Understanding Financial Statements

Lyn M. Fraser, Aileen Ormiston

Chapter 6 The Analysis of Financial Statements - all with Video Answers

Educators

Chapter Questions

Problem 1

________What is the first step in an analysis of financial statements?
(a) Check the auditor's report.
(b) Check references containing financial information.
(c) Specify the objectives of the analysis.
(d) Do a common size analysis.

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Problem 2

________What is a creditor's objective in performing an analysis of financial statements?
(a) To decide whether the borrower has the ability to repay interest and principal on borrowed funds.
(b) To determine the firm's capital structure.
(c) To determine the company's future earnings stream.
(d) To decide whether the firm has operated profitably in the past.

James Kiss

Numerade Educator

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Problem 3

________What is an investor's objective in financial statement analysis?
(a) To determine if the firm is risky.
(b) To determine the stability of earnings.
(c) To determine changes necessary to improve future performance.
(d) To determine whether an investment is warranted by estimating a company's future earnings stream.

James Kiss

Numerade Educator

Problem 4

________What information does the auditor's report contain?
(a) The results of operations.
(b) An unqualified opinion.
(c) An opinion as to the fairness of the financial statements.
(d) A detailed coverage of the firm's liquidity, capital resources, and operations.

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Problem 5

________ Which of the following would be helpful to an analyst evaluating the performance of a firm?
(a) Understanding the economic and political environment in which the company operates.
(b) Reviewing the annual reports of a company's suppliers, customers, and competitors.
(c) Preparing common-size financial statements and calculating key financial ratios for the company being evaluated.
(d) All of the above.

James Kiss

Numerade Educator

03:25

Problem 6

________Which of the following is not required to be discussed in the Management Discussion and Analysis of the Financial Condition and Results of Operations?
(a) Liquidity.
(b) Capital resources.
(c) Operations.
(d) Earnings projections.

Puneet Prajapati

Numerade Educator

Problem 7

________What type of information found in supplementary schedules is required for inclusion in an annual report?
(a) Segmental data.
(b) Inflation data.
(c) Material litigation and management photographs.
(d) Management remuneration and segmental data.

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00:50

Problem 8

________What is Form 10-K?
(a) A document filed with the American Institute of Certified Public Accountants (AICPA) containing supplementary schedules showing management remuneration and elaborations of financial statement disclosures.
(b) A document filed with the SEC by companies selling securities to the public, containing much of the same information as the annual report as well as additional detail.
(c) A document filed with the SEC containing key business ratios and forecasts of earnings.
(d) A document filed with the SEC containing nonpublic information.

Rashmi Sinha

Numerade Educator

Problem 9

________What information can be gained from sources such as Industry Norms and Key Business Ratios, Annual Statement Studies, Analyst's Handbook, and Industry Surveys?
(a) The general economic condition.
(b) Forecasts of earnings.
(c) Elaborations of financial statement disclosures.
(d) A company's relative position within its industry.

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Problem 10

________Which of the following is not a tool or technique used by a financial statement analyst?
(a) Common-size financial statements.
(b) Trend analysis.
(c) Random sampling analysis.
(d) Industry comparisons.

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Problem 11

________What do liquidity ratios measure?
(a) A firm's ability to meet cash needs as they arise.
(b) The liquidity of fixed assets.
(c) The overall performance of a firm.
(d) The extent of a firm's financing with debt relative to equity.

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Problem 12

________Which category of ratios is useful in assessing the capital structure and long-term solvency of a firm?
(a) Liquidity ratios.
(b) Activity ratios.
(c) Leverage ratios.
(d) Profitability ratios.

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Problem 13

________What is a serious limitation of financial ratios?
(a) Ratios are screening devices.
(b) Ratios can be used only by themselves.
(c) Ratios indicate weaknesses only.
(d) Ratios are not predictive.

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Problem 14

________What is the most widely used liquidity ratio?
(a) Quick ratio.
(b) Current ratio.
(c) Inventory turnover.
(d) Debt ratio.

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Problem 15

________What is a limitation common to both the current and the quick ratio?
(a) Accounts receivable may not be truly liquid.
(b) Inventories may not be truly liquid.
(c) Marketable securities are not liquid.
(d) Prepaid expenses are potential sources of cash.

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Problem 16

________ Why is the quick ratio a more rigorous test of short-run solvency than the current ratio?
(a) The quick ratio considers only cash and marketable securities as current assets.
(b) The quick ratio eliminates prepaid expenses for the numerator.
(c) The quick ratio eliminates prepaid expenses for the denominator.
(d) The quick ratio eliminates inventories from the numerator.

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03:16

Problem 17

________What does an increásing collection period for accounts receivable suggest about a firm's credit policy?
(a) The credit policy is too restrictive.
(b) The firm is probably losing qualified customers.
(c) The credit policy may be too lenient.
(d) The collection period has no relationship to a firm's credit policy.

Puneet Prajapati

Numerade Educator

01:22

Problem 18

________ Which of the following statements about inventory turnover is false?
(a) Inventory turnover measures the efficiency of the firm in managing and selling inventory.
(b) Inventory turnover is a gauge of the liquidity of a firm's inventory.
(c) Inventory turnover is calculated with cost of goods sold in the numerator.
(d) A low inventory turnover is generally a sign of efficient inventory management.

Oluwadamilola Ameobi

Numerade Educator

03:28

Problem 19

________Which of the following items would cause the cash conversion cycle to decrease?
(a) Increasing days payable outstanding.
(b) Increasing the average collection period.
(c) Increasing the days inventory held.
(d) None of the above.

Puneet Prajapati

Numerade Educator

Problem 20

________ What do the asset turnover ratios measure?
(a) The liquidity of the firm's current assets.
(b) Management's effectiveness in generating sales from investments in assets.
(c) The overall efficiency and profitability of the firm.
(d) The distribution of assets in which funds are invested.

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Problem 21

________Which of the following ratios would not be used to measure the extent of a firm's debt financing?
(a) Debt ratio.
(b) Debt to equity.
(c) Times interest earned.
(d) Long-term debt to total capitalization.

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Problem 22

________ Why is the amount of debt in a company's capital structure important to the financial analyst?
(a) Debt implies risk.
(b) Debt is less costly than equity.
(c) Equity is riskier than debt.
(d) Debt is equal to total assets.

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Problem 23

________ Why is the fixed charge coverage ratio a broader measure of a firm's coverage capabilities than the times interest earned ratio?
(a) The fixed charge ratio indicates how many times the firm can cover interest payments.
(b) The times interest earned ratio does not consider the possibility of higher interest rates.
(c) The fixed charge ratio includes lease payments as well as interest payments.
(d) The fixed charge ratio includes both operating and capital leases while the times interest earned ratio includes only operating leases.

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Problem 24

________ Which profit margin measures the overall operating efficiency of the firm?
(a) Gross profit margin.
(b) Operating profit margin.
(c) Net profit margin.
(d) Return on equity.

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Problem 25

________ Which ratio or ratios measure the overall efficiency of the firm in managing its investment in assets and in generating return to shareholders?
(a) Gross profit margin and net profit margin.
(b) Return on investment.
(c) Total asset turnover and operating profit margin.
(d) Return on investment and return on equity.

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01:32

Problem 26

________ What does a financial leverage index greater than one indicate about a firm?
(a) The unsuccessful use of financial leverage.
(b) Operating returns more than sufficient to cover interest payments on borrowed funds.
(c) More debt financing than equity financing.
(d) An increased level of borrowing.

Jennifer Stoner

Numerade Educator

01:04

Problem 27

________ What does the price to earnings ratio measure?
(a) The "multiple" that the stock market places on a firm's earnings.
(b) The relationship between dividends and market prices.
(c) The earnings for one common share of stock.
(d) The percentage of dividends paid to net earnings of the firm.

Nick Johnson

Numerade Educator

01:28

Problem 28

Use the following data to answer questions 28 through 31 : JDL Corporation Selected Financial Data December 31, 2009
$$
\begin{array}{lr}
\hline \text { Current assets } & \$ 150,000 \\
\text { Current liabilities } & 100,000 \\
\text { Inventories } & 50,000 \\
\text { Accounts receivable } & 40,000 \\
\text { Net sales } & 900,000 \\
\text { Cost of goods sold } & 675,000 \\
\hline
\end{array}
$$
________ JDL's current ratio is:
(a) 1.0 to 1 .
(b) 0.7 to 1 .
(c) 1.5 to 1 .
(d) 2.4 to 1 .

Lily An

Numerade Educator

01:28

Problem 29

Use the following data to answer questions 28 through 31 : JDL Corporation Selected Financial Data December 31, 2009
$$
\begin{array}{lr}
\hline \text { Current assets } & \$ 150,000 \\
\text { Current liabilities } & 100,000 \\
\text { Inventories } & 50,000 \\
\text { Accounts receivable } & 40,000 \\
\text { Net sales } & 900,000 \\
\text { Cost of goods sold } & 675,000 \\
\hline
\end{array}
$$
________ JDL's quick ratio is:
(a) 1.0 to 1 .
(b) 0.7 to 1 .
(c) 1.5 to 1 .
(d) 2.4 to 1 .

Lily An

Numerade Educator

Problem 30

Use the following data to answer questions 28 through 31 : JDL Corporation Selected Financial Data December 31, 2009
$$
\begin{array}{lr}
\hline \text { Current assets } & \$ 150,000 \\
\text { Current liabilities } & 100,000 \\
\text { Inventories } & 50,000 \\
\text { Accounts receivable } & 40,000 \\
\text { Net sales } & 900,000 \\
\text { Cost of goods sold } & 675,000 \\
\hline
\end{array}
$$
________ JDL's average collection period is:
(a) 6 days.
(b) 11 days.
(c) 16 days.
(d) 22 days.

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Problem 31

Use the following data to answer questions 28 through 31 : JDL Corporation Selected Financial Data December 31, 2009
$$
\begin{array}{lr}
\hline \text { Current assets } & \$ 150,000 \\
\text { Current liabilities } & 100,000 \\
\text { Inventories } & 50,000 \\
\text { Accounts receivable } & 40,000 \\
\text { Net sales } & 900,000 \\
\text { Cost of goods sold } & 675,000 \\
\hline
\end{array}
$$
________ JDL's inventory turnover is:
(a) 1.25 times.
(b) 13.5 times.
(c) 3.0 times.
(d) 37.5 times.

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01:01

Problem 32

Use the following data to answer questions 32 through 35 : RQM Corporation Selected Financial Data December 31, 2009
$$
\begin{array}{lr}
\hline \text { Net sales } & \$ 1,800,000 \\
\text { Cost of goods sold } & 1,080,000 \\
\text { Operating expenses } & 315,000 \\
\text { Net operating income } & 405,000 \\
\text { Net income } & 195,000 \\
\text { Total stockholders' equity } & 750,000 \\
\text { Total assets } & 1,000,000 \\
\text { Cash flow from operating activities } & 25,000 \\
\hline
\end{array}
$$
________ RQM's gross profit margin, operating profit margin, and net profit margin, respectively, are:
(a) $40.00 \%, 22.50 \%, 19.50 \%$
(b) $60.00 \%, 19.50 \%, 10.83 \%$
(c) $60.00 \%, 22.50 \%, 19.50 \%$
(d) $40.00 \%, 22.50 \%, 10.83 \%$

Breanna Ollech

Numerade Educator

Problem 33

Use the following data to answer questions 32 through 35 : RQM Corporation Selected Financial Data December 31, 2009
$$
\begin{array}{lr}
\hline \text { Net sales } & \$ 1,800,000 \\
\text { Cost of goods sold } & 1,080,000 \\
\text { Operating expenses } & 315,000 \\
\text { Net operating income } & 405,000 \\
\text { Net income } & 195,000 \\
\text { Total stockholders' equity } & 750,000 \\
\text { Total assets } & 1,000,000 \\
\text { Cash flow from operating activities } & 25,000 \\
\hline
\end{array}
$$
________ RQM's return on equity is:
(a) $26 \%$
(b) $54 \%$
(c) $42 \%$
(d) $19 \%$

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Problem 34

Use the following data to answer questions 32 through 35 : RQM Corporation Selected Financial Data December 31, 2009
$$
\begin{array}{lr}
\hline \text { Net sales } & \$ 1,800,000 \\
\text { Cost of goods sold } & 1,080,000 \\
\text { Operating expenses } & 315,000 \\
\text { Net operating income } & 405,000 \\
\text { Net income } & 195,000 \\
\text { Total stockholders' equity } & 750,000 \\
\text { Total assets } & 1,000,000 \\
\text { Cash flow from operating activities } & 25,000 \\
\hline
\end{array}
$$
________ RQM's return on investment is:
(a) $22.5 \%$
(b) $26.5 \%$
(c) $19.5 \%$
(d) $40.5 \%$

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Problem 35

Use the following data to answer questions 32 through 35 : RQM Corporation Selected Financial Data December 31, 2009
$$
\begin{array}{lr}
\hline \text { Net sales } & \$ 1,800,000 \\
\text { Cost of goods sold } & 1,080,000 \\
\text { Operating expenses } & 315,000 \\
\text { Net operating income } & 405,000 \\
\text { Net income } & 195,000 \\
\text { Total stockholders' equity } & 750,000 \\
\text { Total assets } & 1,000,000 \\
\text { Cash flow from operating activities } & 25,000 \\
\hline
\end{array}
$$
________ RQM's cash flow margin is:
(a) $1.4 \%$
(b) $2.5 \%$
(c) $10.8 \%$
(d) $12.8 \%$

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