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Analysis Of Financial Statements

Instructions:

Answer 50 questions in 15 minutes.
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Match each statement with the correct term.
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This is a study tool. The 3 wrong answers for each question are randomly chosen from answers to other questions. So, you might find at times the answers obvious, but you will see it re-enforces your understanding as you take the test each time.

1. The ___________________________tells us how efficiently the firm converts inventory to sales.
Debt = $500000 assets - $200000 equity = $300000 $300000 debt
Inventory turnover ratio
X/2044000 = .3390 x(debt) = 692 -916 - Debt/Equity = 692 -916/1351000 = 51%.
Current assets - inventory = $50000 - (.5

2. What is a financial ratio?
The leverage effect is a result of debt on the balance sheet. By using borrowed funds - the firm can increase its ROE.
A financial ratio is a number that expresses the value of one financial variable relative to another. Put more simply - a financial ratio is the result you get when you divide one financial number by another. Calculating an individual ratio is simple
Return on Equity = Earnings Available to Common Stockholders / Common Equity
Credit sales = $4000000

3. Given $20 million in total assets - $14 million in total stockholders' equity - and a debt to total asset ratio of 30 percent for Folson Corporation - what will be the debt to equity ratio?
Total Debt = 0.30 X $20000000 = $6000000 - Debt to Equity ratio = $6000000/$14000000 = 0.43
Current ratio
Du Pont Equation: Return on Assets = Net Profit Margin x Total Asset Turnover
Trend analysis uses ratios to compare a firm's past and present performance.

4. Explain how financial ratio analysis helps financial managers assess the health of a company.
P/E = Market Price per Share / Earnings per Share
Trend analysis uses ratios to compare a firm's past and present performance.
Financial ratios are numbers that express the value of one financial variable relative to another. They are comparative measures because they show relative value and allow the financial analysts to compare information that could not be compared in it
Economic Value Added (EVA) measures the amount of profit remaining after accounting for the return expected by the firm's investors and is said to be an ?estimate of the true economic profit.

5. The ___________________________measures how efficiently a firm utilizes its assets.
Trend analysis
Total asset turnover Ratio
Quick Ratio = Current Assets Less Inventory / Current Liabilities
($100000 current assets - inventory)

6. Explain trend analysis.

7. The difference between the firm's future earnings and liquidation value is the _____________________ of the firm.
Industry analysis
Going concern value
Return on Assets = 0.20 X 0.25 = 0.05 = 5%
Net Profit Margin = Earnings Available to Common Stockholders / Sales

8. The ___________________compares all the current assets of the firm to all the company's current liabilities.
Return on Assets = Earnings Available to Common Stockholders / Total Assets
The Market to Book ratio is useful - but it is only a rough approximation of how liquidation and going concern values compare. This is because the Market to Book ratio uses accounting-based book values. The actual liquidation value of a firm is likel
It enables the investors to see whether the income earned was sufficient to cover their expected return. It is an estimate of the amount that earnings exceed or fall short of the required minimum rate of return investors could get investing in other
Current ratio

9. How do you calculate the debt to total assets? (This is a Debt Ratio)
Return on Assets = Earnings Available to Common Stockholders / Total Assets
Both focus on the value of the stock: MVA focuses on total market value while M/B focuses on per share stock price and both focus on total invested capital.
Debt to Total Assets = Total Debt / Total Assets
Trend analysis

10. In the modified Du Pont equation - ROE is the product of net profit margin - total asset turnover - and the ________________________.
Equity multiplier
Current Ratio = Current Assets / Current Liabilities
EVA = EBIT(1-TR) - (IC x Ka) - Where: EBIT = earnings before interest and taxes - TR = the effective or average income tax rate - IC = invested capital - Ka = investors' required rate of return on their investment.
Sales

11. How do you calculate return on assets? (This is a Profitability Ratio)
Ratios are comparative measures. Because the ratios show relative value - they allow financial analysts to compare information that could not be compared in its raw form. For example - ratios may be used to compare one ratio to a related ratio - a fi
Return on Assets = Earnings Available to Common Stockholders / Total Assets
The Du Pont System of ratio analysis examines the relationships between ratios.
Economic Value Added (EVA) measures the amount of profit remaining after accounting for the return expected by the firm's investors and is said to be an ?estimate of the true economic profit.

12. Jumbo Corp has a quick ratio value of 1.5. It has total current assets of $100000 and total current liabilities of $25000. If sales are $200000 - What is the value of the inventory turnover ratio?
M/B = Market Price per Share / Book Value per Share
Market Value Added (MVA) is the market value of the firm - debt plus equity - minus the total amount of capital invested in the firm and is similar to the market to book (M/B) ratio. MVA - however focuses on total market value and total invested capi
Current Ratio = Current Assets / Current Liabilities
($100000 current assets - inventory)

13. How do you calculate times interest earned? (This is a Debt Ratio)
Economic Value Added (EVA) measures the amount of profit remaining after accounting for the return expected by the firm's investors and is said to be an ?estimate of the true economic profit.
Times Interest Earned = EBIT / Interest Expense
Actually - an analyst would not use the Modified Du Pont equation to calculate ROE for precisely the reason stated above. What an analyst would use the Modified Du Pont equation for is to help analyze the factors that contribute to a firm's ROE. In o
Profitability ratios measure how much company revenue is eaten up by expenses - how much a company earns relative to sales generated - and the amount earned relative to the value of the firm's assets and equity.

14. What is meant by the leverage effect?
Cross-sectional analysis
The leverage effect is a result of debt on the balance sheet. By using borrowed funds - the firm can increase its ROE.
Current liabilities = $200000 total assets - $180000 LTD & CS = $20000 $50000 current assets
Market to book value ratio

15. What are ratios used to compare?

16. What do liquidity ratios measure?
Average collection period
Liquidity Ratios measure the ability of a firm to meet its short-term obligations.
Modified Du Pont Equation: ROE = Net Profit Margin x Total Asset Turnover x Equity Multiplier
Ratios are comparative measures. Because the ratios show relative value - they allow financial analysts to compare information that could not be compared in its raw form. For example - ratios may be used to compare one ratio to a related ratio - a fi

17. ________ uses computed ratio values for several time periods and compares them.
Trend analysis helps financial managers and analysts see whether a company's current financial situation is improving or deteriorating. - Cross-sectional analysis - or industry comparison - allows analysts to put the value of a firm's ratios in the c
Total Debt = 0.30 X $20000000 = $6000000 - Debt to Equity ratio = $6000000/$14000000 = 0.43
Credit sales = $4000000
Trend analysis

18. How do you calculate gross profit margin? (This is a Profitability Ratio)
Net Profit Margin = Earnings Available to Common Stockholders / Sales
It enables the investors to see whether the income earned was sufficient to cover their expected return. It is an estimate of the amount that earnings exceed or fall short of the required minimum rate of return investors could get investing in other
Gross Profit Margin = Gross Profit / Sales
A mixed ratio is a ratio that uses both income statement and balance sheet variables as inputs.

19. Under what circumstances would market to book value ratios be misleading? Explain.
Bankers and other lenders use liquidity ratios to see whether to extend short-term credit to a firm. Liquidity ratios measure the ability of a firm to meet its short-term obligations. These ratios are important because failure to pay such obligations
Going concern value
The Market to Book ratio is useful - but it is only a rough approximation of how liquidation and going concern values compare. This is because the Market to Book ratio uses accounting-based book values. The actual liquidation value of a firm is likel
Operating Profit Margin = Earnings before Interest and Taxes / Sales

20. How do you calculate net profit margin? (This is a Profitability Ratio)
Industry analysis
Net Profit Margin = Earnings Available to Common Stockholders / Sales
Du Pont Equation: Return on Assets = Net Profit Margin x Total Asset Turnover
X/2044000 = .3390 x(debt) = 692 -916 - Debt/Equity = 692 -916/1351000 = 51%.

21. Boca Corporation has a return on assets ratio of 6 percent. If the debt to total assets ratio is .5 - What is the firm's return on equity?
Inventory turnover ratio
Debt
Market to book value ratio
Inventory Turnover = Sales / Inventory

22. What do market value ratios measure?

23. The ___________________________is the market price per share of a company's common stock divided by the accounting book-value-per-share ratio.
Liquidity Ratios measure the ability of a firm to meet its short-term obligations.
Debt to Equity = Total Debt / Equity
The quick ratio is similar to the current ratio but is a more rigorous measure of liquidity because it excludes inventory from current assets.
Market to book value ratio

24. Why are M/B and MVA highly correlated?
Both focus on the value of the stock: MVA focuses on total market value while M/B focuses on per share stock price and both focus on total invested capital.
Market Value Ratios measure the market's perception of the future earning power of a company as reflected in the stock share price.
Du Pont Equation: Return on Assets = Net Profit Margin x Total Asset Turnover
Debt to equity ratio

25. How do you calculate the current ratio? (This is a Liquidity Ratio)
Current Ratio = Current Assets / Current Liabilities
EVA = EBIT(1-TR) - (IC x Ka) - Where: EBIT = earnings before interest and taxes - TR = the effective or average income tax rate - IC = invested capital - Ka = investors' required rate of return on their investment.
Current assets - inventory = $50000 - (.5
P/E = Market Price per Share / Earnings per Share

26. Given $2 -044000 in total assets - $1 -351000 in total stockholders' equity - and debt-to-total-asset ratio of 33.90% - calculate the debt to equity ratio.
It enables the investors to see whether the income earned was sufficient to cover their expected return. It is an estimate of the amount that earnings exceed or fall short of the required minimum rate of return investors could get investing in other
Current assets - inventory = $50000 - (.5
X/2044000 = .3390 x(debt) = 692 -916 - Debt/Equity = 692 -916/1351000 = 51%.
Current liabilities = $200000 total assets - $180000 LTD & CS = $20000 $50000 current assets

27. If the net profit margin of Dobie's Dog Hotel is maintained at 20 percent and total asset turnover ratio is .25 - calculate return on assets.
Return on Assets = 0.20 X 0.25 = 0.05 = 5%
Trend analysis
Gross Profit Margin = Gross Profit / Sales
Debt = $500000 assets - $200000 equity = $300000 $300000 debt

28. One way to judge whether a firm's ratio is too high or too low is to compare it to the ratios of other firms in the industry. This is sometimes called ____________.
Inventory Turnover = 5000000/3000000 = 1.67
Industry analysis
Cross-sectional analysis
($100000 current assets - inventory)

29. The ____________________________measures the average return on the firm's capital contributions from its owners.
Return on equity
Net profit margin
Credit sales = $4000000
Du Pont Equation: Return on Assets = Net Profit Margin x Total Asset Turnover

30. How do you calculate the du pont system of ratio analysis?
A mixed ratio is a ratio that uses both income statement and balance sheet variables as inputs.
Debt
Total Debt = 0.30 X $20000000 = $6000000 - Debt to Equity ratio = $6000000/$14000000 = 0.43
Du Pont Equation: Return on Assets = Net Profit Margin x Total Asset Turnover

31. If total assets are $20 million - noncurrent assets are $2 million - inventory is $3 million - and sales are $5 million for Toronto Brewing Company - what is the inventory turnover ratio?
Actually - an analyst would not use the Modified Du Pont equation to calculate ROE for precisely the reason stated above. What an analyst would use the Modified Du Pont equation for is to help analyze the factors that contribute to a firm's ROE. In o
A mixed ratio is a ratio that uses both income statement and balance sheet variables as inputs.
It enables the investors to see whether the income earned was sufficient to cover their expected return. It is an estimate of the amount that earnings exceed or fall short of the required minimum rate of return investors could get investing in other
Inventory Turnover = 5000000/3000000 = 1.67

32. How do you calculate inventory turnover? (This is an Asset Activity Ratio)
Ratios are comparative measures. Because the ratios show relative value - they allow financial analysts to compare information that could not be compared in its raw form. For example - ratios may be used to compare one ratio to a related ratio - a fi
Inventory Turnover = Sales / Inventory
Market Value Ratios measure the market's perception of the future earning power of a company as reflected in the stock share price.
Du Pont Equation: Return on Assets = Net Profit Margin x Total Asset Turnover

33. Which ratios would a banker be most interested in when considering whether to approve an application for a short-term business loan? Explain.
Du Pont Equation: Return on Assets = Net Profit Margin x Total Asset Turnover
Operating Profit Margin = Earnings before Interest and Taxes / Sales
Average Collection Period = Accounts Receivable / Average Daily Credit Sales
Bankers and other lenders use liquidity ratios to see whether to extend short-term credit to a firm. Liquidity ratios measure the ability of a firm to meet its short-term obligations. These ratios are important because failure to pay such obligations

34. Why are trend analysis and industry comparison important to financial ratio analysis?

35. How do you calculate the modified du pont equation?
Average collection period
Modified Du Pont Equation: ROE = Net Profit Margin x Total Asset Turnover x Equity Multiplier
Credit sales = $4000000
Return on Assets = Earnings Available to Common Stockholders / Total Assets

36. How do you calculate P/E? (This is a Market Value Ratio)
Total asset turnover Ratio
P/E = Market Price per Share / Earnings per Share
Trend analysis
Return on equity

37. The ___________________________is the percentage of debt relative to the amount of equity of the firm.
Liquidity Ratios measure the ability of a firm to meet its short-term obligations.
Debt to equity ratio
It enables the investors to see whether the income earned was sufficient to cover their expected return. It is an estimate of the amount that earnings exceed or fall short of the required minimum rate of return investors could get investing in other
Total Debt = 0.30 X $20000000 = $6000000 - Debt to Equity ratio = $6000000/$14000000 = 0.43

38. Umbrella Company has total sales of $4 million. One-fourth of these are credit sales. The amount of accounts receivable is $100000. What is the average collection period for the company? Use a 365-day year.
Industry analysis
Credit sales = $4000000
Return on equity
The Du Pont System of ratio analysis examines the relationships between ratios.

39. How do you calculate the average collection period? (This is an Asset Activity Ratio)
Return on Equity = Earnings Available to Common Stockholders / Common Equity
Total asset turnover Ratio
Debt to Equity = Total Debt / Equity
Average Collection Period = Accounts Receivable / Average Daily Credit Sales

40. Which ratios would a potential long-term bond investor be most interested in? Explain.

41. What is market value added (MVA)?
Market Value Added (MVA) is the market value of the firm - debt plus equity - minus the total amount of capital invested in the firm and is similar to the market to book (M/B) ratio. MVA - however focuses on total market value and total invested capi
The Du Pont System of ratio analysis examines the relationships between ratios.
Total asset turnover Ratio
Both focus on the value of the stock: MVA focuses on total market value while M/B focuses on per share stock price and both focus on total invested capital.

42. Malpaso Company has current assets of $50000. Total assets are $200000; and longterm liabilities and common stock collectively total $180000. What is the value of the current ratio?
($100000 current assets - inventory)
Current liabilities = $200000 total assets - $180000 LTD & CS = $20000 $50000 current assets
Market to book value ratio
Asset Activity Ratios measure how efficiently a firm uses its assets.

43. What does the du pont system of ratio analysis examine?
Inventory Turnover = 5000000/3000000 = 1.67
Debt to equity ratio
The Du Pont System of ratio analysis examines the relationships between ratios.
Bankers and other lenders use liquidity ratios to see whether to extend short-term credit to a firm. Liquidity ratios measure the ability of a firm to meet its short-term obligations. These ratios are important because failure to pay such obligations

44. How do you calculate the debt to equity? (This is a Debt Ratio)
Credit sales = $4000000
Debt to Equity = Total Debt / Equity
Total Debt = 0.30 X $20000000 = $6000000 - Debt to Equity ratio = $6000000/$14000000 = 0.43
Trend analysis uses ratios to compare a firm's past and present performance.

45. How do you calculate M/B (market to book ratio)? (This is a Market Value Ratio)
Economic Value Added (EVA) measures the amount of profit remaining after accounting for the return expected by the firm's investors and is said to be an ?estimate of the true economic profit.
The Market to Book ratio is useful - but it is only a rough approximation of how liquidation and going concern values compare. This is because the Market to Book ratio uses accounting-based book values. The actual liquidation value of a firm is likel
Financial ratios are numbers that express the value of one financial variable relative to another. They are comparative measures because they show relative value and allow the financial analysts to compare information that could not be compared in it
M/B = Market Price per Share / Book Value per Share

46. What is a mixed ratio?
A mixed ratio is a ratio that uses both income statement and balance sheet variables as inputs.
Current and potential lenders of long-term funds - such as banks and bondholders - are interested in debt ratios. When a business's debt ratios increase significantly - bondholder and lender risk increases because more creditors compete for that firm
Market to book value ratio
Return on Assets = Earnings Available to Common Stockholders / Total Assets

47. Why do analysts calculate financial ratios?
Liquidity Ratios measure the ability of a firm to meet its short-term obligations.
Financial ratios are numbers that express the value of one financial variable relative to another. They are comparative measures because they show relative value and allow the financial analysts to compare information that could not be compared in it
Inventory Turnover = Sales / Inventory
Ratios are comparative measures. Because the ratios show relative value - they allow financial analysts to compare information that could not be compared in its raw form. For example - ratios may be used to compare one ratio to a related ratio - a fi

48. What does economic value added (EVA) measure?

49. How do you calculate EVA?

50. How do you calculate total asset turnover? (This is an Asset Activity Ratio)
Sales
Net profit margin
Total Asset Turnover = Sales / Total Assets
Current Ratio = Current Assets / Current Liabilities