Chapter 13 – Financial Performance Measurement
TRUE/FALSE
1. It is in the best interests of a company to base executive compensation on a single performance
measure.
2. Per the Sarbanes-Oxley Act of 2002, a compensation committee, comprised of a public corporation’s
top executives, must be established to determine the salaries and wages of its employees.
3. Per the Sarbanes-Oxley Act of 2002, public corporations must establish a compensation committee to
determine how its top executives will be compensated.
4. Investors, creditors, and customers are considered external users of financial statements.
5. Liquidity is the ability to earn a satisfactory net income.
6. Profitability is the ability to pay bills when due and to meet unexpected needs for cash.
7. Past performance is rarely a good indicator of future performance.
8. In general, the greater the investment risk taken, the lower the return required as compensation.
9. The analysis of risk and return is important to both investors and creditors.
10. Financial statement analysis can be both past- and future-oriented.
11. Disclosure of segment information is useless in the analysis of diversified companies.
12. Accounting methods may be a source of incomparability among companies.
13. Form 10-Q refers to the annual report filed with the SEC.
14. The most complete financial newspaper in the United States is the Financial Times.
15. Interim financial statements are subjected to a full audit by an independent auditor.
16. Companies file their quarterly reports with the SEC on Form 8K.
17. The use of rule-of-thumb measures is not an exact science and should be used with great care.
18. Rule-of-thumb measures are the best standards of comparison in financial performance evaluation.
19. A limitation of using industry norms in financial performance evaluation is that some companies in the
same industry may not be comparable.
20. Both diversified companies and conglomerates operate in a single, well-defined industry.
21. Companies in the same industry are required to use the same methods to value inventory and to
depreciate similar assets.
22. In a diversified company, segments may be represented by different industries, geographical markets,
and major customers.
23. The comparison of financial measures or ratios of the same company over a period of times is superior
to the use of rule-of-thumb measures.
24. Most companies issue interim financial statements to the public on a monthly basis.
25. Interim financial statements report data for a period of more than one year.
26. The annual report of a publicly held corporation usually does not contain the auditors’ report.
27. For details about the financial histories of companies, one could consult publications of Moody’s and
Standard & Poor’s.
28. The quality of a company’s earnings refers to the substance of earnings and their sustainability into
future accounting periods.
29. Quality of earnings is only affected by accounting methods and accounting estimates.
30. Accounting estimates rarely affect the reported income of a company.
31. Earnings caused by one-time items are typically sustained in the future.
32. A reduction in the value of an asset below its carrying value on the balance sheet is called a
restructuring.
33. Both write-downs and restructurings reduce current operating income and boost future income by
shifting future costs to the current period.
34. Full disclosure in financial statements reduces problems in the interpretation of financial statements.
35. Different accounting methods will often have different effects on net income.
36. If two companies have identical net sales and use different inventory methods, income from continuing
operations will likely be identical also.
37. One-time decreases in earnings always indicate that earnings will be poor in the future.
38. Vertical analysis will result in common-size statements.
39. Trend analysis requires the establishment of a base year for comparison purposes.
40. Vertical analysis is the same as common-size analysis.
41. Horizontal analysis will reveal, for example, the percentage of net sales consumed by salaries expense.
42. In a common-size income statement, each item is expressed as a percentage of net revenues.
43. In a common-size income statement, net income is represented by 100 percent.
44. In horizontal analysis, the base year is the most current year being examined.
45. It is possible for horizontal analysis to indicate a decrease in revenues from one year to another and an
increase in net income.
46. In a common-size balance sheet, total assets are represented by 100 percent.
47. Determining the percentage change in an item from one year to the next is a type of horizontal
analysis.
48. The index number used in trend analysis is computed by dividing the base year amount by the index
year amount, and multiplying that result by 100.
49. When using an index number, one sets the first (oldest) number in a series equal to 100.
50. Common-size statements are useful in assessing the changes in the composition of statements over
time.
51. A primary purpose of vertical analysis is to observe trends over a five-year period.
52. Trend analysis is a variation on horizontal analysis.
53. A 20 percent change in net sales will result in a 20 percent change in net income.
54. The quick ratio and the debt to equity ratio are measures of short-term debt-paying ability.
55. Ratio analysis is useful only if the ratio states a meaningful relationship between two numbers.
56. The cash flow yield equals net income divided by net cash flows from operating activities.
57. Dividends yield is a market strength ratio.
58. To calculate cash flows to assets and cash flows to sales, one needs the figure for net cash flows from
financing activities.
59. Inventory turnover is a measure of liquidity that focuses on the relative size of inventory.
60. Days’ payable measures the relative size of accounts payable.
61. Asset turnover is most closely associated with a company’s liquidity position.
62. Both profit margin and asset turnover affect a company’s return on assets.
63. Declining profitability and liquidity ratios are indications that a company may not survive.
64. The interest coverage ratio and the debt to equity ratio are short-term measures of liquidity.
65. The market price of a stock represents investors’ collective view at a point in time.
66. The price/earnings (P/E) ratio is an indication of investor confidence in a company.
67. The operating cycle is equal to days’ sales uncollected plus days’ inventory on hand.
68. The sale of plant assets and the payment of dividends will reduce free cash flow.
69. The debt to equity ratio indicates the extent to which a company is leveraged.
MULTIPLE CHOICE
1. Executive officers’ compensation is typically comprised of all of the following except
a.
incentive bonuses.
b.
annual base salaries.
c.
declared dividends.
d.
stock option awards.
2. The ability to pay bills when due and to meet unexpected needs for cash most closely describes
a.
liquidity.
b.
long-term solvency.
c.
profitability.
d.
cash flow adequacy.
3. A general rule in choosing among alternative investments is the greater the risk taken, the
a.
lower the potential expected.
b.
lower the profits expected.
c.
greater the return required.
d.
greater the price of the investment.
4. A company is referred to as a diversified company or a conglomerate if it operates in
a.
one single major industry.
b.
many unrelated industries.
c.
many related industries.
d.
many and varied locations throughout the world.
5. Dun & Bradstreet publishes
a.
credit ratings of companies.
b.
data on average ratios and relationships.
c.
data on industry norms.
d.
all of these are correct.
6. All of the following are standard forms of the SEC, except
a.
Form 10-K.
b.
Form 8-K.
c.
Form 1040.
d.
Form 10-Q.
7. A corporation’s compensation committee, as required by the Sarbanes-Oxley Act of 2002, determines
the pay of
a.
the hourly wage earners.
b.
the top executives.
c.
the independent auditors.
d.
the members of the board of directors.
8. All of the following are key sources of financial news, except
a.
Barron’s.
b.
Newsweek.
c.
Fortune.
d.
Forbes.
9. Which of the following must be reported by diversified companies for each of their operating
segments?
a.
Assets, liabilities, and earnings per share
b.
Segment profit or loss, certain revenue and expense items, and segment assets
c.
Segment profit or loss, expenses, and unidentifiable assets
d.
Segment profit or loss, expenses, and earnings per share
10. Which of the following is the least useful in evaluating a relationship as either favorable or
unfavorable?
a.
Industry averages
b.
Past performance of the company
c.
Past and current performances of the company
d.
Rule-of-thumb measures
11. The existence of diversified companies makes which of the following very difficult?
a.
The preparation of interim financial statements
b.
Use of more than one depreciation or inventory method
c.
The compilation of segmented information
d.
Comparison with industry norms
12. Which of the following situations severely limits the use of industry norms as standards of
comparison?
a.
The existence of conglomerates
b.
The fact that little information exists on industry norms
c.
The presentation of segmented information
d.
A downward turn in the economy
13. Publicly held corporations must file annual reports with the SEC. All such reports are available
a.
to the general public.
b.
only to the SEC, the company’s owners and management, and the company’s auditors.
c.
only to the SEC, the company’s management, and the company’s auditors.
d.
only to other SEC companies and the issuing company’s owners and management.
14. One of the best places to look for early signals of change in a company’s profitability is the
a.
year-end financial statements.
b.
annual report sent to stockholders.
c.
annual report sent to the SEC.
d.
interim financial statements.
15. To find the most comprehensive information about a company’s performance during the year, one
would look to
a.
the annual report sent to stockholders.
b.
the annual report sent to the SEC.
c.
The Wall Street Journal.
d.
interim financial statements.
16. The financial objective of long-term solvency is to
a.
be able to pay bills when they fall due.
b.
earn a satisfactory net income.
c.
be able to increase stockholders’ wealth.
d.
be able to survive for many years.
17. All of the following are limitations on the use of industry norms, except
a.
companies that are not strictly comparable.
b.
the use of different accounting procedures.
c.
the existence of conglomerates.
d.
the presentation of interim financial statements.
18. Which of the following does not affect quality of earnings?
a.
Accounting estimates
b.
One-time items
c.
Accounting methods
d.
Industry norms
19. An example of an accounting method that could affect operating income is
a.
inventory valuation method.
b.
revenue recognition method.
c.
depreciation method.
d.
all of these could affect operating income.
20. A reduction in the value of an asset below its carrying value on the balance sheet is called a
a.
discontinued operation.
b.
write-down.
c.
restructuring.
d.
gain.
21. The choice of accounting method doesn’t affect cash flows except for possible differences in
a.
income taxes paid.
b.
depreciation expense recognized.
c.
rent expense paid.
d.
unearned revenues recognized.
22. The nonoperating items that appear on the income statement include
a.
discontinued operations.
b.
gains or losses on the sale or disposal of these segments.
c.
both discontinued operations and gains or losses on the sale or disposal of these segments.
d.
neither discontinued operations nor gains or losses on the sale or disposal of these
segments.
23. A balance sheet that displays only component percentages is called a
a.
segmented balance sheet.
b.
common-size balance sheet.
c.
condensed balance sheet.
d.
comparative balance sheet.
24. Horizontal analysis of comparative financial statements includes the
a.
calculation of the percentage of net sales for each item listed.
b.
calculation of dollar amount changes and percentage changes from the previous to the
current year.
c.
development of common-size statements.
d.
calculation of liquidity ratios.
25. In trend analysis, each item is expressed as a percentage of the
a.
total assets amount.
b.
retained earnings amount.
c.
net income amount.
d.
base year amount.
26. An example of horizontal analysis is
a.
common-size statements.
b.
trend analysis.
c.
ratio analysis.
d.
profitability analysis.
27. What is the best way to study the relationship of the components of financial statements?
a.
Perform horizontal analysis
b.
Perform ratio analysis
c.
Prepare common-size statements
d.
Perform trend analysis
28. In conducting horizontal analysis, it is important to focus attention on the changes in
a.
the rate of inflation.
b.
the composition of the statements.
c.
dollar amounts and their percentages.
d.
the accounting methods employed.
29. One reason that a common-size statement is a useful tool in financial performance evaluation is that it
enables the user to
a.
make better comparisons of two companies of different sizes in the same industry.
b.
determine which companies in a single industry are of the same value.
c.
determine which companies in a single industry are of the same size.
d.
judge the relative potential of two companies of similar size in different industries.
30. In a common-size income statement for a retail store, the 100 percent amount is for
a.
cost of goods sold.
b.
net revenues.
c.
gross profit.
d.
net income.
31. In a common-size income statement for a retail store, the 100 percent amount is for
a.
cost of goods sold.
b.
net revenues.
c.
gross profit.
d.
net income.
32. In a common-size balance sheet for a retail store, the 100 percent amount is for
a.
total property, plant, and equipment.
b.
merchandise inventory.
c.
total current assets.
d.
total assets.
33. In a common-size balance sheet, which of the following is given a designation of 100 percent?
a.
Total assets
b.
Net income
c.
Current assets
d.
Cost of goods sold
34. In a common-size financial statement, a designation of 25 percent could not be given to
a.
net revenues.
b.
total current assets.
c.
total long-term debt.
d.
net earnings.
35. In a trend analysis, an index number of 139 for 2013 sales indicates that
a.
sales for 2013 were 139 percent higher than sales for the same company in the base year.
b.
sales for 2013 were 139 percent of the sales for the same company in the base year.
c.
actual sales for 2013 exceeded budgeted sales for 2013 by 39 percent.
d.
sales for 2013 for this company were 139 percent of the sales figure of another company
being used in the comparison.
36. If Year 1 equals $1,400, Year 2 equals $1,554, and Year 3 equals $1,834, the index number to be
assigned for Year 3 in trend analysis, assuming that Year 1 is the base year, is
a.
100%.
b.
131%.
c.
136%.
d.
141%.
37. If sales for 2011 (the base year), 2012, and 2013 are $20,000, $15,600, and $29,600, respectively, the
index numbers assigned to 2012 and 2013, respectively, are
a.
156% and 143%.
b.
78% and 148%.
c.
128.2% and 158%.
d.
62.4% and 153%.
38. If dividends declared per share during 2011 (the base year), 2012, and 2013 are $2.40, $1.80, and
$1.92, respectively, the index numbers assigned to 2012 and 2013, respectively, are
a.
75% and 80%.
b.
180% and 70%.
c.
133.3% and 100%.
d.
60% and 85%.
39. A common measure of profitability is the
a.
debt to equity ratio.
b.
asset turnover.
c.
current ratio.
d.
receivable turnover.
40. A common measure of capital structure and leverage is the
a.
asset turnover.
b.
debt to equity ratio.
c.
current ratio.
d.
receivable turnover.
41. Return on assets is most closely related to
a.
inventory turnover and profit margin.
b.
profit margin and asset turnover.
c.
interest coverage and the debt to equity ratios.
d.
profit margin and the debt to equity ratio.
42. Which of the following ratios involves the market price of a company’s stock?
a.
Return on equity
b.
Cash flow yield
c.
Profit margin
d.
Dividends yield
43. Liquidity ratios are an indication of a company’s
a.
ability to pay bills when they are due and to meet unexpected needs for cash.
b.
overall debt position.
c.
overall debt to equity position.
d.
ability to effectively employ its resources.
44. The calculation of free cash flow contains a deduction for
a.
interest expense.
b.
dividends.
c.
net cash flows from operating activities.
d.
depreciation.
45. The current ratio is a
a.
long-term solvency ratio.
b.
market strength ratio.
c.
profitability ratio.
d.
liquidity ratio.
46. The receivable turnover and inventory turnover ratios are used to analyze
a.
profitability.
b.
liquidity.
c.
long-term solvency.
d.
leverage.
47. Days’ inventory on hand is used to analyze
a.
long-term solvency.
b.
cash flow adequacy.
c.
profitability.
d.
liquidity.
48. Which of the following describes the interest coverage ratio?
a.
Income after income taxes plus interest expense divided by interest expense
b.
Income before income taxes plus interest expense divided by interest expense
c.
Income after income taxes divided by interest expense
d.
Income before income taxes minus interest expense divided by interest expense
49. Which of the following describes the asset turnover ratio?
a.
Average total assets divided by net income
b.
Average total assets divided by sales
c.
Net sales divided by average total assets
d.
Net sales divided by net income
50. Which of the following describes the return on assets ratio?
a.
Net income divided by average total assets
b.
Net income plus income tax expense divided by average total assets
c.
Average total assets divided by net sales
d.
Average total assets divided by net income
51. Which of the following best describes the debt to equity ratio?
a.
Stockholders’ equity divided by total liabilities
b.
Average total assets divided by stockholders’ equity
c.
Average total assets divided by total liabilities
d.
Total liabilities divided by stockholders’ equity
52. The number of days’ sales uncollected is determined by dividing
a.
the number of days in a year by average accounts receivable.
b.
sales by average accounts receivable.
c.
the number of days in a year by the receivable turnover.
d.
net income by average accounts receivable.
53. Days’ payable is a measure of
a.
volatility.
b.
long-term solvency.
c.
profitability.
d.
operating asset management.
54. Cash flows to sales and cash flows to assets are measured in terms of
a.
times.
b.
a percentage.
c.
dollars.
d.
days.
55. Which of the following is a leverage ratio?
a.
Return on equity
b.
Dividends yield
c.
Debt to equity ratio
d.
Payables turnover
56. Which of the following is not a profitability ratio?