Anaysis of Financial Statements

Question 1

Low Current Ratio indicates?

Answer 1

Solvency problem; inability to pay current obligations

Question 2

A low receivable turnover and low inventory turnover indicates?

Answer 2

A need for a higher current ratio because they are not being converted to cash quick enough.

Question 3

What does Quick (Acid-Test) Ratio measure?

Answer 3

Firms ability to easily pay short-term debts. Removes inventory valuation issues.

Question 4

What does Accounts Receivable Turnover measure?

Answer 4

Efficiency of A/R collection.

Question 5

What does a high Inventory Turnover mean?

Answer 5

Excess levels of inventory not being carried by company.

Question 6

What does Fixed Asset Turnover measure?

Answer 6

How efficiently the company is deploying its investment in PP&E to generate revenue.

Question 7

What does the Total Asset Turnover measure?

Answer 7

How efficiently the company is deploying the totality of resources to generate revenue.

Question 8

What is Solvency?

Answer 8

A firm’s ability to pay non-current obligations as they come due.

Question 9

What are the key ingredients of Solvency?

Answer 9

The company’s Capital Structure and degree of leverage (DOL)

Question 10

What is capital structure?

Answer 10

Its sources of financing (both internal and external).

Question 11

What is the impact of a higher percentage of debt capital?

Answer 11

Firm will be considered riskier and a higher rate of return will be expected by investors.

Question 12

A low Debt to Capital Ratio means?

Answer 12

More of the firm’s capital is in the form of equity. Low is preferred by creditors.

Question 13

What is Earnings Coverage?

Answer 13

Measure of a company’s ability to satisfy long-term debts and remain solvent.

Question 14

What are the two types of leverage?

Answer 14

Operating Leverage and Financial Leverage

Question 15

Operating Leverage?

Answer 15

Use of a high level of plant and machinery in the production process from depreciation, property taxes, etc.

Question 16

Financial Leverage?

Answer 16

Use of a high level of debt in the firm’s financing structure from amounts paid for interest.

Question 17

Risk from higher operating leverage?

Answer 17

Greater because fixed costs must be covered regardless of the level of sales.

Question 18

Risk from higher financial leverage?

Answer 18

Greater because debt must be serviced regardless of the level of earnings.

Question 19

What does a low A/R turnover and low Inventory Turnover ratio indicate?

Answer 19

Need for a higher Current Ratio

Question 20

What ratio does LIFO lower?

Answer 20

Current Ratio

Question 21

What does Cash Flow Ratio signify

Answer 21

This ratio reflects the significance of cash flow for settling obligations as they become due?

Question 22

Which is the most conservative of the working capital ratios?

Answer 22

Net Working Capital Ratio

Question 23

Solvency

Answer 23

A firm’s ability to pay its noncurrent obligations as they come due and thus remain in business in the long run. The key ingredients of solvency are the firm’s capital structure and degree of leverage.

Question 24

Capital Structure

Answer 24

A firm’s capital structure includes its sources of financing, both long- and short-term. These sources can be in the form of debt (external sources) or equity (internal sources). Debt is the creditor interest in the firm. Equity is the ownership interest in the firm.

Question 25

Leverage

Answer 25

A firm’s leverage is the relative amount of the fixed cost of capital, principally debt, in a firm’s capital structure. Leverage creates financial risk, which relates directly to the question of the cost of capital. The more leverage, the higher the financial risk, and the higher the cost of debt capital.

Question 26

Earnings Coverage

Answer 26

A creditor’s best measure of a firm’s ongoing ability to generate the earnings that will allow it to satisfy it’s long-term debts and remain solvent.

Question 27

Times-interest-earned Ratio

Answer 27

EBIT / Interest expense

An income statement approach to evaluation a firm’s ongoing ability to meet the interest payments on its debt obligations.

Question 28

Earnings-to-fixed-charges Ratio (Fixed charge coverage ratio)

Answer 28

Extends the times-interest-earned ratio to include the interest portion associated with long-term lease obligations

Question 29

Cash flow-to-fixed-charges Ratio

Answer 29

Removes the difficulties of comparing amounts prepared on an accrual basis

Question 30

Activity Ratios

Answer 30

Measure how quickly the 2 major non-cash assets are converted to cash. They measure results over a period of time and thus draw information from the firm’s income statement.

Question 31

Cash Cycle

Answer 31

The portion of the operating cycle that is not days purchases in accounts payable-the portion of the operating cycle when the company does not have cash, i.e., when cash is tied up in the form of inventory or A/R.
Cash cycle = Operating Cycle-Days purchases in payables

Question 32

Operating Cycle

Answer 32

The amount of time for a firm that passes between the acquisition of inventory and the collection of cash on the sale of that inventory.
Operating Cycle = Days sales in receivables + Days sales in inventory

Question 33

Liquidity

Answer 33

A firm’s ability to pay its current obligation as they come due and thus remain in business in the short run. Liquidity measures the ease with which assets can be converted to cash.

Question 34

Liquidity Index

Answer 34

A measure of the proportion that the 2 major non-cash current assets (weighted) make up of all liquid assets

Question 35

What are the right and wrong ways to use the Notes to the financial statements””

Answer 35

RIght way: To amplify information and to be in accordance with GAAP.
Wrong Way: to correct improper presentations.

Question 36

Users with Direct Interests in FInancial Statements

Answer 36

1) Investors or potential investors
2) Suppliers and creditors
3) Employees
4) Management

Question 37

Users with Indirect interests in Financial Statements

Answer 37

1) Financial advisers and analysts
2) Stock markets or exchanges
3) Regulatory authorities

Question 38

How do internal users use financial statements

Answer 38

To assess financial strengths and deficiencies, to evaluate performance results and past decisions, and to plan for future financial goals and steps toward accomplishing them.

Question 39

Uses of Common Size Statement

Answer 39

1 To compare elements in a Single Years FS
2 To analyse trends across a no of years for one Business
3. To compare businesses of different size within an industry
4. To compare Companys performance with an Industry Average

Question 40

Vertical Common Size Statement

Answer 40

Elements within the Statements are expressed as a %.

For eg for Balance Sheet it is Total Assets and for Income Statement it is Sales

Question 41

Horizontal Common Size Statement

Answer 41

Compares Key Financials statement values and relationships for the same Company for a series of periods
Also called Variation Analysis or Trend Analysis
Uses include Cost Control, spot Unusual Changes

Question 42

Liquidity of Current Liabilities

Answer 42

The ease with which a firm can issue new debt or raise new structured funds.