Deck 10: Analysis and Interpretation of Financial Statements

Question 1

On what does the adequacy of the gross profit margin depend?

A)Selling price
B)Buying price
C)Total expenses
D)Both A and B

Answer 1

Both A and B

Question 2

Why is interest added back to profit before tax when calculating return on total assets?

A)Because interest rates vary over time
B)To indicate to lenders that some risk is involved
C)Because the efficient use of resources should be examined independently from the method of financing
D)Both A and B

Answer 2

C

Question 3

From the following information, calculate Todd Ltd's rate of return on ordinary shareholders' funds. Ordinary share capital $\$ 600,000$ .
Retained profits and reserves $\$ 200,000$ .
180,000 fully paid $\$ 2.0010 \%$ Preference shares.
Net profit after tax and before preference dividend $\$ 276,000$ .

A)30.0%
B)16.0%
C)20.0%
D)26.0%

Answer 3

30.0%

Question 4

Place the key steps in financial ratio analysis in order of occurrence. i) Select the ratios considered appropriate and carry out the calculations.
ii) Interpret and evaluate what the ratios reveal.
iii) Identify the users and their information needs.

A)ii, i, iii.
B)iii, ii, i.
C)iii, i, ii.
D)i, ii, iii.

Question 5

Which ratios measure the degree of risk associated with borrowing money from outsiders to finance the business?

A)Liquidity ratios
B)Investment ratios
C)Gearing ratios
D)Efficiency ratios

Question 6

A firm has total assets of $900 000 and total liabilities of $400 000. There are no preference shareholders. Earnings before interest and taxes are $100 000. Interest is $21 000 and taxes are $34 000. The return on ordinary shareholders' funds is:

A)8.0%
B)12.5%
C)9.0%
D)3.8%

Question 7

Which ratios are specifically concerned with assessing the returns and performance of shares held for investment purposes?

A)Liquidity ratios
B)Gearing ratios
C)Investment ratios
D)Efficiency ratios

Question 8

A firm has total assets of $800 000 and total liabilities of $200 000. If profit after tax and interest is $150 000, the return on shareholders' funds is:

A)25%
B)8%
C)12.5%
D)9%

Question 9

SSS Ltd has provided the following information from its financial statements for the year ended 30 June 2018. $\begin{array}{ll}\text { Sales (all on credit) } & \$ 2,000,000 \\\text { Gross profit on sales } & 1,000,000 \\\text { Net profit } & 150,000 \\\text { Cost of sales } & 1,000,000 \\\text { Inventory at end of year } & 200,000 \\\text { Accounts receivable at end of year } & 500,000\end{array}$

-The company trades 365 days per year. The number of times SSS's accounts receivable turned over for 2018 is:

A)5.0 times.
B)1.8 times.
C)3.8 times.
D)4.0 times.

Question 10

SSS Ltd has provided information from its financial statements for the year ended 30 June 2018. $\begin{array}{ll}\text { Sales (all on credit) } & \$ 2,000,000 \\\text { Gross profit on sales } & 1,000,000 \\\text { Net profit } & 150,000 \\\text { Cost of sales } & 1,000,000 \\\text { Inventory at end of year } & 200,000 \\\text { Accounts receivable at end of year } & 500,000\end{array}$

-The company trades 365 days per year. The number of times SSS's inventory turned over for 2018 is:

A)2.0 times.
B)5.0 times.
C)5.5 times.
D)2.2 times.

Question 11

Operating profit before interest and taxation, divided by sales × 100/1 is the formula for:

A)return on capital employed.
B)asset turnover period.
C)return on shareholders' funds.
D)operating profit margin.

Question 12

Calculate the return on capital employed if net profit before interest and tax is $440 000, shareholders' funds are $5 000 000 and long-term loans are $4 000 000.

A)4.9%
B)11.0%
C)6.2%
D)12.2%

Question 13

Which of these is not an efficiency ratio?

A)Current ratio
B)Average settlement period for accounts receivable
C)Asset turnover period
D)Average inventory turnover period

Question 14

R Co had a profit of $100 000 before tax, after deducting $18 000 in interest expense. R Co's non-current liabilities and equity total $1 000 000. Return on capital employed, before interest and tax is:

A)13%
B)11.8%
C)10%
D)9%

Question 15

If gross profit is $500 000, interest expense is $200 000, sales is $1 900 000 and total assets are $5 400 000, calculate the gross profit margin.

A)6.3%
B)18.9%
C)26.3%
D)10%

Question 16

Ratios should not be used in isolation because:

A)different ratios may give contradictory messages.
B)their behaviour is interrelated.
C)a decision will often have a number of aspects.
D)All of the above

Question 17

The formula for gross profit margin is gross profit divided by:

A)sales.
B)total assets.
C)total equity.
D)share capital + long-term loans.

Question 18

Which ratio is considered to be the primary measure of overall profitability as it assesses how effectively the business has used its funds?

A)Return on ordinary shareholders' funds
B)Gross profit margin
C)Return on capital employed
D)Operating profit margin

Question 19

What is a good benchmark to compare business performance during a given period?

A)Budgeted performance
B)Past performance
C)Competitor's performance
D)All of the above

Question 20

The incorrect statement concerning financial ratios is:

A)A ratio expresses the relationship between two figures appearing in the financial statements.
B)Ratios are easy to interpret but difficult to calculate.
C)Ratios adjust for scale of operations and allow comparisons between businesses of different sizes.
D)None of the above, i.e., all are true statements

Question 21

What does the current ratio measure?

A)Use of assets
B)Profitability
C)Investments
D)Liquidity

Question 22

Which of these is not an advantage of a shorter inventory turnover period?

A)It means fewer funds are tied up in inventory so more are available for use in the business.
B)It means less storage space is needed for inventory.
C)It means that management can have the cost advantage of buying in bulk.
D)It means that inventory is less likely to become obsolete or out of date.

Question 23

Which of these ratios is not directly relevant to the evaluation of a company's short-term liquidity position?

A)Operating profit ratio
B)Current ratio
C)Quick ratio
D)Acid test ratio

Question 24

Because a company's inventory is less liquid than its other current assets when investors are assessing liquidity, they should examine the:

A)debt-equity ratio.
B)accounts receivable turnover ratio.
C)acid test ratio.
D)current ratio.

Question 25

Which ratios are specifically concerned with assessing the efficiency with which assets have been used by the business?

A)Liquidity ratios
B)Efficiency ratios
C)Gearing ratios
D)Investment ratios

Question 26

Using the information below find the average inventory turnover for Vox Ltd in days. $\begin{array}{ll}\text { Sales } & \$ 1,800,000 \\\text { Cost of sales } & 1,200,000 \\\text { Stock on hand start } & 360,000 \\\text { Stock on hand end } & 312,000\end{array}$

A)102.2 days
B)63.26 days
C)94.8 days
D)68 days

Question 27

If the turnover period for accounts receivable is 8.1 times per annum, what is the average number of days it takes to collect cash from accounts receivable?

A)81 days
B)45 days
C)295 days
D)60 days

Question 28

Which statement is not correct?

A)A business will prefer a shorter settlement time for its accounts receivable rather than a longer settlement period.
B)An asset turnover figure of 1.5 times is preferred to a figure of 1.2 times.
C)A business will prefer a longer average inventory turnover time rather than a shorter turnover time.
D)None of the statements, i.e., all are correct

Question 29

Which of the following businesses would you expect to have the highest current ratio?

A)Service business that sells on credit
B)Manufacturer
C)Retailer
D)Service business that sells for cash

Question 30

If current assets exceed current liabilities, the payment of accounts payable will:

A)decrease the current ratio.
B)increase the level of cash held.
C)increase the current ratio.
D)None of the above

Question 31

Dollar Ltd has a current ratio of 2:1. This means that:

A)there is $2 of current assets for every $1 of current liabilities.
B)its current assets are half its current liabilities.
C)its current assets are insufficient to meet its current liabilities.
D)its current assets are equal to its current liabilities.

Question 32

Which statement concerning the average settlement period for accounts payable is correct?

A)It is always best for the business to make creditors wait for their money for as long as possible.
B)It is best to pay accounts payable as quickly as possible.
C)Accounts payable provide a free source of finance for a business.
D)A change in the accounts payable turnover period of 56 days to 65 days means that accounts payable are being paid faster.

Question 33

What does the inventory turnover period ratio measure?

A)The liquidity of the firm
B)How much the firm's current assets could decrease and still leave it able to pay its current liabilities
C)Profitability
D)The average time an organisation holds inventory

Question 34

Sports Ltd reports the following information: $\begin{array}{lr}\text { Net profit } & \$ 30,000 \\\text { Total assets } & 950,000 \\\text { Current liabilities } & 285,000 \\\text { Deferred liabilities } & 405,000\end{array}$ If current assets represent 60% of total assets, Sports Ltd's current ratio is:

A)150%
B)67%
C)200%
D)50%

Question 35

Trendy Traders reported total sales amounting to $1 800 000 in the year 2018, of which 80% were on credit. At 31 December, customers owed $200 000. If the firm operates for 365 days a year, how long, on average, does it take to collect money from its debtors?

A)29 days
B)13 days
C)10 days
D)51 days

Question 36

If Line Ltd has a current ratio of 2.5:1 and current assets are $600 000, how much are the company's current liabilities?

A)$240 000
B)$300 000
C)$360 000
D)$200 000

Question 37

The following information was extracted from the financial records of Ross Ltd for the year ended 30 June 2018: $\begin{array}{ll}\text { Cash Sales } & \$ 50,000 \\\text { Credit Sales } & 200,000 \\\text { Accounts receivable } & 25,000 \\\text { Cost of Sales } & 130,000\end{array}$ If there are 365 trading days per year, calculate for the managing director the number of days that accounts receivable are outstanding at 30 June 2018.

A)86 days
B)51 days
C)114 days
D)46 days

Question 38

What does the acid test ratio eliminate from its calculation, because it is considered the least liquid of the current assets?

A)Bank bills
B)Accounts receivable
C)Government securities
D)Inventory

Question 39

Solvent Ltd has a quick ratio of 1.2:1 and its current liabilities amount to $200 000. If it purchased $40 000 of inventory on credit, its new quick ratio would be:

A)unable to be calculated.
B)higher.
C)unaffected by the transaction.
D)lower.

Question 40

U2 Ltd is considering whether to offer trade credit to A1 Ltd. The ratio from A1's accounts that will be most useful in assessing the firm's ability to repay its trade debts on time is the:

A)gearing.
B)asset turnover period.
C)interest cover.
D)average settlement period for accounts payable.

Question 41

Brad's Engineering Pty Ltd
SHAREHOLDERS' EQUITY
Additional Information:
REQUIRED:
a)From the information provided above, calculate each of the following ratios for each of the years ending 30 June 2017 and 2018.
b)Comment on the movements in the ratios over the two years and the adequacy of the level of gearing and interest cover.
_____________________________________________________________________________________________
_____________________________________________________________________________________________

Question 42

Blue Company reported: $\begin{array}{ll}\text { Share price } & \$ 18 \\\text { Net profit } & \$ 3000 \\\text { Preference dividend } & \$ 500 \\\text { Ordinary dividend } & \$ 1000 \\\text { Issued ordinary shares } & 1000 \text { shares }\end{array}$

- The price-earnings ratio per ordinary share is:

A)1.8:1
B)7.2:1
C)5.0:1
D)3.0:1

Question 43

The current market price of Fixit Ltd's ordinary shares is $5.00 each. If the latest earnings per share is $0.50, the company's price-earnings ratio is:

A)10 times.
B)2.0 times.
C)2.5 times.
D)20 times.

Question 44

Which of these is a factor that can influence the amount a company is prepared to distribute as dividends to its shareholders?

A)The availability of cash
B)Investors expectations
C)The need to retain funds within the business for future growth
D)All of the above

Question 45

Dividend yield on ordinary shares is calculated as:

A)dividends per share divided by market price per share.
B)annual dividend divided by issued capital.
C)annual dividend divided by earnings.
D)None of the above

Question 46

Blue Company reported: $\begin{array}{ll}\text { Share price } & \$ 18 \\\text { Net profit } & \$ 3000 \\\text { Preference dividend } & \$ 500 \\\text { Ordinary dividend } & \$ 1000 \\\text { Issued ordinary shares } & 1000 \text { shares }\end{array}$

- Earnings per ordinary share is:

A)$2.50
B)$3.00
C)$1.80
D)$1.50

Question 47

Trendy Ltd's net profit after tax was $1 200 and its interest expense was $400. Assuming corporate tax is $400, what is the company's interest cover ratio?

A)1.8
B)3.0
C)5.0
D)1.2

Question 48

Dividend yield is calculated as:

A)market price per share/dividend per share.
B)dividend per share/market price per share.
C)dividend/ number of issued shares.
D)net profit/market price per share.

Question 49

What ratio helps to measure the risk involved in financing a business with borrowed funds?

A)Asset turnover ratio
B)Current ratio
C)Interest cover ratio
D)Profit margin ratio

Question 50

Which user would be interested in examining the results of the profitability and gearing ratios?

A)Shareholders
B)Long-term lenders
C)Potential investors
D)All of the above

Question 51

If the price-earnings ratio is 8 times, the earnings yield is:

A)8%
B)12.5%
C)80%
D)10%

Question 52

Dividends announced during the period divided by the number of shares on issue is the formula for:

A)the dividend yield ratio.
B)the dividend per share ratio.
C)the dividend payout ratio.
D)the return on dividends ratio.

Question 53

Use this data to calculate earnings per ordinary share (EPS)for Orange Ltd. Market price for each Orange Ltd share $\quad$$\$ 7.80$
Net Profit (after interest, tax) $\quad$$\quad$$\quad$$\quad$$\$ 6400$
Number of ordinary shares issued $\quad$$\quad$$\quad$ 15000

A)$0.19
B)$0.43
C)$0.39
D)$0.61

Question 54

What does financial solvency refer to the ability of an entity to do?

A)Meet its long-term obligations
B)Earn a high rate of profit
C)Improve sales
D)Both A and B

Question 55

Which of these are alternative measures of gearing?

A)Total liabilities/total assets
B)Total liabilities/total owners' equity
C)Long-term liabilities/ total owners' equity
D)All are alternative measures of gearing

Question 56

Which of these ratios measure returns to shareholders?

A)Earnings per share
B)Dividend yield
C)Return on ordinary shareholders' funds
D)All of the above

Question 57

Which of these is not an advantage of using borrowed funds to finance a business?

A)Interest on borrowings is tax deductible.
B)Borrowing can be used to boost returns to owners, as long as the return on the funds exceeds the cost of interest.
C)Lenders do not dilute ownership interest in the business.
D)Interest on borrowing is a legal commitment that must be met.

Question 58

Success Ltd has a price-earnings ratio of 5 and earnings per share of 22 cents. Its issued capital consists of 2 000 000 $1 ordinary shares. The market price per share is:

A)$1.10
B)$1.00
C)$4.40
D)None of the above

Question 59

A company with a higher level of gearing will have:

A)a high liabilities/total assets ratio.
B)a lower owners' equity/total assets ratio.
C)a higher owners' equity/total assets ratio.
D)Both A and B

Question 60

Using the formula, gearing ratio = long-term liabilities/(shareholders' funds + long-term liabilities)× 100/1, calculate the gearing ratio from the following information. Long-term liabilities $18m
Shareholders' funds $14m

A)128%
B)56%
C)78%
D)44%

Question 61

If the earnings yield is 6.67%, the price-earnings ratio is:

A)12:1
B)15:1
C)6:1
D)6.7:1

Question 62

If earnings per share is 30c and the market price of each share is $6, the price-earnings ratio is:

A)20:1
B)10:1
C)5:1
D)25:1

Question 63

The type of analysis being carried out when a company's gross profit ratio for three years is graphed and compared with the average industry gross profit ratio calculated over the same time period is:

A)parallel analysis.
B)vertical analysis.
C)trend analysis.
D)gearing analysis.

Question 64

Which of these is a limitation of financial ratio analysis?

A)Suitable yardsticks for comparisons are not always available.
B)Ratios have a restricted vision as they only assess the past.
C)Year-end data is not necessarily typical of the position during the year.
D)All of the above

Question 65

Which of these is not a limitation of ratio analysis?

A)Different accounting methods used by competitors
B)Firms of different size cannot be compared
C)One ratio is not enough information to make an overall judgement
D)All are limitations

Question 66

If earnings per share is 85c, dividend per share is 50c, and the market price of each share is $9.35, the price-earnings ratio is:

A)18.7:1
B)11:1
C)9:1
D)5:1

Question 67

Which of these is not considered a limitation of financial ratio analysis?

A)Ratios are difficult to calculate.
B)It does not consider qualitative factors.
C)There is no adjustment for the effects of inflation.
D)All of the above