Topic 6: Introduction to Financial Statement Analysis

The following data came from the financial statements of the Green Company: Cash from operations $900,000 Total assets 350,000 Cash from financing activities 220,000 Cash paid for investing activities 55,000 Net income 425,000 Compute the cash flow adequacy ratio.

16.36 Cash flow adequacy: $900,000 / $55,000 = 16.36

The following data came from the financial statements of the Green Company: Cash from operations $900,000 Cash from investing activities 350,000 Cash from financing activities 220,000 Cash paid for capital expenditures 55,000 Net income 425,000 Compute the cash flow-to-net income ratio.

2.12 Cash flow-to-net income: $900,000 / $425,000 = 2.12

Selected information for Isaac Company is as follows: Common stock $1,200,000 Additional paid-in capital 500,000 Retained earnings 740,000 Sales revenue for year 1,830,000 Net income for year 480,000 Isaac's return on equity, rounded to the nearest percentage point, is

20% Return on Equity: $480,000 / ($1,200,000 + $500,000 + $740,000) = 20%

The following data came from the financial statements of the Cheviot Company: Revenue $1,800,000 Assets $1,200,000 Expenses 1,200,000 Liabilities 200,000 Net income 600,000 Equity 1,000,000 Compute the return on sales.

33% $600,000 / $1,800,000

The balance sheet at the end of the first year of operations indicates the following: 2012 Total current assets $600,000 Total investments 85,000 Total property, plant, and equipment 900,000 Total current liabilities 250,000 Total long-term liabilities 350,000 Common stock, $10 par 600,000 Paid-in capital in excess of par-common stock 60,000 Retained earnings 325,000 What is the debt ratio for 2012 (rounded to one decimal places)?

37.9% Debt Ratio: ($250,000 + $350,000) / ($600,000 + $85,000 + $900,000) = 37.9%

Selected information for Alastair Company is as follows: 2012 Current assets $450,000 Total assets 725,000 Cost of goods sold 700,000 Sales revenue 915,000 Net income 145,000 What is the percentage that would be given to current assets on a common-size balance sheet using the percent of sales method (round to the nearest percent)?

49% Sales revenue: $450,000 / $915,000 = 49%

Selected information for Alastair Company is as follows: 2012 Current assets $450,000 Total assets 725,000 Cost of goods sold 700,000 Sales revenue 915,000 Net income 145,000 What is the percentage that would be given to cost of goods sold on a common-size income statement (round to the nearest percent)?

77% Sales revenue: $700,000 / $915,000 = 77%

Which cash flow ratio reflects the extent to which accrual accounting adjustments and assumptions have been included in net income?

A. Cash flow-to-net income

Which of the following below generally is the most useful in analyzing companies of different sizes?

A. Common-sized financial statements

The ratio that reflects the mix of sources of financing for a company is the

A. Debt-to-equity ratio

Sales divided by assets and is interpreted as the number of dollars in sales generated by each dollar of assets.

Asset turnover

Assets divided by equity and is interpreted as the number of dollars of assets acquired for each dollar invested by stockholders.

Assets-to-equity ratio

Which of the following ratios is used to measure a firm's efficiency at using its assets?

B. Asset turnover

Which cash flow ratio reflects a company's ability to finance its capital expansion through cash from operations? A. Cash flow-to-operating profit B. Cash flow adequacy C. Cash flow-to-net income D. Cash flow frequency

B. Cash flow adequacy

Borrowing that allows a company to purchase more assets than its stockholders are able to pay for is

B. Leverage

Which of the following transactions could increase a firm's current ratio? B. Payment of accounts payable

B. Payment of accounts payable

The particular analytical measures chosen to analyze a company may be influenced by all BUT which one of the following?

B. Product quality or service effectiveness

Financial statement analysis is greatly enhanced when financial ratios are compared with A. Both past values and values for other firms in the same industry

Both past values and values for other firms in the same industry

Which of the following ratios is used to measure a firm's leverage?

C. Assets ÷ Equity

Which of the following ratios is decomposed using the DuPont framework?

C. Return on equity

A useful tool in financial statement analysis is the common-size financial statement. What does this tool enable the financial analyst to do?

Compare the mix of revenue, and expenses, and determine efficient use of resources within a company over time or between companies within a given industry without respect to relative size.

Which one of these is NOT one of the benchmarking problems that arises when analyzing financial statements? A. Reported financial statement numbers may actually be a measurement of different things B. Companies that are being compared may be conglomerates C. Not all companies use the same accounting practices D. All of these are benchmarking problems

D. All of these are benchmarking problems

Which of the following statements best describes financial statement analysis? A. Measurements for a specific company should be compared only with the past. B. Financial statement analysis evaluates future performance. C. Financial statement analysis involves relationships and trends. D. All of these are correct.

D. All of these are correct.

Which of the following ratios is calculated using numbers from both the income statement and the balance sheet? D. Return on equity

D. Return on equity

A systematic approach to identifying general factors causing ROE to deviate from normal.

DuPont framework

Areas in which additional data must be gathered, including details of significant transactions, market share information, competitors' plans, and customer demand forecasts.

Financial statement analysis

Sales divided by average fixed assets and is interpreted as the number of dollars in sales generated by each dollar of fixed assets.

Fixed asset turnover

In general, most companies have significant noncash expenses that reduce net income and also cause the cash flow-to-net income ratio to be

Greater than 1

Borrowing that allows a company to purchase more assets than its stockholders are able to pay for through their own investment.

Leverage

Net income divided by total assets and is the number of pennies of net income generated by each dollar of assets.

Return on assets

Net income divided by sales and is interpreted as the number of pennies in profit generated from each dollar of sales.

Return on sales

In a common-size income statement, each item on the statement is expressed as a percentage of

Revenue

When analyzing financial statements, diagnosis is

The identification of where a business has problems

When analyzing financial statements, prognosis is

The prediction of how a business will perform in the future

Shows the average number of days that elapse between sale and cash collection.

average collection period

Cash from operations divided by expenditures for fixed asset additions and acquisitions of new businesses

cash flow adequacy ratio

A financial analysis tool that indicates the interest payment ability of an entity

cash times interest earned ratio

All amounts for a given year being shown as a percentage of that denominator for the year.

common-size financial statements

A comparison of current assets (cash, receivables, and inventory) with current liabilities. It is computed by dividing total current assets by total current liabilities.

current ratio

A frequently used measure of leverage, computed as total liabilities divided by total assets.

debt ratio

Total liabilities divided by total equity and is interpreted as the number of dollars of borrowing for each dollar of equity investment

debt-to-equity ratio

Relationships between financial statement amounts

financial ratios

A company's ability to pay its debts in the short run

liquidity

The profitability of each dollar in sales

margin

Calculated by dividing average inventory by average daily cost of goods sold and is interpreted as the average number of days of sales that can be made using only the supply of inventory on hand.

number of days' sales in inventories

an equity valuation multiple. It is defined as market price per share divided by annual earnings per share.

price-earnings ratio

The overall measure of the performance of a company.

return on equity

The degree to which assets are used to generate sales

turnover