Financial Statement Analysis Basics

Question 1

__________ analysis is conducted as a restatement of financial information info in ratio or percent form, used as a comparison.

Answer 1

vertical

Question 2

__________ analysis examines changes in financial data across time of a single company.

Answer 2

horizontal

Question 3

When you are said to disaggregate the ROA into two sections, ROA =

Answer 3

(profit margin) * (asset turnover)

Question 4

The profit margin is conceptually able to tell you the

Answer 4

profit from each dollar of revenue

Question 5

The asset turnover is conceptually able to tell you the

Answer 5

level of sales generated by each dollar invested in assets

Question 6

Statements compared in a vertical financial statement analysis are also called…

Answer 6

common-size financial statements

Question 7

When a ratio includes both an IS item and a BS item, you have to…

Answer 7

average the balance sheet item over multiple periods

Question 8

In calculating the ROA, you exclude the…

Answer 8

effects of interest payments to creditors + dividends payments to shareholders

Question 9

ROA can be increased by these two methods:

Answer 9

1. targeting higher profit margins
2. increasing asset turnover

Question 10

True or false: ROA focuses on how the company financed the assets.

Answer 10

FALSE

Question 11

Explain the “Gucci and H&M” analogy when looking at asset turnover versus profit margins.

Answer 11

H&M likely has a high asset turnover and lower profit margins, while Gucci has higher profit margins but lower asset turnover. Both could have the same ROA in theory.

Question 12

When conducting a horizontal analysis of financial statements, the amount of change for a given year =

Answer 12

(Final - Initial) / (Initial)
or
(Current Year - Prior Year) / (Prior Year)

Question 13

In vertical analysis, components of the Income Statement are expressed as a percentage of…

Answer 13

net sales

Question 14

In vertical analysis, components of the Balance Sheet are expressed as a percentage of…

Answer 14

total assets

Question 15

When a ratio includes an item from the income statement and an item from the balance sheet, you have to

Answer 15

average the balance sheet item over multiple periods

Question 16

The availability of cash and other near-cash resources to meet near-term obligations is

Answer 16

liability

Question 17

The current ratio for a company tells you the

Answer 17

amount of current liabilities available for every $1 of current liabilites

Question 18

The higher the current ratio, the higher a company’s liquidity. This is (better/worse) for the company

Answer 18

better

Question 19

The quick ratio reflects a company’s ability to

Answer 19

meet its current liabilities without liquidating inventories that could include markdowns

Question 20

The quick ratio calculation excludes

Answer 20

inventories and prepaid assets

Question 21

Working capital answers the question:

Answer 21

How many assets are left over after we meet current liabilities?

Question 22

Positive working capital implies

Answer 22

more expected cash inflows than outflows in the short run

Question 23

Companies can effectively manage working capital through the following:

Answer 23

1. minimizing receivables
2. maximizing payables

Question 24

The operating cash flow to current liabilities (OCFCL) relates…

Answer 24

the net amount of cash from operating activities to the amount of current liabilities

Question 25

The operating cash flow to current liabilities (OCFCL) is a key indicator of a company’s ability to…

Answer 25

PAY DEBTS

Question 26

A company’s ability to meet debt obligations is called…

Answer 26

solvency

Question 27

The debt-to-equity ratio conveys…

Answer 27

how reliant a company is on creditor financing in comparison to equity financing

Question 28

A higher debt-to-equity ratio means (higher/lower) solvency

Answer 28

lower

Question 29

Higher debt-to-equity ratio means lower solvency. This poses a (smaller/greater) risk to the company.

Answer 29

greater risk

Question 30

The times interest earned ratio determines…

Answer 30

how much operating profit is available to pay interest

Question 31

Lenders prefer the times interest earned ratio to be (high/low)

Answer 31

high, because it implies smaller risk of default

Question 32

A company’s profit margin measures its ability to…

Answer 32

control the level of expenses relative to sales

Question 33

A company’s asset turnover measures…

Answer 33

how effectively a company is able to use its assets to generate revenue / sales

Question 34

Debt increases…

Answer 34

default risk

Question 35

The return on financial leverage (ROFL) measures…

Answer 35

the amount of ROE that can be attributed to financial leverage

Question 36

The use of debt and other liabilities to fund assets of the firm, adding risk and volatility to a company, is called…

Answer 36

financial leverage

Question 37

Operating activities may be restricted by…

Answer 37

debt covenants

Question 38

Restrictions on operating activities imposed by creditors are called…

Answer 38

debt covenants

Question 39

This ratio analyzes the relationship between financial performance and the stock price.

Answer 39

the Price-Earnings Ratio (P/E ratio)