Financial Statement Analysis Quiz
48 Questions
0 Views

Choose a study mode

Play Quiz
Study Flashcards
Spaced Repetition
Chat to lesson

Podcast

Play an AI-generated podcast conversation about this lesson

Questions and Answers

What is the main purpose of financial statement analysis?

  • To assess a company's financial health and performance (correct)
  • To generate financial statements for external stakeholders
  • To prepare taxation documents for businesses
  • To evaluate a company's historical share price trends

    • Which technique would be most beneficial for comparing financial statements of different companies?

  • Gross profit variance analysis
  • Horizontal analysis
  • Vertical analysis (correct)
  • Financial ratios

    • Which of the following correctly describes vertical analysis?

  • It compares financial statements over multiple years only.
  • It expresses each line item as a percentage of a base amount. (correct)
  • It requires multiple base amounts for analysis.
  • It focuses solely on profit margins.

    • What is one benefit of using vertical analysis?

    <p>It simplifies comparisons across different time periods.</p> Signup and view all the answers

    Which aspect of financial health can vertical analysis help evaluate?

    <p>The relationships between different components of financial statements</p> Signup and view all the answers

    In financial statement analysis, cash flow analysis primarily focuses on which of the following?

    <p>The liquidity and solvency of the firm</p> Signup and view all the answers

    What does horizontal analysis typically evaluate?

    <p>Performance over different time periods</p> Signup and view all the answers

    Which stakeholder would be least likely to benefit from financial statement analysis?

    <p>Competitors seeking market share analysis</p> Signup and view all the answers

    Which ratio indicates the proportion of total liabilities to total equity?

    <p>Debt-Equity Ratio</p> Signup and view all the answers

    How is the Average Age of Trade Payables calculated?

    <p>Days in a Year / Payables Turnover</p> Signup and view all the answers

    Which of the following ratios measures the efficiency of a firm in generating earnings from each ordinary share?

    <p>Earnings Per Share</p> Signup and view all the answers

    What is the formula for calculating Times Interest Earned?

    <p>EBIT / Interest Expense</p> Signup and view all the answers

    Which formula computes the Financial Leverage?

    <p>Return on Assets compared to Fixed Rate of Return on Borrowed Funds</p> Signup and view all the answers

    Which ratio indicates how well a company can cover its fixed charges?

    <p>Times Fixed Charges Earned</p> Signup and view all the answers

    Which of the following ratios measures the ability of a firm to meet its short-term liabilities?

    <p>Defensive Interval Ratio</p> Signup and view all the answers

    How is the Return on Assets calculated when measuring total management effort?

    <p>Net Income / Average Total Assets</p> Signup and view all the answers

    Which of the following indicates the number of years needed to recover an investment in fixed assets?

    <p>Sales to Fixed Assets Ratio</p> Signup and view all the answers

    What does the Payable Turnover ratio measure?

    <p>Speed of paying suppliers</p> Signup and view all the answers

    What information does the Dividend Pay-Out Ratio provide?

    <p>Proportion of income distributed as dividends</p> Signup and view all the answers

    Which ratio indicates the proportion of fixed assets financed by long-term liabilities?

    <p>Fixed Assets to Long-term Liabilities Ratio</p> Signup and view all the answers

    What does the Cash Flow Margin measure?

    <p>Ability to convert sales into cash</p> Signup and view all the answers

    Which of the following describes the Current Assets Turnover ratio?

    <p>Cost of Goods Sold + Cash Operating Expenses Related to Current Assets / Average Current Assets</p> Signup and view all the answers

    Which element is NOT included in the calculation of Free Cash Flow?

    <p>Sales revenue</p> Signup and view all the answers

    Which ratio reflects the rate of return on equity generated by a company?

    <p>Return on Equity</p> Signup and view all the answers

    What does the Capital Intensity Ratio indicate?

    <p>Efficiency of generating sales through assets employed</p> Signup and view all the answers

    What type of variance does a change in unit cost represent in gross profit variance analysis?

    <p>Cost Price Variance</p> Signup and view all the answers

    What does a negative Additional Funds Needed (AFN) signify?

    <p>Capital surplus available</p> Signup and view all the answers

    Which factor does NOT influence the change in a company's gross profit?

    <p>Interest rates</p> Signup and view all the answers

    How is the Rate of Return on Average Current Assets calculated?

    <p>Net Income / Average Current Assets</p> Signup and view all the answers

    Which part of Free Cash Flow reflects the impact of non-cash charges on cash generation?

    <p>NCC (Non-Cash Charges)</p> Signup and view all the answers

    What does an increase in retained earnings indicate in the AFN formula?

    <p>Increased sales profit margin</p> Signup and view all the answers

    Which metric closely examines how effectively a company can manage its finances?

    <p>Cash Flow Analysis</p> Signup and view all the answers

    Which factor primarily determines the sales volume variance?

    <p>Difference in actual versus expected sales volume</p> Signup and view all the answers

    What does Operating Profit Margin assess?

    <p>Profitability after operating costs</p> Signup and view all the answers

    What is a primary purpose of horizontal analysis?

    <p>To compare financial statements over time</p> Signup and view all the answers

    Which of the following statements about trend percentages is true?

    <p>They express percentage change relative to a base period.</p> Signup and view all the answers

    What is the consequence of using an incorrectly chosen base period in horizontal analysis?

    <p>It can lead to misinterpretations of financial performance.</p> Signup and view all the answers

    Which measure would best assess a company's ability to meet short-term obligations?

    <p>Current Ratio</p> Signup and view all the answers

    What is a significant limitation of vertical analysis?

    <p>It does not consider the absolute size of the company.</p> Signup and view all the answers

    How does index analysis differ from trend percentages?

    <p>Index analysis begins at a base value of 100.</p> Signup and view all the answers

    Which formula represents the Quick Ratio?

    <p>Quick Assets / Current Liabilities</p> Signup and view all the answers

    What is necessary when calculating financial ratios using balance sheet numbers?

    <p>Both must be from the same balance sheet date.</p> Signup and view all the answers

    Which of the following is NOT a type of activity ratio?

    <p>Current Ratio</p> Signup and view all the answers

    What does the Average Age of Receivables indicate?

    <p>The average duration for collecting receivables.</p> Signup and view all the answers

    Which formula correctly calculates Average Age of Inventory?

    <p>360 or 365 days / Inventory Turnover</p> Signup and view all the answers

    What is one benefit of horizontal analysis?

    <p>It allows year-over-year trend identification.</p> Signup and view all the answers

    What is the primary utility of financial ratios?

    <p>To assess performance against industry standards.</p> Signup and view all the answers

    What is typically expressed as an average when calculating growth ratios?

    <p>Balance sheet accounts when using income statements.</p> Signup and view all the answers

    Study Notes

    Financial Statement Analysis

    • Financial statement analysis is the process of examining and interpreting financial statements to assess a company’s financial health and performance
    • The analysis provides information about:
      • Profitability of the business entity
      • Ability to meet business obligations
      • Safety of investment in the business
      • Effectiveness of management in running the firm
    • Common techniques include:
      • Vertical analysis
      • Horizontal analysis (trend or index analysis)
      • Financial ratios
      • Gross profit variance analysis
      • Cash flow analysis

    Vertical Analysis

    • Also known as common-size analysis and expresses each line item in a financial statement as a percentage of a base amount
    • Typically total sales for the income statement and total assets for the balance sheet
    • Useful tool for comparing financial statements of different companies or of the same company over time
    • Expresses all line items as percentages, making it easier to see how the different components of a financial statement relate to each other and to identify trends over time
    • Benefits:
      • Makes it easier to compare financial statements of different companies or of the same company over time
      • Helps to identify trends over time
      • Can help to identify areas where a company may be overspending or underperforming
    • Drawbacks:
      • Can be difficult to interpret if the base amount is not chosen carefully
      • Does not take into account the absolute size of the company

    Horizontal Analysis

    • Compares financial statements of a company over time
    • Calculates the percentage change in each line item from one period to the next
    • Used to identify trends in a company’s financial performance
    • Trend percentages: express the percentage change in each line item from one period to the next, relative to the base period (typically the first period being analyzed)
    • Index analysis: expresses the percentage change in each line item from one period to the next, relative to a base value of 100
    • Benefits:
      • Can be used to identify trends in a company’s financial performance
      • Can help to identify areas where a company may be overspending or underperforming
      • Can be used to compare the financial performance of a company to its peers or to industry standards
    • Drawbacks:
      • Can be difficult to interpret if the base period is not chosen carefully
      • Does not take into account the absolute size of the company

    Financial Ratios

    • Compare a company’s financial performance to its peers or to industry standards
    • Calculated by dividing one financial statement item by another
    • Used to assess a company’s liquidity, solvency, activity, profitability, growth, and other aspects of its financial health

    Types of Financial Ratios

    Liquidity Ratios
    • Measure a company’s ability to meet its short-term financial obligations
    • Common liquidity ratios:
      • Current Ratio/Banker’s Ratio/Working Capital Ratio – primary test of liquidity to meet current obligations from current assets (Current Ratio = Current Assets / Current Liabilities)
      • Quick Ratio/Acid Test Ratio – measures the number of times the current liabilities could be paid with available cash and near-cash assets (e.g., cash, current receivables and marketable securities) (Quick Ratio = Quick Assets / Current Liabilities)
    Activity/Efficiency Ratios
    • Measure how efficiently a company is using its assets
    • Common activity ratios:
      • Receivables Turnover – number of times that receivables are collected during the period (Accounts Receivable Turnover = Net Credit Sales / Average Receivables)
      • Average Age of Receivables/Average Collection Period/Days’ Sales in Receivables – average number of days during which the company must wait before receivables are collected (Average Age of Receivables = 360 or 365 days / Receivables Turnover)
      • Inventory Turnover – number of times that the inventory is replaced during the period (Inventory Turnover = Cost of Goods Sold / Average Inventory)
      • Average Age of Inventory/ Inventory Conversion Period /Days’ Sales in Inventory/Average Sales Period – average number of days during which the company must wait before the inventories are sold (Average Age of Inventory = 360 or 365 days / Inventory Turnover)
      • Average Age of Trade Payables/Payable Deferral Period/Days’ Purchases in Payables – length of time during which payables remain unpaid (Average Age of Trade Payables = 360 or 365 days / Payables Turnover)
      • Current Assets Turnover – movement and utilization of current assets to meet operating requirements (Current Assets Turnover = Cost of Goods Sold + Cash Operating Expenses Related to Current Assets / Average Current Assets)
      • Operating Cycle (Calculated by adding average age of inventory and average age of receivables)
    Leverage/Solvency Ratios
    • Measure the extent of a firm’s financing, with debt relative to equity and its ability to cover interest and other fixed charges such as rent and sinking fund contributions
    • Additionally, these ratios measure the ability of the enterprise to survive over a long period of time
    • Common solvency ratios:
      • Times Interest Earned – determines the extent to which operations cover interest expense (Times Interest Earned = EBIT / Interest Expense)
      • Debt-Equity Ratio – proportion of assets provided by creditors compared to that provided by shareholders (Debt-Equity Ratio = Total Liabilities / Total Shareholders’ Equity)
      • Debt Ratio – proportion of assets provided by creditors (Debt Ratio = Total Liabilities / Total Assets)
      • Equity Ratio – proportion of assets provided by shareholders (Equity Ratio = Total Shareholders’ Equity / Total Assets)
      • Financial Leverage – acquiring assets with funds at a fixed rate of interest or dividend (Positive Financial Leverage if Return on Assets > Fixed Rate of Return on Borrowed Funds; Negative Financial Leverage if Return on Assets < Fixed Rate of Return on Borrowed Funds)
    Profitability Ratios
    • Measure the overall performance of the firm and its efficiency managing assets, liabilities, and owners’ equity
    • Common profitability ratios:
      • Return on Sales – portion of sales that went into company’s earnings (Return on Sales = Net Income / Net Sales)
      • Return on Assets – efficiency with which assets are used to operate the business (Return on Assets – operational performance = EBIT / Average Total Assets or Net Income + after-tax interest / Average Total Assets)
      • Return on Equity – amount earned on the owners’ or shareholders’ investment (Return on Equity = Net Income / Average Equity)
      • Earnings Per Share (EPS) – amount of net income earned by each ordinary share (EPS = Net Income – Preferred Dividends / Weighted Average Ordinary Shares Outstanding)
    Market Ratios
    • Type of financial ratio that compares a company’s stock price to its financial performance
    • Used to assess a company’s valuation and to compare its stock price to the stock prices of its peers
    • Common market ratios:
      • Price-Earnings (P/E) Ratio – number of pesos required to buy P1 or earnings (P/E Ratio = Price Per Share / Earnings Per Share)
      • Dividend Yield Ratio – rate of return in the investor’s Ordinary Share/ordinary share investments (Dividend Yield = Dividend Per Share / Price Per Share)
      • Dividend Pay-Out Ratio – proportion of earnings distributed as dividends (Dividend Pay-Out = Common Dividend Per Share / Earnings Per Share)

    Other Meaningful Ratios:

    • Fixed Assets to Total Equity Ratio – proportion of fixed assets to shareholders’ equity (Fixed Assets to Total Equity Ratio = Fixed Assets / Total Equity)
    • Fixed Assets to Total Assets Ration – possible over-expansion of plant and equipment (Fixed Assets to Total Assets Ratio = Fixed Assets / Total Assets)
    • Sales to Fixed Assets Ratio/ Plant Turnover – efficiency of management in keeping plant assets employed (Sales to Fixed Assets Ratio = Net Sales / Net Fixed Assets)
    • Book Value Per Share - Ordinary Share – recoverable amount by Ordinary Shareholders in the event of liquidation if assets are realized at their book values (Book Value Per Share - Ordinary Share = Ordinary Shareholders’ Equity / Common Shares Outstanding)
    • Times Preferred Dividend Earned – ability to provide dividends to preferred stockholders (Times Preferred Dividend Earned = Net Income After Taxes / Preferred Dividends)
    • Capital Intensity Ratio – efficiency of the firm to generate sales through employment of its resources (Capital Intensity Ratio = Total Assets / Net Sales)
    • Times Fixed Charges Earned – ability to meet fixed charges (Times Fixed Charges Earned = Net Income Before Taxes and Fixed Charges / Fixed Charges + Sinking Fund Payments)
    • Working Capital Turnover – adequacy of working capital to support operation (sales) (Working Capital Turnover = Net Sales / Average Working Capital)
    • Defensive Interval Ratio – coverage of current liabilities (Defensive Interval Ratio = Current Liabilities / Cash and Cash Equivalent)
    • Payable Turnover – efficiency of the company in meeting the accounts payable (Payable Turnover = Net Purchases / Average Accounts Payable)
    • Fixed Assets to Long-term Liabilities Ratio – extent of the utilization of resources from long-term debt (Fixed Assets to Long-term Liabilities Ratio = Fixed Assets / Long-term Liabilities)
    • Rate of Return on Average Current Asset – profitability of current assets invested (Rate of Return on Average Current Asset = Net Income / Average Current Assets)
    • Operating Profit Margin – profit generated after consideration of operating costs (Operating Profit Margin = Operating Profit / Net Sales)
    • Cash Flow Margin – ability of the firm to translate sales to cash (Cash Flow Margin = Operating Cash Flow / Net Sales)

    Cash flow analysis

    • Assesses a company’s financial health by examining its cash flows
    • Cash flow is the lifeblood of any business
    • Free cash flow is a measure of a company’s ability to generate cash after taking into account its operating, investing, and financing activities
    • Free cash flow shows how much cash the company has available to invest in its business or to return to its shareholders
    • Free cash flow = NI + NCC + [Int ×(1 − tax rate)] − FCInv − WCInv
      • NI = net income
      • NCC = non cash charges (e.g., depreciation and change in deferred taxes)
      • Int = interest expense
      • FCInv = fixed capital investment (capital expenditures)
      • WCInv = working capital investment

    Gross profit variance analysis

    • Identifies the factors that have caused changes in a company’s gross profit
    • Valuable tool for managers to understand how their company is performing and to make informed decisions about pricing, cost control, and production volume
    • Three main factors that can affect a company’s gross profit:
      • Price – can change due to a number of factors, such as changes in demand, changes in competition, or changes in the cost of materials
      • Cost – can change due to a number of factors, such as changes in the cost of materials, changes in wages, or changes in overhead
      • Volume – can change due to a number of factors, such as changes in demand, changes in marketing, or changes in the economy
    • Gross profit variances can be due to:
      • Change in selling price (Sales price variance)
      • Change in unit cost (Cost price variance)
      • Change in sales volume (Volume variance)

    Additional Funds Needed (AFN)

    • Amount of money that a company must raise from external sources to finance the increase in assets needed to support an increase in sales
    • Also known as external financing needed
    • Assumes that the company’s financial ratios do not change
    • In response to an increase in sales, a company must increase its assets (e.g., PPE, inventories, accounts receivable, etc.)
    • Part of this increase is offset by spontaneous increase in liabilities (e.g., accounts payable, taxes, etc.) and part is offset by increase in retained earnings
    • AFN = Increase in Assets – Spontaneous Increase in Liabilities – Increase in Retained Earnings
      • Increase in Assets = Current level of assets × sales growth rate
      • Spontaneous Increase in Liabilities = Current level of liabilities × sales growth rate
      • Increase in Retained Earnings = New level of sales × profit margin × retention ratio
    • A negative figure AFN means that there is a surplus of capital.

    Studying That Suits You

    Use AI to generate personalized quizzes and flashcards to suit your learning preferences.

    Quiz Team

    Description

    Test your knowledge on financial statement analysis, including key techniques like vertical and horizontal analysis. Understand profitability, investment safety, and management effectiveness through financial ratios and cash flow insights.

    More Like This

    Use Quizgecko on...
    Browser
    Open
    Browser
    Browser