Financial Statement Analysis

MODULE 10 most meaningful in the small firm.

C. Relative numbers would be most meaningful for the large firm; absolute numbers would
FINANCIAL STATEMENT ANALYSIS be most meaningful for the small firm.
D. Relative numbers would be most meaningful for both the large and small firm, especially
THEORIES: for interfirm comparisons.
6. Management is a user of financial analysis. Which of the following comments does not
represent a fair statement as to the management perspective? 4. Which of these statements is false?
A. Management is always interested in maximum profitability. A. Many companies will not clearly fit into any one industry.
B. Management is interested in the view of investors. B. A financial service uses its best judgment as to which industry the firm best fits.
C. Management is interested in the financial structure of the entity. C. The analysis of an entity's financial statements can be more meaningful if the results are
D. Management is interested in the asset structure of the entity. compared with industry averages and with results of competitors.
D. A company comparison should not be made with industry averages if the company does
Limitations not clearly fit into any one industry.
1. A limitation in calculating ratios in financial statement analysis is that
A. it requires a calculator. Common-sized financial statements
B. no one other than the management would be interested in them. 9. Which of the following generally is the most useful in analyzing companies of different sizes?
C. some account balances may reflect atypical data at year end. A. comparative statements C. price-level accounting
D. they seldom identify problem areas in a company. B. common-sized financial statements D. profitability index

2. Which of the following is not a limitation of financial statement analysis? 12. Statements in which all items are expressed only in relative terms (percentages of a base) are
A. The cost basis. C. The diversification of firms. termed:
B. The use of estimates. D. The availability of information. A. Vertical statements C. Funds Statements
B. Horizontal Statements D. Common-Size Statements
5. Which of the following does not represent a problem with financial analysis?
A. Financial statement analysis is an art; it requires judgment decisions on the part of the 10. The percent of property, plant and equipment to total assets is an example of:
analyst. A. vertical analysis C. profitability analysis
B. Financial analysis can be used to detect apparent liquidity problems. B. solvency analysis D. horizontal analysis
C. There are as many ratios for financial analysis as there are pairs of figures.
D. Some industry ratio formulas vary from source to source. 15. Vertical analysis is a technique that expresses each item in a financial statement
A. in pesos and centavos.
77. The use of alternative accounting methods: B. as a percent of the item in the previous year.
A. is not a problem in ratio analysis because the footnotes disclose the method used. C. as a percent of a base amount.
B. may be a problem in ratio analysis even if disclosed. D. starting with the highest value down to the lowest value.
C. is not a problem in ratio analysis since eventually all methods will lead to the same end.
D. is only a problem in ratio analysis with respect to inventory. 17. In performing a vertical analysis, the base for prepaid expenses is
A. total current assets. C. total liabilities.
Industry Analysis B. total assets. D. prepaid expenses in a previous year.
3. 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? Horizontal analysis
A. Absolute numbers would be most meaningful for both the large and small firm. 8. The percentage analysis of increases and decreases in individual items in comparative
B. Absolute numbers would be most meaningful in the large firm; relative numbers would be financial statements is called:

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A. vertical analysis C. profitability analysis Financial ratios

B. solvency analysis D. horizontal analysis 7. Ratios are used as tools in financial analysis
A. instead of horizontal and vertical analyses.
11. Horizontal analysis is also known as B. because they can provide information that may not be apparent from inspection of the
A. linear analysis. C. trend analysis. individual components of a particular ratio.
B. vertical analysis. D. common size analysis. C. because even single ratios by themselves are quite meaningful.
D. because they are prescribed by GAAP.
13. 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. 18. In the near term, the important ratios that provide the information critical to the short-run
B. There is no amount in the base year. operation of the firm are:
C. There is a negative amount in the base year and a negative amount in the subsequent A. liquidity, activity, and profitability C. liquidity, activity, and equity
year. B. liquidity, activity, and debt D. activity, debt, and profitability
D. There is a negative amount in the base year and a positive amount in the subsequent
year. 75. 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:
14. Horizontal analysis is a technique for evaluating a series of financial statement data over a A. solvency and leverage C. solvency and liquidity
period of time B. solvency and profitability D. solvency and equity
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. Liquidity ratios
C. to determine which items are in error. Interested parties
D. to determine the amount and/or percentage increase or decrease that has taken place. 19. The primary concern of short-term creditors when assessing the strength of a firm is the
entity’s
Trend analysis A. short-term liquidity C. market price of stock
16. Trend analysis allows a firm to compare its performance to: B. profitability D. leverage
A. other firms in the industry C. other industries
B. other time periods within the firm D. none of the above 35. Short-term creditors are usually most interested in assessing
A. solvency. C. marketability.
Risk and return B. liquidity. D. profitability.
29. The present and prospective stockholders are primarily concerned with a firm’
A. profitability C. leverage 36. The two categories of ratios that should be utilized to asses a firm’s true liquidity are the
B. liquidity D. risk and return A. current and quick ratios C. liquidity and profitability ratios
B. liquidity and debt ratios D. liquidity and activity ratios
69. Which suppliers of funds bear the greatest risk and should therefore earn the greatest return?
A. common stockholders C. preferred shareholders 47. Which of the following is the most of interest to a firm’s suppliers?
B. general creditors such as banks D. bondholders A. profitability C. asset utilization
B. debt D. liquidity
Measures of Risk
54. The following groups of ratios primarily measure risk: Measures of liquidity
A. liquidity, activity, and common equity C. liquidity, activity, and debt 21. The ratios that are used to determine a company’s short-term debt paying ability are
B. liquidity, activity, and profitability D. activity, debt, and profitability A. asset turnover, times interest earned, current ratio, and receivables turnover.
B. times interest earned, inventory turnover, current ratio, and receivables turnover.

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C. times interest earned, acid-test ratio, current ratio, and inventory turnover. 30. Which of the following ratios is rated to be a primary measure of liquidity and considered of
D. current ratio, acid-test ratio, receivables turnover, and inventory turnover. highest significance rating of the liquidity ratios a bank analyst?
A. Debt/Equity
20. Which of the following is a measure of the liquidity position of a corporation? B. Current ratio
A. earnings per share C. Degree of Financial Leverage
B. inventory turnover D. Accounts Receivable Turnover in Days
C. current ratio
D. number of times interest charges earned 41. A weakness of the current ratio is
A. the difficulty of the calculation.
37. Which one of the following ratios would not likely be used by a short-term creditor in B. that it does not take into account the composition of the current assets.
evaluating whether to sell on credit to a company? C. that it is rarely used by sophisticated analysts.
A. Current ratio C. Asset turnover D. that it can be expressed as a percentage, as a rate, or as a proportion.
B. Acid-test ratio D. Receivables turnover
Acid-test or quick ratio
51. Which of the following ratios would be least helpful in appraising the liquidity of current 42. A measure of a company’s immediate short-term liquidity is the
assets? A. current ratio.
A. Accounts Receivable turnover C. Current Ratio B. current cash debt coverage ratio.
B. Days’ sales in inventory D. Days’ sales in accounts receivable C. cash debt coverage ratio.
D. acid-test ratio.
53. Which ratio is most helpful in appraising the liquidity of current assets?
A. current ratio C. acid-test ratio 23. The acid-test or quick ratio
B. debt ratio D. accounts receivable turnover 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.
Not a measure of liquidity C. is calculated by taking one item from the income statement and one item from the balance
79. Which one of the following ratios would not likely be used by a short-term creditor in evaluating sheet.
whether to sell on credit to a company? D. is the same as the current ratio except it is rounded to the nearest whole percent.
A. accounts receivable turnover. C. acid test ratio.
B. asset turnover. D. current ratio. Not a liquidity ratio
28. Which one of the following would not be considered a liquidity ratio?
Current ratio A. Current ratio. C. Quick ratio.
24. Typically, which of the following would be considered to be the most indicative of a firm's short- B. Inventory turnover. D. Return on assets.
term debt paying ability?
A. working capital C. acid test ratio Activity ratios
B. current ratio D. days’ sales in receivables Days receivable & receivable turnover
Quality of receivables
22. The current ratio is 25. Which of the following does not bear on the quality of receivables?
A. calculated by dividing current liabilities by current assets. A. shortening the credit terms
B. used to evaluate a company’s liquidity and short-term debt paying ability. B. lengthening the credit terms
C. used to evaluate a company’s solvency and long-term debt paying ability. C. lengthening the outstanding period
D. calculated by subtracting current liabilities from current assets. D. all of the above bear on the quality of receivables

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Days receivable D. earnings per share.

27. A general rule to use in assessing the average collection period is
A. that is should not exceed 30 days. 90. The tendency of the rate earned on stockholders' equity to vary disproportionately from the
B. it can be any length as long as the customer continues to buy merchandise. rate earned on total assets is sometimes referred to as:
C. that it should not greatly exceed the discount period. A. leverage C. yield
D. that it should not greatly exceed the credit term period. B. solvency D. quick assets

Asset utilization ratios 55. Using financial leverage is a good financial strategy from the viewpoint of stockholders of
Performance measures companies having:
65. All of the following are asset utilization ratios except: A. a high debt ratio C. a steadily declining current ratio
A. average collection period C. receivables turnover B. steady or rising profits D. cyclical highs and lows
B. inventory turnover D. return on assets
46. The ratio that indicates a company’s degree of financial leverage is the
Asset turnover A. cash debt coverage ratio. C. free cash flow ratio.
63. Asset turnover measures B. debt to total assets. D. times-interest earned ratio.
A. how often a company replaces its assets.
B. how efficiently a company uses its assets to generate sales. 73. Interest expense creates magnification of earnings through financial leverage because:
C. the portion of the assets that have been financed by creditors. A. while earnings available to pay interest rise, earnings to residual owners rise faster
D. the overall rate of return on assets. B. interest accompanies debt financing
C. interest costs are cheaper than the required rate of return to equity owners
66. Total asset turnover measures the ability of a firm to: S. the use of interest causes higher earnings
A. generate profits on sales
B. generate sales through the use of assets Measures of solvency
C. cover long-term debt 34. The set of ratios that is most useful in evaluating solvency is
D. buy new assets A. debt ratio, current ratio, and times interest earned
B. debt ratio, times interest earned, and return on assets
76. A measure of how efficiently a company uses its assets to generate sales is the C. debt ratio, times interest earned, and quick ratio
A. asset turnover ratio. C. profit margin ratio. D. debt ratio, times interest earned, and cash flow to debt
B. cash return on sales ratio. D. return on assets ratio.
49. Which of the following ratios is most relevant to evaluating solvency?
Solvency ratios A. Return on assets C. Days’ purchases in accounts payable
Interested parties B. Debt ratio D. Dividend yield
50. Long-term creditors are usually most interested in evaluating
A. liquidity. C. profitability. Fixed assets to long-term liabilities
B. marketability. D. solvency. 44. Which of the following ratios provides a solvency measure that shows the margin of safety of
noteholders or bondholders and also gives an indication of the potential ability of the business
Financial Leverage to borrow additional funds on a long-term basis?
45. Trading on the equity (leverage) refers to the A. ratio of fixed assets to long-term liabilities
A. amount of working capital. B. ratio of net sales to assets
B. amount of capital provided by owners. C. number of days' sales in receivables
C. use of borrowed money to increase the return to owners. D. rate earned on stockholders' equity

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D. fixed charge ratio will be overstated, based upon the financial statements
Debt ratio
59. The debt ratio indicates: Profitability ratios
A. a comparison of liabilities with total assets Interested parties
B. the ability of the firm to pay its current obligations 39. The return on assets ratio is affected by the
C. the efficiency of the use of total assets A. asset turnover ratio.
D. the magnification of earnings caused by leverage B. debt to total assets ratio.
C. profit margin ratio.
78. The debt to total assets ratio measures D. asset turnover and profit margin ratios.
A. the company’s profitability.
B. whether interest can be paid on debt in the current year. 52. Stockholders are most interested in evaluating
C. the proportion of interest paid relative to dividends paid. A. liquidity. C. profitability.
D. the percentage of the total assets provided by creditor. B. solvency. D. marketability.

Debt-to-equity ratio Performance measures

60. Which of the following statements best compares long-term borrowing capacity ratios? 48. The set of ratios that are most useful in evaluating profitability is
A. The debt/equity ratio is more conservative than the debt ratio. A. ROA, ROE, and debt to equity ratio C. ROA, ROE, and acid-test ratio
B. The debt to tangible net worth ratio is more conservative than the debt/equity ratio. B. ROA, ROE, and dividend yield D. ROA, ROE, and cash flow to debt
C. The debt/equity ratio is more conservative than the debt to tangible net worth ratio.
D. The debt ratio is more conservative than the debt/equity ratio. Earnings per share
82. Which of the following ratios appears most frequently in annual reports?
Times interest earned A. Earnings per Share C. Profit Margin
74. A times interest earned ratio of 0.90 to 1 means that B. Return on Equity D. Debt/Equity
A. the firm will default on its interest payment
B. net income is less than the interest expense Return on assets
C. the cash flow is less than the net income 64. Return on assets
D. the cash flow exceeds the net income A. can be determined by looking at a balance sheet
B. should be smaller than return on sales
Fixed charge coverage C. can be affected by the company’s choice of a depreciation method
61. A fixed charge coverage: D. should be larger than return on equity
A. is a balance sheet indication of debt carrying ability
B. is an income statement indication of debt carrying ability Return on investments
C. frequently includes research and development 72. Return on investment measures:
D. computation is standard from firm to firm A. return to all suppliers of funds C. return to all long-term suppliers of funds
B. return to all long-term creditors D. return to stockholders
Off-balance sheet liabilities
62. If a firm has substantial capital or financing leases disclosed in the notes but not capitalized in Market test ratios
the financial statements, then the Price-earnings ratio
A. times interest earned ratio will be overstated, based upon the financial statements 56. The price/earnings ratio
B. debt ratio will be understated A. measures the past earning ability of the firm
C. working capital will be understated B. is a gauge of future earning power as seen by investors

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C. relates price to dividends 33. Which of the following would be most detrimental to a firm's current ratio if that ratio is
D. relates currently 2.0?
A. Buy raw materials on credit
58. Which of the following ratios usually reflects investors opinions of the future prospects for the B. Sell marketable securities at cost
firm? C. Pay off accounts payable with cash
A. dividend yield C. book value per share D. Pay off a portion of long-term debt with cash
B. price/earnings ratio D. earnings per share
Fixed asset turnover ratio
Dividend yield 68. Which of the following circumstances will cause sales to fixed assets to be abnormally high?
57. Which of the following ratios represents dividends per common share in relation to market A. A labor-intensive industry.
price per common share? B. The use of units-of-production depreciation.
A. dividend payout C. price/earnings C. A highly mechanized facility.
B. dividend yield D. book value per share D. High direct labor costs from a new union contract.

Financial Statement Analysis Total asset turnover

Accounts Receivable 81. A firm with a total asset turnover lower than the industry standard and a current ratio which
26. Which of the following reasons should not be considered in order to explain why the meets industry standard might have excessive:
receivables appear to be abnormally high? A. Accounts receivable C. Debt
A. Sales volume decreases materially late in the year. B. Fixed assets D. Inventory
B. Receivables have collectibility problems and possibly some should have been written off.
C. Material amount of receivables are on the installment basis. Profitability analysis
D. Sales volume expanded materially late in the year. 84. Denver Dynamics has net income of P2,000,000. Oakland Enterprises has net income of
P2,500,000. Which of the following best compares the profitability of Denver and Oakland?
31. An acceleration in the collection of receivables will tend to cause the accounts receivable A. Oakland Enterprises is 25% more profitable than Denver Dynamics.
turnover to: B. Oakland Enterprises is more profitable than Denver Dynamics, but the comparison can't
A. decrease C. either increase or decrease be quantified.
B. remain the same D. increase C. Oakland Enterprises is only more profitable if it is smaller than Denver Dynamics.
D. Further information is needed for a reasonable comparison.
Inventories
32. Which of the following would best indicate that the firm is carrying excess inventory? Debt ratio
A. a decline in the current ratio 86. Companies A and B are in the same industry and have similar characteristics except that
B. stable current ratio with declining quick ratios Company A is more leveraged than Company B. Both companies have the same income
C. a decline in days' sales in inventory before interest and taxes and the same total assets. Based on this information we could
D. a rise in total asset turnover conclude that
A. Company A has higher net income than Company B
89. When Tri-C Corp. compares its ratios to industry averages, it has a higher current ratio, an B. Company A has a lower return on assets than company B
average quick ratio, and a low inventory turnover. What might you assume about Tri-C? C. Company A is more risky than Company B.
A. Its cash balance is too low. C. Its current liabilities are too low. D. Company A has a lower debt ratio than company B
B. Its cost of goods sold is too low. D. Its average inventory is too high.
Sensitivity Analysis
Current ratio Current ratio

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40. A firm has a current ratio of 1:1. In order to improve its liquidity ratios, this firm should Collection of receivable No effect Increase No effect Decrease
A. improve its collection practices, thereby increasing cash and increasing its current and
quick ratios.
B. improve its collection practices and pay accounts payable, there decreasing current Profit margin
liabilities and increasing the current and quick ratios. 70. Which of the following would most likely cause a rise in net profit margin?
C. decrease current liabilities by utilizing more long-term debt, thereby increasing the A. increased sales C. decreased operating expenses
current and quick ratios. B. decreased preferred dividends D. increased cost of sales
D. increase inventory, thereby increasing current assets and the current and quick ratios.
Return on assets
43. Recently the M&M Company has been having problems. As a result, its financial situation has 67. Return on assets cannot fall under which of the following circumstances?
deteriorated. M&M approached the First National Bank for a badly needed loan, but the loan
A. B. C. D.
officer insisted that the current ratio (now 0.5) be improved to at least 0.8 before the bank
would even consider granting the credit. Which of the following actions would do the most to Net profit margin Decline Rise Rise Decline
improve the ratio in the short run?
A. Using some cash to pay off some current liabilities. Total asset turnover Rise Decline Rise Decline
B. Collecting some of the current accounts receivable.
C. Paying off some long-term debt.
Debt ratio
D. Purchasing additional inventory on credit (accounts payable).
83. Jones Company has long-term debt of P1,000,000, while Smith Company, Jones' competitor,
has long-term debt of P200,000. Which of the following statements best represents an
87. Tyner Company had P250,000 of current assets and P90,000 of current liabilities before
analysis of the long-term debt position of these two firms?
borrowing P60,000 from the bank with a 3-month note payable. What effect did the
A. Jones obviously has too much debt when compared to its competitor.
borrowing transaction have on Tyner Company's current ratio?
B. Smith Company's times interest earned should be lower than Jones.
A. The ratio remained unchanged.
C. Smith has five times better long-term borrowing ability than Jones.
B. The change in the current ratio cannot be determined.
D. Not enough information to determine if any of the answers are correct.
C. The ratio decreased.
D. The ratio increased.
Times interest earned
85. Which of the following will not cause times interest earned to drop? Assume no other changes
88. Which of the following actions will increase a firm's current ratio if it is now less than 1.0?
than those listed.
A. Convert marketable securities to cash.
A. A rise in preferred stock dividends.
B. Pay accounts payable with cash.
B. A drop in sales with no change in interest expense.
C. Buy inventory with short term credit (i.e. accounts payable).
C. An increase in interest rates.
D. Sell inventory at cost.
D. An increase in bonds payable with no change in operating income.
Acid-test ratio
DuPont Analysis
38. If a company has an acid-test ratio of 1.2:1, what respective effects will the borrowing of
71. Which of the following could cause return on assets to decline when net profit margin is
cash by short-term debt and collection of accounts receivable have on the ratio?
increasing?
A. B. C. D. A. sale of investments at year-end C. purchase of a new building at year-end
B. increased turnover of operating assets D. a stock split
Short-term borrowing Increase Increase Decrease Decrease
80. A firm with a lower net profit margin can improve its return on total assets by

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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
Inventory 140,000
Marketable securities 250,000
PROBLEMS: Notes payable, short-term 85,000
Horizontal analysis Prepaid expenses 15,000
1. 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 4. The amount of working capital for the company is:
2008. The respective net income reported by Kline Corporation for 2007 and 2008 are: A. P351,000 C. P211,000
A. P 600,000 and P5,500,000 C. P1,400,000 and P3,500,000 B. P361,000 D. P336,000
B. P5,500,000 and P 600,000 D. P1,400,000 and P5,500,000
5. The company’s current ratio as of the balance sheet date is:
2. Assume that Axle Inc. reported a net loss of P50,000 in 2006 and net income of P250,000 in A. 2.67:1 C. 2.02:1
2007. The increase in net income of P300,000: B. 2.44:1 D. 1.95:1
A. can be stated as 0% C. cannot be stated as a percentage
B. can be stated as 100% increase D. can be stated as 200% increase 6. The company’s acid-test ratio as of the balance sheet date is:
A. 1.80:1 C. 2.02:1
Liquidity ratios B. 2.40:1 D. 1.76:1
3. The following financial data have been taken from the records of Ratio Company:
Accounts receivable P200,000 Activity ratios
Accounts payable 80,000 Receivables turnover
Bonds payable, due in 10 years 500,000 7. Pine Hardware Store had net credit sales of P6,500,000 and cost of goods sold of
Cash 100,000 P5,000,000 for the year. The Accounts Receivable balances at the beginning and end of the
Interest payable, due in three months 25,000 year were P600,000 and P700,000, respectively. The receivables turnover was
Inventory 440,000 A. 7.7 times. C. 9.3 times.
Land 800,000 B. 10.8 times. D. 10.0 times.
Notes payable, due in six months 250,000
What will happen to the ratios below if Ratio Company uses cash to pay 50 percent of its 8. Milward Corporation’s books disclosed the following information for the year ended December
accounts payable? 31, 2007:
Net credit sales P1,500,000
A. B. C. D.
Net cash sales 240,000
Current ratio Increase Decrease Increase Decrease Accounts receivable at beginning of year 200,000
Accounts receivable at end of year 400,000
Acid-test ratio Increase Decrease Decrease Increase Milward’s accounts receivable turnover is
A. 3.75 times C. 5.00 times
B. 4.35 times D. 5.80 times
Question Nos. 4 through 6 are based on the data taken from the balance sheet of Nomad
Company at the end of the current year:
Days receivable
Accounts payable P145,000
9. Batik Clothing Store had a balance in the Accounts Receivable account of P390,000 at the
Accounts receivable 110,000
beginning of the year and a balance of P410,000 at the end of the year. The net credit sales
Accrued liabilities 4,000
during the year amounted to P4,000,000. Using 360-day year, what is the average collection

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period of the receivables? Accounts receivable, beginning of year 45,000

A. 30 days C. 73 days Accounts receivable, end of year 35,000
B. 65 days D. 36 days Inventory, beginning of year 90,000
Inventory, end of year 110,000
Cash collection A. 3.3 C. 3.7
10. Deity Company had sales of P30,000, increase in accounts payable of P5,000, decrease in B. 8.3 D. 3.0
accounts receivable of P1,000, increase in inventories of P4,000, and depreciation expense of
P4,000. What was the cash collected from customers? Days inventory
A. P31,000 C. P34,000 15. Selected information from the accounting records of Eternity Manufacturing Company follows:
B. P35,000 D. P25,000 Net sales P3,600,000
Cost of goods sold 2,400,000
Inventory turnover Inventories at January 1 672,000
11. During 2007, Tarlac Company purchased P960,000 of inventory. The cost of goods sold for Inventories at December 31 576,000
2007 was P900,000, and the ending inventory at December 31, 2007 was P180,000. What What is the number of days’ sales in average inventories for the year?
was the inventory turnover for 2007? A. 102.2 C. 87.6
A. 6.4 C. 5.3 B. 94.9 D. 68.1
B. 6.0 D. 5.0
Turnover ratios
12. Selected information from the accounting records of Petals Company is as follows: Asset turnover
Net sales for 2007 P900,000 Asset
Cost of goods sold for 2007 600,000 16. Net sales are P6,000,000, beginning total assets are P2,800,000, and the asset turnover is
Inventory at December 31, 2006 180,000 3.0. What is the ending total asset balance?
Inventory at December 31, 2007 156,000 A. P2,000,000. C. P2,800,000.
Petals’ inventory turnover for 2007 is B. P1,200,000. D. P1,600,000.
A. 5.77 times C. 3.67 times
B. 3.85 times D. 3.57 times Solvency ratios
Debt ratio
13. The Moss Company presents the following data for 2007. 17. Jordan Manufacturing reports the following capital structure:
Net Sales, 2007 P3,007,124 Current liabilities P100,000
Net Sales, 2006 P 930,247 Long-term debt 400,000
Cost of Goods Sold, 2007 P2,000,326 Deferred income taxes 10,000
Cost of Goods Sold, 2007 P1,000,120 Preferred stock 80,000
Inventory, beginning of 2007 P 341,169 Common stock 100,000
Inventory, end of 2007 P 376,526 Premium on common stock 180,000
The merchandise inventory turnover for 2007 is: Retained earnings 170,000
A. 5.6 C. 7.5 What is the debt ratio?
B. 15.6 D. 7.7 A. 0.48 C. 0.93
B. 0.49 D. 0.96
14. Based on the following data for the current year, what is the inventory turnover?
Net sales on account during year P 500,000 Times interest earned
Cost of merchandise sold during year 330,000 18. House of Fashion Company had the following financial statistics for 2006:

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 Financial Statement Analysis

Long-term debt (average rate of interest is 8%) P400,000 22. The times interest earned ratio of Mikoto Company is 4.5 times. The interest expense for
Interest expense 35,000 the year was P20,000, and the company’s tax rate is 40%. The company’s net income is:
Net income 48,000 A. P22,000 C. P54,000
Income tax 46,000 B. P42,000 D. P66,000
Operating income 107,000
What is the times interest earned for 2006? Profitability Ratios
A. 11.4 times C. 3.1 times Return on Common Equity
B. 3.3 times D. 3.7 times 23. Selected information for Ivano Company as of December 31 is as follows:
2006 2007
19. Brava Company reported the following on its income statement:
Income before taxes P400,000 Preferred stock, 8%, par P100, nonconvertible, P250,000 P250,000
Income tax expense 100,000 noncumulative
Net income P300,000
An analysis of the income statement revealed that interest expense was P100,000. Brava Common stock 600,000 800,000
Company’s times interest earned (TIE) was
A. 5 times C. 3.5 times Retained earnings 150,000 370,000
B. 4 times D. 3 times
Dividends paid on preferred stock for the year 20,000 20,000
20. The balance sheet and income statement data for Candle Factory indicate the following: Net income for the year 120,000 240,000
Bonds payable, 10% (issued 1998 due 2022) P1,000,000
Preferred 5% stock, P100 par (no change during year) 300,000 Ivano’s return on common stockholders’ equity, rounded to the nearest percentage point, for
Common stock, P50 par (no change during year) 2,000,000 2007 is
Income before income tax for year 350,000 A. 17% C. 21%
Income tax for year 80,000 B. 19% D. 23%
Common dividends paid 50,000
Preferred dividends paid 15,000 Dividend yield
Based on the data presented above, what is the number of times bond interest charges were 24. The following information is available for Duncan Co.:
earned (round to one decimal point)? 2006
A. 3.7 C. 4.5 Dividends per share of common stock P 1.40
B. 4.4 D. 3.5 Market price per share of common stock 17.50
Which of the following statements is correct?
21. The following data were abstracted from the records of Johnson Corporation for the year: A. The dividend yield is 8.0%, which is of interest to investors seeking an increase in market
Sales P1,800,000 price of their stocks.
Bond interest expense 60,000 B. The dividend yield is 8.0%, which is of special interest to investors seeking current returns
Income taxes 300,000 on their investments.
Net income 400,000 C. The dividend yield is 12.5%, which is of interest to bondholders.
How many times was bond interest earned? D. The dividend yield is 8.0 times the market price, which is important in solvency analysis.
A. 7.67 C. 12.67
B. 11.67 D. 13.67 Market Test Ratios
Market/Book value ratio
Net income Price per share

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 Financial Statement Analysis

25. What is the market price of a share of stock for a firm with 100,000 shares outstanding, a book B. 66.7 percent D. 71.4 percent
value of equity of P3,000,000, and a market/book ratio of 3.5?
A. P8.57 C. P85.70 P/E ratio & Payout ratio
B. P30.00 D. P105.00 Use the following information for question Nos. 33 and 34:
Terry Corporation had net income of P200,000 and paid dividends to common stockholders of
P/E ratio P40,000 in 2007. The weighted-average number of shares outstanding in 2007 was 50,000
26. Orchard Company’s capital stock at December 31 consisted of the following: shares. Terry Corporation’s common stock is selling for P60 per share in the local stock
• Common stock, P2 par value; 100,000 shares authorized, issued, and outstanding. exchange.
• 10% noncumulative, nonconvertible preferred stock, P100 par value; 1,000 shares
authorized, issued, and outstanding. 29. Terry Corporation’s price-earnings ratio is
Orchard’s common stock, which is listed on a major stock exchange, was quoted at P4 per A. 3.8 times C. 18.8 times
share on December 31. Orchard’s net income for the year ended December 31 was P50,000. B. 15 times D. 6 times
The yearly preferred dividend was declared. No capital stock transactions occurred. What
was the price earnings ratio on Orchard’s common stock at December 31? 30. Terry Corporation’s payout ratio for 2007 is
A. 6 to 1 C. 10 to 1 A. P4 per share C. 20.0 percent
B. 8 to 1 D. 16 to 1 B. 12.5 percent D. 25.0 percent

27. On December 31, 2006 and 2007, Renegade Corporation had 100,000 shares of common DuPont Model
stock and 50,000 shares of noncumulative and nonconvertible preferred stock issued and Debt ratio
outstanding. 31. The Board of Directors is dissatisfied with last year's ROE of 15%. If the profit margin and
Additional information: asset turnover remain unchanged at 8% and 1.25 respectively, by how much must the total
Stockholders’ equity at 12/31/07 P4,500,000 debt ratio increase to achieve 20% ROE?
Net income year ended 12/31/07 1,200,000 A. Total debt ratio must increase by .5
Dividends on preferred stock year ended 12/31/07 300,000 B. Total debt ratio must increase by 5
Market price per share of common stock at 12/31/07 144 C. Total debt ratio must increase by 5%
The price-earnings ratio on common stock at December 31, 2007, was D. Total debt ratio must increase by 50%
A. 10 to 1 C. 14 to 1
B. 12 to 1 D. 16 to 1 32. Assume you are given the following relationships for the Orange Company:
Sales/total assets 1.5X
Payout ratio Return on assets (ROA) 3%
28. Selected financial data of Alexander Corporation for the year ended December 31, 2007, is Return on equity (ROE) 5%
presented below: The Orange Company’s debt ratio is
Operating income P900,000 A. 40% C. 35%
Interest expense (100,000) B. 60% D. 65%
Income before income taxes 800,000
Income tax (320,000) Leverage Ratio
Net income 480,000 Degree of financial leverage
Preferred stock dividend (200,000) 33. A summarized income statement for Leveraged Inc. is presented below.
Net income available to common stockholders 280,000 Sales P1,000,000
Common stock dividends were P120,000. The payout ratio is: Cost of Sales 600,000
A. 42.9 percent C. 25.0 percent Gross Profit P 400,000

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 Financial Statement Analysis

Operating Expenses 250,000 Current ratio 2.00 to 1

Operating Income P 150,000 Quick ratio 1.25 to 1
Interest Expense 30,000 Average Collection period 42 days
Earnings Before Tax P 120,000 Working days 360
Income Tax 40,000 The estimated inventory amount is:
Net Income P 80,000 A. 840,000 C. 720,000
The degree of financial leverage is: B. 600,000 D. 550,000
A. P 150,000 ÷ P 30,000 C. P1,000,000 ÷ P400,000
B. P 150,000 ÷ P120,000 D. P 150,000 ÷ P 80,000 37. The following data were obtained from the records of Salacot Company:
Current ratio (at year end) 1.5 to 1
Other Ratios Inventory turnover based on sales and ending inventory 15 times
Book value per share Inventory turnover based on cost of goods sold and ending inventory 10.5 times
34. M Corporation’s stockholders’ equity at December 31, 2007 consists of the following: Gross margin for 2007 P360,000
6% cumulative preferred stock, P100 par, liquidating value What was Salacot Company’s December 31, 2007 balance in the Inventory account?
was P110 per share; issued and outstanding 50,000 shares P5,000,000 A. P120,000 C. P 80,000
Common stock, par, P5 per share; issued and B. P 54,000 D. P 95,000
outstanding, 400,000 shares 2,000,000
Retained earnings 1,000,000 Net sales
Total P8,000,000 38. Selected data from Mildred Company’s year-end financial statements are presented below.
Dividends on preferred stock have been paid through 2006. The difference between average and ending inventory is immaterial.
At December 31, 2007, M Corporation’s book value per share was Current ratio 2.0
A. P5.50 C. P6.75 Quick ratio 1.5
B. P6.25 D. P7.50 Current liabilities P120,000
Inventory turnover (based on cost of sales) 8 times
35. The following data were gathered from the annual report of Desk Products. Gross profit margin 40%
Market price per share P30.00 Mildred’s net sales for the year were
Number of common shares 10,000 A. P 800,000 C. P 480,000
Preferred stock, 5% P100 par P10,000 B. P 672,000 D. P1,200,000
Common equity P140,000
The book value per share is: Gross margin
A. P30.00 C. P14.00 39. Selected information from the accounting records of the Blackwood Co. is as follows:
B. P15.00 D. P13.75 Net A/R at December 31, 2006 P 900,000
Net A/R at December 31, 2007 P1,000,000
Integrated ratios Accounts receivable turnover 5 to 1
Liquidity & activity ratios Inventories at December 31, 2006 P1,100,000
Inventory Inventories at December 31, 2007 P1,200,000
36. The current assets of Mayon Enterprise consists of cash, accounts receivable, and Inventory turnover 4 to 1
inventory. The following information is available: What was the gross margin for 2007?
Credit sales 75% of total sales A. P150,000 C. P300,000
Inventory turnover 5 times B. P200,000 D. P400,000
Working capital P1,120,000

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 Financial Statement Analysis

Market Test Ratio Retained earnings 300,000 210,000

Dividend yield
40. Recto Co. has a price earnings ratio of 10, earnings per share of P2.20, and a pay out ratio Net income is P115,000 and interest expense is P30,000 for 2007.
of 75%. The dividend yield is What is the rate earned on total assets for 2007 (round percent to one decimal point)?
A. 25.0% C. 7.5% A. 9.3 percent C. 8.9 percent
B. 22.0% D. 10.0% B. 10.1 percent D. 7.4 percent

41. The following were reflected from the records of Salvacion Company: 43. What is the rate earned on stockholders' equity for 2007 (round percent to one decimal point)?
Earnings before interest and taxes P1,250,000 A. 10.6 percent C. 12.4 percent
Interest expense 250,000 B. 11.2 percent D. 15.6 percent
Preferred dividends 200,000
Payout ratio 40 percent 44. What is the earnings per share on common stock for 2007, (round to two decimal places)?
Shares outstanding throughout 2006 A. P1.92 C. P1.77
Preferred 20,000 B. P1.89 D. P1.42
Common 25,000
Income tax rate 40 percent 45. If the market price is P30, what is the price-earnings ratio on common stock for 2007 (round to
Price earnings ratio 5 times one decimal point)?
The dividend yield ratio is A. 17.0 C. 12.4
A. 0.50 C. 0.40 B. 12.1 D. 15.9
B. 0.12 D. 0.08

Comprehensive
42. The balance sheets of Magdangal Company at the end of each of the first two years of
operations indicate the following:
2007 2006
Total current assets P600,000 P560,000
Total investments 60,000 40,000
Total property, plant, and equipment 900,000 700,000
Total current liabilities 150,000 80,000
Total long-term liabilities 350,000 250,000
Preferred 9% stock, P100 par 100,000 100,000
Common stock, P10 par 600,000 600,000
Paid-in capital in excess of par-common stock 60,000 60,000

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 Financial Statement Analysis

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

Current Ratio (740,000 ÷ 355,000) 2.08:1.00

Acid-test Ratio (300,000 ÷ 355,000) 0.85:1.00

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.

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 Financial Statement Analysis

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

Working Capital P351,000

5. Answer: B
Current Ratio: Current Assets ÷ Current Liabilities
(P595,000 ÷ P244,000) = 2.44:1.00

6. Answer: A
Acid-Test Ratio: Liquid Assets ÷ Current Liabilities
(P440,000 ÷ P244,000) = 1.80:1.00

7. Answer: D
AR Turnover: Credit sales ÷ Average AR
6,500,000/650,000 = 10.0 times

8. Answer: C
Accounts Receivable Turnover: Net Credit Sales ÷ Average Accounts Receivable
P1,500,000 ÷ [(P200,000 + P400,000) ÷ 2] = 5.0 times

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 Financial Statement Analysis

9. Answer: D
Average Daily Sales: Annual credit sales ÷ Days’ Year
P4 million ÷ 360 days = P11,111

Average Collection Period: Average Accounts Receivable ÷ Average Daily Sales

[(P390,000 + P410,000) ÷ 2] ÷ P11,111 = 36 days

10. Answer: A
Sales P30,000
Add decrease in Accounts Receivable 1,000
Cash collected from sales P31,000

11. Answer: B
Inventory Turnover: Cost of Goods Sold ÷ Average Inventory
Cost of goods sold P 900,000
Add Ending inventory 180,000
Total cost available for sales 1,080,000
Deduct cost of purchases 960,000
Beginning inventory P 120,000
Average Inventory: (P120,000 + P180,000) ÷ 2 P150,000
Inventory Turnover: (P900,000 ÷ P150,000) 6 times
An alternative computation of the inventory turnover is to use Net Sales instead of Cost of Goods Sold.

12. Answer: D
Average inventory: (P180,000 + P156,000) ÷ 2 P168,000
Inventory Turnover: (P600,000 ÷ P168,000) 3.57 times

13. Answer: A
Average Inventory: (P341,169 + P376,526) ÷ 2 P358,847.50
Inventory Turnover: (P2,000,326 ÷ P358,847.50) 5.6 times

14. Answer: A
Average Inventory: (P90,000 + P110,000) ÷ 2 P100,000
Inventory Turnover: (P330,000 ÷ P100,000) 3.3 times

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 Financial Statement Analysis

15. Answer: B
Average Inventory: (P672,000 + P576,000) ÷2 P624,000
Inventory Turnover: (P2,400,000 ÷ P624,000) 3.846 times
Inventory Turnover in Days: 365 days ÷ 3.846 94.9 days

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

Net sales: (P950,000 x 5) P4,750,000

Cost of goods sold (P1,150,000 x 4) 4,600,000
Gross margin P 150,000

17. Answer: B
Current liabilities P 100,000
Long-term debt 400,000
Deferred income tax 10,000
Total Liabilities 510,000
Stockholders’ Equity
Preferred stock P 80,000
Common stock 100,000
Premium on common stock 180,000
Retained earnings 170,000 530,000
Total Assets P1,040,000

Debt Ratio: P510,000 ÷ P1,040,000 = 0.49

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 Financial Statement Analysis

18. Answer: D
Times interest earned: Earnings before interest ÷ Interest
Income before tax (P48,000 + P46,000) P 94,000
Add Interest expense 35,000
Income before Interest expense P129,000

TIE: P129,000 ÷ P35,000 3.7 times

19. Answer: A
TIE: Income before interest expense ÷ Interest expense
Income before income tax P400,000
Add back Interest expense 100,000
Income before interest expense P500,000

TIE: P500,000 ÷ P100,000 5 times

20. Answer: C
Interest Expense: P1M x 0.1 P100,000
Income before interest expense: P350,000 + P100,000 P450,000
Times interest earned: (P450,000 ÷ P100,000) 4.5 times

21. Answer: C
Net income P400,000
Add: Income taxes P300,000
Interest 60,000 360,000
Income before interest P760,000

TIE: P760,000 ÷ P60,000 12.67 times

22. Answer: B
Earnings before interest expense (P20,000 x 4.5) P90,000
Deduct interest expense 20,000
Income before income tax P70,000
Deduct income tax (P70,000 x 0.4) 28,000
Net income P42,000

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 Financial Statement Analysis

23. Answer: D
Income to Common; (P240,000 – P20,000) P220,000
Average Common Equity: (P750,000 + P1,170,000) ÷ 2 P960,000
Return on Common Equity: (P220 ÷ P960) 23 percent

24. Answer: B
The dividend yield is 8 percent (P1.40 ÷ P17.50)
The dividend yield measures the return of investment in terms of dividends received. The total expected returns consists of Dividend Yield and the Appreciation in market price and dividend

25. Answer: D
Market Value of Equity (P3M x 3.5) P10,500,000
Market price per share: (P10.5M ÷ 100,000) P105

26. Answer: B
EPS: P50,000 ÷ 100,000 shares P0.50
P/E Ratio: P4.00 ÷ P0.50 8 to 1

27. Answer: D
EPS: (P1,200,000 – P300,000) ÷ 100,000 P9.00
P/E Ratio: 144 ÷ 9 16

28. Answer: A
Payout Ratio: Common Dividends ÷ Income Available to Common
P120,000 ÷ P280,000 = 42.9%

29. Answer: B
Price-earnings ratio: Market price ÷ EPS
EPS: Net income ÷ /Weighted-average common shares
EPS: P200,000 ÷ 50,000 shares P4.00
P/E Ratio: P60 ÷ P4 15.0X

30. Answer: C
Payout Ratio: Dividends ÷ Income to Common
P40,000÷ P200,000 = 20.0%

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 Financial Statement Analysis

31. Answer: D
ROE: (8% x 1.25) 10.00%
Last year’s Debt Ratio 1 – (10% ÷ 15%) 33.33%
Proposed Debt Ratio 1 – (10% ÷ 20%) 50.00%
Increase in debt ratio: (50.00% - 33.33%) ÷ 33.33% 50.00%

32. Answer: A
1 – (0.03 ÷ 0.05) = 40%

33. Answer: B
Degree of Financial Leverage: Operating Income ÷ Interest Expense

34. Answer: A
Total stockholders’ equity P8,000,000
Deduct:
Liquidation value of Preferred Stock (50,000 s P110) P5,500,000
Unpaid Preferred Dividends (P5M x 6%) 300,000 5,800,000
Common Equity P2,200,000

Book Value per Share: P2.2M ÷ 400,000 shares P5.50

35. Answer: C
Book Value per Share: Common Equity ÷ Outstanding Shares
P140,000 ÷ 10,000 shares = P14.00

36. Answer: A
The inventory amount can be calculated as follows:
Current liabilities: Working Capital = current liabilities based on 2:1 current ratio. At 2:1 current ratio, the amount of working capital and current liabilities are both P1,120,000.

Inventory: Current liabilities x (Current ratio – Acid test ratio)

P1,120,000 x (2.0 – 1.25) P840,000

A detailed computation can be made as follows:

Current assets: P1,120,000 x 2 P2,240,000
Liquid assets: P1,120,000 x 1.25 1,400,000
Inventory P 840,000

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 Financial Statement Analysis

37. Answer: C
Inventory balance: Gross profit ÷ (Difference between 2 inventory turnovers)
360,000/(15 – 10.5) = P80,000

38. Answer: A
Inventory balance (P120,000 x (2.0 – 1.5) P 60,000
Cost of goods sold 60,000 x 8 P480,000
Sales (P480,000 ÷ 0.60) P800,000

39. Answer: A
Average Accounts Receivable: (P900,000 ÷ P1,000,000) ÷ 2 P 950,000
Average inventory; (P1.1M + P1.2M) ÷ 2 P1,150,000

Net sales: (P950,000 x 5) P4,750,000

Cost of goods sold (P1,150,000 x 4) 4,600,000
Gross margin P 150,000

40. Answer: C
Dividend per share: 0.75 x P2.20 P1.65
Market price: 10 x 2.20 22.00
Dividend yield: P1.65 ÷ P22.00 = 7.5%

41. Answer: D
EBIT 1,250,000
Less interest expense 250,000
Earnings before tax 1,000,000
Less Income tax 40% 400,000
Net income 600,000
Less Preferred dividends 200,000
Earnings to Common Stock 400,000
Earnings per share 400,000/25,000 16.00
Dividend per share: 400,000 x 0.40 ÷ 25,000 6.40

Dividend yield 6.4 ÷ (16 x 5) 8.0%

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 Financial Statement Analysis

42. Answer: B
ROA: Operating income ÷ Average Total Assets
P145,000 ÷ P1,430,000 = 10.1%

43. Answer: B
Return on stockholders’ equity: Net income ÷ Average stockholders’ equity
P115,000 ÷ P1,027,500 = 11.2%

44. Answer: C
Net income P115,000
Deduct Preferred Dividends 9,000
Income available to common shares P106,000

EPS: (P106,000 ÷ 60,000) P1.77

45. Answer: A
P/E Ratio: P30 ÷ 1.766 = 17.0 times

588