Financial Accounting: An Integrated Statements Approach, 2nd Edition

684 Chapter 14 Financial Statement Analysis

ANSWERS TO SELF-STUDY QUESTIONS

1. A Percentage analysis indicating the relationship of the
   component parts to the total in a financial statement, such as
   the relationship of current assets to total assets (20% to 100%)
   in the question, is called vertical analysis (answer A). Percentage
   analysis of increases and decreases in corresponding items in
   comparative financial statements is called horizontal analysis
   (answer B). An example of horizontal analysis would be the
   presentation of the amount of current assets in the preceding
   balance sheet, along with the amount of current assets at the
   end of the current year, with the increase or decrease in current
   assets between the periods expressed as a percentage.
   Profitability analysis (answer C) is the analysis of a firm’s abil-
   ity to earn income. Asset efficiency analysis (answer D) seg-
   ments the asset turnover ratio into subcategories of assets.


2. D Current Ratio: Current Assets
   Current Liabilities

=

$275,000 = 2.75

$100,000

Quick Ratio: Quick Assets =

Current Liabilities

$175,000 = 1.75

$100,000

3. D Accounts receivable turnover:

Sales (net) =

Average Accounts Receivable (net)

$1,000,000 = 4.0

($200,000 + $300,000)/2

Number of days’ sales in accounts receivable:

Accounts Receivable, Average

=

Average Daily Sales

($200,000 + $300,000)/2

= 91.25

$1,000,000 ÷ 365

4. A The DuPont ratio segments the rate earned on total
   assets into the product of the profit margin and the asset
   turnover (answer A). The rate earned on stockholders’ equity
   is not explained by the DuPont ratio, but is explained by
   leverage. (Answers B and C are true statements, but they are
   not the Dupont formula.) Answer D is meaningless.


5. C The number of days’ sales in inventory (answer C),
   which is determined by dividing the inventories at the end of
   the year by the average daily cost of goods sold, expresses the
   relationship between the cost of goods sold and inventory. It
   indicates the efficiency in the management of inventory.
   The working capital ratio (answer A) indicates the ability of
   the business to meet currently maturing obligations (debt).
   The quick ratio (answer B) indicates the “instant” debt-paying
   ability of the business. The ratio of fixed assets to long-term
   liabilities (answer D) indicates the margin of safety for long-
   term creditors.