Chapter 14

Financial Statement Analysis

CHAPTER 14 NAME #

10-MINUTE QUIZ A SECTION

Indicate the best answer to each question in the space provided.

1 The quick ratio is considered more useful than the current ratio for:
a Evaluating the profitability of a business that sells inventory very quickly,
such as a restaurant.
b Evaluating the solvency of a business that turns inventory into cash very
slowly, such as a shipbuilder.
c Evaluating long-term credit risk.
d Evaluating investors’ expectations concerning future earnings.

2 The debt ratio is a measure of:

a Net cash flows relating to financing activities.
b Long-term credit risk.
c Short-term solvency.
d Profitability, independent of the manner in which assets are financed.

3 In the long-run, it is most important for a business to generate an inflow of cash

from its:
a Operating activities.
b Stockholders.
c Investing activities.
d Creditors.

4 Return on assets measures the efficiency with which management:

a Generates earnings from the assets under its control, regardless of how these
assets are financed.
b Generates earnings from the assets under its control, giving consideration to
any costs of financing these assets.
c Generates cash from the assets under its control, regardless of accrual-based
measures of profitability.
d Converts its current assets into cash.

5 A transaction that will increase the quick ratio but cause the current ratio to decline
is:
a Short-term borrowing.
b Investing cash in plant assets.
c Sale of inventory at a price below cost.
d Collection of an account receivable.

800
CHAPTER 14 NAME #

10-MINUTE QUIZ B SECTION

Shown below are data taken from a recent annual report of Griffith Co. (Dollar amounts in millions.)
Beginning End
of Year of Year

Balance sheet data:

Current assets .............................................................. $ 1,014 $ 1,098
Total assets .................................................................. 1,502 1,786
Current liabilities ......................................................... 372 312
Total liabilities............................................................. 535 468
Total stockholders’ equity ........................................... 981 1,193

Income statement data:

Net sales ...................................................................... 2,705
Gross profit ................................................................. 1,239
Operating income ........................................................ 563
Net income .................................................................. 413

Based upon the above information, indicate the best answer in the space provided.

1 The current ratio at year-end (rounded to the nearest tenth) is:

a 2.3 to 1. c 3.5 to 1.
b .6 to 1. d Some other answer.

2 The amount of working capital at the beginning of the year (in millions) was:
a $785 c $479.
b $1,193. d Some other answer.

3 The gross profit rate for the year (rounded to the nearest 1 percent) was:
a 46%. c 69%.
b 54%. d Some other answer

4 The return on average total assets during the year (rounded to the nearest percent)
was:
a 24%. c 79%.
b 34%. d Some other answer.

5 The return on average total stockholders’ equity during the year (rounded to the
nearest 1 percent) was:
a 50%. c 38%.
b 41%. d Some other answer.

801
CHAPTER 14 NAME #

10-MINUTE QUIZ C SECTION

Shown below are data taken from a recent annual report of, Topaz, Inc. (Dollar amounts in millions.)
Beginning End
of Year of Year

Balance sheet data:

Current assets .............................................................. $ 625 $ 700
Total assets .................................................................. 1,050 1,200
Current liabilities ......................................................... 275 175
Total liabilities............................................................. 500 600
Total stockholders’ equity ........................................... 575 725

Income statement data:

Net sales ...................................................................... 1,900
Gross profit ................................................................. 900
Operating income ........................................................ 450
Net income .................................................................. 300

Instructions Compute the following:

a Current ratio at year-end (round to nearest tenth). ........ ________ to 1

$700 $175 = 4

b Working capital at the beginning of the year

(in millions) $____________

. $625 - $275 = $350

c Gross profit rate for the year (round to the

nearest 1 percent) ______%

$900 $1,900 = 47.4%

d Return on average total assets for the year

(round to the nearest 1 percent) ______%

$450 [($1,050 + $1,200) 2] = 40%

e Return on average total equity for the year

(round to the nearest 1 percent) ______%

$300 [($575 + $725) 2] = 46.2%

802
CHAPTER 14 NAME #

10-MINUTE QUIZ D SECTION

Given below are comparative balance sheets and an income statement for the Sterling
Corporation:

Sterling Corporation Sterling Corporation

Balance Sheets – Current Year Income Statement for the
Dec. 31 Jan. 1 Current Year
Cash $ 24,300 $ 20,700 Sales $720,000
Accounts receivable 193,500 166,500 Cost of goods sold (396,000)
Inventory 133,200 136,800 Gross profit on sales $324,000
Equipment (net) 99,000 117,000 Operating expenses (340,000)
$450,000 $441,000 Operating income $ 90,000
Interest expense and
Accounts payable 103,500 113,400
income taxes (30,060)
Dividends payable 13,500 10,800 Net income $ 59,940

Capital stock, $9 par

90,000 90,000
Retained earnings 243,000 226,800
$450,000 $441,000

All sales were made on account. Cash dividends declared during the year totaled $43,740.
Compute the following:

a Average accounts receivable turnover. ($720,000 $180,000) = 4 times

b Book value per share at the end of the current year ($333,000 10,000 shares) = $33.30

c Earnings per share of capital stock. ($59,940 10,000 shares) = $5.99

d Return on assets. ($90,000 $445,500) = 20%

e Return on common stockholders’ equity is computed by dividing $59,940 by $324,900.

[($333,000 + $316,800) 2]

803
 CHAPTER 14 SELF-TEST QUESTIONS FROM TEXTBOOK

Choose the best answer for each of the following questions and insert the identifying letter
in the space provided.

1 Which of the following usually is least important as a measure of short-term

liquidity?
a Quick ratio.
b Debt ratio.
c Current ratio.
d Cash flow from operating activities.

2 In each of the last five years, the net sales of Plaza Co. have increased at about half
the rate of inflation, but net income has increased at approximately twice the rate of
inflation. During this period, the company’s total assets, liabilities, and equity have
remained almost unchanged; dividends are approximately equal to net income.
These relationships suggest (indicate all correct answers):
a Management is successfully controlling costs and expenses.
b The company is selling more merchandise every year.
c The annual return on assets has been increasing.
d Financing activities are likely to result in a net use of cash.

3 From the viewpoint of a stockholder, which of the following relationships do you

consider of the least significance?
a The return on assets consistently is higher than the industry average.
b The return on equity has increased in each of the past five years.
c Net income is greater than the amount of working capital.
d The return on assets is greater than the rate of interest being paid to creditors.

4 The following data are available from the annual report of Frixall Motors:

Current assets ...................... $ 480,000 Current liabilities...............

$300,000
Average total assets ............. 2,000,000 Operating income .............. 240,000
Average total equity ............ 800,000 Net income ........................ 80,000

Which of the following statements are correct? (More than one statement may be
correct.)
a The return on equity exceeds the return on assets.
b The current ratio is .625 to 1.
c Working capital is $1,200,000.
d None of the above answers are correct.

Why answers A, B, and C in question 4 are incorrect:

A-)The return on assets, 12% ($240,000 $2,000,000), exceeds the return on equity, which is 10%
($80,000 $800,000).
B-) The current ratio is 1.6 to 1 ($480,000 $300,000).
C -) Working capital amounts to $180,000 ($480,000 - $300,000).

804
 5 Hart Corporation’s net income was $400,000 in 2004 and $160,000 in 2005. What
percentage increase in net income must Hart achieve in 2006 to offset the decline
in profits in 2005?
a 60%. b 150%. c 600%. d 67%.

Increase in net income required in question 5: ($400,000 - $160,000) $160,000 = 150%

6 If a company’s current ratio declined in a year during which its quick ratio
improved, which of the following is the most likely explanation?
a Inventory is increasing.
b Inventory is declining.
c Receivables are being collected more rapidly than in the past.
d Receivables are being collected more slowly than in the past.

7 In financial statement analysis, the most difficult of the following items to predict
is whether:
a The company will be liquid in six months.
b The company’s market share is increasing or declining.
c Profits will increase in the coming year.
d The market price of capital stock will rise or fall over the next two months.

805