Handout 7

Question 1

shows the financial position of a business on a certain date (usually the end of the
month or year).

Answer 1

balance sheet

Question 2

also called the statement of financial position (or SFP)

Answer 2

balance sheet

Question 3

primary functions of a balance sheet:

Answer 3

• Business funds
• Business value
• Business assets and claims
• Business performance

Question 4

The statement of financial position shows the capital contribution of owners and outside lenders. It also presents the acquired assets of the business.

Answer 4

Business funds.

Question 5

The statement of financial position provides a starting point for assessing a firm’s value since it lists all the assets and business claims.

Answer 5

Business value.

Question 6

It can be helpful to look at relationships between various statements of financial position items, for example, the relationship between how much wealth is tied up in current assets and how much is owed in the short-term (current liabilities).

Answer 6

Business assets and claims

Question 7

The effectiveness of a business in generating wealth can be assessed against the amount of investment involved.

Answer 7

Business performance

Question 8

summarizes the revenues earned and expenses incurred by a business over an accounting period.

Answer 8

Income Statement

Question 9

also called the profit-and-loss (P&L) statement

Answer 9

Income Statement

Question 10

The income statement may help in providing information on:

Answer 10

• Wealth generation
• Profit derivative

Question 11

Assessing how much wealth has been created is vital for businesses. The income statement reveals the firm’s profit for a given period. It provides a measure of the wealth created for the owners.

Answer 11

Wealth generation

Question 12

useful measures of wealth creation.

Answer 12

Gross profit and operating profit

Question 13

The income statement also provides information needed to gauge business performance. It reveals the level of sales revenue and the nature and amount of expenses incurred, which can help understand how profit was derived

Answer 13

Profit derivative.

Question 14

focuses on liquidity (or balancing the cash inflows and outflows to enable firms to operate and pay their bills when they are due).

Answer 14

Cash Flow Statement

Question 15

the inflows and outflows of cash into and out of business.

Answer 15

Cash flows

Question 16

difference between inflows and outflows.

Answer 16

Net cash flows

Question 17

The following are the common types of ratios:

Answer 17

• Return on Investments (ROI)
• Profit Margin/Return on Sales (ROS)
• Return on Assets (ROA)
• Current Ratio
• Quick Ratio (Acid-Test Ratio)
• Debt Ratio
• Stockholder’s Ratio
• Debt-Equity Ratio
• Interest Coverage Ratio

Question 18

generally means the return on the owner’s equity; hence it is
sometimes referred to as return on equity (ROE).

Answer 18

Return on Investments (ROI)

Question 19

relates income or profit after income tax to the total stockholder’s equity (preferably on the average stockholder’s equity).

Answer 19

ROI

Question 20

the income to net sales ratio. On a basic level, a low-profit margin can be interpreted as indicating that a company’s profitability is not secure.

Answer 20

Profit Margin/Return on Sales (ROS)

Question 21

This profitability measure shows how effectively the company has utilized its assets. In other words, it is a measure of asset utilization.

Answer 21

Return on Assets (ROA)

Question 22

relates current assets to current liabilities and shows a firm’s immediate solvency and
liquidity.

Answer 22

Current Ratio

Question 23

the ability of a firm to meet long-term obligations

Answer 23

Solvency

Question 24

refers to an enterprise’s ability to pay short-term bills and debts

Answer 24

liquidity

Question 25

indicates a company’s short-term liquidity and measures its ability to meet its shortterm obligations with its most liquid assets.

Answer 25

Quick Ratio (Acid-Test Ratio)

Question 26

compares a company’s total debt to its total assets. It gives creditors and investors a general idea of the amount of leverage a company uses

Answer 26

Debt Ratio

Question 27

indicates the firm’s financial stability in the long run. It measures how much of a company’s assets are funded by issuing stock rather than borrowing money

Answer 27

Stockholder’s Ratio

Question 28

measures the percentage of the company’s balance sheet financed by suppliers, lenders, creditors, and obligors versus what the shareholders have committed.

Answer 28

Debt-Equity Ratio

Question 29

indicates a company’s ability to meet its interest payment obligations. It is computed by dividing the operating income by the interest expense.

Answer 29

Interest Coverage Ratio