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Exam 9: Financial Statement Analysis

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Question 31

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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. ______

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Ratio analysis may involve studying rela...

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Question 32

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The current ratio is one of the most common measures of solvency.

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Question 33

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Assume that you are considering purchasing some of a company's long-term bonds as an investment. Which of the company's financial statement ratios would you probably be most interested in?

Which ratio measures how effectively a company is using assets to generate revenue?

Explain the difference between horizontal analysis and vertical analysis of a company's financial statements.

Crawford Company's current ratio for Year 2 was 1.42, which was slightly above the current ratio for similar companies in its industry. Crawford's quick ratio for Year 2 was 0.68, which is substantially lower than for similar companies in its industry. What conclusion would you draw based on this information?

The following balance sheet information was provided by Western Company: $\begin{array}{lrr}\text { Assets } & \text { Year 2 } & \text { Year 1 } \\\text { Cash } & \$ 3,400 & \$ 2,900 \\\text { Accounts receivable } & \$ 22,000 & \$ 20,000 \\\text { Inventory } & \$ 38,000 & \$ 44,000\end{array}$ Assuming Year 2 net credit sales totaled $134,000, what was the company's average days to collect receivables? (Use 365 days in a year. Do not round your intermediate calculations.)

A company has an obligation to provide highly detailed information on its financial statements.

Ratios can be used for different purposes. For example, a variety of ratios have been developed to assess a firm's liquidity. Similarly, ratios have been developed to assess solvency, profitability, and stock market strength. A sample of commonly used ratios for these purposes is provided in the table below. Required: In the middle column of the table, provide the formula to compute the specified ratio. In the final column, indicate the purpose (Liquidity, Solvency, Profitability, and Stock market strength) for which the ratio is most commonly used. The first item is completed as an example.

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?

Osgood Company provided the following income statement for Year 1 and Year 2: $\begin{array}{lrr}&\text { Year } 2 & \text { Year } 1\\\text { Sales } & \$ 220,000 & \$ 160,000 \\\text { Cost of goods sold } & 156,000 & 105,000 \\\text { Gross margin } & 64,000 & 55,000 \\\text { Less operating expenses: } & &\\\\\text { Selling and administrative expenses } & 26,000 & 15,000 \\\text { Interest expense } & 2,000 & 3,000 \\\text { Income before tax } & 36,000 & 37,000 \\\text { Income tax expense } & 10,800 & 11,100 \\\text {Net income } & \$ 25,200 & \$ 25,900\end{array}$ Required: Perform vertical analysis on Osgood's income statements for Year 1 and Year 2. Round your answer to one decimal place (i.e., 22.4%).Comment on the results, comparing Year 1 to Year 2.

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

Grove Corporation had sales of $3,000,000, cost of goods sold of $2,250,000, and average inventory of $500,000. What was Grove's inventory turnover ratio for the period?

Comparative income statements for Pearle Company are provided below: $\begin{array}{c}\text {Pearle Company}\\\text {Comparative Income Statement}\\\text {Years Ended December 31,}\\\begin{array}{lrr}&\text {Year 2}&\text {Year 1}\\\text { Sales } & \$ 595,000 & \$ 532,200 \\\text { Less cost of goods sold } & 386,200 & 357,650 \\\text { Gross margin } & 208,800 & 174,550 \\\text { Less operating expenses } & 108,950 & 99,770 \\\text { Income before taxes } & 99,850 & 74,780 \\\text { Income taxes } & 39,940 & 29,912 \\\text { Net income } & \$ 59,910 & \$ 44,868\end{array}\end{array}$ Required: Perform a horizontal analysis of Pearle Company's income statement by computing horizontal percentages for each item. Round your answer to one decimal place (i.e., 22.5%).

You are considering an investment in Facebook stock and wish to assess the company's position in the stock market. All of the following ratios can be used except:

Select the term from the list provided that best matches each of the following descriptions or definitions:

Indicate whether each of the following statements about financial statement analysis is true or false. Vertical analysis of a company's balance sheet is useful in assessing its liquidity. ______ Common size financial statements are a form of vertical analysis, but the common size statements for two or more years may usefully be compared. ______ Vertical analysis of a balance sheet involves converting each component to a percentage of stockholders' equity. ______ Small percentage changes resulting from vertical analysis may still represent large dollar amounts; therefore, changes in both absolute dollar amounts and percentages should be examined. ______ A common size income statement is prepared by converting each component to a percentage of net income. ______

Cost of goods sold divided by average inventory is the formula for which of these analytical measures?

Which of the following statements about financial statements is incorrect?

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?