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FINANCIAL STATEMENT ANALYSIS 1. Which of the following statements regarding financial analysis is true? a. Financial analysis will show how a company is guaranteed to perform in the future. b. Financial analysis should not be relied upon as an indicator of future performance. c. Financial analysis should be performed only by managers and creditors. d. Financial analysis provides supplemental information not provided directly by the financial statements. 2. Which of the following is not a limitation of financial statement analysis? a. the cost basis b. the use of estimates c. the diversification of firms d. the availability of information 3. Which of the following statements is true regarding ratio analysis? a. A ratio for a particular company is often compared to industry standards using various publications. b. A ratio for a particular company is unique and, therefore should not be compared to other companies' ratios. c. Ratio analysis should be kept, as simple as possible, often accomplished by using just one ratio to measure a company's performance. d. Ratio analysis will not be affected by different accounting methods or assumptions. 4. Suppose you are comparing two firms in the steel industry. One firm is large and the other is small. Which type of numbers would be most meaningful for statement analysis? a. Absolute numbers would be most meaningful for both the large and small firm. b. Absolute numbers would be most meaningful in the large firm; relative numbers would be most meaningful in the small firm. c. Relative numbers would be most meaningful for the large firm; absolute numbers would be most meaningful for the small firm. d. Relative numbers would be most meaningful for both the large and small firm, especially for interfirm comparisons. 5. Which one of these statements is false? a. Many companies will not clearly fit into any one industry. b. A financial service uses its best judgement as to which industry the firm best fits. c. The analysis of an entity's financial statements can be more meaningful if the results are compared with industry averages and with results of competitors. d. A company comparison should not be made with industry averages if the company does not clearly fit into any one industry. 6. Pia, Inc. is a retailer with annual sales less than P10 million. At the end of 2010, ratio analysis is performed on Pia's financial statements by various stakeholders. Pia's 2010 ratios are not likely to be compared to: a. Pia's 2009 ratios b. Pia's 2010 budgeted ratios. c. other retailers with annual sales of less than P10 million. d. A manufacturer with annual sales of less than P10 million. 7. Management is a user of financial analysis. Which of the following comments does not represent a fair statement as to the management perspective? 8. 9. 10. 11. 12. 13. 14. 15. a. Management is always interested in maximum profitability. b. Management is interested in the view of investors. c. Management is interested in the financial structure of the entity. d. Management is interested in the asset structure of the entity. Ratios are used as tools in financial analysis a. instead of horizontal and vertical analyses. b. because they can provide information that may not be apparent from inspection of the individual components of a particular ratio. c. because even single ratio by itself is quite meaningful. d. because they are prescribed by PFRS. Analyzing financial statement account balances over time for the same company is called: a. vertical analysis. b. horizontal analysis. c. common-size analysis. d. price analysis. The percentage analysis of increases and decreases in individual items in comparative financial statements is called: a. vertical analysis. b. solvency analysis. c. profitability analysis. d. horizontal analysis. Which of the following statements regarding horizontal analysis is false? a. Horizontal analysis can include more than two years of financial data. b. Horizontal analysis is facilitated by computing peso and percentage changes in financial statement items. c. Horizontal analysis analyzes ratio differences occurring between companies. d. Horizontal analysis can include the statement of cash flows. Which of the following generally is the most useful in analyzing companies of different sizes? a. comparative statements b. common-size financial statements c. price-level accounting d. profitability index Statements in which all items are expressed only in relative terms (percentages of a base) are termed: a. vertical statements. b. horizontal statements. c. funds statements. d. common-size statements. To perform vertical analysis a. items on the balance sheet need to be restated to their fair market values. b. items on the balance sheet need to be indexed for inflation. c. common-size financial statements need to be prepared. d. horizontal analysis should have been done early. In which of the following cases may a percentage change be computed? a. The trend of the amounts is decreasing but all amounts are positive. b. There is no amount in the base year. 16. 17. 18. 19. 20. 21. 22. 23. 24. c. There is a negative amount in the base year and a negative amount in the subsequent year. d. There is a negative amount in the base year and a positive amount in the subsequent year. Horizontal analysis is a technique for evaluating a series of financial statement data over a period of time a. that has been arranged from the highest number to the lowest number. b. that has been arranged from the lowest number to the highest number. c. to determine which items are in error. d. to determine the amount and/or percentage increase or decrease that has taken place. Vertical analysis is a technique that expresses each item in a financial statement a. in pesos and centavos. b. as a percent of the item in the previous year. c. as a percent of a base amount. d. starting with the highest value down to the lowest value. Trend analysis allows a firm to compare its performance to: a. other firms in the industry. b. other firms over periods within the firm. c. other industries. d. none of the given choices. In the near term, the important ratios that provide the information critical to the short-run operation of the firm are: a. liquidity, activity, and profitability. b. liquidity, activity, and debt. c. liquidity, activity, and equity. d. activity, debt, and profitability. The primary concern of short-term creditors when assessing the strength of a firm is the entity's a. short-term liquidity b. profitability c. market price of stock d. leverage Which of the following is a measure of the liquidity portion of a corporation? a. earnings per share b. inventory turnover c. current ratio d. number of times interest charges earned The ratios that are used to determine a company's short-term debt paying ability are a. asset turnover, times interest earned, current ratio, and receivables turnover. b. times interest earned, inventory turnover, current ratio, and receivables turnover. c. times interest earned, acid-test ratio, current ratio, and inventory turnover. d. current ratio, acid-test ratio, receivables turnover, and inventory turnover. The current ratio is a. calculated by dividing current liabilities by current assets. b. used to evaluate a company's liquidity and short-term debt paying ability c. used to evaluate a company's solvency and long-term debt paying ability d. calculated by subtracting current liabilities from current assets. Which of the following ratios is the best measure of liquidity? 25. 26. 27. 28. 29. 30. 31. 32. a. debt-to-equity ratio b. times-interest-earned ratio c. return on assets ratio d. acid-test ratio The acid-test or quick ratio a. is used to quickly determine a company's solvency and long-term debt paying ability. b. relates cash, short-term investments, and net receivables to current liabilities. c. is calculated by taking one item from the income statement and one item from the balance sheet. d. is the same as the current ratio except it is rounded to the nearest whole number. Typically, which of the following would be considered to be the most indicative of a firm's shortterm debt paying ability? a. working capital b. current ratio c. acid test ratio d. day's sales in receivables Which of the following does not bear on the quality of receivables? a. shortening the credit terms b. lengthening the credit terms c. lengthening the outstanding period d. all of the given choices bear on the quality of receivables Which of the following reasons should not be considered in order to explain why the receivables appear to be abnormally high? a. sales volume decreases materially late in the year b. receivables have collectibility problems and possibly some should have been written off c. material amount of receivables are on the installment basis d. sales volume expanded materially late in the year A general rule to use in assessing the average collection period is a. that it should not exceed 30 days. b. it can be any length as long as the customer continues to buy merchandise. c. that it should not greatly exceed the discount price. d. that it should not greatly exceed the credit term period. The present and prospective stockholders are primarily concerned with a firm's a. profitability. b. liquidity. c. leverage. d. risk and return. Which of the following ratios is rated to be a primary measure of liquidity and considered of highest significance rating of the liquidity ratios bank analyst? a. debt/equity b. current ratio c. Degree of Financial Leverage d. Accounts Receivable Turnover in Days As a company's accounts receivable turnover ratio increases from one year to the next, they will find that the number of days' sales in receivables: a. decreases. b. increases. 33. 34. 35. 36. 37. 38. 39. 40. c. stays the same. d. cannot be determined. An acceleration in the collection of receivables will tend to cause the accounts receivable turnover to: a. decrease. b. remain the same. c. either increase or decrease. d. increase. DOC, Inc. has recently calculated the accounts receivable turnover for the current year to be 15. In prior years, the same ratio was always higher. Which of the following statements would be the best interpretation for the reason for the ratio's change? a. The company had less sales in the current year than in prior years. b. The company had more sales in the current year than in prior years. c. The company had fewer accounts receivables in the current year than in prior years. d. The company took longer to collect on their accounts receivables in the current year than in prior years. Ted, Inc. has recently calculated the inventory turnover for the current year to be 30. In prior years, the same ratio was always lower. Which of the following statements would be the best interpretation for the reason for the ratio's change? a. The company had less sales in the current year than in prior years. b. The company purchased less inventory in the current year than in prior years. c. The company took fewer days to sell its inventory in the current year than in prior years. d. The company took more days to sell its inventory in the current year than in prior years. Which of the following would best indicate that the firm is carrying excess inventory? a. A decline in the current ratio b. stable current ratio with declining quick ratios c. a decline in days' sales in inventory d. a rise in total asset turnover As a company's inventory turnover ratio decreases from one year to the next, they will find that the number of days inventory is held before sale: a. decreases. b. increases. c. stays the same. d. cannot be determined. Which of the following would be the most detrimental to a firm's current ratio if that ratio is currently 2.0? a. Buy raw materials on credit. b. Sell marketable securities at cost. c. Pay off accounts payable with cash. d. Pay off a portion of long-term debt with cash. The set of ratios that is most useful in evaluating solvency is a. debt ratio, current ratio, and times interest earned. b. debt ratio, times interest earned, and return on assets. c. debt ratio, times interest earned, and quick ratio. d. debt ratio, times interest earned, and cash flow to debt. The two categories of ratios that should be utilized to assess a firm's true liquidity are the a. current and quick ratios. b. liquidity and debt ratios. c. liquidity and profitability ratios. d. liquidity and activity ratios. 41. Which one of the following ratios would not likely be used by a short-term creditor in evaluating whether to sell on credit to a company? a. current ratio b. acid-test ratio c. asset turnover d. receivable turnover 42. If a company has an acid-test ratio of 1.2:1, what respective effects will the borrowing of cash in short-term debt and collection of accounts receivable have on the ratio? 43. 44. 45. 46. 47. 48. Short- Term Borrowing Collection of Receivable a. Increase No Effect b. Increase Increase c. Decrease No Effect d. Decrease Decrease Solvency measures a company's ability: a. to meet long-term obligations as they become due. b. to meet short-term obligations as they become due. c. to make a profit in the short-term. d. to make a profit in the long-term. Which of the following ratios would not be the best measure of solvency? a. return on assets ratio b. debt-to-equity ratio c. debt service coverage ratio d. times-interest-earned-ratio The return on assets ratio is affected by the a. asset turnover ratio. b. debt to total assets ratio. c. profit margin ratio. d. asset turnover and profit margin ratios. A firm has a current ratio of 1:1. In order to improve its liquidity ratios, this firm should a. improve its collection practices, thereby increasing cash and increasing its current and quick ratios. b. improve its collection practices and pay accounts payable, thereby decreasing current liabilities and increasing the current and quick ratios. c. decrease current liabilities by utilizing more long-term debt, thereby increasing the current and quick ratios. d. increase inventory, thereby increasing current assets and the current and quick ratios. A weakness of the current ratio is a. the difficulty of the calculations. b. that it does not take into account the composition of the current assets. c. that it is rarely used by sophisticated analysis. d. that it can be expressed as a percentage, as a rate, or as a proportion. Trading on equity (leverage) refers to the a. amount of working capital. 49. 50. 51. 52. 53. 54. 55. 56. 57. b. amount of capital provided by owners. c. use of borrowed money to increase the return to owners. d. earnings per share. Which of the following ratios would be the best measure of solvency? a. return on assets ratio b. price earnings ratio c. current ratio d. times-interest-earned ratio The ratio that indicates a company's degree of financial leverage is the a. cash debt coverage ratio b. debt to total assets c. free cash flow ratio d. times-interest-earned ratio Which of the following is the most of interest to a firm's suppliers? a. profitability b. debt c. asset utilization d. liquidity Trapez, Inc. has determined that it needs to increase its current ratio in order to comply with a creditor's loan agreement. All else being equal, which of the following ways would be best for increasing their current ratio? a. increasing long-term assets b. decreasing current assets c. decreasing current liabilities d. increasing long-term liabilities The set of ratios are most useful in evaluating profitability is a. ROA, ROE, and debt to equity ratio b. ROA, ROE, and divided yield c. ROA, ROE, and acid-test ratio d. ROA, ROE and cash flow to debt Which of the following ratios is most relevant to evaluating solvency? a. return on assets b. debt ratio c. days' purchases in accounts payable d. dividend yield Long-term creditors are usually most interested in evaluating a. liquidity. b. marketability. c. profitability. d. solvency. Stockholders are most interested in evaluating a. liquidity. b. solvency. c. profitability. d. marketability. Which ratio is most helpful in appraising the liquidity of current assets? a. current ratio b. debt ratio 58. 59. 60. 61. 62. 63. 64. 65. c. acid-test ratio d. accounts receivable turnover The following groups of ratios primarily measure risk: a. liquidity, activity, and common equity. b. liquidity, activity, and profitability. c. liquidity, activity, and debt. d. activity, debt, and profitability. Which of the following statements would be the best interpretation of a company's low debt-toequity ratio? a. The company chooses to pay cash for most of its major purchases. b. The company is not liquid. c. The company prefers to pay stockholders high dividends out of their retained earnings. d. The company prefers to raise funds by issuing capital stock than long-term borrowing. Using financial leverage is a good financial strategy from the viewpoint of stockholders of companies that have: a. a high debt ratio. b. steady or rising profits. c. a steadily declining current ratio. d. cyclical highs and lows. The price/earnings ratio a. measures the past earning ability of the firm. b. is a gauge of future earning power as seen by investors. c. relates the price to dividends. d. relates to yield on dividends. Which of the following ratios represent dividends per common share in relation to market price per common share? a. dividend payout b. dividend yield c. price/earnings d. book value per share Which of the following ratios usually reflects investors' opinions of the future prospects for the firm? a. dividend yield b. price/earnings ratio c. book value per share d. earnings per share Which ratio would be best for measuring a company's ability to repay both principal and interest on outstanding loans from cash generated from operating activities? a. current ratio b. times-interest-earned ratio c. debt service coverage ratio d. debt-to-equity ratio Which ratio gives an indication of how investors believe a company's stock will perform in the future compared to other companies? a. return on stockholders' equity b. earnings per share c. price earnings (P/E) d. return on assets 66. Return on assets a. can be determined by looking at a balance sheet. b. should be smaller than return on sales. c. can be affected by the company's choice of a depreciation method. d. should be larger than return on equity. 67. Return on assets cannot fall under which of the following circumstances? NET PROFIT MARGIN a. Decline b. Rise c. Rise d. Decline TOTAL ASSET TURNOVER Rise Decline Rise Decline 68. Which of the following circumstances will cause sales to fixed assets to be abnormally high? a. a labor-intensive industry b. the use of units-of-production depreciation c. a highly mechanized facility d. high direct labor costs from a new union contract 69. Which suppliers of funds bear the greatest risk and should therefore earn the greatest return? a. common stockholders b. general creditors such as banks c. preferred shareholders d. bondholders 70. Which of the following could cause return on assets to decline when net profit margin is increasing? a. sales of investments at year-end b. increased turnover of operating assets c. purchase of a new building at year-end d. a stock split 71. Return on investment measures return to a. all supplier of funds. b. all long-term creditors. c. all long-term suppliers of funds. d. stockholders. 72. A times interest earned ratio of 90.0 to 1 means the: a. firm will default on its interest payment. b. net income is less than the interest expense. c. cash flow is less than the net income. d. cash flow exceeds the net income. 73. The ability of a business to pay its debts as they come due and to earn a reasonable amount of income is referred to as solvency and a. leverage. b. profitability. c. liquidity. d. equity. 74. A firm with a lower net profit margin can improve its return on total assets by a. increasing its debt ratio. b. decreasing its fixed assets turnover. c. increasing its total asset turnover. (Need to review) d. decreasing its total asset turnover. 75. A firm with a total asset turnover lower than the industry standard and a current ratio which meets industry standard might have excessive a. accounts receivable. b. fixed assets. c. debt. d. inventory. 76. Which of the following ratios appear most frequently in annual reports? a. earnings per share b. return on equity c. profit margin d. debt/equity 77. Companies A and B are in the same industry and have similar characteristics except that Company A is more leveraged than Company B. Both companies have the same income before interest and taxes and the same total assets. Based on this information, we could conclude that a. Company A has higher net income than Company B. b. Company A has a lower return on assets than Company B. c. Company A is more risky than Company B. (Need to review) d. Company A has a lower debt ratio than Company B. 78. JAX Company had P250,000 of current assets and P90,000 of current liabilities before borrowing P60,000 from the bank with a 3-month note payable. What effect did the borrowing transaction have on JAX Company's current ratio? a. The ratio remained unchanged. b. The change in the current ratio cannot be determined. c. The ratio decreased. d. The ratio increased. 79. Which of the following actions will increase a firm's current ratio if it is now less than 1.0? a. convert marketable securities to cash b. pay accounts payable with cash c. buy inventory with short term credit d. sell inventory at cost 80. The tendency of the rate earned on stockholders' equity to vary disproportionately from the rate earned on total assets is sometimes referred to as a. leverage. b. solvency. c. yield. d. quick assets