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Financial Statement Analysis Flashcards

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  1. When evaluating a company's earnings quality, which of the following is considered a red flag?

    Answer: Net income is primarily driven by non-recurring gains

    Net income driven mainly by one-time gains rather than core operations suggests poor earnings quality and may not be sustainable going forward.

  2. A company's return on equity (ROE) increases while return on assets (ROA) remains flat. Using DuPont analysis, this is most consistent with:

    Answer: Increased financial leverage

    ROE = ROA × Equity Multiplier; if ROA is unchanged but ROE rises, the equity multiplier (financial leverage) must have increased.

  3. Which accounting method recognizes revenue only when cash is received from the customer?

    Answer: Cash basis

    Cash basis accounting records revenue when cash is actually received, rather than when goods or services are delivered.

  4. An analyst finds that a company's book value per share is $25 but its market price is $60. This implies a price-to-book (P/B) ratio of:

    Answer: 2.4

    P/B ratio = Market Price ÷ Book Value per Share = $60 ÷ $25 = 2.4, meaning the market values the company at 2.4 times its net assets.

  5. In bank lending, which financial statement is most critical for assessing a business borrower's repayment capacity?

    Answer: Cash flow statement

    The cash flow statement shows actual cash generated from operations, which is the primary source for debt repayment rather than accounting profits.

  6. A company capitalizes a major expense rather than expensing it immediately. What is the immediate effect on the financial statements?

    Answer: Higher net income and higher assets

    Capitalizing an expense spreads the cost over multiple periods, resulting in higher current net income and a higher asset balance on the balance sheet.

  7. Which of the following ratios is most useful for comparing the profitability of companies with different capital structures?

    Answer: EBITDA margin

    EBITDA margin excludes interest expense, so it reflects operating profitability independent of how the company is financed, enabling fair cross-company comparisons.