Financial Accounting Module 6 - Analyzing Financial Statements

At the end of the third quarter, a department store is showing lower cash flows and lower sales on its financial statements compared to the average of the previous four quarters. It also shows an increase in inventory compared to the second quarter. Which of the following options is MOST likely to be the cause? A. Seasonality B. Depreciation C. In Decline Stage D. Efficiency

"A. Seasonality" is correct Seasonality is causing the department store to build up its inventory for the holiday season and would anticipate a lower inventory and increased sales and cash flows for the 4th quarter financial statement.

Which of the following companies is most likely to have a negative Cash Conversion Cycle? A. A discount retailer B. A farmer who grows corn and sells to a distributor C. A manufacturer who makes high-quality steam evaporators for nuclear power plants D. A car dealership that provides their own in-house financing

A discount retailer is correct A discount retailer sells most of its inventory quickly and for cash, while delaying payments to suppliers. A farmer who grows corn and sells to a distributor The farmer needs a long time to process his inventory (grow the corn) and his distributor will get credit terms to pay later. A manufacturer who makes high-quality steam evaporators for nuclear power plants The manufacturing process will cause inventories to remain for extended periods and the power plants will likely pay slowly. A car dealership that provides their own in-house financing Cars remain in inventory for extended periods of time, and the in-house financing means that most of their customers will owe them payment for years.

Company A has a higher Accounts Payable Turnover Ratio than Company B. Which of the following statements is true regarding these two companies?

Accounts Payable Turnover = Credit Purchases / Average Accounts Payable Balance Accounts Payable Turnover measures the number of times a company can pay off its average account payable balance during a time period.

As a result of continued demand growth, Company A's revenue was growing from 2011 to 2013. However, the company's gross profit margin decreased from 2011 to 2013: 2011: 39.51% 2012: 37.84% 2013: 36.28% Which of the following is a reasonable explanation for the inverse trends?

Although the market was growing with the demand, competition was driving the prices down. is correct This is the correct answer! This is not an unusual situation and it would explain the inverse trends.

Suppose the following were the gross profit margins for Green Mountain Coffee Roasters (GMCR) from 2011 through 2013. 2011: 34.13% 2012: 32.89% 2013: 37.16% What could be an explanation of the fluctuations in gross profit margins for GMCR from 2011 through 2013?

An increase in manufacturing capacity at the beginning of 2012 caused overhead to increase but allowed for greater efficiency and significant sales growth later. is correct This is the correct answer! The increase in overhead costs could hurt 2012 margins but pave the way for more profitable operations in 2013.

Sheetz, a paper manufacturer, has total revenue of $280,910 and total expenses of $243,873 at the end of 2015. Their total assets and liabilities at the end of 2015 are $317,000 and $193,451, respectively. Total assets and liabilities at the end of 2014 are $286,064 and $140,203, respectively. What is the asset turnover observed in 2015?

Asset Turnover is calculated by dividing the annual revenue by the average asset value for the year. To calculate average assets, take the ending amount of assets for 2014, $286,064, add the ending amount of assets for 2015, $317,000, and divide by two. Average assets = $301,532 Revenue / Average Assets = 280,910 / 301,532 = 0.93

Which ratio measures the ability of a company to make a profit relative to revenue generated during a period?

Profit Margin Profit Margin (Net Income/Sales) measures the ability of a company to make a profit relative to revenue generated during a period.

Suppose the profit margin for Cardullo's Gourmet Shoppe, Inc for Q1 was 4.99% and Q2 was 10.57%. Which of the following statements can you conclude regarding Cardullo's?

Cardullo's does a better job in cost control in Q2 than in Q1. is correct This is the correct answer! Profit margin is the percentage of selling price that turned into profit. Cardullo's could increase its profit by reducing costs, thus increase its profit margin.

The current ratios of 2012 and 2013 for Cardullo's Gourmet Shoppe are listed below. 2012: 1.39 2013: 1.69 What does the upward trend in the ratio mean for Cardullo's?

Cardullo's has better ability to pay off its short-term liabilities in 2013 than in 2012. is correct Current ratio indicates a company's liquidity. A higher current ratio means a higher proportion of current assets available to cover current liabilities.

Suppose the gross profit margin for Cardullo's Gourmet Shoppe, Inc for Q1 was 47.25% and Q2 was 47.70%. Which of the following is a reasonable explanation for the change in the ratio?

Cardullo's negotiated with vendors and successfully reduced overall inventory prices. is correct This is the correct answer! If the cost of inventory decreased, Cardullo's could make more money off of each item it sold.

Company A has a higher Days Purchases Outstanding than Company B. Which of the following statements is true regarding these two companies?

Company A has a lower Accounts Payable Turnover than Company B. is correct Days Purchases Outstanding = 365 / (Credit Purchases / Average Accounts Payable Balance) Days Purchases Outstanding is inversely related to Accounts Payable Turnover. A company with a higher Days Purchases Outstanding would have a lower Accounts Payable Turnover. The Days Purchases Outstanding does not measure a company's ability to pay off its short-term liabilities.

Company A has a higher Days Inventory than Company B. Which of the following statements is true regarding these two companies?

Company A has a lower Inventory Turnover than Company B. is correct Days Inventory = Average Inventory / (COGS / 365) Days Inventory is inversely related to Inventory Turnover. A company with a lower Inventory Turnover would have a higher Days Inventory.

Grocery Retail chain

Company A has high inventory which indicates it is retail. It also has high plant & equipment which means it has many and large stores. The low receivables collection period indicates that the company makes most of its sales in cash or credit card. It also has a high inventory turnover, which means it sells its inventory quickly. All of these signs point to a grocery retail chain.

Company A has a shorter Average Collection Period than Company B using the formula 365 / (Credit Sales / Average AR Balance). Which of the following statements is true regarding these two companies?

Company A is more efficient in collecting receivables from customers than Company B.

Company A has a shorter Average Collection Period than Company B. Which of the following statements is true regarding these two companies?

Company A is more efficient in collecting receivables from customers than Company B. is correct Average Collection Period = 365 / (Credit Sales / Average AR Balance) A lower Average Collection Period means the company is more efficient in collecting from their customers.

Based on the breakdown of the DuPont framework for two companies below, which of the following might explain why Company A has a higher ROE than Company B?

Company A is more efficient in utilizing its assets than Company B. is correct Company A has a higher ROE than Company B because it has a higher Asset Turnover Ratio, which means Company A is more efficient in utilizing its assets.

Electronic consumer product

Company B has a very high inventory turnover, indicating that whatever inventory they have moves quickly. The relatively low plant and equipment combined with the high inventory turnover suggests that a lot of sales are made online and there are relatively few brick and mortar stores. The high receivables collection period is usually due to an extension of credit, so the company likely makes a lot of sales business-to-business, rather than directly to the consumer. So this is in the electronic consumer products industry.

Fast food chain

Company B has high cash and low accounts receivable, and related, a low receivables collection period, which suggests sales are made in cash or with a credit card. Based on this rationale, Company B is the fast food restaurant chain and Company E is the package delivery company.

Department store

Company C has a relatively high inventory level. Since a retailer by definition has a high level of inventory this company must be a retailer. Furthermore, the low collections period confirms that sales are made either through cash or credit to consumers, which is consistent with a retailer. This firm also has a relatively high percentage of PPE, which is attributable to brick and mortar stores. So this is the Department Store.

Airline

Company C has zero inventory, which indicates it is likely a service industry. It also has very high plant & equipment. So this must be in the airline industry.

Which of the following companies would likely have the LEAST difficulty making the interest payments on its debts? A. Company A with Net Income of $100,000, Interest Expense of $25,000, and Tax Expense of $15,000 B. Company B with Net Income of $100,000, Interest Expense of $30,000, and Tax Expense of $10,000 C. Company C with Net Income of $100,000, Interest Expense of $25,000, and Tax Expense of $20,000

Company C will likely have the least difficulty making interest payments on its debt, because it has the highest Interest Coverage Ratio.The Interest Coverage Ratio can be calculated as ( EBIT / Interest Expense ) Company A has an EBIT of $140,000 ( $100,000 + $25,000 + $15,000 ) Company A's Interest Coverage Ratio is 5.6 ( $140,000 / $25,000 ) Company B has an EBIT of $140,000 ( $100,000 + $30,000 + $10,000 ) Company B's Interest Coverage Ratio is 4.7 ( $140,000 / $30,000 ) Company C has an EBIT of $145,000 ( $100,000 + $25,000 + $20,000 ) Company C's Interest Coverage Ratio is 5.8 ( $145,000 / $25,000 )

Online auction

Company D holds no inventory, which indicates that is it is likely a service company. Furthermore, it has very low plant & equipment, which also suggests service, possibly online with very few buildings or infrastructure. These results are consistent with an online auction company.

Package delivery

Company E has a higher level of accounts receivables and higher receivables collection period, which is more likely attributable to a business-to-business rather than business-to-consumer since businesses are typically extended at least a 30 day credit period. Based on this rationale, Company B is the fast food restaurant chain and Company E is the package delivery company.

Which of the following items is NOT related to a company's ability to pay off its debts? A. Current Ratio B. Quick Ratio C. Debt to Equity Ratio

Current Ratio INCORRECT Current ratio measures the ability of a company to pay its short-term debts. Quick Ratio INCORRECT Quick Ratio measures the ability of a company to use its quick assets to pay off its short-term debts. "C. Debt to Equity Ratio" is correct Debt to Equity Ratio measures a company's leverage, not ability to pay off debts.

Fran's Furniture Store has an Inventory Turnover of 8.0, an Accounts Receivable Turnover of 10.5, and an Accounts Payable Turnover of 12.1. What is the length of their Cash Conversion Cycle?

Days Inventory + Average Collection Period - Days Purchases Outstanding = Cash Conversion Cycle Days Inventory = 365 / Inventory Turnover Average Collection Period = 365 / Accounts Receivable Turnover Days Purchases Outstanding = 365 / Accounts Payable Turnover ( 365 / 8.0 + 365 / 10.5 - 365 / 12.1 ) = 50.2

Bob's Burgers has an Inventory Turnover of 6.0, an Accounts Receivable Turnover of 8.5, and an Accounts Payable Turnover of 10.1. What is the length of their Cash Conversion Cycle?

Days Inventory + Average Collection Period - Days Purchases Outstanding = Cash Conversion Cycle Days Inventory = 365 / Inventory Turnover Average Collection Period = 365 / Accounts Receivable Turnover Days Purchases Outstanding = 365 / Accounts Payable Turnover ( 365 / 6.0 + 365 / 8.5 - 365 / 10.1 ) = 67.6

Which of the following measures does not reflect a company's profitability?

Days Sales in Accounts Receivable is correct Days Sales in Accounts Receivable is the average number of days a company takes to collect payments on goods sold. It is not related to profitability.

The current ratios for Cardullo's and H&M are listed below. Cardullo's: 1.69 H&M: 2.25 Which of the following statements is true regarding the two companies?

H&M likely has better ability to pay off its short-term liabilities than Cardullo's. is correct Current ratio indicates a company's liquidity. A higher current ratio means a higher proportion of current assets available to cover current liabilities.

Notice how overall Amazon's gross profit % trend is increasing while the profit margin trend is decreasing.

Higher demand has allowed Amazon to increase their prices, while higher overhead expenses have been hurting overall profits. is correct This is the correct answer! Higher selling prices would result in a higher gross profit margin, but increasing operating expenses could eat away the profits before they hit the bottom line.

Days purchases outstanding = average accounts payable/annual credit purchase/365 = average accounts payable/COGS/365= 365/accounts payable turnover

Increase in inventory ending balance is correct Asset Turnover = Sales / Average Assets An increase in the inventory ending balance will cause Average Assets, the denominator, to increase, and thus will decrease Asset Turnover.

Company X reported the following information on its 2015 income statement: Interest Expense $10,000 Income Tax $50,000 Net Income $140,000 What is Company X's Interest Coverage Ratio for 2015?

Interest Coverage Ratio = EBIT / Interest Expense = (Net Income + Income Tax + Interest Expense) (140,000 +50,000 + 10,000) / 10,000) = 20.0

Company X reported the following information on its 2015 income statement: Interest Expense $12,000 Income Tax $54,000 Net Income $144,000 What is Company X's Interest Coverage Ratio for 2015?

Interest Coverage Ratio = EBIT / Interest Expense = (Net Income + Income Tax + Interest Expense) (144,000 +54,000 + 12,000) / 12,000) = 17.5

A company's Inventory Turnover decreased during the year. Which of the following is a reasonable explanation to this trend?

Inventories were less marketable compared with last year. is correct Inventory Turnover = Cost of goods sold / Average inventory As the inventories became less marketable, the company would be less efficient in operating its inventories, and thus the Inventory Turnover would decrease.

Company A has a higher Inventory Turnover Ratio than Company B. Which of the following statements is true regarding these two companies?

Inventory Turnover = Cost of goods sold / Average inventory Inventory Turnover measures the number of times inventory is sold or used in a time period. It is an indicator of operating efficiency.

The gross profit margin for Amazon for each year from 2010 to 2012 is listed below. 2010: 22.35% 2011: 22.44% 2012: 24.75% Which explanation below is a reasonable explanation for the trend in the ratio?

Inventory prices have fallen resulting in decreased COGS. is correct This is the correct answer! If the cost of inventory decreased, Amazon could make more money off of each item it sold.

You have just reviewed the financial statements of Penelope's Candy Store (PCS). You have determined that PCS has a Profit Margin of 19%. How do you explain this to owner Penelope Hassey?

Profit Margin (Net Income/Sales) measures the ability of a company to make a profit relative to revenue generated during a period. A Profit Margin of 19% tells us that for every $100 in sales, $19 ended up in Net Income.

Which of the following ratios measures the ability of a company to make a profit relative to the revenue generated during the period?

Profit margin shows the % of each dollar of sales that ends up as net profit.

The profit margin for East Corp. for each year from 2011 to 2013 is listed below. 2011: 7.13% 2012: 7.68% 2013: 8.14% Which of the following is NOT a reasonable explanation for the trend in the ratio?

Lower variable costs would result in a higher profit margin. Increase in sales price would result in a higher profit margin. East Corp. declared a cash dividend to shareholders. is correct This is the correct answer! This situation wouldn't directly impact a company's profit margin.

How do you calculate the profit margin ratio within the DuPont Framework?

Net income/Sales is correct This is the correct answer! This ratio shows the % of each dollar of sales that ends up as net profit.

Utility company

Of the companies that remain, Company A, B, and E all have low inventory and high plant and equipment. Company A has the highest in terms of PPE, which would likely be the utility company. Company A also has low cash and low accounts receivable, which also point to a utility company.

Why is it important to consider seasonality of industries when analyzing financial statements of companies?

Outcomes of the analysis would depend on when you are looking at the statements. is correct Ratio analysis could differ significantly by looking at peak times as opposed to the entire fiscal year.

The Peach Pit, a restaurant, has Net Income of $25,000, Sales of $55,000, Assets of $115,000, and no debt. What is their ROE?

ROE = (Net Income / Sales) X (Sales / Assets) X (Assets / Equity) If a company has no debt, then their equity multiplier is 1. (25,000/55,000) * (55,000/115,000) * 1 = 21.7%

Initech finances their business using a combination of equity and liabilities. Which of the following numbers is most likely Initech's equity multiplier? -1 0 1 1.5

The correct answer is 1.5. A company that finances using only equity will have an equity multiplier of 1. Any amount over 1 shows the proportion financed using liabilities. Since Initech uses a combination of equity and liabilities to finance operations, the only option that would most likely be their equity multiplier is option 4, 1.5.

Based on the breakdown of the DuPont framework for two companies below, which company is more likely to be a high volume retailer?

The correct answer is Company B. Company B is likely a high volume retailer because its low profit margin indicates that it isn't adding a lot of value to products, and the high asset turnover means that it is selling through a lot of inventory.

How does the equity multiplier measure the impact of debt for a company if the formula does not include debt at all under the DuPont Framework?

The debt is implied in the numerator (total assets) is correct As liabilities (including debt) increase, the equity multiplier will be higher than one. Increasing leverage has the potential of higher returns but the investment become riskier too.

What does the asset turnover represent in the DuPont formula?

The efficiency with which assets are used to generate revenue is correct DuPont framework measures a business' operating efficiency using Asset Turnover, which indicates how well a business is using its assets to produce sales. A business that can create more revenue with fewer assets is considered to be more efficient.

Gross profit and profit margins followed similar patterns in years 2011, 2012 and 2013 for Apple Inc. 2011 2012 2013 Gross Profit Margin 40.5% 43.9% 37.6% Profit Margin 23.9% 26.7% 21.7% What could explain the increase of ratios in 2012?

The introduction of new products or versions of a product with temporarily higher margins is correct This is the correct answer! Changes in product mix can have a significant impact on profitability from year to year for a consumer technology company like Apple.

What is measured by the DuPont Framework?

The return that a business generates during a period on equity invested in the business by the owners of the business. This is the definition of ROE (Return on Equity), which is measured by the DuPont Framework.