Interpreting financial statements module 10

return on assets formula

Net income / Total assets Significance- effectiveness of the use of assets in generating income

comparative financial statement

Statement with data for two or more successive periods placed in side-by-side columns, often with changes shown in dollar amounts and percents.

return on sales formula

net income/net sales indicator of the amount of net profit on each dollar of sales

Acid- Test or Quick Ratio

quick assets/current liabilities a company's short-term debt paying ability ratio of quick assets (cash, marketable securities, and net receivables) to current liabilities. Marketable securities are temporary investments such as short-term ownership of stocks and bonds of other companies. short term creditors are interested in this ratio, which relates the pool of cash and immediate cash flows to immediate cash outflow.

Which ratio cannot be used to determine a company's profitability? Quick ratio Return on sales EPS ratio Return on assets

quick ratio The quick ratio, quick assets to current liabilities, is a liquidity ratio.

horizontal analysis can be calculated by

% change = Current Yr. - Prior Yr. / Prior Yr.

earnings per share of common stock formula

(net income - preferred dividends) / average common stockholders' equity measure of the return to investors per share

Profitability is concerned with two areas: (1) relationships on the ___________________________________ that indicate a company's ability to recover costs and expenses, and (2) relationships of income to various __________________________ measures that indicate the company's relative ability to earn income on assets employed.

1. Income stmt. 2. Balance sheet

From __________________________ point of view, a high proportion of stockholders' equity is highly desirable. From ____________________________ point of view, a high proportion of equity may or may not be desirable.

1. a creditors- From a creditor's point of view, a high proportion of stockholders' equity is desirable. A high equity ratio indicates the existence of a large protective buffer for creditors in the event a company suffers a loss. 2. an owner's-A lower percentage of equity may be desirable to owners if the business can use borrowed funds to generate income in excess of the net after-tax cost of the interest on such funds.

two liquidity ratios

1. current ratio 2. Acid test (quick ratio)

the __________________ and the _______________ are examples of liquidity ratios

1. current ratio-The current ratio is an example of a liquidity ratio, which provides information about the ability to pay our current obligations with our current assets. 2. acid test-

2 leverage ratios

1. equity ratio 2. debt to equity ratio

_____________users must rely on the general-purpose financial statements that companies publish. These statements include a balance sheet, an income statement, a statement of stockholders' equity, a statement of cash flows, and the ____________________ notes that accompany the financial statements.

1. external 2. explanatory

profitability ratios concerned w. 2 areas when evaluated profitability

1. relationship on the income statement that indicates a company's ability to cover operating cost and expenses 2. relationship of income to various balance sheet measures that indicate the company's relative ability to earn income on assets employed

profitability ratio (3)

1. return on assets 2. return on sale 3. earnings per share of common stock

Liquidity Ratios

Measures of the short-term ability of the company to pay its maturing obligations and to meet unexpected needs for cash.

The return on sales ratio for the Family Legacy Company is 5%. Which answer choice below best describes what this ratio means for the Family Legacy Company? Family Legacy Company is earning net income equal to $50 for every $100 of net sales earned by the company. Family Legacy Company is earning net income equal to $5 for every $100 of net sales earned by the company. The net income for the Family Legacy Company increased by 5% in the current year over the prior year. The net income for Family Legacy Company increased by 50% in the current year over the prior year.

Family Legacy Company is earning net income equal to $5 for every $100 of net sales earned by the company.

Which of the following is not a feature of financial statement analyses? Financial statement analysis involves reconciling accrual accounts to cash basis. Financial statements analyses involve determining if significant trends exist in the financial data and the financial statements publicly released by a company. Financial statement analyses involve making future predictions using financial statements publicly released by a company. Financial statement analyses involve applying analytical tools and techniques to a company's published financial statements.

Financial statement analysis involves reconciling accrual accounts to cash basis.

Which accounts are excluded from assets when calculating the acid-test ratio and why? Inventories are excluded from current assets to compute quick assets because they might not be readily convertible into cash. Inventories and prepaid expenses are excluded from current assets to compute quick assets because they might not be readily convertible into cash. Supplies are excluded from current assets to compute quick assets because they have to be used during the period. Marketable securities are excluded from current assets to compute quick assets because they have to be sold on the stock market before being available for cash.

Inventories and prepaid expenses are excluded from current assets to compute quick assets because they might not be readily convertible into cash. Analysts exclude inventories and prepaid expenses from current assets to compute quick assets because they might not be readily convertible into cash.

What is a characteristic of vertical analysis? It calculates dollar changes in statement items. It is an expression of logical relationships between items in a single period. It calculates percentages of single items to a total. It calculates changes in comparative statement items or totals.

It calculates percentages of single items to a total. Vertical analysis reports each amount on a financial statement as a percentage of another item. On the balance sheet, each item is calculated as a percentage of total assets and on the income statement as a percentage of sales revenue

Which expression below correctly states how to calculate Earnings Per Share (EPS)? Net operating income divided by the average number of common shares outstanding Net income divided by net sales Net income divided by the average number of common shares outstanding Gross profit divided by the average number of common shares outstanding

Net income divided by the average number of common shares outstanding

Equity Ratio Formula

SH equity/ total assets ( or total equity) index of long- run solvency and saftey

debt to equity ratio formula

SH equity/ total debt measure of the relative proportion of SH and creditors equities

A vertical analysis of the company income statement from Year 1 (the first year) to Year 2 shows that the ratio of net income to net sales has changed from 5.4% to 10.4%. Which statement is correct regarding this information? The total profitability of this company has remained the same from Year 1 to Year 2. The total working capital of this company has increased from Year 1 to Year 2. The total profitability of this company has declined from Year 1 to Year 2. The total profitability of this company has increased from Year 1 to Year 2.

The total profitability of this company has increased from Year 1 to Year 2. The increase in the ratio of net income to net sales in this situation shows that the total profitability of the company has increased from Year 1 to Year 2. The company is now earning profit or net income $10.40 for each $100 of net sales in Year 2 compared to earning $5.40 of profit for each $100 of net sales in Year 1.

A horizontal analysis you performed of a company balance sheet from Year 1 (the first year) to Year 2 shows that total current assets have increased $50 million over the past year, and total current liabilities have increased by $200 million over the past year. Which statement is correct regarding this information you have obtained from performing this horizontal analysis? The working capital for this company has decreased. The return on assets in this situation has increased. The acid-test ratio in this situation has increased. The working capital for this company has increased.

The working capital for this company has decreased. The working capital has decreased by $150 million ($50 million minus $200 million).

Why would internal users, but not external users, of accounting information analyze financial statements?

To plan and evaluate operations

can show a relationship between two items on the same financial statement or between two items on different financial statements.

a ratio

common-sized statements

all items are expressed as percentages with no dollar amounts shown

Which of the following is not an example of financial statement analyses? Assessing company management's future decisions Assessing a company's current financial position Assessing a company's liquidity Assessing a company's past financial performance

assessing a company's mgmt.. future decisions

Current ratio

called working capital is the excess of total assets over total current liabilities working capital = Current asset - Current liabilities ability of a company to pay its current liabilities CR > 1 is desirable in some industries a CR of 2 may be standard Current ratio = CA/CL

Which external users of financial statement data would likely be most interested in predicting a company's solvency?

creditors

The ratio that relates _____________________________ assets to _________________ liabilities is the current (or working capital) ratio.

current current

In evaluating the liquidity of a company that you are considering investing in, you obtain the company's balance sheet. Which item on the balance sheet would you look for in order to calculate the current ratio for this company? Current assets and current liabilities Current assets, long-term assets, long-term liabilities, and stockholders' (owners') equity Current assets, current liabilities, net sales, and net income Current assets, long-term assets, current liabilities, and long-term liabilities

current assets and current liabilites

Which accounting ratio should be used to determine a company's ability to pay debt in the next 12 months? Return on assets Return on sales ratio Current ratio Debt ratio

current ratio measures liquidity

Which ratio might express that creditors held a 51.2-percent interest in the assets of a company is equivalent to saying stockholders held a 48.8-percent interest? Earnings per share Current ratio Equity Debt to equity

debt to equity

Which ratio is a leverage ratio? Return on sales ratio Equity ratio Quick ratio Working capital ratio

equity ratio total SH equity / total assets

ratio

expression of logical relationship between items in the financial stmt. of a single period

true or false Consolidated financial statements include data for a period of one year.

false Consolidated financial statements include a balance sheet containing two years of comparative data; an income statement containing three years of comparative data; a statement of cash flows containing three years of comparative data; and a statement of shareholders' equity containing three years of comparative data.

True/False The return on sales ratio shows the earning power of the company as a bundle of assets.

false The return on assets ratio shows effectiveness of the use of assets in generating income.

True/False Vertical analysis helps detect changes in a company's performance over several periods and highlights trends

false Horizontal analysis provides useful information about the changes in a company's performance over several periods by analyzing comparative financial statements of the same company for two or more successive periods.

True/False Liquidity ratios indicate a company's long-term debt-paying ability.

false Liquidity ratios indicate a company's short-term debt-paying ability.

True/False Earnings per Share (EPS) ratio measures the proportion of the sales dollar that remains after deducting all expenses.

false Return on sales ratio measures the proportion of the sales dollar that remains after deducting all expenses.

Which analysis uses accounting data from more than one period to detect changes in a company's performance and highlights trends?

horizontal analysis The calculation of dollar changes or percentage changes in the statement items or totals is horizontal analysis. This analysis detects changes in a company's performance and highlights trends.

______________analysis calculates changes in comparative statement items or totals, whereas -Select- ________________analysis consists of a comparison of items on a single financial statement.

horizontal-Horizontal analysis calculates percentage changes in comparative statement items or totals over two or more periods. Vertical- Vertical analysis consists of a comparison of items on a single financial statement. Vertical analysis takes each number on a statement as a percentage of gross sales on the income statement and total assets on the balance sheet.

Which types of ratios show the relationship between debt and equity financing in a company? Leverage Profitability Current Liquidity

leverage Leverage, or equity ratios, show the relationship between debt and equity financing in a company.

ratios include

liquidity ratios equity, or long-term solvency, ratios profitability tests market tests

Which ratio should be used to determine the level of profitability of a company during the last quarter? Equity Current Debt to equity Return on sales

return on sales indicator of the amount of net profit on each dollar

_____________________are particularly interested in the _____________________ ratio, which relates the pool of cash and immediate cash inflows to immediate cash outflows.

short- term quick

leverage ratio ( leverage)

show the relationship between debt and equity financing in a company

trend percentage

similar to horizontal analysis except that comparisons are made to a selected base year or period

vertical analysis

single financial stmt, such as an income statement. % of single items to an aggregate total

Which of the following is not a financial ratio that can be used to measure a firm's profitability? The acid test Return on assets Earnings per share Return on sales

the acid test measures liquidity, not profitability

An objective of financial statement analysis is to provide information about the company's past performance and current financial position.

true

True/False Liquidity ratios show a company's capacity to pay maturing current liabilities.

true

True/False The acid test is the ratio of quick assets to current liabilities.

true The acid-test (quick) ratio is the ratio of quick assets (cash, marketable securities, and net receivables) to current liabilities.

True/False The equity ratio indicates the proportion of total assets provided by stockholders on any given date

true The equity (stockholders' equity) ratio indicates the proportion of total assets (or total equities) provided by stockholders (owners) on any given date. It is an index of long-run solvency and safety.

Financial statements that show only percentages and no absolute dollar amounts are common-size statements.

true The use of common-size statements facilitates vertical analysis of a company's financial statements and reduces dollar-value bias in companies of different sizes.