Cambridge Business Publishers, 2021

© Cambridge Business Publishers, 2021 1-1 Financial Statement Analysis & Valuation, 6 th Edition Module 1

Framework for Analysis and Valuation

Learning Objectives – Coverage by question

True/False Multiple Choice LO1 – Explain and assess the four main business activities.

LO2 – Identify and discuss the users and suppliers of financial statement information.

1-4 1, 2

LO3 – Review the four financial statements. 5-10 3-19 LO4 – Assess business operations within the context of a competitive environment.

11-13 20-25

LO5 –Apply basic profitability analysis. 14 26, 27 LO6 – Describe the financial statement forecasting process.

LO7 – Explain the role of financial information in business valuation.

15 28-30

LO8 – Access and analyze financial datasets.

These questions are available to assign in myBusinessCourse.

(Financial Statement Analysis & Valuation, 6e Easton, McAnally, Sommers) (Test Bank Latest Edition 2023-24, Grade A+, 100% Verified) 1 / 4

© Cambridge Business Publishers, 2021 Test Bank (T/F & MC), Module 1 1-2

Module 1: Framework for Analysis and Valuation

True/False

Topic: Users of Financial Statement Information

LO: 2

• Shareholders demand financial information primarily to assess profitability and risk whereas bankers

demand information primarily to assess cash flows to repay loan interest and principal.

Answer: True

Rationale: While both shareholders and bankers are interested in all the information companies provide, shareholders care about more about a company’s profitability and bankers care more about solvency and creditworthiness.

Topic: Publicly Available Financial Reports

LO: 2

• Publicly traded companies are required to provide quarterly financial reports directly to the public.

Answer: False

Rationale: Companies provide electronic versions of quarterly financial statements to the SEC, which posts them to the Internet for the public to access them.

Topic: Users of Financial Statement Information

LO: 2

• Publicly traded companies provide financial information primarily to satisfy the SEC and the tax

authorities (that is, the Internal Revenue Service).

Answer: False

Rationale: Demand for information extends to many users; the regulators such as the SEC and the IRS are only one class of users.

Topic: SEC Filings

LO: 2

• Publicly traded companies must provide to the Securities Exchange Commission annual audited

financial statements (10-K reports) and quarterly audited financial statements (10-Q reports).

Answer: False

Rationale: Quarterly reports do not need to be audited.

Topic: Balance Sheet

LO: 3

• If a company reports retained earnings of $175.3 million on its balance sheet, it must also report

$175.3 million in cash.

Answer: False

Rationale: The accounting equation requires total assets to equal total liabilities plus stockholders’ equity. That does not imply, however, that liability and equity accounts relate directly to specific assets. 2 / 4

© Cambridge Business Publishers, 2021 1-3 Financial Statement Analysis & Valuation, 6 th Edition

Topic: Balance Sheet

LO: 3

• A balance sheet shows a company’s position over a period of time, whereas an income statement,

statement of stockholders’ equity, and statement of cash flows show its position at a point in time.

Answer: False

Rationale: The statement is reversed: A balance sheet shows a company’s position at a point in time, whereas an income statement, statement of equity, and statement of cash flows show its position over a period of time.

Topic: Accounting Equation

LO: 3

• Assets must always equal liabilities plus equity.

Answer: True

Rationale: The accounting equation is Assets = Liabilities + Equity. This relation must always hold.

Topic: Income Statement

LO: 3

• The income statement reports net income which is defined as the company’s profit after all expenses

and dividends have been paid.

Answer: False

Rationale: The statement contains two errors. First, net income does not include any dividends during the period; these are a distribution of profits and not part of its calculation. Second, the income statement is prepared on an accrual basis and thus includes expenses incurred (as opposed to paid).

Topic: Statement of Cash Flows

LO: 3

• A statement of cash flows reports on cash flows for operating, investing and financing activities at a

point in time.

Answer: False

Rationale: A statement of cash flows reports on cash flows for operating, investing, and financing activities over a period of time.

Topic: Statement of Stockholders’ Equity

LO: 3

• An increase in common stock would be reflected in the statement of stockholders’ equity.

Answer: True

Rationale: The statement of stockholders’ equity reports on changes in the accounts that make up stockholders’ equity. This includes contributed capital, retained earnings, and other equity.

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© Cambridge Business Publishers, 2021 Test Bank (T/F & MC), Module 1 1-4

Topic: Return on Assets

LO: 4

• Return on Assets (ROA) measures the profit the company makes on each dollar of total assets it

uses.

Answer: True

Rationale: Return on Assets is a profitability metric that measures how much profit the company made for each dollar of assets the company holds on average during the year.

Topic: Return on Assets

LO: 4

• Return on Assets (ROA) = (Net Income / Sales) × Asset Turnover

Answer: True

Rationale: Return on Assets = Net Income / Average Assets. This is the disaggregation of the ROA into its components

Topic: Asset Turnover

LO: 4

• Consider two companies (A and B) with equal profit margins of 18%. Company A has an asset

turnover of 1.2 and Company B has an asset turnover of 1.5. If all else is equal, Company B with its’ higher asset turnover, is less profitable because it requires more revenue to turn its assets over.

Answer: False

Rationale: Asset turnover is an efficiency metric. The higher the turnover, the more efficient the company is with its assets and thus, the more profitable. Algebraically, ROA = PM × AT. Company A above is less profitable: 18% × 1.2 = 21.6% whereas Company B’s ROA is 18% × 1.5 = 27.0%.

Topic: Financial Accounting and Business Analysis

LO: 5

• Financial statements are influenced by five important forces that determine a company’s competitive

intensity: (A) industry competition, (B) buyer power, (C) supplier power, (D) product substitutes, and (E) threat of entry.

Answer: True

Rationale: By systematically considering these five business forces, we can gain better insights from financial statements.

Topic: Audit Report

LO: 7

• A “clean” audit report asserts—among other things—that (a) the auditor has prepared all necessary

financial statements and (b) management has expressed its opinion that they are prepared in conformity with GAAP.

Answer: False

Rationale: The statement is reversed: A “clean” audit report asserts—among other things—that (a) management has prepared all necessary financial statements and (b) the auditor has expressed its opinion that they are prepared in conformity with GAAP.

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