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Exam 13: Financial Statement Analysis

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Question 41

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Sable Company is seeking a short-term loan from its local bank. The banker needs assurance that the company will be able to repay the loan. Describe three financial ratios the banker should consider including in the loan approval process. What information does each of your selected ratios provide?

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Question 42

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Solvency ratios are used to analyze the long-term debt-paying ability and the composition of the financing structure of the firm.

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Question 43

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Gamma Company and Chi Company are similar and similar-sized companies operating in the same industry. At the end of the most recent year, Gamma's price-earnings ratio was 22.0, and Chi's price-earnings ratio was 14.2. What conclusion would you draw based on the difference in price-earnings ratios for the two companies?

A limitation of financial statement analysis stems from the discretion of management to choose accounting procedures that cast the best light on the firm's performance.

The accounts receivable turnover ratio can be used to asses a firm's solvency.

The Fortune Company reported the following income for Year 2: What is the company's number of times interest is earned ratio? $\begin{array} { | l | r | } \hline \text { Sales } & \$ 130,000 \\\hline \text { Cost of goods sold } & 80,000 \\\hline \text { Gross margin } & \$ 50,000 \\\hline \text { Selling and administrative expense } & 15,000 \\\hline \text { Operating income } & \$ 35,000 \\\hline \text { Interest expense } & 5,000 \\\hline \text { Income before taxes } & \$ 30,000 \\\hline\text { Income tax expense } & 10,000 \\\hline \text { Net income } & \$ 20,000 \\\hline\end{array}$

Two ratios that provide insight on the relationship between credit sales and receivables are:

As of December 31, Year 1, Gant Corporation had a current ratio of 1.29, quick ratio of 1.05, and working capital of $18,000. The company uses a perpetual inventory system and sells merchandise for more than it cost. On January 1, Year 2, Gant sold inventory on account for $6,000. Which of the following statements is incorrect?

Darden Company has cash of $40,000, accounts receivable of $60,000, inventory of $32,000, and equipment of $100,000. Assuming current liabilities of $48,000, this company's working capital is:

The following balance sheet information was provided by Western Company: Assuming Year 2 net credit sales totaled $270,000, what was the company's average days to collect receivables? (Use 365 days in a year. Do not round your intermediate calculations.) $\begin{array} { | l | r r | r r | } \hline \text { Assets } & & 2014 & 2013 \\\hline \text { Cash } & \$ & 4,000 & \$ & 2,000 \\\hline \text { Accounts receivable } & & 15,000 & & 12,000 \\\hline \text { Inventory } & \$ & 35,000 & \$ 38,000 \\\hline\end{array}$

Which ratio compares the earnings per share of a company to the market price for a share of the company's stock?

Indicate whether each of the following statements about financial statement analysis is true or false.The reason behind a financial statement ratio or percentage analysis result is usually self-evident and does not require further study or analysis.In horizontal percentage analysis, an item from the financial statements is expressed as a percentage of the same item from a previous year's financial statements.Horizontal analysis for several years can be done by choosing one year as a base year and calculating increases or decreases in relation to that year.One form of horizontal analysis is the preparation of common size financial statements.Vertical analysis compares two or more financial statement items within the same time period.

Common methods of financial statement analysis include all of the following except:

Which of the following statements regarding ratio analysis is incorrect?

On December 31, Year 1, Allen Company's total current assets were $600,000 and its total current liabilities were $380,000. On January 1, Year 2, Allen paid $20,000 on accounts payable.Required: (a) Compute Allen's working capital before and after paying the account payable.(b) Compute Allen's current ratio before and after paying the account payable. Round your answer to two decimal places.

Indicate whether each of the following statements about financial statement analysis is true or false.Meaningful comparisons between two companies generally should be made using percentage analysis or ratio analysis, not absolute amounts.The materiality of accounting information refers to whether it is viewed as favorable (good news) or unfavorable (bad news).Companies must account for immaterial items in compliance with generally accepted accounting principles.To judge the materiality of an absolute financial statement amount, one must consider the size of the company reporting it.Comparing percentages derived from financial statement analysis has the drawback of varying materiality levels.

The following balance sheet information is provided for Patton Company: Assuming Year 2 cost of goods sold is $730,000, what is the company's average days to sell inventory? (Use 365 days in a year. Do not round your intermediate calculations.) $\begin{array} { | l | r r | r r | } \hline \text { Assets } & & 2014 & 2013 \\\hline \text { Cash } & \$ & 4,000 & \$ & 2,000 \\\hline \text { Accounts receivable } & & 15,000 & & 12,000 \\\hline \text { Inventory } & \$ & 35,000 & \$ & 38,000 \\\hline\end{array}$

Indicate whether each of the following statements about financial statement analysis is true or false.Ratio analysis may involve studying relationships between an item reported on the balance sheet and another reported on the income statement.Comparing sales in Year 2 with sales for Year 1 is a form of vertical analysis.Comparing net income in Year 2 with sales for Year 2 is a form of horizontal analysis.Liquidity ratios measure a company's ability to generate cash flows in the short term.Working capital is calculated by using the following formula: current assets - current liabilities.

Vertical analysis always involves comparing financial statement elements over a span of time.

Financial ratio analysis is a form of horizontal analysis in that comparisons are made between different accounts in the same set of financial statements.