Analysis Of Financial Statements

Instructions:

• Answer 50 questions in 15 minutes.
• If you are not ready to take this test, you can study here.
• Match each statement with the correct term.
• Don't refresh. All questions and answers are randomly picked and ordered every time you load a test.

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. What is meant by the leverage effect?
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.
The leverage effect is a result of debt on the balance sheet. By using borrowed funds - the firm can increase its ROE.
Quick Ratio = Current Assets Less Inventory / Current Liabilities
Trend analysis


2. How do you calculate total asset turnover? (This is an Asset Activity Ratio)
Return on Equity = Earnings Available to Common Stockholders / Common Equity
Current Ratio = Current Assets / Current Liabilities
Current assets - inventory = $50000 - (.5
Total Asset Turnover = Sales / Total Assets


3. How do you calculate M/B (market to book ratio)? (This is a Market Value Ratio)
Inventory Turnover = 5000000/3000000 = 1.67
Asset Activity Ratios measure how efficiently a firm uses its assets.
Sales
M/B = Market Price per Share / Book Value per Share


4. In the modified Du Pont equation - ROE is the product of net profit margin - total asset turnover - and the ________________________.
Debt to Equity = Total Debt / Equity
Equity multiplier
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


5. What do liquidity ratios measure?
The Du Pont System of ratio analysis examines the relationships between ratios.
Liquidity Ratios measure the ability of a firm to meet its short-term obligations.
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
($100000 current assets - inventory)


6. Under what circumstances would market to book value ratios be misleading? Explain.
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
Credit sales = $4000000
Operating Profit Margin = Earnings before Interest and Taxes / Sales
Debt


7. _________ (Cross-Sectional analysis) judges whether a firm's ratio is too high or too low in comparison with other firms in the industry.
Industry analysis
Debt Ratios assess the relative size of a firm's debt load and the firm's ability to pay off the debt.
Total Debt = 0.30 X $20000000 = $6000000 - Debt to Equity ratio = $6000000/$14000000 = 0.43
($100000 current assets - inventory)


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

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9. What does the du pont system of ratio analysis examine?
Cross-sectional analysis
Net Profit Margin = Earnings Available to Common Stockholders / Sales
The Du Pont System of ratio analysis examines the relationships between ratios.
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.


10. Explain the difference between the current and the quick ratio.
Current liabilities = $200000 total assets - $180000 LTD & CS = $20000 $50000 current assets
The quick ratio is similar to the current ratio but is a more rigorous measure of liquidity because it excludes inventory from current assets.
Modified Du Pont Equation: ROE = Net Profit Margin x Total Asset Turnover x Equity Multiplier
Times Interest Earned = EBIT / Interest Expense


11. The ___________________________tells us how efficiently the firm converts inventory to sales.
Total Debt = 0.30 X $20000000 = $6000000 - Debt to Equity ratio = $6000000/$14000000 = 0.43
Inventory turnover ratio
Credit sales = $4000000
Debt Ratios assess the relative size of a firm's debt load and the firm's ability to pay off the debt.


12. How do you calculate net profit margin? (This is a Profitability Ratio)
Debt
Net Profit Margin = Earnings Available to Common Stockholders / Sales
Inventory Turnover = Sales / Inventory
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


13. Why are M/B and MVA highly correlated?
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
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
Industry analysis


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

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15. The difference between the firm's future earnings and liquidation value is the _____________________ of the firm.
A mixed ratio is a ratio that uses both income statement and balance sheet variables as inputs.
Going concern value
Current assets - inventory = $50000 - (.5
Du Pont Equation: Return on Assets = Net Profit Margin x Total Asset Turnover


16. ________ uses computed ratio values for several time periods and compares them.
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.
Current assets - inventory = $50000 - (.5
Trend analysis
Trend analysis uses ratios to compare a firm's past and present performance.


17. Norman Bates Corporation has total assets of $500000. Its equity is $200000. What is the company's debt to total asset ratio?
Market Value Ratios measure the market's perception of the future earning power of a company as reflected in the stock share price.
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.
Debt = $500000 assets - $200000 equity = $300000 $300000 debt
Return on Equity = Earnings Available to Common Stockholders / Common Equity


18. Explain how financial ratio analysis helps financial managers assess the health of a company.
Market to book value ratio
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
Equity multiplier
Debt to equity ratio


19. How do you calculate times interest earned? (This is a Debt 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
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
Times Interest Earned = EBIT / Interest Expense
Sales


20. How do you calculate operating profit margin? (This is a Profitability 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 liabilities = $200000 total assets - $180000 LTD & CS = $20000 $50000 current assets
Operating Profit Margin = Earnings before Interest and Taxes / Sales
Industry analysis


21. 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.
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
Gross Profit Margin = Gross Profit / Sales
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
Return on Assets = 0.20 X 0.25 = 0.05 = 5%


22. What are debt ratios?

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23. If one-half the current assets in ST-2 consist of inventory - What is the value of the quick ratio?
Return on equity
Current assets - inventory = $50000 - (.5
Trend analysis
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


24. How do you calculate the current ratio? (This is a Liquidity Ratio)
Average Collection Period = Accounts Receivable / Average Daily Credit Sales
Market to book value ratio
Current Ratio = Current Assets / Current Liabilities
Return on Assets = Earnings Available to Common Stockholders / Total Assets


25. How do you calculate inventory turnover? (This is an Asset Activity Ratio)
Inventory Turnover = Sales / Inventory
Modified Du Pont Equation: ROE = Net Profit Margin x Total Asset Turnover x Equity Multiplier
Return on Equity = Earnings Available to Common Stockholders / Common Equity
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.


26. 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?
Times Interest Earned = EBIT / Interest Expense
X/2044000 = .3390 x(debt) = 692 -916 - Debt/Equity = 692 -916/1351000 = 51%.
Inventory Turnover = 5000000/3000000 = 1.67
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


27. How do you calculate gross profit margin? (This is a Profitability Ratio)
Total Asset Turnover = Sales / Total Assets
Total Debt = 0.30 X $20000000 = $6000000 - Debt to Equity ratio = $6000000/$14000000 = 0.43
Asset Activity Ratios measure how efficiently a firm uses its assets.
Gross Profit Margin = Gross Profit / Sales


28. Why do analysts calculate financial ratios?
Credit sales = $4000000
Market Value Ratios measure the market's perception of the future earning power of a company as reflected in the stock share price.
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
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


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

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30. 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?
Modified Du Pont Equation: ROE = Net Profit Margin x Total Asset Turnover x Equity Multiplier
Current Ratio = Current Assets / Current Liabilities
Debt to equity ratio
Debt


31. The ___________________________measures how efficiently a firm utilizes its assets.
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
Total asset turnover 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
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


32. How do you calculate P/E? (This is a Market Value Ratio)
P/E = Market Price per Share / Earnings per Share
The leverage effect is a result of debt on the balance sheet. By using borrowed funds - the firm can increase its ROE.
Debt to Total Assets = Total Debt / Total Assets
Quick Ratio = Current Assets Less Inventory / Current Liabilities


33. 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?
Total asset turnover Ratio
($100000 current assets - inventory)
Operating Profit Margin = Earnings before Interest and Taxes / Sales
Sales


34. Umbrella Corporation has total assets of $5 million and an asset turnover ratio of 4. If net income is $2 million - What is the value of the net profit margin?
Sales
The leverage effect is a result of debt on the balance sheet. By using borrowed funds - the firm can increase its ROE.
Return on Assets = 0.20 X 0.25 = 0.05 = 5%
Total Asset Turnover = Sales / Total Assets


35. 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.
P/E = Market Price per Share / Earnings per Share
Credit sales = $4000000
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
Total Asset Turnover = Sales / Total Assets


36. What is market value added (MVA)?
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.
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
P/E = Market Price per Share / Earnings per Share
Total Asset Turnover = Sales / Total Assets


37. What do profitability ratios measure?

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38. How do you calculate EVA?

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39. 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 ____________.
Cross-sectional analysis
Equity multiplier
Net Profit Margin = Earnings Available to Common Stockholders / Sales
Debt to equity ratio


40. 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.
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.
X/2044000 = .3390 x(debt) = 692 -916 - Debt/Equity = 692 -916/1351000 = 51%.
A mixed ratio is a ratio that uses both income statement and balance sheet variables as inputs.
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


41. The ____________________________measures how much profit out of each sales dollar is left after all expenses are subtracted.
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.
Cross-sectional analysis
Net profit margin
The leverage effect is a result of debt on the balance sheet. By using borrowed funds - the firm can increase its ROE.


42. What are ratios used to compare?

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43. The ___________________compares all the current assets of the firm to all the company's current liabilities.
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
Current assets - inventory = $50000 - (.5
Current ratio
Return on equity


44. How do you calculate the average collection period? (This is an Asset Activity Ratio)
Trend analysis
Credit sales = $4000000
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
Average Collection Period = Accounts Receivable / Average Daily Credit Sales


45. How do you calculate the quick ratio? (This is a Liquidity 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
The leverage effect is a result of debt on the balance sheet. By using borrowed funds - the firm can increase its ROE.
Du Pont Equation: Return on Assets = Net Profit Margin x Total Asset Turnover
Quick Ratio = Current Assets Less Inventory / Current Liabilities


46. What do asset activity ratios measure?
Asset Activity Ratios measure how efficiently a firm uses its assets.
Liquidity Ratios measure the ability of a firm to meet its short-term obligations.
Total Asset Turnover = Sales / Total Assets
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


47. Why is the EVA an important new tool in financial analysis?
Going concern value
Current 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
($100000 current assets - inventory)


48. How do you calculate the modified du pont equation?
Du Pont Equation: Return on Assets = Net Profit Margin x Total Asset Turnover
Modified Du Pont Equation: ROE = Net Profit Margin x Total Asset Turnover x Equity Multiplier
Net Profit Margin = Earnings Available to Common Stockholders / Sales
Inventory Turnover = 5000000/3000000 = 1.67


49. The ___________________________measures how many days - on average - the company's credit customers take to pay their accounts.
Current liabilities = $200000 total assets - $180000 LTD & CS = $20000 $50000 current assets
Return on equity
Liquidity Ratios measure the ability of a firm to meet its short-term obligations.
Average collection period


50. How do you calculate return on equity? (This is a Profitability Ratio)
Current Ratio = Current Assets / Current Liabilities
One ratio to a related ratio - The firm's performance to management's goals - The firm's past and present performance - The firm's performance to that of similar firms.
Return on Equity = Earnings Available to Common Stockholders / Common Equity
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