Topic 3 - Financial Statements

Question 1

What are the four primary financial statements?

Answer 1

Balance sheet, income statement, statement of cash flows, and statement of shareholders’ equity.

Example sentence: The company prepares these statements annually for stakeholders.

Question 2

What does a balance sheet show?

Answer 2

A company’s financial position at a specific point in time, showing assets, liabilities, and shareholders’ equity.

Additional information: Also known as a statement of financial position.

Question 3

What does an income statement show?

Answer 3

A company’s financial performance over a period of time, detailing revenues, expenses, and profits.

Example sentence: The income statement helps investors assess the company’s profitability.

Question 4

What is the difference between current and long-term assets?

Answer 4

Current assets are expected to be converted into cash within a year, while long-term assets provide benefits over multiple years.

Example sentence: Examples of current assets include cash and accounts receivable.

Question 5

What is the accounting equation?

Answer 5

Assets = Liabilities + Shareholders’ Equity.

Example sentence: The accounting equation must always balance.

Question 6

What is working capital?

Answer 6

The difference between a firm’s current assets and current liabilities.

Example sentence: Positive working capital indicates a company’s ability to cover short-term obligations.

Question 7

What does the statement of cash flows show?

Answer 7

How changes in the balance sheet and income affect cash, divided into operating, investing, and financing activities.

Example sentence: The statement of cash flows helps investors understand the sources and uses of cash.

Question 8

What is EBIT?

Answer 8

Earnings before interest and taxes; a measure of a company’s profitability.

Example sentence: EBIT is used to assess a company’s operational performance.

Question 9

What is depreciation?

Answer 9

The allocation of the cost of a long-term asset over its useful life.

Example sentence: Depreciation is a non-cash expense that reduces a company’s taxable income.

Question 10

What is the difference between gross profit and net profit?

Answer 10

Gross profit is revenue minus the cost of goods sold, while net profit is gross profit minus all expenses, taxes, and interest.

Example sentence: Gross profit is a key indicator of a company’s core profitability.

Question 11

What is a liquidity ratio?

Answer 11

A ratio that measures a company’s ability to pay its short-term obligations.

Example sentence: The current ratio and quick ratio are common liquidity ratios.

Question 12

What is the current ratio?

Answer 12

Current assets divided by current liabilities, indicating a company’s short-term liquidity.

Example sentence: A current ratio of 2.0 means the company has twice as many current assets as liabilities.

Question 13

What is the quick ratio?

Answer 13

(Current assets - Inventory) / Current liabilities, measuring liquidity without relying on inventory.

Example sentence: The quick ratio provides a more stringent measure of liquidity than the current ratio.

Question 14

What is a solvency ratio?

Answer 14

A measure of a company’s ability to meet its long-term obligations.

Example sentence: The debt-to-equity ratio is a common solvency ratio.

Question 15

What is leverage?

Answer 15

The use of borrowed funds to increase the potential return on equity.

Example sentence: Leverage can amplify both gains and losses for shareholders.

Question 16

What is the debt-to-equity ratio?

Answer 16

Total debt divided by shareholders’ equity, indicating financial leverage.

Example sentence: A high debt-to-equity ratio may indicate higher financial risk.

Question 17

What is ROE (Return on Equity)?

Answer 17

Net income divided by shareholders’ equity, showing how efficiently a company uses shareholders’ capital.

Example sentence: ROE is a key metric for evaluating a company’s profitability.

Question 18

What is ROA (Return on Assets)?

Answer 18

Net income divided by total assets, showing how efficiently a company uses its assets.

Example sentence: ROA measures a company’s ability to generate profits from its assets.

Question 19

What is the purpose of financial ratio analysis?

Answer 19

To evaluate the financial health and performance of a company.

Example sentence: Financial ratio analysis helps identify strengths and weaknesses in a company’s operations.

Question 20

What is financial forecasting?

Answer 20

The process of predicting a company’s future financial performance based on historical data and assumptions.

Example sentence: Financial forecasting is crucial for strategic planning and decision-making.

Question 21

What is the sustainable growth rate?

Answer 21

The rate at which a company can grow without needing to raise additional external financing.

Example sentence: Sustainable growth rate depends on internal sources of funding.

Question 22

What is the DuPont Identity?

Answer 22

A formula that breaks down ROE into three components: profit margin, asset turnover, and financial leverage.

Example sentence: The DuPont Identity helps analyze the drivers of a company’s return on equity.

Question 23

What is capital expenditure (CAPEX)?

Answer 23

Funds used by a company to acquire or upgrade physical assets such as property, industrial buildings, or equipment.

Example sentence: Capital expenditure is essential for maintaining or expanding a company’s operations.

Question 24

What is the difference between cash flow from operations and net income?

Answer 24

Cash flow from operations reflects cash inflows and outflows from day-to-day activities, while net income is accounting profit after expenses.

Example sentence: Cash flow from operations is a key indicator of a company’s ability to generate cash.

Question 25

What is free cash flow?

Answer 25

Cash available for distribution to shareholders and debt holders after expenses and investments in working capital and capital assets. ## Footnote Example sentence: Free cash flow can be used for dividends, share buybacks, or debt repayment.

Question 26

What is a pro forma financial statement?

Answer 26

A projected financial statement that shows future financial results based on assumptions. ## Footnote Example sentence: Pro forma financial statements are often used for budgeting and forecasting purposes.

Question 27

What is the plowback ratio?

Answer 27

The proportion of net income retained in the company rather than paid out as dividends. ## Footnote Example sentence: A high plowback ratio indicates a company reinvests earnings for growth.

Question 28

What is dividend payout ratio?

Answer 28

Dividends divided by net income, showing the percentage of earnings distributed to shareholders. ## Footnote Example sentence: A low dividend payout ratio suggests the company retains more earnings for reinvestment.

Question 29

Why is liquidity important for a firm?

Answer 29

It ensures that a firm can meet its short-term obligations and avoid financial distress. ## Footnote Example sentence: Liquidity is crucial for maintaining operational stability.

Question 30

What is financial leverage?

Answer 30

The use of debt to amplify returns to equity shareholders. ## Footnote Example sentence: Financial leverage can increase a company's return on equity.

Question 31

What is accounts payable?

Answer 31

Money owed by a company to its suppliers, shown as a liability on the balance sheet. ## Footnote Example sentence: Accounts payable represent short-term obligations to vendors.

Question 32

What is accounts receivable?

Answer 32

Money owed to a company by its customers, shown as an asset on the balance sheet. ## Footnote Example sentence: Accounts receivable are typically collected within a specific period.

Question 33

What is a cash flow statement?

Answer 33

A financial statement that shows the company's cash inflows and outflows over a period of time. ## Footnote Example sentence: The cash flow statement helps assess a company's liquidity and financial health.

Question 34

What is the difference between operating and non-operating expenses?

Answer 34

Operating expenses are incurred from core business activities, while non-operating expenses arise from secondary activities. ## Footnote Example sentence: Non-operating expenses include interest and taxes.

Question 35

What is the profit margin?

Answer 35

Net income divided by revenue, showing how much profit a company generates for every dollar of sales. ## Footnote Example sentence: Profit margin is a key indicator of a company's profitability.

Question 36

What is the return on investment (ROI)?

Answer 36

A measure of the profitability of an investment, calculated as (Net Profit / Cost of Investment). ## Footnote Example sentence: ROI helps investors assess the efficiency of their investments.

Question 37

What is gross margin?

Answer 37

Gross profit divided by revenue, showing the percentage of revenue that exceeds the cost of goods sold. ## Footnote Example sentence: Gross margin indicates how efficiently a company produces goods or services.

Question 38

What is retained earnings?

Answer 38

The portion of net income not paid out as dividends but retained by the company to reinvest in its business. ## Footnote Example sentence: Retained earnings are an important source of internal funding for growth.

Question 39

What is earnings per share (EPS)?

Answer 39

Net income divided by the number of outstanding shares, indicating the profitability per share of stock. ## Footnote Example sentence: EPS is a key metric for evaluating a company's financial performance.

Question 40

What is a balance sheet date?

Answer 40

The specific date at which a company's financial position is measured and reported. ## Footnote Example sentence: The balance sheet date is crucial for assessing a company's financial health at a specific point in time.

Question 41

What is accrual accounting?

Answer 41

An accounting method where revenues and expenses are recorded when they are earned or incurred, not when cash is exchanged. ## Footnote Example sentence: Accrual accounting provides a more accurate representation of a company's financial performance.

Question 42

What is a contingent liability?

Answer 42

A potential liability that may occur depending on the outcome of an uncertain future event. ## Footnote Example sentence: Contingent liabilities are disclosed in the notes to the financial statements.

Question 43

What is a trial balance?

Answer 43

A bookkeeping worksheet in which the balances of all ledgers are compiled into debit and credit columns to ensure they balance. ## Footnote Example sentence: The trial balance is used to detect errors in the accounting records.

Question 44

What is inventory turnover?

Answer 44

A ratio that measures how many times a company's inventory is sold and replaced in a given period. ## Footnote Example sentence: High inventory turnover indicates efficient inventory management.

Question 45

What is sheet date?

Answer 45

The specific date at which a company's financial position is measured and reported. ## Footnote Example sentence: The sheet date for XYZ Company is December 31, 2020.

Question 46

What is accrual accounting?

Answer 46

An accounting method where revenues and expenses are recorded when they are earned or incurred, not when cash is exchanged. ## Footnote Additional information: Accrual accounting provides a more accurate picture of a company's financial health.

Question 47

What is a contingent liability?

Answer 47

A potential liability that may occur depending on the outcome of an uncertain future event. ## Footnote Example sentence: The lawsuit against the company is a contingent liability.

Question 48

What is a trial balance?

Answer 48

A bookkeeping worksheet in which the balances of all ledgers are compiled into debit and credit columns to ensure they balance. ## Footnote Example sentence: The accountant prepared a trial balance to check for errors in the financial records.

Question 49

What is inventory turnover?

Answer 49

A ratio that measures how many times a company's inventory is sold and replaced over a period. ## Footnote Additional information: High inventory turnover indicates efficient sales and inventory management.

Question 50

What is operating cash flow?

Answer 50

Cash generated from a company’s normal business operations, excluding cash from investing and financing activities. ## Footnote Example sentence: The operating cash flow for the quarter was $500,000.

Question 51

What is goodwill?

Answer 51

An intangible asset that represents the excess of purchase price over the fair value of a company's net assets. ## Footnote Additional information: Goodwill is often created through acquisitions.

Question 52

What is a classified balance sheet?

Answer 52

A balance sheet that organizes assets and liabilities into categories such as current and non-current. ## Footnote Example sentence: The classified balance sheet helps investors understand the company's financial position.

Question 53

What is the matching principle in accounting?

Answer 53

The matching principle states that expenses should be recorded in the same period as the revenues they help generate. ## Footnote Additional information: This principle ensures accurate financial reporting.

Question 54

What is deferred revenue?

Answer 54

Money received by a company for goods or services not yet delivered, recorded as a liability until the service is provided. ## Footnote Example sentence: The company recognized deferred revenue for the prepaid service contracts.

Question 55

What is a fiscal year?

Answer 55

A 12-month period used by a company for accounting purposes, which may or may not align with the calendar year. ## Footnote Additional information: The fiscal year for many companies starts on January 1st.