ANALYSIS OF FINANCIAL STATEMENTS

Question 1

IMPORTANCE OF STATEMENT ANALYSIS

Answer 1

The purpose of financial statement analysis is to assist statement users in predicting the future.

Question 2

Three techniques commonly used to make comparisons and to detect trends:

Answer 2

• Peso and percentage changes in financial statement items
• Common-size statements
• Financial Ratios

Question 3

The financial statements are placed side by side (comparative form).

Answer 3

HORIZONTAL (TREND) ANALYSIS

Question 4

Restate a time-series of financial data in terms of a base year. It indicates business direction and shows how have things changed over the years (year to year comparison).

Answer 4

TREND PERCENTAGES

Question 5

The ____ ____ is the earliest year and set equal to 100%. __________ ____ are expressed as a percentage of the base period.

Answer 5

base year, Subsequent years

Question 6

The difference (increase or decrease) between two statements can be shown in separate columns in both peso and percentage forms.

Answer 6

PESO AND PERCENTAGE CHANGES ON STATEMENTS

Question 7

It shows each item as a percentage of a total rather than in peso form. These kinds of statements make it much easier to compare firms of different sizes and to track balance sheet and income statement relationships within a company over time as its size changes.

Answer 7

VERTICAL (COMMON-SIZE) ANALYSIS

Question 8

These ratios measure the firm’s ability to pay off debts that are maturing within a year or within the next operating cycle

Answer 8

LIQUIDITY RATIOS

Question 9

The capital of a business used in day-to-day operations.

Answer 9

WORKING CAPITAL

Question 10

A measure of short-term paying ability; a test of ability to meet current obligations from current assets; measure of adequacy of working capital.

Answer 10

CURRENT RATIO

Question 11

This is a more severe test of immediate liquidity. Quick Assets = Cash, Marketable Securities and Accounts Receivable.

Inventories and Prepaid Assets are excluded from the total current assets leaving only the more liquid assets to be divided by current liabilities.

Answer 11

QUICK RATIO OR ACID-TEST RATIO

Question 12

These ratios measure the efficiency of a firm in using its assets.

Answer 12

ACTIVITY RATIOS AND ASSET MANAGEMENT RATIOS

Question 13

A measure of the efficiency of management to generate sales and thus earn more profit for the firm.

Answer 13

ASSET TURNOVER

Question 14

Measures the efficiency and velocity of collection of accounts receivable. It indicates how many times a company’s accounts receivable have been turned into cash during the year.

Answer 14

ACCOUNTS RECEIVABLE TURNOVER

Question 15

It is the average number of days required to convert receivable into cash. It helps evaluate the liquidity of accounts receivable and the firm’s credit policies.

Answer 15

AVERAGE COLLECTION PERIOD

Question 16

It measures the efficiency of the firm in managing and selling inventories. It shows how many times inventory was sold during the period.

Answer 16

INVENTORY TURNOVER

Question 17

It is the average number of days to sell or consume the average inventory.

Answer 17

AVERAGE SALE PERIOD

Question 18

These ratios measure how the firm has financed its assets with debt relative to equity as well as the firm’s ability to repay its long-term debt, interest and other fixed charges (such as rent, sinking fund payments, etc.)

It indicates how risky the firm is and how much of its operating income must be paid to bondholders rather than stockholders.

Answer 18

LEVERAGE OR DEBT MANAGEMENT RATIOS

Question 19

It shows proportion of all assets that are financed with debt. The higher the proportion of debt, the greater the risk because creditors must be satisfied before owners in the event of bankruptcy.

Answer 19

DEBT RATIO

Question 20

Indicates proportion of assets provided by investors/owners.

Answer 20

EQUITY RATIO

Question 21

It shows the debt relative to amounts of resources provided by owners. It measures the riskiness of the firm’s capital structure in terms of relationship between the funds supplied by creditors and investors.

Answer 21

DEBT-TO-EQUITY RATIO

Question 22

Measures how many times interest expense is covered by operating profit. It is the most common measure of the ability of a firm’s operations to provide protection to long-term creditors.

Answer 22

TIMES-INTEREST-EARNED

Question 23

These are ratios that measure the overall performance of the firm and its efficiency in managing assets, liabilities, and equity.

Answer 23

PROFITABILITY RATIOS

Question 24

Measures profit generated after consideration of cost of products sold. It measures the ability of a company both to control costs and inventories or manufacturing of products and to pass along price increases through sales to customers.

Answer 24

GROSS MARGIN RATIO

Question 25

Measures profitability after considering all revenues and expenses, including interest, taxes and nonoperating items.

Answer 25

NET PROFIT MARGIN

Question 26

Measures the overall efficiency of the firm in managing assets and generating profits.

Answer 26

RETURN ON ASSETS

Question 27

Measures rate of return on resources provided by owners.

Answer 27

RETURN ON EQUITY

Question 28

These ratios consider the stock price that gives and idea of what investors think about the firm and its future prospects.

Answer 28

MARKET-BOOK RATIOS