debt obligations.
industry
liquidity
profitability
*
solvency
Hint for question 3
What type of ratio assesses the ability to meet long-term debt obligations?
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4.
The __________ ratio measures a company's ability to pay current
liabilities with current assets.
quick
*
current
debt
coverage
Hint for question 4
Quick, current, debt, or coverage?
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5.
The __________ ratio measures how effectively a company is using
assets to generate income.
profit margin
return on assets
return on equity
*
total asset turnover
Hint for question 5
All "return on" ratios include net income in the numerator. All "return on"
ratios compare net income to something else.
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Submit for Grade
Chapter F12: Financial Statement Analysis
Essay Questions
1.
Describe the three major categories of ratio analysis. List at least two
ratios from each major category.
2.
List the three major users of financial statement analysis and the
objectives of each. List the types of ratios that would be of primary
concern to each.
3.
Ratio values standing by themselves have little to no meaning. Describe
three different ways to make ratios more useful.
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