REVIEW OF FINANCIAL STATEMENT PREPARATION, ANALYSIS AND INTERPRETATION

Question 1

the numbers included in the statement of comprehensive income and statement of financial position will be broken down for analysis in what is called

Answer 1

financial ratio analysis

Question 2

involves the comparison of figures shown in the financial statements of two or more consecutive periods

Answer 2

Horizontal analysis

Question 3

The purpose of horizontal analysis is for the users of financial data to analyze trends in the firm’s financial performance. Thus, it is also sometimes referred to as

Answer 3

trend analysis

Question 4

is done through the comparison of the figures in the financial statements of a single period

Answer 4

Vertical analysis

Question 5

It involves conversion of figures in the statement to a common base.

Answer 5

Vertical analysis

Question 6

vertical analysis is also known as

Answer 6

common-size analysis

Question 7

are typically used as common bases for the vertical analysis of the statement of financial position and the comprehensive statement of income, respectively

Answer 7

Total assets and net sales

Question 8

Financial ratios or accounting ratios may be categorized into five types

Answer 8

a. Liquidity
b. Activity or asset utilization
c. Solvency or leverage
d. Profitability or performance
e. Valuation

Question 9

measure the firm’s ability to satisfy its short term obligations. These are calculated by looking at the current items in the statement of financial position such as current assets, inventory, and current liabilities.

Answer 9

Liquidity ratios

Question 10

is useful in assessing how the company will fund its short term operations. It shows how much liquid asset is available after deducting short-term liabilities. More formally, it is derived by deducting current liabilities from current assets.

Answer 10

Net working capital

Question 11

3 liquidity ratios and their formulas

Answer 11

> Net working capital <
Net working capital= Current Assets- Current liabilities

> Current Ratio<
Current Ratio= Current Assets/
Current liabilities

> Quick Ratio or Acid-test Ratio <
= Current Assets- Inventory/
Current Liabilities

Question 12

measures the firm’s ability to settle its short-term liabilities using its most liquid assets such as cash and cash equivalents, accounts receivable, and other short-term securities, if any. It excludes inventory because inventory cannot be converted as “quickly” into cash as other current assets.

Answer 12

Quick Ratio or Acid-test Ratio

Question 13

The second set of financial ratios analyzes the operational efficiency of a company in terms of its business operation.

Answer 13

ACTIVITY OR ASSET UTILIZATION RATIOS

Question 14

Indicates how fast the firm “turn over” or collects its account receivable.

Answer 14

Accounts Receivable Turnover

Question 15

6 ACTIVITY OR ASSET UTILIZATION RATIOS & their formulas

Answer 15

> Accounts Receivable Turnover<
= Net Sales/ Average Accounts Receivable

> Days of Sales Outstanding <
= Number of Days in a Year/ Accounts Receivable Turnover

> Inventory Turnover <
=Cost of Sales/ Average Inventory

> Average Age Inventory<
= Number of Days in a Year/ Inventory Turnover

> Operating Cycle<
= Days of Sales Outstanding + Average Age of Inventory

> Total Asset Turnover <
= Net Sales/ Average Total Assets

Question 16

measures the firm’s ability to satisfy long-term debts as they become due.

Answer 16

Solvency Ratios

Question 17

3 Solvency (Leverage and Debt Service) Ratios and their formulas

Answer 17

<Debt-to-Assets>
= Total Liabilities/
Total Assets

<Debt-to-equity>
= Total Liabilities / Shareholder’s Equity

<Times>
= EBIT / Interest Expense
</Times></Debt-to-equity></Debt-to-Assets>

Question 18

measure a firm’s ability to make profits. These ratios provide insights on the overall performance of the business, which is vital to business owners and investors alike.

Answer 18

Profitability or Performance

Question 19

4 Profitability or Performance ratios and their formulas

Answer 19

“Gross Profit Margin”
= Gross Profit /
Net Sales

“Profit Margin “
= Net Income/
Net Sales

“Return on Total Assets “
= Net Income/ Average Total Assets

“Return on Equity”
= Net Income/
Average Shareholder’s Equity