Chapter 17
ANALYSIS OF FINANCIAL STATEMENTS
1. Financial statement analysis is the application of analytical tools to general-purpose
financial statements and related data for making business decisions.
2. Financial statement analysis lessens the need for expert judgment.
3. Financial statement analysis may be used for personal investment decisions.
4. The evaluation of company performance and financial condition includes evaluation of (1)
past and current performance, (2) current financial position, and (3) future performance and
risk.
5. External users of accounting information make the strategic and operating decisions of a
company.
6. One purpose of financial statement analysis for internal users is to provide information
helpful in improving the company’s efficiency and effectiveness in providing products and
services.
7. Evaluation of company performance does not include analysis of (1) past and current
performance, (2) current financial position, and (3) future performance and risk.
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8. A company’s board of directors analyzes financial statements to assess future company
prospects for making operating decisions.
9. Financial analysis only refers to the communication of relevant financial information to
decision makers.
10. Profitability is the ability to generate future revenues and meet long-term obligations.
11. Liquidity and efficiency are considered to be building blocks of financial statement
analysis.
12. Market prospects are the ability to provide financial rewards sufficient to attract and retain
financing.
13. Profitability is the ability to generate positive market expectations.
14. Financial reporting includes not only general purpose financial statements, but also
information from SEC filings, press releases, shareholders’ meetings, forecasts, management
letters, auditor’s reports, and Webcasts.
15. The building blocks of financial statement analysis include (1) liquidity, (2) salability, (3)
solvency, and (4) profitability.
16. General-purpose financial statements include the (1) income statement, (2) balance sheet,
(3) statement of stockholders’ equity (or statement of retained earnings), (4) statement of cash
flows, and (5) notes to these statements.
17. Standards for comparison are necessary when making judgments about a company’s
performance.
18. Standards for comparison when interpreting financial statement analysis include
competitor and industry performance data.
19. Measures taken from a selected competitor or a group of competitors are often excellent
standards of comparison for analysis.
20. Intra-company analysis is based on comparisons with competitors.
21. General standards of comparisons include the 2:1 level for the current ratio and 1:1 level
for the acid-test ratio.
22. Vertical analysis is the comparison of a company’s financial condition and performance
across time.
23. Horizontal analysis is the comparison of a company’s financial condition and performance
to a base amount.
24. Three of the most common tools of financial analysis include horizontal analysis, vertical
analysis, and ratio analysis.
25. A financial statement analysis report helps to reduce uncertainty in business decisions
through a rigorous and sound evaluation.
26. A good financial report does not link interpretations and conclusions of analysis with the
underlying information.
27. A good financial statement analysis report often includes the following sections: executive
summary, analysis overview, evidential matter, assumptions, key factors, and inferences.
28. Earnings per share are calculated only on income from continuing operations.
29. Analysis of a single financial number is often of limited value.
30. Comparative financial statements are reports that show financial amounts placed side by
side in columns on a single statement for analysis purposes.
31. Vertical analysis is used to reveal patterns in data covering successive periods.
32. Trend analysis is a form of horizontal analysis that can reveal patterns in data across
successive periods.
33. Trend analysis of financial statement items can include comparisons of relations between
items on different financial statements.
34. Comparative horizontal analysis is used to reveal patterns in data covering successive
periods.
35. A trend percent, or index number, is calculated by dividing the analysis period amount by
the base period amount and multiplying the result by 100.
36. The percent change is computed by subtracting the analysis period amount from the base
period amount, dividing the result by the base period amount and multiplying that result by
100.
37. Vertical analysis is a tool to evaluate individual financial statement items or groups of
items in terms of a specific base amount.
38. Horizontal analysis is used to reveal changes in the relative importance of each financial
statement item.
39. The base amount for a common-size balance sheet is usually total assets.
40. An advantage of common-size statements is that they reflect the dollar magnitude (size) of
the different companies under analysis.
41. Graphical analysis of the balance sheet can be useful in assessing sources of financing.
42. A corporation reported cash of $14,000 and total assets of $178,300. Its common-size
percent for cash equals 7.85%.
43. A ratio expresses a mathematical relation between two quantities and can be expressed as
a percent, rate, or proportion.
44. Ratios, like other analysis tools, are only historically oriented.
45. Liquidity refers to the availability of resources to meet short-term cash requirements.
46. Working capital is computed as current liabilities minus current assets.
47. The current ratio is calculated as current liabilities divided by current assets.
48. Total asset turnover reflects a company’s ability to use its assets to generate sales and is an
important indication of operating efficiency.
49. Capital structure refers to a company’s long-run financial viability and its ability to cover
long-term obligations.
50. The use of debt is sometimes described as financial leverage because debt can have the
effect of increasing the return on equity.
51. The greater the times interest earned ratio, the greater the risk a company is exposed to.
52. Efficiency refers to how productive a company is in using its assets, and is usually
measured relative to how much revenue is generated from a certain level of assets.
53. The higher the accounts receivable turnover, the less quickly accounts receivable are
collected.
54. A company with a high inventory turnover requires a smaller investment in inventory than
one producing the same sales with a lower turnover.
55. A rough guideline states that for a company with no discounts offered, days’ sales
uncollected should not exceed 1 1/3 times the days in its credit period.
56. A company that has days’ sales uncollected of 30 days and days’ sales in inventory of 18
days implies that inventory will be converted to cash in about 12 days.
57. The return on total assets can be calculated as profit margin times total asset turnover.
58. The return on common stockholder’s equity measures a company’s success in reaching the
goal of earning net income for its owners.
59. A high level of expected risk suggests a low price-earnings ratio.
60. The return on total assets ratio is a profitability measure.
61. A company reports basic earnings per share of $3.50, cash dividends per share of $0.75,
and a market price per share of $64.75. The company’s dividend yield equals 21.4%.
62. Financial statement analysis:
A. Is the application of analytical tools to general-purpose financial statements and related
data for making business decisions.
B. Involves transforming accounting data into useful information for decision-making.
C. Helps users to make better decisions.
D. Helps to reduce uncertainty in decision-making.
E. All of the options are correct.
63. Evaluation of company performance can include comparison and/or assessment of:
A. Past performance.
B. Current performance.
C. Current financial position.
D. Future performance and risk.
E. All of the choices are correct.
64. External users of financial information:
A. Are those individuals involved in managing and operating the company.
B. Include internal auditors and consultants.
C. Are not directly involved in operating the company.
D. Make strategic decisions for a company.
E. Make operating decisions for a company.
65. Internal users of financial information:
A. Are not directly involved in operating a company.
B. Are those individuals involved in managing and operating the company.
C. Include shareholders and lenders.
D. Include directors and customers.
E. Include suppliers, regulators, and the press.
66. The building blocks of financial statement analysis include:
A. Liquidity and efficiency.
B. Solvency.
C. Profitability.
D. Market prospects.
E. All of the choices are building blocks of financial statement analysis.
67. Financial reporting refers to:
A. The application of analytical tools to general-purpose financial statements.
B. The communication of financial information useful for decision making.
C. Financial statements only.
D. Ratio analysis.
E. Profitability.
68. The ability to meet short-term obligations and to efficiently generate revenues is called:
A. Liquidity and efficiency.
B. Solvency.
C. Profitability.
D. Market prospects.
E. Creditworthiness.
69. The ability to generate future revenues and meet long-term obligations is referred to as:
A. Liquidity and efficiency.
B. Solvency.
C. Profitability.
D. Market prospects.
E. Creditworthiness.
70. The ability to provide financial rewards sufficient to attract and retain financing is called:
A. Liquidity and efficiency.
B. Solvency.
C. Profitability.
D. Market prospects.
E. Creditworthiness.
71. The ability to generate positive market expectations is called:
A. Liquidity and efficiency.
B. Liquidity and solvency.
C. Profitability.
D. Market prospects.
E. Creditworthiness.