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business
financial statement analysis

Questions and Answers of Financial Statement Analysis

1–29. Explain the claim: While we theoretically use the effective interest rate to compute a bond’s present value, in practice it is the other way around.
1–28. What is meant by “time value of money”? Explain the role of this concept in valuation.
1–27. Identify four specialized financial analysis tools.
1–26. Ratio analysis is an important tool in financial analysis. Identify at least four ratios using:a. Balance sheet data exclusively.b. Income statement data exclusively.c. Both balance sheet and
1–25. Identify and describe limitations of ratio analysis.
1–24. What is a necessary condition for usefulness of a ratio of financial numbers? Explain.
1–23. Common-size analysis is an important tool in financial analysis.a. Describe a common-size financial statement. Explain how one is prepared.b. Explain what a common-size financial statement
1–22. Explain what useful information is derived from index-number trend analysis.
1–21. Describe criteria in selecting a base year for index-number trend analysis.
1–20. Identify conditions that prevent computation of a valid percent change. Provide an example.
1–19. Compare the “absolute amount of change” with the percent change as an indicator of change. Which is better for analysis?
1–18. Is past trend a good predictor of future trend? Justify your response.
1–17. Comparative analysis is an important tool in financial analysis.a. Explain the usefulness of comparative financial statement analysis.b. Describe how financial statement comparisons are
1–16. Identify and describe at least four categories of financial analysis tools.
1–15. Identify and discuss at least two areas of financial analysis.
1–14. Identify at least seven additional sources of financial reporting information (beyond financial statements)that are useful for analysis.
1–13. Explain why financial statements are important to the decision-making process in financial analysis. Also, identify and discuss some of their limitations for analysis purposes.
1–12. Identify and discuss the four primary financial statements of a business.
1–11. Explain how financial statements reflect the business activities of a company.
1–10. Identify and discuss the four major activities of a business enterprise.
1–9. Identify at least five different internal and external users of financial statements.
1–8. Describe financial statement analysis and identify its objectives.
1–7. Describe the importance of accounting analysis for financial analysis.
1–6. What are the various component processes in business analysis? Explain with reference to equity analysis.
1–5. What is fundamental analysis? What is its main objective?
1–4. What are the main differences between credit analysis and equity analysis? How do these impact the financial statement information that is important for each type of analysis?
1–3. Describe the different types of business analysis. Identify the category of users of financial statements that applies to each different type of business analysis.
1–2. Explain the claim: Financial statement analysis is an integral part of business analysis.
1–1. Describe business analysis and identify its objectives.
1. Analyze and measure earnings quality and its determinants(Appendix 2B).
1. Explain the relevance of auditing and the audit report (opinion)for financial statement analysis (Appendix 2A).
1. Describe the need for and techniques of accounting analysis.
1. Explain fair value accounting and its differences from the historical cost model; identify the merits and demerits of fair value accounting and its implications for analysis.
1. Understand economic concepts of income, and distinguish it from cash flows and reported income; learn to make adjustments to reported income to meet analysis objectives.
1. Explain the importance of accrual accounting and its strengths and limitations.
1. Describe the relevance of accounting information to business analysis and valuation, and identify its limitations.
1. Describe the objectives of financial accounting; identify qualities of accounting information and principles and conventions that determine accounting rules.
1. Identify what constitutes generally accepted accounting principles (GAAP).
1. Explain the financial reporting and analysis environment.
1. Explain the purpose of financial statement analysis in an efficient market.
1. Define and formulate some basic valuation models.
1. Apply several basic financial statement analysis techniques.
1. Analyze and interpret financial statements as a preview to more detailed analyses.
1. Identify the relevant analysis information beyond financial statements.
1. Describe the purpose of each financial statement and linkages between them.
1. Explain business activities and their relation to financial statements.
1. Describe component analyses that constitute business analysis.
1. Identify and discuss different types of business analysis.
1. Explain business analysis and its relation to financial statement analysis.
8–1. Describe the usefulness of return measures in financial statement analysis.
8–1. Explain return on invested capital and variations in its computation.
8–1. Analyze return on net operating assets and its relevance for analysis.
8–1. Describe disaggregation of return on net operating assets and the importance of its components.
8–1. Describe the relation between profit margin and asset turnover.Analyze return on common shareholders’ equity and its role in analysis.
8–1. Describe disaggregation of return on common shareholders’equity and the relevance of its components.
8–1. Explain operating and financial leverage and how to assess a company’s success in using leverage to increase returns.
8–1. Describe the importance of prospective analysis.
8–1. Explain the process of projecting the income statement, the balance sheet, and the statement of cash flows.
8–1. Discuss and illustrate the importance of sensitivity analysis.
8–1. Describe the implementation of the projection process for valuation of equity securities.
8–1. Discuss the concept of value drivers and their reversion to long-run equilibrium levels.
8–1. Explain the importance of liquidity, and describe working capital measures of liquidity and their components.
8–1. Interpret the current ratio and cash-based measures of liquidity.
8–1. Analyze operating cycle and turnover measures of liquidity and their interpretation.
8–1. Illustrate what-if analysis for evaluating changes in company conditions and policies.
8–1. Describe capital structure and its relation to solvency.
8–1. Explain financial leverage and its implications for company performance and analysis.
8–1. Analyze adjustments to accounting book values to assess capital structure.
8–1. Describe analysis tools for evaluating and interpreting capital structure composition and for assessing solvency.
8–1. Analyze asset composition and coverage for solvency analysis.
8–1. Explain earnings-coverage analysis and its relevance in evaluating solvency.
8–1. Describe capital structure risk and return and its relevance to financial statement analysis.
8–1. Interpret ratings of organizations’ debt obligations(Appendix 10A).
8–1. Describe prediction models of financial distress(Appendix 10B).
8–1. Analyze earnings persistence, its determinants, and its relevance for earnings forecasting.
8–1. Explain recasting and adjusting of earnings and earnings components for analysis.
8–1. Describe equity valuation and its relevance for financial analysis.
8–1. Analyze earning power and its usefulness for forecasting and valuation.
8–1. Explain earnings forecasting, its mechanics, and its effectiveness in assessing company performance.
8–1. Analyze interim reports and consider their value in monitoring and revising earnings estimates.
8–1. Describe the steps in analyzing financial statements.
8–1. Review the building blocks of financial statement analysis.
8–1. Explain important attributes of reporting on financial statement analysis.
8–1. Describe implications for financial statement analysis of evaluating companies in specialized industries or with unique characteristics.
8–1. Analyze in a comprehensive manner the financial statements and notes of Campbell Soup Company.
8–1. How is return on invested capital used as an internal management tool?
8–3. Why is interest, expense ignored when computing return on net operating assets (RNOA)?
8–9. What is the purpose of measuring asset turnover for different asset categories?
8–10. What factors (limitations) enter into our evaluation of return on net operating assets?
8–11. How is the equity growth rate computed? What does it measure?
8–12.a. How do return on net operating assets and return on common equity differ?b. What are the components of return on common shareholders’ equity? What do the components measure?
8–13.a. Equity turnover is sales divided by average shareholders’ equity. What does equity turnover measure?How is it related to return on common equity? (Hint: Look at the components of ROCE.)b.
8–14. What circumstances justify including convertible debt as equity capital when computing return on shareholders’equity?
EXERCISE 8–1 Selected financial information from Syntex Corporation is reproduced below:1. NOA turnover (average NOA equals ending NOA) is 2.2. NOPAT margin equals 5%.3. Leverage ratio (average
EXERCISE 8–1 Refer to the financial data in Case 10–5 (on page 595). In analyzing this company, you feel it is important to differentiate between operating success and financing
EXERCISE 8–1 Selected financial information for ADAM Corporation is reproduced below:1. NOA turnover (average NOA equals ending NOA) is 3.2. NOPAT margin is 7%.3. Leverage ratio (average NFO to
EXERCISE 8–1 Rose Corporation’s condensed balance sheet for Year 2 is reproduced below:Assets Current assets................................... $ 250,000 Noncurrent assets
EXERCISE 8–1 1. Which of the following situations best correspond with a ratio of “sales to average net tangible assets”exceeding the industry norm? (Choose one answer.)a. A company expanding
EXERCISE 8–1 2. A measure of asset utilization (turnover) is (choose one answer):a. Sales divided by average long-term operating assets.b. Return on net operating assets.c. Return on common
EXERCISE 8–1 Return on net operating assets depends on the (choose one answer):a. Interest rates and pretax profits.c. After-tax operating profit margin and NOA turnover.b. Debt to equity ratio.d.

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