Chapter 3 - GAAP Financial Statement Analysis

Question 1

The use of common-size statements to highlight basic relationships among items within a single set of financial statements.

Answer 1

Vertical analysis

Question 2

An analysis that identifies patterns in losses and then projects these patterns into the future. Also a comparison of financial statement data across two or more periods.

Answer 2

Trend analysis

Question 3

A financial analysis tool used to study the financial condition of an account; two or more data items from accounting records of a company are related to one another and the result is compared to the results for prior accounting periods or for similar businesses.

Answer 3

Ratio analysis

Question 4

A financial statement in which amounts are reported as a percentage of a base figure.

Answer 4

Common-size statement

Question 5

What are the four broad categories of financial ratios?

Answer 5

Efficiency, Liquidity, Leverage and Profitability

Question 6

Name the three turnover ratios used to evaluate efficiency

Answer 6

Accounts Receivable Ratio, Asset Turnover Ratio, and Inventory Turnover Ratio

Question 7

An efficiency ratio that indicates how quickly a business collects the amounts owed by its customers

Answer 7

Accounts Receivable Turnover Ratio = credit sales / accounts receivable

Question 8

A measure of the number if days it takes, on average, for a company to collect its accounts receivable

Answer 8

Days sales outstanding = 365 / accounts receivable turnover ratio

Question 9

An efficiency ratio that measures the use of assets to generate sales

Answer 9

Asset Turnover = Sales / Total Assets

Question 10

Resources that can not be expected to be sold or consumed within the business’s normal operating cycle and that are usually considered to be long lived

Answer 10

Fixed Assets

Question 11

An efficiency ratio that indicates how quickly inventory is sold, generating either cash (from cash sales) or accounts receivable (from credit sales)

Answer 11

Inventory Turnover Ratio = Cost of Goods Sold / Inventory

Question 12

Indicates how well a company is performing and generating income

Answer 12

Efficiency Ratios

Question 13

Refers to a company’s ability to convert assets to cash in order to satisfy obligations

Answer 13

Liquidity

Question 14

A company’s current assets less current liabilities is its…

Answer 14

Working capital

Question 15

The three main formulas or ratios used to measure liquidity

Answer 15

Working Capital, Current Ratio, Acid Test (Quick) Ratio

Question 16

A liquidity ratio that indicates a company’s ability to meet its short-term financial obligations

Answer 16

Current Ratio = Current Assets / Current Liabilities

Question 17

A liquidity ratio that provides a measure of a company’s ability to meet its current obligations if it can’t sell its inventory

Answer 17

Acid-test ratio (Quick Ratio) = (cash + marketable securities + accounts receivable) / current liabilities

Question 18

A measure of the extent to which a company has borrowed money

Answer 18

Leverage

Question 19

A leverage ratio that measures the extent to which a company is financed using borrowings rather than its own funds (owners’ equity)

Answer 19

Debt-to-equity Ratio = Long-term debt / shareholders’ equity

Can also = total liabilities / shareholders’ equity depending on industry

Question 20

A leverage ratio that shows the extent to which a company’s assets are financed by debt

Answer 20

Debt-to-assets Ratio (or Debt Ratio) = total liabilities / total assets

Question 21

A profitability ratio that measures the percentage of sales remaining after deducting all expenses that indicates how effective an insurer is at cost control

Answer 21

Net Profit Margin = Net income (after taxes) / sales

Gross profit / Sales is also sometimes used

Question 22

A profitability ratio that shows how well a company has used its resources

Answer 22

Return On Assets (ROA) = net income / total assets

Some use the average of all assets at the end of a period as denominator

Question 23

A profitability ratio that shows the rate of return that shareholders are earning on their equity in the company’s assets

Answer 23

Return On Equity (ROE) = net income / shareholders’ equity

Some use average of shareholder’s equity over a certain period as denominator

Question 24

An analysis of ROA and ROE by breaking them down into their component ratios

Answer 24

DuPont Identity

Question 25

ROA can be broken down into two component ratios. What are they?

Answer 25

1. Net Profit Margin = net income / sales
   Multiplied By
2. Asset Turnover Ratio = sales / total assets

Question 26

ROE can be broken down into two component ratios. What are they?

Answer 26

1. ROA = Net profit margin x asset turnover ratio
   Multiplied By
2. Equity Multiplier = total assets / equity

Question 27

Accounts receivable turnover ratio

Answer 27

Credit sales divided by accounts receivable.

Question 28

Day sales outstanding

Answer 28

365/accounts receivable turnover ratio.

Question 29

Asset turnover ratio

Answer 29

Sales/total assets

Question 30

Inventory turnover ratio

Answer 30

Cost of goods sold/inventory

Question 31

Working capital

Answer 31

Current assets - current liabilities

Question 32

Current ratio

Answer 32

Current assets/current liabilities

Question 33

Acid test ratio or quick ratio

Answer 33

(Cash + marketable securities + accounts receivable) / current liabilities

Question 34

Debt to equity ratio

Answer 34

Long term debt / shareholder’s equity

Question 35

Debt to assets ratio

Answer 35

Total liabilities divided by total assets

Question 36

Equity multiplier

Answer 36

Total assets divided by shareholders equity

Question 37

Net profit margin

Answer 37

Net income divided by sales

Question 38

Return on assets

Answer 38

Net income divided by total assets

Question 39

Return on equity

Answer 39

Net income divided by shareholders equity

Question 40

Du Pont identity – return on equity

A profitability ratio

Answer 40

(Net income / by sales)
X (sales/Total assets)
X (Total assets/Shareholders equity)