Chapter 16—Financial Statement Analysis
TRUE/FALSE
1. In horizontal analysis, the base year can be the immediately preceding period, or it can be a period
further in the past.
2. A primary purpose of vertical analysis is to observe trends over a three-year period.
3. Common-size analysis expresses each item in a financial statement as a percent of a base amount.
4. In vertical analysis of the income statement, cost of goods sold is represented by 100%.
5. In vertical analysis of the balance sheet, total liabilities are represented by 100%.
6. In the vertical analysis of a balance sheet, the base for current liabilities is total liabilities.
7. The use of common-size analysis makes comparisons more meaningful because percentages eliminate
the effects of size.
8. Two major forms of common-size analysis are horizontal analysis and vertical analysis.
9. Horizontal analysis involves comparing two or more years’ financial data for a single company.
10. Common-size statements are statements of companies of similar size and operations.
11. An example of horizontal analysis is the increase in cost of goods sold by 25% from 2013 to 2014.
12. For meaningful analysis, ratios should be compared with a standard.
13. Companies in the same industry may use different accounting methods, diminishing the usefulness of
some industrial averages.
14. Small sample sizes for an industrial report rarely cause a comparability problem in using standards.
15. Labor markets can impact industrial statistics and standards.
16. Industrial statistics should be taken as absolute norms as far as standards for comparability.
17. Terms of sale can produce statistical variations among companies within the same industry.
18. A number of online sources contain competitive information on individual company’s ratios.
19. Industrial figures, standards and statistics should be used with so much care that they are not a very
good reference point to compare companies.
20. Liquidity ratios measure the ability of a company to meet its current obligations.
21. The current ratio is a measure of the ability of a company to pay its short-term liabilities out of
short-term assets.
22. The inventory turnover ratio measures the number of days the average balance of accounts receivable
is outstanding before being converted into cash.
23. Inventory turnover is a measure of liquidity that focuses on efficient use of inventory.
24. The quick ratio should be larger than the current ratio.
25. All debt is considered in the computation of the quick ratio.
26. When computing the quick ratio, a short-term note receivable would be included.
27. Jill’s Market has an inventory turnover of 120 times. Scott’s Market has a turnover of 128 times. Scott’s
is more effective in managing inventory.
28. Profitability ratios assess the ability of a company to meets its long- and short-term obligations.
29. The dividend payout ratio is equal to common dividends divided by (Net Income − Preferred
Dividends).
30. Dividing the market price of a share of stock by the earnings per share gives the price-earnings ratio.
MATCHING
Match the classifications of ratios with each description.
a.
Liquidity Ratio
b.
Leverage Ratio
c.
Profitability Ratio
d.
Horizontal Analysis
e.
Trend Analysis
1. Measures the earning ability of a company
2. Measures the ability of a company to meet long and short term obligations
3. Measures the degree of protection provided to company creditors
4. Measures the ability of the company to meet its current obligations
5. Allows evaluation of the extent to which funds are used efficiently
Indicate the type of each ratio listed below.
a.
Liquidity Ratio
b.
Leverage Ratio
c.
Profitability Ratio
6. Current ratio
7. Debt-to-equity ratio
8. Earnings per share
9. Return on sales
10. Dividend payout ratio
11. Inventory turnover ratio
12. Times-interest-earned ratio
13. Return on total assets ratio
14. Debt ratio
15. Price-earnings ratio
Select the ratio that each statement below most properly satisfies.
a.
Dividend yield ratio
b.
Current ratio
c.
Debt ratio
d.
Return on common stockholders’ equity ratio
e.
Times-interest-earned ratio
f.
Quick ratio
g.
Debt-to-equity ratio
h.
Dividend payout ratio
i.
Price-earnings ratio
16. A measure of the company’s ability to pay its short-term liabilities out of short-term assets
17. A measure that compares only the most liquid assets to current liabilities
18. An income statement measure of the ability of a company to service its debts
19. A measure of the degree of protection afforded creditors in case of insolvency
20. A ratio that indicates what proportion of equity and debt the company is using to finance its assets.
21. A measure of the company’s success in earning a return for the common stockholders
22. The relationship between dividends and the market price of a company’s stock
23. A measure viewed by many investors as an important indicator of stock values. It is found by dividing
the market price per share by the earnings per share
24. A measure that tells an investor the proportion of earnings that a company pays in dividends
COMPLETION
1. _________________ expresses a line item as a percentage of some prior-period amount.
2. _____________________ expresses a line item as a percentage of some other line item for the same
period.
3. ____________ are fractions or percentages computed by dividing one account or line-item amount by
another.
4. _________________ measure the ability of a company to meet its current obligations.
5. The measures of the ability of a company to meets its long– and short-term obligations are known as
_______________.
6. For meaningful analysis, ratios should be compared with a ____________.
7. The ________________ is a measure of the ability of a company to pay its short-term liabilities out of
short-term assets.
8. The _________________ is a measure of liquidity that compares only the most liquid assets with
current liabilities.
9. How long it takes a company to turn its receivables into cash is known as the ________________.
10. The _____________________ gives the number of days inventory is held before being sold.
11. The _________________ uses the income statement to assess a company’s ability to service its debt.
12. The ________________ is computed by dividing a company’s total liabilities by its total assets.
13. ______________ and ____________ are the two major sources of capital.
14. The ________________ is calculated by dividing total liabilities by total stockholders’ equity.
15. Creditors would like the debt-to-equity ratio to be _______, indicating that stockholders have financed
most of the assets of the firm.
16. ____________________ represents the percentage of each sales dollar that is left over from net
income after all expenses have been subtracted.
17. The ratios that allow investors, creditors, and managers to evaluate the extent to which invested funds
are being used efficiently are called ____________.
18. A company measures how efficiently it is using its assets by calculating the _______________.
19. The ___________________ is calculated by dividing the market price per share by earnings per share.
20. Investors who prefer gains through appreciation will generally prefer a ___________ payout ratio.
MULTIPLE CHOICE
1. The two major techniques for financial analysis are
a.
horizontal analysis and circular analysis.
b.
receivable analysis and profitability analysis.
c.
vertical analysis and budget analysis.
d.
common-size analysis and ratio analysis.
2. Horizontal analysis is also known as
a.
linear analysis.
b.
vertical analysis.
c.
trend analysis.
d.
budget analysis.
3. Horizontal analysis is a technique for evaluating a series of financial statement data over a period of
time
a.
that has been arranged from the highest amount to the lowest amount.
b.
that has been arranged from lowest amount to the highest amount.
c.
to determine which items are in error.
d.
to determine the amount and/or percentage increase or decrease that has taken place.
4. In horizontal analysis, each item is expressed as a percentage of the
a.
retained earnings figure.
b.
total assets figure.
c.
net income figure.
d.
base year figure.
5. In vertical analysis, line items on the balance sheet are generally expressed as a percentage of
a.
total liabilities.
b.
net income.
c.
total assets.
d.
cost of goods sold.
6. In vertical analysis, line items on the income statement are generally expressed as a percentage of
a.
net income.
b.
net sales.
c.
cost of goods sold.
d.
total assets.
7. Vertical analysis is a technique that expresses each item in a financial statement
a.
in dollars and cents.
b.
as a percent of the item in the previous year.
c.
as a percent of a base amount.
d.
starting with the highest value down to the lowest value.
8. In vertical analysis
a.
a base amount is required.
b.
a base amount is optional.
c.
the same base is used across all financial statements analyzed.
d.
the results of the horizontal analysis are necessary inputs for performing the analysis.
9. The type of analysis that is concerned with the relationships among the components of the financial
statements is to prepare a
a.
vertical analysis.
b.
trend analysis.
c.
profitability analysis.
d.
ratio analysis.
10. Horizontal analysis is analysis
a.
of percentage changes over several years.
b.
in which all items are presented as a percentage of one selected item on a financial
statement.
c.
in which a statistic is calculated for the relationship between two items on a single
financial statement or for two items on different financial statements.
d.
of all ratios that increased or decreased over past accounting periods.
11. Trend analysis is analysis
a.
of percentage changes over several years.
b.
in which all items are presented as a percentage of one selected item on a financial
statement.
c.
in which a statistic is calculated for the relationship between tow items on a single
financial statement or for two items on different financial statements.
d.
of all ratios that increased or decreased over past accounting periods.
12. If year one equals $800,000, year two equals $840,000, and year three equals $896,000, the percentage
to be assigned for year three in a trend analysis, assuming that year 1 is the base year, is
a.
100%.
b.
89%.
c.
105%.
d.
112%.
13. Assume the following sales data for a company:
2014
$1,000,000
2013
900,000
2012
750,000
2008
500,000
If 2008 is the base year, what is the percentage increase in sales from 2008 to 2012?
a.
100%
b.
180%
c.
50%
d.
55.5%
14. Which one of the following is not a characteristic generally evaluated in ratio analysis?
a.
liquidity
b.
profitability
c.
leverage
d.
marketability
15. Many industrial averages and figures are published in the each of the following except?
a.
Key Business Ratios, Dun and Bradstreet
b.
The Almanac of Business and Industrial Financial Ratios, Prentice-Hall
c.
Annual Random Studies, Robert Morris Associates
d.
Standard and Poor’s Industry Survey, Standard & Poor’s
e.
Dow Jones-Irwin Business and Investment Almanac, Dow Jones-Irwin
16. For meaningful analysis, ratios are best compared with
a.
historical company averages.
b.
industrial averages.
c.
historical and industrial averages.
d.
no standard.
17. Short-term creditors are usually most interested in assessing
a.
leverage.
b.
liquidity.
c.
marketability.
d.
profitability.
18. A common measure of liquidity is
a.
return on total assets.
b.
accounts receivable turnover.
c.
return on sales.
d.
debt to equity ratio.
19. The current ratio is a
a.
liquidity ratio.
b.
profitability ratio.
c.
leverage ratio.
d.
cash flow ratio.
20. The quick ratio
a.
is used to quickly determine a company’s leverage and long-term debt-paying ability.
b.
relates cash, marketable securities, and net receivables to current liabilities.
c.
is calculated by taking one item from the income statement and one item from the balance
sheet.
d.
is the same as the current ratio except it is rounded to the nearest whole percent.
21. The accounts receivable turnover and inventory turnover ratios are used to analyze
a.
long-term debt-paying ability.
b.
profitability.
c.
leverage.
d.
liquidity.
22. A high accounts receivable turnover ratio indicates
a.
customers are making payments quickly.
b.
a large portion of the company’s sales are on credit.
c.
many customers are not paying their receivables.
d.
the company’s sales have increased.
23. Which one of the following would not be considered a liquidity ratio?
a.
current ratio
b.
inventory turnover ratio
c.
quick ratio
d.
return on total assets ratio
24. The ratios that are used to determine a company’s short-term debt paying ability are
a.
asset turnover, times interest earned, current ratio, and account receivable turnover.
b.
times interest earned, inventory turnover, current ratio, and accounts receivable turnover.
c.
times interest earned, quick ratio, current ratio, and inventory turnover.
d.
current ratio, quick ratio, accounts receivable turnover, and inventory turnover.
25. Swanson Company had $250,000 of current assets and $90,000 of current liabilities before borrowing
$60,000 from the bank with a 3-month note payable. What effect did the borrowing transaction have
on Swanson Company’s current ratio?
a.
The ratio remained unchanged.
b.
The change in the current ratio cannot be determined.
c.
The ratio decreased.
d.
The ratio increased.
26. If equal amounts are added to the numerator and the denominator of a current ratio equal to one, the
ratio will
a.
increase.
b.
decrease.
c.
remain the same.
d.
equal zero.
27. The quick ratio
a.
does not include inventory as part of the numerator.
b.
does not include all current liabilities in the calculation.
c.
is a quick calculation of an approximation of the current ratio.
d.
includes prepaid expenses as part of the numerator.
28. The inventory turnover is calculated by dividing
a.
cost of goods sold by the ending inventory.
b.
cost of goods sold by the beginning inventory.
c.
cost of goods sold by the average inventory.
d.
average inventory by cost of goods sold.
29. A successful grocery store would probably have
a.
a low inventory turnover.
b.
a high inventory turnover.
c.
zero profit margin.
d.
low volume.
30. An aircraft company would most likely have
a.
a high inventory turnover.
b.
a low profit margin.
c.
high volume.
d.
a low inventory turnover.
31. Which of the following is an example of liquidity analysis?
a.
Bonds payable are divided by total liabilities and stockholders’ equity.
b.
Current assets are divided by current liabilities.
c.
Net income is divided by the number of shares of stock outstanding.
d.
Net income is divided by total assets.
32. Which of the following is considered a liquidity analysis ratio?
a.
return on total assets ratio
b.
quick ratio
c.
dividend yield ratio
d.
return on sales ratio
33. The Gift Shoppe’s inventory turned over five times during the year. Similar gift shops have an
inventory turnover equal to ten times per year. What explains the Gift Shoppe’s inventory
management?
a.
The Gift Shoppe sold too much inventory during the year.
b.
The Gift Shoppe needs to increase sales and decrease the amount of goods on hand.
c.
The Gift Shoppe is performing twice as well as it competitors.
d.
The Gift Shoppe should increase the amount of goods on hand to accommodate the
additional inventory demand.
34. The quick ratio differs from the current ratio in that it
a.
represents the amount of cash on hand instead of the amount of working capital.
b.
is a stricter test of a company’s ability to pay its current debts as they are due.
c.
excludes inventories and accounts receivable from the numerator of the fraction because
of obsolescence and possible default on payment.
d.
is more difficult to calculate.
35. Which of the following formulas would be used to determine the inventory turnover ratio?
a.
Net credit sales/Average inventory
b.
Average inventory/Net credit sales
c.
Cost of goods sold/Average inventory
d.
Average inventory/Cost of goods sold
36. Toller Drug Store had net credit sales of $6,000,000 and cost of goods sold of $2,000,000 for the year.
The Accounts Receivable balances at the beginning and end of the year were $350,000 and $250,000,
respectively. The accounts receivable turnover ratio was
a.
17.1 times.
b.
10.0 times.
c.
13.3 times.
d.
20.0 times.
37. The Grand Department Store had net credit sales of $12,000,000 and cost of goods sold of $8,000,000
for the year. The average inventory for the year amounted to $1,600,000.
The inventory turnover ratio for the year is
a.
4.0 times.
b.
7.2 times.
c.
5.0 times.
d.
2.5 times.
38. A company has an account receivable turnover ratio of 6. The average accounts receivable during the
period are $350,000. What is the amount of net sales for the period?
a.
$350,000
b.
$2,100,000
c.
$58,333
d.
Cannot be determined from the information given.
39. If the accounts receivable turnover is 42 days, what is the account receivable turnover ratio (assuming
a 365 day year)?
a.
7.14 times
b.
8.69 times
c.
4.52 times
d.
None of these
40. Dartmouth Company has a quick ratio of 2.5 to 1. It has current liabilities of $40,000 and noncurrent
assets of $70,000. If Dartmouth‘s current ratio is 3.1 to 1, its inventory and prepaid expenses must be
a.
$12,400.
b.
$24,000.
c.
$30,000.
d.
$40,000.