Question 1

Using vertical analysis of the income statement, a company's net income as a percentage of sales is 15%; therefore, the cost of goods sold as a percentage of sales must be 85%.

Accepted Answer

Vertical analysis only shows the proportion of each line item in the income statement relative to sales. It does not provide information on the relationship between different line items, such as cost of goods sold and net income. Therefore, we cannot determine the cost of goods sold as a percentage of sales based on the given information.

Question 2

In a common-sized income statement, each item is expressed as a percentage of net income.

Accepted Answer

In a common-sized income statement, each item is expressed as a percentage of revenue/sales, not net income.

Question 3

In horizontal analysis, the current year is the base year.

Accepted Answer

In horizontal analysis, the base year is typically the earlier year and the current year is compared to it.

Question 4

A financial statement showing each item on the statement as a percentage of one key item on the statement is called a common-sized financial statement.

Accepted Answer

This is correct. Common-sized financial statements express each line item as a percentage of one key item on the statement, typically sales or revenue. This allows for easier analysis and comparison of financial data.

Question 5

Factors that reflect the ability of a business to pay its debts and earn a reasonable amount of income are referred to as solvency, profitability, and liquidity.

Accepted Answer

Solvency refers to the ability of a business to pay its debts, profitability refers to the ability to earn a reasonable amount of income, and liquidity refers to the ability to convert assets into cash quickly to meet immediate obligations.

Question 6

In the vertical analysis of a balance sheet, the base for current liabilities is total liabilities.

Accepted Answer

In the vertical analysis of a balance sheet, the base for current liabilities is total assets, not total liabilities. This method compares each line item to a base amount, which, for the balance sheet, is typically total assets.

Question 7

An advantage of the current ratio is that it considers the makeup of the current assets.

Accepted Answer

The current ratio measures a company's ability to pay short-term obligations with its short-term assets without considering the makeup or quality of those assets.

Question 8

Current position analysis is used by short-term creditors to assess how quickly they will be repaid.

Accepted Answer

Current position analysis is a tool used by short-term creditors to evaluate a company's liquidity and ability to pay back short-term debt obligations. It assesses the relationship between a company's current assets and current liabilities, determining whether there is sufficient liquidity to meet short-term obligations. This information is important to creditors, who may use it to determine whether to grant credit, set payment terms, or assess creditworthiness.

Question 9

In the vertical analysis of an income statement, each item is generally stated as a percentage of total assets.

Accepted Answer

In the vertical analysis of an income statement, each item is generally stated as a percentage of total revenues or sales, not total assets.

Question 10

Using measures to assess a business's ability to pay its current liabilities is called current position analysis.

Accepted Answer

Current position analysis involves using measures to evaluate a business's ability to meet its current obligations, such as its current ratio or working capital ratio.

Question 11

On a common-sized income statement, all items are stated as a percent of total assets or equities at year-end.

Accepted Answer

On a common-sized income statement, all items are stated as a percent of total revenue or sales, not assets or equities.

Question 12

Dollar amounts of working capital are difficult to assess when comparing companies of different sizes or in comparing such amounts with industry figures.

Accepted Answer

This is because the dollar amount of working capital will vary depending on the scale of operations and the nature of the business. Therefore, it is better to analyze working capital ratios or turnover ratios to compare the efficiency of working capital management between companies or with industry standards.

Question 13

The relationship of each asset item as a percent of total assets is an example of vertical analysis.

Accepted Answer

Vertical analysis involves expressing each item in a financial statement as a percentage of a base amount within the same statement. In this case, the base amount is the total assets, and each asset item is expressed as a percentage of total assets.

Question 14

The excess of current assets over current liabilities is referred to as working capital.

Accepted Answer

This statement is true. Working capital is calculated as current assets minus current liabilities and represents the amount of funds a business has available for day-to-day operations.

Question 15

If two companies have the same current ratio, their ability to pay short-term debt is the same.

Accepted Answer

The current ratio only provides a snapshot of liquidity and does not account for the quality of assets, the timing of cash flows, or the companies' debt structures, which can all affect their ability to pay short-term debt.

Question 16

Comparative financial statements are designed to compare the financial statements of two or more corporations.

Accepted Answer

Comparative financial statements are designed to compare the financial statements of the same corporation over two or more periods, not between different corporations.

Question 17

The analysis of increases and decreases in the amount and percentage of comparative financial statement items is referred to as horizontal analysis.

Accepted Answer

This statement is true, as horizontal analysis involves comparing financial statement items over time to analyze changes in amounts and percentages.

Question 18

Vertical analysis refers to comparing the financial statements of a single company over several years.

Accepted Answer

Vertical analysis is a method of financial statement analysis in which each entry for each of the three major categories of accounts (assets, liabilities, and equities) in a balance sheet is represented as a proportion of the total account. It is not about comparing financial statements over several years, but rather analyzing a single financial statement to understand the relative proportions of its components.

Question 19

The ratio of the sum of cash, receivables, and marketable securities to current liabilities is referred to as the current ratio.

Accepted Answer

The ratio described is the quick ratio or acid-test ratio, not the current ratio. The current ratio includes all current assets, not just cash, receivables, and marketable securities, in its calculation against current liabilities.

Question 20

A 15% change in sales will result in a 15% change in net income.

Accepted Answer

The change in net income depends on several factors such as fixed costs, variable costs, taxes, and other expenses. A 15% change in sales may not directly result in a 15% change in net income.

Quiz 14: Financial Statement Analysis