FINANCIAL STATEMENT ANALYSIS

THEORY
1. When a balance sheet amount is related to an income statement amount in computing a ratio,
a. The income statement amount should be converted to an average for the year.
b. Comparisons with industry ratios are not meaningful.
c. The balance sheet amount should be converted to an average for the year.
d. The ratio loses its historical perspective because a beginning-of-the-year amount is
combined with an end-of-the-year amount.

2. How are financial ratios used in decision making?

a. They can help identify the reasons for success and failure in business, but decision
making requires information beyond the ratios.
b. They remove the uncertainty of the business environment.
c. They aren’t useful because decision making is too complex.
d. They give clear signals about the appropriate action to take.

3. A useful tool in financial statement analysis is the common-size financial statement. What
does this tool enable the financial analyst to do?
a. Evaluate financial statements of companies within a given industry of approximately the
same value.
b. Determine which companies in the same industry are at approximately the same stage of
development.
c. Compare the mix of assets, liabilities, capital, revenue, and expenses within a company
over time or between companies within a given industry without respect to relative size.
d. Ascertain the relative potential of companies of similar size in different industries.

4. Which of the following is not revealed on a common size balance sheet?

a. The debt structure of a firm.
b. The capital structure of a firm.
c. The peso amount of assets and liabilities.
d. The distribution of assets in which funds are invested.

5. If a transaction causes total liabilities to decrease but does not affect the owners’ equity, what
change if any, will occur in total assets?
a. Assets will be increased. c. No change in total assets.
b. Assets will be decreased. d. None of the above.

6. Last year, a business had no long-term investments; this year long term investments amount
to P100,000. In a horizontal analysis the change in long-term investments should be
expressed as
a. An absolute value of P100,000, and an increase of 100%
b. An absolute value of P100,000 and an increase of 1,000%
c. An absolute value of P100,000 and no value for a percentage change
d. No change in any terms because there was no investment in the previous year.

7. In a set of comparative financial statements, you observed a gradual decline in the net of
gross ratio, i.e., between net sales and gross sales. This indicates that:
a. There is a stiffening in the grant of discounts to the customers.
b. The discount period is being lengthened.
c. There is adherence to the collection policies of the company.
d. Sales volume is decreasing.

8. Which of these ratios are measures of a company’s profitability?

1. Earnings per share 5. Return on assets
2. Current ratio 6. Inventory turnover
3. Return on sales 7. Receivables turnover
4. Debt-equity ratio 8. Price-earnings ratio
a. All eight ratios. c. 1, 3, 5, 6, 7, and 8 only.
b. 1, 3, 5, and 8 only. d. 1, 3, and 5 only
9. Which ratio is most helpful in appraising the liquidity of current assets?
a. Current ratio. c. Debt ratio.
b. Acid-test ratio. d. Accounts receivable turnover.

10. Which one of the following ratios would provide a best measure of liquidity?
A. Sales minus returns to total debt.
B. Total assets minus goodwill to total equity.
C. Current assets minus inventories to current liabilities.
D. Net profit minus dividends to interest expense.

11. North Bank is analyzing Belle Corp.’s financial statements for a possible extension of credit.
Belle’s quick ratio is significantly better than the industry average. Which of the following
factors should North consider as possible limitation of using this ratio when evaluating
Belle’s creditworthiness?
a. Fluctuating market prices of short-term investments may adversely affect the ratio.
b. Increasing market prices for Belle’s inventory may adversely affect the ratio.
c. Belle may need to sell its available-for-sale investments to meet its current obligations.
d. Belle may need to liquidate its inventory to meet its long-term obligations.

12. The ratio of analytical measurements which measures the productivity of assets regardless of
capital structure is
a. Current ratio. c. Quick (acid test) ratio.
b. Debt ratio. d. Return on total assets.

13. How are the following used in the calculation of the dividend-pay-out ratio for a company
with only common stock outstanding?
A. B. C. D.
Dividends per share Denominator Denominator Numerator Numerator
Earnings per share Numerator Not used Denominator Not used
Book value per share Not used Numerator Not used Denominator

14. An investor has been given several financial ratios for an enterprise but none of the financial
reports. Which combination of ratios can be used to derive return on equity?
A. Market-to-book-value ratio and total-debt-to-total-assets ratio.
B. Price-to-earnings ratio, earnings per share, and net profit margin.
C. Price-to-earnings ratio and return-on-assets ratio.
D. Net profit margin, total assets turnover, and equity multiplier.

15. Which of the following actions will increase a company’s quick ratio?
a. Reduce inventories and use the proceeds to reduce long-term debt.
b. Reduce inventories and use the proceeds to reduce current liabilities.
c. Issue short-term debt and use the proceeds to purchase inventory.
d. Issue long-term debt and use the proceeds to purchase fixed assets.
e. Issue equity and use the proceeds to purchase inventory.

16. On December 31, 1991, Northpark Co. collected a receivable due from a major customer.
Which of the following ratios would be increased by this transaction?
a. Inventory turnover ratio. c. Current ratio.
b. Receivable turnover ratio. d. Quick ratio.

17. Jack & Sons, Inc. has a 2 to 1 acid test (quick) ratio. This ratio would decrease to less than 2
to 1 if the company
a. Purchased inventory on open account.
b. Sold merchandise on open account that earned a normal gross margin.
c. Collected an account receivable.
d. Paid an account payable.
18. The ratio that measures a firm's ability to generate earnings from its resources is
A. Days' sales in inventory. C. Days' sales in receivables.
B. Sales to working capital. D. Asset turnover.

19. In comparing the current ratios of two companies, why is it invalid to assume that the
company with the higher current ratio is the better company?
a. The current ratio includes assets other than cash.
b. A high current ratio may indicate inadequate inventory on hand.
c. A high current ratio may indicate inefficient use of various assets and liabilities.
d. The two companies may define working capital in different terms.

20. Mabuhay Corp. has current assets of P180,000 and current liabilities of P360,000. Which of
the following transactions would improve Mabuhay’s current ratio?
a. Refinancing a P60,000 long-term mortgage with a short-term note.
b. Collecting P20,000 of short-term accounts receivable.
c. Purchasing P100,000 of merchandise inventory with a short-term accounts payable.
d. Paying P40,000 of short-term accounts payable.