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MODULE 10 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.
FINANCIAL STATEMENT ANALYSIS B. Absolute numbers would be most meaningful in the large firm; relative numbers would be
most meaningful in the small firm.
THEORIES: C. Relative numbers would be most meaningful for the large firm; absolute numbers would
6. Management is a user of financial analysis. Which of the following comments does not be most meaningful for the small firm.
represent a fair statement as to the management perspective? D. Relative numbers would be most meaningful for both the large and small firm, especially
A. Management is always interested in maximum profitability. for interfirm comparisons.
B. Management is interested in the view of investors.
C. Management is interested in the financial structure of the entity. 4. Which of these statements is false?
D. Management is interested in the asset structure of the entity. A. Many companies will not clearly fit into any one industry.
B. A financial service uses its best judgment as to which industry the firm best fits.
Limitations C. The analysis of an entity's financial statements can be more meaningful if the results are
1. A limitation in calculating ratios in financial statement analysis is that compared with industry averages and with results of competitors.
A. it requires a calculator. D. A company comparison should not be made with industry averages if the company does
B. no one other than the management would be interested in them. not clearly fit into any one industry.
C. some account balances may reflect atypical data at year end.
D. they seldom identify problem areas in a company. Common-sized financial statements
9. Which of the following generally is the most useful in analyzing companies of different sizes?
2. Which of the following is not a limitation of financial statement analysis? A. comparative statements C. price-level accounting
A. The cost basis. C. The diversification of firms. B. common-sized financial statements D. profitability index
B. The use of estimates. D. The availability of information.
12. Statements in which all items are expressed only in relative terms (percentages of a base) are
5. Which of the following does not represent a problem with financial analysis? termed:
A. Financial statement analysis is an art; it requires judgment decisions on the part of the A. Vertical statements C. Funds Statements
analyst. B. Horizontal Statements D. Common-Size Statements
B. Financial analysis can be used to detect apparent liquidity problems.
C. There are as many ratios for financial analysis as there are pairs of figures. 10. The percent of property, plant and equipment to total assets is an example of:
D. Some industry ratio formulas vary from source to source. A. vertical analysis C. profitability analysis
B. solvency analysis D. horizontal analysis
77. The use of alternative accounting methods:
A. is not a problem in ratio analysis because the footnotes disclose the method used. 15. Vertical analysis is a technique that expresses each item in a financial statement
B. may be a problem in ratio analysis even if disclosed. A. in pesos and centavos.
C. is not a problem in ratio analysis since eventually all methods will lead to the same end. B. as a percent of the item in the previous year.
D. is only a problem in ratio analysis with respect to inventory. C. as a percent of a base amount.
D. starting with the highest value down to the lowest value.
Industry Analysis
3. Suppose you are comparing two firms in the steel industry. One firm is large and the other is 17. In performing a vertical analysis, the base for prepaid expenses is
55
Financial Statement Analysis
A. total current assets. C. total liabilities. 69. Which suppliers of funds bear the greatest risk and should therefore earn the greatest return?
B. total assets. D. prepaid expenses in a previous year. A. common stockholders C. preferred shareholders
B. general creditors such as banks D. bondholders
Horizontal analysis
8. The percentage analysis of increases and decreases in individual items in comparative Measures of Risk
financial statements is called: 54. The following groups of ratios primarily measure risk:
A. vertical analysis C. profitability analysis A. liquidity, activity, and common equity C. liquidity, activity, and debt
B. solvency analysis D. horizontal analysis B. liquidity, activity, and profitability D. activity, debt, and profitability
56
Financial Statement Analysis
36. The two categories of ratios that should be utilized to asses a firm’s true liquidity are the A. accounts receivable turnover. C. acid test ratio.
A. current and quick ratios C. liquidity and profitability ratios B. asset turnover. D. current ratio.
B. liquidity and debt ratios D. liquidity and activity ratios
Current ratio
47. Which of the following is the most of interest to a firm’s suppliers? 24. Typically, which of the following would be considered to be the most indicative of a firm's short-
A. profitability C. asset utilization term debt paying ability?
B. debt D. liquidity A. working capital C. acid test ratio
B. current ratio D. days’ sales in receivables
Measures of liquidity
21. The ratios that are used to determine a company’s short-term debt paying ability are 22. The current ratio is
A. asset turnover, times interest earned, current ratio, and receivables turnover. A. calculated by dividing current liabilities by current assets.
B. times interest earned, inventory turnover, current ratio, and receivables turnover. B. used to evaluate a company’s liquidity and short-term debt paying ability.
C. times interest earned, acid-test ratio, current ratio, and inventory turnover. C. used to evaluate a company’s solvency and long-term debt paying ability.
D. current ratio, acid-test ratio, receivables turnover, and inventory turnover. D. calculated by subtracting current liabilities from current assets.
20. Which of the following is a measure of the liquidity position of a corporation? 30. Which of the following ratios is rated to be a primary measure of liquidity and considered of
A. earnings per share highest significance rating of the liquidity ratios a bank analyst?
B. inventory turnover A. Debt/Equity
C. current ratio B. Current ratio
D. number of times interest charges earned C. Degree of Financial Leverage
D. Accounts Receivable Turnover in Days
37. 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? 41. A weakness of the current ratio is
A. Current ratio C. Asset turnover A. the difficulty of the calculation.
B. Acid-test ratio D. Receivables turnover B. that it does not take into account the composition of the current assets.
C. that it is rarely used by sophisticated analysts.
51. Which of the following ratios would be least helpful in appraising the liquidity of current D. that it can be expressed as a percentage, as a rate, or as a proportion.
assets?
A. Accounts Receivable turnover C. Current Ratio Acid-test or quick ratio
B. Days’ sales in inventory D. Days’ sales in accounts receivable 42. A measure of a company’s immediate short-term liquidity is the
A. current ratio.
53. Which ratio is most helpful in appraising the liquidity of current assets? B. current cash debt coverage ratio.
A. current ratio C. acid-test ratio C. cash debt coverage ratio.
B. debt ratio D. accounts receivable turnover D. acid-test ratio.
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Financial Statement Analysis
C. is calculated by taking one item from the income statement and one item from the balance 66. Total asset turnover measures the ability of a firm to:
sheet. A. generate profits on sales
D. is the same as the current ratio except it is rounded to the nearest whole percent. B. generate sales through the use of assets
C. cover long-term debt
Not a liquidity ratio D. buy new assets
28. Which one of the following would not be considered a liquidity ratio?
A. Current ratio. C. Quick ratio. 76. A measure of how efficiently a company uses its assets to generate sales is the
B. Inventory turnover. D. Return on assets. A. asset turnover ratio. C. profit margin ratio.
B. cash return on sales ratio. D. return on assets ratio.
Activity ratios
Days receivable & receivable turnover Solvency ratios
Quality of receivables Interested parties
25. Which of the following does not bear on the quality of receivables? 50. Long-term creditors are usually most interested in evaluating
A. shortening the credit terms A. liquidity. C. profitability.
B. lengthening the credit terms B. marketability. D. solvency.
C. lengthening the outstanding period
D. all of the above bear on the quality of receivables Financial Leverage
45. Trading on the equity (leverage) refers to the
Days receivable A. amount of working capital.
27. A general rule to use in assessing the average collection period is B. amount of capital provided by owners.
A. that is should not exceed 30 days. C. use of borrowed money to increase the return to owners.
B. it can be any length as long as the customer continues to buy merchandise. D. earnings per share.
C. that it should not greatly exceed the discount period.
D. that it should not greatly exceed the credit term period. 90. The tendency of the rate earned on stockholders' equity to vary disproportionately from the
rate earned on total assets is sometimes referred to as:
Asset utilization ratios A. leverage C. yield
Performance measures B. solvency D. quick assets
65. All of the following are asset utilization ratios except:
A. average collection period C. receivables turnover 55. Using financial leverage is a good financial strategy from the viewpoint of stockholders of
B. inventory turnover D. return on assets companies having:
A. a high debt ratio C. a steadily declining current ratio
Asset turnover B. steady or rising profits D. cyclical highs and lows
63. Asset turnover measures
A. how often a company replaces its assets. 46. The ratio that indicates a company’s degree of financial leverage is the
B. how efficiently a company uses its assets to generate sales. A. cash debt coverage ratio. C. free cash flow ratio.
C. the portion of the assets that have been financed by creditors. B. debt to total assets. D. times-interest earned ratio.
D. the overall rate of return on assets.
73. Interest expense creates magnification of earnings through financial leverage because:
58
Financial Statement Analysis
A. while earnings available to pay interest rise, earnings to residual owners rise faster Debt-to-equity ratio
B. interest accompanies debt financing 60. Which of the following statements best compares long-term borrowing capacity ratios?
C. interest costs are cheaper than the required rate of return to equity owners A. The debt/equity ratio is more conservative than the debt ratio.
S. the use of interest causes higher earnings B. The debt to tangible net worth ratio is more conservative than the debt/equity ratio.
C. The debt/equity ratio is more conservative than the debt to tangible net worth ratio.
Measures of solvency D. The debt ratio is more conservative than the debt/equity ratio.
34. The set of ratios that is most useful in evaluating solvency is
A. debt ratio, current ratio, and times interest earned Times interest earned
B. debt ratio, times interest earned, and return on assets 74. A times interest earned ratio of 0.90 to 1 means that
C. debt ratio, times interest earned, and quick ratio A. the firm will default on its interest payment
D. debt ratio, times interest earned, and cash flow to debt B. net income is less than the interest expense
C. the cash flow is less than the net income
49. Which of the following ratios is most relevant to evaluating solvency? D. the cash flow exceeds the net income
A. Return on assets C. Days’ purchases in accounts payable
B. Debt ratio D. Dividend yield Fixed charge coverage
61. A fixed charge coverage:
Fixed assets to long-term liabilities A. is a balance sheet indication of debt carrying ability
44. Which of the following ratios provides a solvency measure that shows the margin of safety of B. is an income statement indication of debt carrying ability
noteholders or bondholders and also gives an indication of the potential ability of the business C. frequently includes research and development
to borrow additional funds on a long-term basis? D. computation is standard from firm to firm
A. ratio of fixed assets to long-term liabilities
B. ratio of net sales to assets Off-balance sheet liabilities
C. number of days' sales in receivables 62. If a firm has substantial capital or financing leases disclosed in the notes but not capitalized in
D. rate earned on stockholders' equity the financial statements, then the
A. times interest earned ratio will be overstated, based upon the financial statements
Debt ratio B. debt ratio will be understated
59. The debt ratio indicates: C. working capital will be understated
A. a comparison of liabilities with total assets D. fixed charge ratio will be overstated, based upon the financial statements
B. the ability of the firm to pay its current obligations
C. the efficiency of the use of total assets Profitability ratios
D. the magnification of earnings caused by leverage Interested parties
39. The return on assets ratio is affected by the
78. The debt to total assets ratio measures A. asset turnover ratio.
A. the company’s profitability. B. debt to total assets ratio.
B. whether interest can be paid on debt in the current year. C. profit margin ratio.
C. the proportion of interest paid relative to dividends paid. D. asset turnover and profit margin ratios.
D. the percentage of the total assets provided by creditor.
52. Stockholders are most interested in evaluating
59
Financial Statement Analysis
60
Financial Statement Analysis
61
Financial Statement Analysis
Profit margin
70. Which of the following would most likely cause a rise in net profit margin? PROBLEMS:
A. increased sales C. decreased operating expenses Horizontal analysis
1
B. decreased preferred dividends D. increased cost of sales . Kline Corporation had net income of P2 million in 2006. Using the 2006 financial elements as
the base data, net income decreased by 70 percent in 2007 and increased by 175 percent in
Return on assets 2008. The respective net income reported by Kline Corporation for 2007 and 2008 are:
67. Return on assets cannot fall under which of the following circumstances? A. P 600,000 and P5,500,000 C. P1,400,000 and P3,500,000
A. B. C. D. B. P5,500,000 and P 600,000 D. P1,400,000 and P5,500,000
Net profit margin Decline Rise Rise Decline 2
Total asset turnover Rise Decline Rise Decline . Assume that Axle Inc. reported a net loss of P50,000 in 2006 and net income of P250,000 in
2007. The increase in net income of P300,000:
Debt ratio A. can be stated as 0% C. cannot be stated as a percentage
83. Jones Company has long-term debt of P1,000,000, while Smith Company, Jones' competitor, B. can be stated as 100% increase D. can be stated as 200% increase
has long-term debt of P200,000. Which of the following statements best represents an
analysis of the long-term debt position of these two firms? Liquidity ratios
3
A. Jones obviously has too much debt when compared to its competitor. . The following financial data have been taken from the records of Ratio Company:
B. Smith Company's times interest earned should be lower than Jones. Accounts receivable P200,000
C. Smith has five times better long-term borrowing ability than Jones. Accounts payable 80,000
D. Not enough information to determine if any of the answers are correct. Bonds payable, due in 10 years 500,000
Cash 100,000
Times interest earned Interest payable, due in three months 25,000
85. Which of the following will not cause times interest earned to drop? Assume no other changes Inventory 440,000
than those listed. Land 800,000
A. A rise in preferred stock dividends. Notes payable, due in six months 250,000
B. A drop in sales with no change in interest expense. What will happen to the ratios below if Ratio Company uses cash to pay 50 percent
C. An increase in interest rates. of its accounts payable?
D. An increase in bonds payable with no change in operating income. A. B. C. D.
Current ratio Increase Decrease Increase Decrease
DuPont Analysis Acid-test ratio Increase Decrease Decrease Increase
71. Which of the following could cause return on assets to decline when net profit margin is
increasing? Question Nos. 4 through 6 are based on the data taken from the balance sheet of Nomad
A. sale of investments at year-end C. purchase of a new building at year-end Company at the end of the current year:
B. increased turnover of operating assets D. a stock split Accounts payable P145,000
Accounts receivable 110,000
80. A firm with a lower net profit margin can improve its return on total assets by Accrued liabilities 4,000
A. increasing its debt ratio C. increasing its total asset turnover Cash 80,000
B. decreasing its fixed assets turnover D. decreasing its total asset turnover Income tax payable 10,000
62
Financial Statement Analysis
Inventory 140,000 during the year amounted to P4,000,000. Using 360-day year, what is the average collection
Marketable securities 250,000 period of the receivables?
Notes payable, short-term 85,000 A. 30 days C. 73 days
Prepaid expenses 15,000 B. 65 days D. 36 days
4
. The amount of working capital for the company is: Cash collection
10
A. P351,000 C. P211,000 . Deity Company had sales of P30,000, increase in accounts payable of P5,000, decrease in
B. P361,000 D. P336,000 accounts receivable of P1,000, increase in inventories of P4,000, and depreciation expense of
P4,000. What was the cash collected from customers?
5
. The company’s current ratio as of the balance sheet date is: A. P31,000 C. P34,000
A. 2.67:1 C. 2.02:1 B. P35,000 D. P25,000
B. 2.44:1 D. 1.95:1
Inventory turnover
6 11
. The company’s acid-test ratio as of the balance sheet date is: . During 2007, Tarlac Company purchased P960,000 of inventory. The cost of goods sold for
A. 1.80:1 C. 2.02:1 2007 was P900,000, and the ending inventory at December 31, 2007 was P180,000. What
B. 2.40:1 D. 1.76:1 was the inventory turnover for 2007?
A. 6.4 C. 5.3
Activity ratios B. 6.0 D. 5.0
Receivables turnover
7 12
. Pine Hardware Store had net credit sales of P6,500,000 and cost of goods sold of . Selected information from the accounting records of Petals Company is as follows:
P5,000,000 for the year. The Accounts Receivable balances at the beginning and end of the Net sales for 2007 P900,000
year were P600,000 and P700,000, respectively. The receivables turnover was Cost of goods sold for 2007 600,000
A. 7.7 times. C. 9.3 times. Inventory at December 31, 2006 180,000
B. 10.8 times. D. 10.0 times. Inventory at December 31, 2007 156,000
Petals’ inventory turnover for 2007 is
8
. Milward Corporation’s books disclosed the following information for the year ended December A. 5.77 times C. 3.67 times
31, 2007: B. 3.85 times D. 3.57 times
Net credit sales P1,500,000
13
Net cash sales 240,000 . The Moss Company presents the following data for 2007.
Accounts receivable at beginning of year 200,000 Net Sales, 2007 P3,007,124
Accounts receivable at end of year 400,000 Net Sales, 2006 P 930,247
Milward’s accounts receivable turnover is Cost of Goods Sold, 2007 P2,000,326
A. 3.75 times C. 5.00 times Cost of Goods Sold, 2007 P1,000,120
B. 4.35 times D. 5.80 times Inventory, beginning of 2007 P 341,169
Inventory, end of 2007 P 376,526
Days receivable The merchandise inventory turnover for 2007 is:
9
. Batik Clothing Store had a balance in the Accounts Receivable account of P390,000 at the A. 5.6 C. 7.5
beginning of the year and a balance of P410,000 at the end of the year. The net credit sales B. 15.6 D. 7.7
63
Financial Statement Analysis
64
Financial Statement Analysis
21
. The following data were abstracted from the records of Johnson Corporation for the year: B. The dividend yield is 8.0%, which is of special interest to investors seeking current returns
Sales P1,800,000 on their investments.
Bond interest expense 60,000 C. The dividend yield is 12.5%, which is of interest to bondholders.
Income taxes 300,000 D. The dividend yield is 8.0 times the market price, which is important in solvency analysis.
Net income 400,000
How many times was bond interest earned? Market Test Ratios
A. 7.67 C. 12.67 Market/Book value ratio
B. 11.67 D. 13.67 Price per share
25
. What is the market price of a share of stock for a firm with 100,000 shares outstanding, a book
Net income value of equity of P3,000,000, and a market/book ratio of 3.5?
22
. The times interest earned ratio of Mikoto Company is 4.5 times. The interest expense for A. P8.57 C. P85.70
the year was P20,000, and the company’s tax rate is 40%. The company’s net income is: B. P30.00 D. P105.00
A. P22,000 C. P54,000
B. P42,000 D. P66,000 P/E ratio
26
. Orchard Company’s capital stock at December 31 consisted of the following:
Profitability Ratios Common stock, P2 par value; 100,000 shares authorized, issued, and
Return on Common Equity outstanding.
. Selected information for Ivano Company as of December 31 is as follows:
23
10% noncumulative, nonconvertible preferred stock, P100 par value; 1,000 shares
2006 2007 authorized, issued, and outstanding.
Preferred stock, 8%, par P100, nonconvertible, P250,000 P250,000 Orchard’s common stock, which is listed on a major stock exchange, was quoted at P4 per
noncumulative share on December 31. Orchard’s net income for the year ended December 31 was P50,000.
Common stock 600,000 800,000 The yearly preferred dividend was declared. No capital stock transactions occurred. What
Retained earnings 150,000 370,000 was the price earnings ratio on Orchard’s common stock at December 31?
Dividends paid on preferred stock for the year 20,000 20,000 A. 6 to 1 C. 10 to 1
Net income for the year 120,000 240,000 B. 8 to 1 D. 16 to 1
Ivano’s return on common stockholders’ equity, rounded to the nearest percentage point, for 27
2007 is . On December 31, 2006 and 2007, Renegade Corporation had 100,000 shares of common
A. 17% C. 21% stock and 50,000 shares of noncumulative and nonconvertible preferred stock issued and
B. 19% D. 23% outstanding.
Additional information:
Dividend yield Stockholders’ equity at 12/31/07 P4,500,000
24
. The following information is available for Duncan Co.: Net income year ended 12/31/07 1,200,000
2006 Dividends on preferred stock year ended 12/31/07 300,000
Dividends per share of common stock P 1.40 Market price per share of common stock at 12/31/07 144
Market price per share of common stock 17.50 The price-earnings ratio on common stock at December 31, 2007, was
Which of the following statements is correct? A. 10 to 1 C. 14 to 1
A. The dividend yield is 8.0%, which is of interest to investors seeking an increase in market B. 12 to 1 D. 16 to 1
price of their stocks.
65
Financial Statement Analysis
Payout ratio
28 32
. Selected financial data of Alexander Corporation for the year ended December 31, 2007, is . Assume you are given the following relationships for the Orange Company:
presented below: Sales/total assets 1.5X
Operating income P900,000 Return on assets (ROA) 3%
Interest expense (100,000) Return on equity (ROE) 5%
Income before income taxes 800,000 The Orange Company’s debt ratio is
Income tax (320,000) A. 40% C. 35%
Net income 480,000 B. 60% D. 65%
Preferred stock dividend (200,000)
Net income available to common stockholders 280,000 Leverage Ratio
Common stock dividends were P120,000. The payout ratio is: Degree of financial leverage
33
A. 42.9 percent C. 25.0 percent . A summarized income statement for Leveraged Inc. is presented below.
B. 66.7 percent D. 71.4 percent Sales P1,000,000
Cost of Sales 600,000
P/E ratio & Payout ratio Gross Profit P 400,000
Use the following information for question Nos. 33 and 34: Operating Expenses 250,000
Terry Corporation had net income of P200,000 and paid dividends to common stockholders of Operating Income P 150,000
P40,000 in 2007. The weighted-average number of shares outstanding in 2007 was 50,000 Interest Expense 30,000
shares. Terry Corporation’s common stock is selling for P60 per share in the local stock Earnings Before Tax P 120,000
exchange. Income Tax 40,000
Net Income P 80,000
29
. Terry Corporation’s price-earnings ratio is The degree of financial leverage is:
A. 3.8 times C. 18.8 times A. P 150,000 ÷ P 30,000 C. P1,000,000 ÷ P400,000
B. 15 times D. 6 times B. P 150,000 ÷ P120,000 D. P 150,000 ÷ P 80,000
30
. Terry Corporation’s payout ratio for 2007 is Other Ratios
A. P4 per share C. 20.0 percent Book value per share
34
B. 12.5 percent D. 25.0 percent . M Corporation’s stockholders’ equity at December 31, 2007 consists of the following:
6% cumulative preferred stock, P100 par, liquidating value
DuPont Model was P110 per share; issued and outstanding 50,000 shares P5,000,000
Debt ratio Common stock, par, P5 per share; issued and
31
. The Board of Directors is dissatisfied with last year's ROE of 15%. If the profit margin and outstanding, 400,000 shares 2,000,000
asset turnover remain unchanged at 8% and 1.25 respectively, by how much must the total Retained earnings 1,000,000
debt ratio increase to achieve 20% ROE? Total P8,000,000
A. Total debt ratio must increase by .5 Dividends on preferred stock have been paid through 2006.
B. Total debt ratio must increase by 5 At December 31, 2007, M Corporation’s book value per share was
C. Total debt ratio must increase by 5% A. P5.50 C. P6.75
D. Total debt ratio must increase by 50% B. P6.25 D. P7.50
66
Financial Statement Analysis
67
Financial Statement Analysis
Comprehensive
. The balance sheets of Magdangal Company at the end of each of the first two
42
68
1
. Answer: A
2007: P2,000,000 (1 – 0.7) = P600,000
2008: P2,000,000 (1 + 1.75) = P5,500,000
Note: For 2007 & 2008, 2006 was used as a base year.
2
. Answer: C
3
. Answer: C
Current Assets:
Cash P100,000
Accounts receivable 200,000
Total liquid assets 300,000
Inventory 440,000
Total current assets P740,000
Current Liabilities:
Accounts payable P 80,000
Notes payable, due in 6 months 250,000
Interest payable 25,000
Total current liabilities P355,000
Before any payment, the current ratio is above 1:1 and acid test ratio is below 1:1. Therefore, the current ratio shall
rise but acid test ratio shall go down. If any of these two ratios is below 1:1, the equal change in current assets and
current liabilities brings direct effect on the ratio, that is, equal increase in current assets and current liabilities causes
the ratio to rise.
4
. Answer: A
Working capital equals the difference between the total current assets and total current liabilities.
Current Assets:
Cash P 80,000
Marketable securities 250,000
Accounts receivable 110,000
Total liquid assets 440,000
Inventory 140,000
Prepaid expense 15,000
Total Current Assets P595,000
Current Liabilities:
Accounts payable P145,000
Income tax payable 10,000
Notes payable, short-term 85,000
Accrued liabilities 4,000 244,000
Alternative Computation:
Average daily cost of goods sold: = (P2,400,000 ÷ 365) P6,575.34
Turnover in Days: P624,000 ÷ P6,575.34 94.9 days
16
. Answer: A
Average Accounts Receivable: (P900,000 ÷ P1,000,000) ÷ 2 P 950,000
Average inventory; (P1.1M + P1.2M) ÷ 2 P1,150,000