Financial Statement Analysis
Pre-Test Questions
Course Introduction
Financial Statement Analysis is a comprehensive course that explores the principles and techniques used to evaluate the financial health and performance of businesses through their published financial statements. Students will learn how to interpret balance sheets, income statements, and cash flow statements, and how to use ratio analysis, trend analysis, and other analytical tools to assess profitability, liquidity, solvency, and efficiency. The course emphasizes practical applications, enabling students to critically analyze real-world financial data, assess risks, and make informed decisions from the perspective of investors, creditors, and management.
Recommended Textbook
Financial Reporting Financial Statement Analysis and Valuation 6th Edition by Clyde P. Stickney
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Chapter 1: Overview of Financial Reporting, Financial
Statement Analysis, and Valuation
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Sample Questions
Q1) When assessing buyer power using Porter's five forces which of the following is not consistent with low buyer power?
A) Brand loyalty
B) Control of distribution channel
C) Large number of suppliers
D) Low price
Answer: C
Q2) Another important step in financial statement analysis is to assess the quality of a firm's ________________________________________ and if necessary adjust them for such characteristics as sustainability or comparability.
Answer: financial statements
Q3) On a common size basis, which of the following assets is normally largest for a electric utility?
A) Accounts receivable
B) Inventory
C) Property, Plant and Equipment
D) Cash and Marketable Securities
Answer: C
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Chapter 2: Asset and Liability Valuation and Income
Measurement
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Sample Questions
Q1) Accord Inc. income tax return shows taxes currently payable for 2006 of $85,000. The company reported deferred tax assets of $35,000 at the end of 2005 and $24,000 at the end of 2006. Accord reported deferred tax liabilities of $48,000 at the end of 2006 and $54,000 at the end of 2006.
Determine the amount of income tax expense reported by Accord for 2006.
Answer: Accord's income tax expense for 2006 can be determined by this journal entry: 11ea92c5_78a0_5edc_9469_07b64fb00f6e_TB5976_00
Q2) Net income equals revenues plus ____________________ minus expenses and ____________________.
Answer: gains, losses
Q3) Shareholders' equity consists of what three components:
A) Assets, liabilities, and contributed capital.
B) Contributed capital, accumulated other comprehensive income, and retained earnings.
C) Liabilities, contributed capital, and retained earnings.
D) Liabilities, contributed capital, and accumulated other comprehensive income. Answer: B
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Page 4
Chapter 3: Income Flows Versus Cash Flows: Key
Relationships in the Dynamics of a Business
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Sample Questions
Q1) ____________________ activities relate to transactions between the firm and its creditors and owners.
Answer: Financing
Q2) Free cash flows to all debt and common equity shareholders represents the excess of cash flows from
A) operating activities over cash flows for financing activities
B) investing over cash flows for operating activities
C) investing over cash flows for financing activities
D) operating activities over cash flows for investing activities
Answer: D
Q3) Cash flows from ____________________ activities will normally be negative during all of the introduction and growth phase of the product life cycle.
Answer: inv esting
Q4) The receipt of cash when employees exercise stock options is a (an) ____________________ activity.
Answer: financing
Q5) Many analysts use ____________________ as a crude measure of a firm's ability to pay down debt.
Answer: EBITDA
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Chapter 4: Profitability Analysis
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Sample Questions
Q1) Asset turnover represents
A) The ability of the firm to generate income from operations for a particular level of sales.
B) The ability to generate sales from a particular investment in assets.
C) The ability to manage the level of investment in assets for a particular level of assets.
D) The number of days, on average, it takes management to turnover assets.
Q2) Return on assets can be a misleading ratio when analyzing technology firms because two important assets, ______________________________ and ______________________________ do not appear on their balance sheets
Answer:
Q3) The ability of a firm to generate income from operations given a particular level of sales is measured by the ______________________________.
Answer:
Q4) Economic theory suggests that higher levels of ____________________ in any activity should lead to higher levels of
Answer:
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Chapter 5: Risk Analysis
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Q1) _________________________ concerns a firm's ability to make interest and principal payments on borrowings as they become due.
Q2) Refer to the financial statement data for Patriot Comp. for 2006 and 2005. Complete the table by computing the ratios.
Q3) Common shareholders benefit with increasing proportions of debt in the capital structure as long as the firm maintains an excess of ____________________ over the after-tax cost of debt
Q4) When management takes deliberate steps at a balance sheet date to produce a better current ratio than is normal it is called
Q5) Which of the following is not one of the three explanatory variables that determines a firm's market beta?
A) Degree of investing leverage.
B) Degree of operating leverage.
C) Degree of financial leverage.
D) Variability of sales.
Q6) The source of risk related to political unrest and exchange rate changes are
Q7) Beta captures the _________________________ of the firm.
Page 7
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Chapter 6: Quality of Accounting Information and Adjustments to Reported Financial Statement Data
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Q1) Some firms attempt to maximize the amount of restructuring charge in a particular year, analysts refer to this as the _________________________ approach.
Q2) Many times a financial analyst may decide to make adjustments to the financial statements in order to make the statements more useful. Which of the following would not require an adjustment to the financial statement?
A) A company signs a new contract with a customer.
B) A delivery company incurs a loss from disposition of used delivery trucks.
C) A company changes the useful life of its equipment from 5 years to 8 years.
D) A company incurs a charge related restructuring its operations.
Q3) When evaluating the quality of accounting information the user should consider the ____________________ of the measurements made.
Q4) When evaluating the quality of accounting information, an analyst should consider all of the following except:
A) reliability of the measurements made
B) adequacy of disclosures
C) comparability of estimates
D) economic faithfulness of the measurements made
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Chapter 7: Revenue Recognition and Related Expenses
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Q1) Under current accounting rules an asset is ____________________ when its carrying amount is deemed "not recoverable".
Q2) ___________________________________ is primarily a question of timing.
Q3) When cash collectibility is uncertain, a firm using the ____________________ method recognizes revenue as it collects portions of the selling price in cash.
Q4) Firms recognize an ______________________________ when the carrying amount of a fixed asset exceeds its fair value and is deemed not recoverable.
Q5) A company may try to paint a favorable picture of itself by accelerating the timing of revenues or estimating the collectible amounts too aggressively. In these cases the quality of accounting information declines because it does not represent the company's true economic condition and may not be sustainable. List four conditions which might suggest that a company is recognizing revenues too early?
Q6) The process of allocating the historical cost of certain assets to the periods of their use in a reasonably systematic manner is referred to as ____________________.
Q7) A company that uses LIFO will experience a ______________________________ during a period it sells more units than it purchases.
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Chapter 8: Liability Recognition and Related Expenses
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Q1) Dividing a company's income tax expense by its book income before income taxes provides the company's ___________________________________.
Q2) When firms use derivatives effectively to manage risks, the net gain or loss each period should be relatively ____________________.
Q3) Liabilities requiring the future delivery of goods or services appear on the balance sheet at the ______________________________ of those goods and services.
Q4) The _____________________________________________ is equal to the actuarial present value of amounts that the employer expects to pay to retired employees based on the employees' service to date and using expected future salary amounts.
Q5) Under an operating lease agreement the lessee recognizes ______________________________ each period that the leased asset is used.
Q6) Many firms use derivative instruments to hedge exposure to changes in the fair value an asset or liability or to hedge exposure to variability in expected future cash flows. As an analyst examining the financial reports of a company that uses derivative instruments to hedge, what questions should be asked when thinking about derivatives and accounting quality?
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Page 10
Chapter 9: Intercorporate Entities
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Q1) When a foreign entity operates as a relatively self-contained and integrated unit within a foreign country, normally, its functional currency is the
Q2) An investing firm consolidates the variable interest entity if it absorbs the majority of the entity's expected ____________________ if they occur, receives a majority of the entity's expected ______________________________ if they occur, or both.
Q3) Under the equity method the investor's share of investee income ____________________ the investment account and dividends ____________________ the investment account.
Q4) When a company has a minority passive investment it will recognize changes in the market value of the investment as ____________________ gains and losses.
Q5) Unrealized holding gains and losses from investments classified as trading are reported in the ___________________________________.
Q6) When a foreign entity operates as a direct and integral extension of the U.S. parent, normally, its functional currency is the _________________________.
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Chapter 10: Forecasting Financial Statements
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Q1) When projecting ____________________, the analyst should consider economy-wide factors such as the expected rate of general price inflation in the economy.
Q2) A firm in transition from the high growth to the mature phase of its life cycle, or a firm with significant technological improvements in its production processes, might expect increases in ______________________________ but decreases in sales prices per unit.
Q3) Many times an analyst will compute ending accounts receivable or inventory balances using turnover ratios, discuss the advantage and disadvantage of using this methodology.
Q4) Realistic expectations are ____________________ and ____________________.
Q5) Financial statement forecasts are important analysis tools because forecasts of ______________________________ play a central role in valuation and many other financial decision contexts.
Q6) The analyst can capture projected levels of operating activity by using ______________________________ to develop forecasts for individual assets.
Q7) For some types of assets, such as accounts receivable asset growth typically ____________________ future sales growth.
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Chapter 11: Risk-Adjusted Expected Rates of Return and the Dividends Valuation Approach
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Q1) Provide the rationale for using expected dividends in a valuation model.
Q2) In some valuation scenarios, such as a leveraged buyout, it may be necessary to adjust the market equity beta to reflect a ________________________________________.
Q3) Under the assumption of clean surplus accounting how would you compute total dividends paid to common equityholders in order to value the firm?
Q4) One criticism in using the CAPM to calculate the cost of equity capital is that ______________________________ and the __________________________________________________ are quite sensitive to the time period and methodology used in their computation.
Q5) Implementing a dividend valuation model to determine the value of the common shareholders' equity requires an analyst to measure three elements. Discuss what three elements need to be measured by the analyst.
Q6) To determine the appropriate weights to use in the weighted average cost of capital, an analyst will need to determine the ______________________________ of the debt, preferred stock and common equity capital.
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Q7) In theory, the value of a share of common equity is the present value of ____________________________________________________________.
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Chapter 12: Valuation: Cash-Flow-Based Approaches
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Q1) If an analyst wants to value a potential investment in the common stock equity in a firm the relevant cash flows the analyst should use are
A) free cash flow from operations
B) free cash flows for all debt and equity capital stakeholders
C) free cash flows to common equity shareholders
D) cash flow from operations
Q2) The conceptual framework for free cash flows separates the balance sheet equation into the following categories:
A) CA + LT A = CL + LT L + SE
B) OA + FA = OL + FL + SE
C) OA + FA = OL + FL + OSE + FSE
D) Non-FA + FA = Non-FL + FL + SE
Q3) Free cash flow from operations equals cash flow from operations adjusted for net interest after tax and adjusted for
Q4) The risk-adjusted discount rate used to compute the present value of all the projected free cash flows for common equity shareholders equals the
Q5) What three elements are needed to value a resource when using cash flows?
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Chapter 13: Valuation: Earnings-Based Approaches
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Q1) The appropriate discount rate for the residual income model is
A) Weighted average cost of capital
B) The risk free interest rate
C) The risk free interest rate plus the market premium
D) Cost of common equity capital
Q2) The residual income valuation approach assumes that accounting for net income and book value of shareholders' equity follows ________________________________________.
Q3) Residual income valuation focuses on
A) dividend-paying capacity in free-cash flows.
B) earnings as a periodic measure of shareholder wealth creation.
C) free cash flows as a periodic measure of shareholder wealth creation.
D) dividends as a periodic measure of shareholder wealth creation.
Q4) If an analyst expects a firm to generate net income each period exactly equal to required earnings, then the value of the firm will be equal to the ______________________________ of common shareholders' equity.
Q5) The foundation for residual income valuation is the classical _____________________________________________.
Q6) What is meant by the term clean surplus accounting?
Page 15
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Chapter 14: Valuation: Market-Based Approaches
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Q1) Discuss how risk and profitability factors cause differences in price-earnings ratios across firms.
Q2) What is the value of reverse engineering stock prices? How does the process work?
Q3) A company with a PEG ratio of greater than one would be interpreted as having a stock price
A) that is consistent with the company's growth prospects
B) that is low relative to the company's growth prospects
C) that is high relative to the company's growth prospects
D) that is undervalued
Q4) Market multiples capture ____________________ valuation per dollar of book value or per dollar of earnings.
Q5) Investors have invested $25,000 in common equity in a company. The investors expect that the company will reinvest all income back into projects. The company is forecasted to earn $6,000 the first year, $5,000 the second year, $5,500 the third year and $6,244 each year after the third year. The company's current stock price is $17 per share. Assuming that the company has 3,200 shares outstanding and the risk free rate of interest is 6% calculate the price differential for this company?
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