Banking Exam Financial Statement Analysis 3 — Questions and Answers
Question 1: A company's quick ratio is 0.6 while its current ratio is 2.1. The large discrepancy is most likely due to:
- High levels of long-term debt
- A significant amount of inventory relative to current assets (Correct answer)
- Large prepaid expenses on the balance sheet
- Excessive accounts payable
Correct answer: A significant amount of inventory relative to current assets
The quick ratio excludes inventory, so a big gap between quick and current ratios indicates inventory makes up a large portion of current assets.
Question 2: When a lender performs vertical analysis on a borrower's balance sheet, what is typically used as the base (100%)?
- Total equity
- Total revenue
- Total assets (Correct answer)
- Total current liabilities
Correct answer: Total assets
In balance sheet vertical analysis, total assets serve as the base, so each asset, liability, and equity item is shown as a percentage of total assets.
Question 3: Which of the following best describes goodwill on a balance sheet?
- The fair value of tangible assets acquired in a merger
- The excess purchase price paid over the fair value of identifiable net assets in an acquisition (Correct answer)
- A reserve for future legal settlements
- Accumulated amortization of intangible assets
Correct answer: The excess purchase price paid over the fair value of identifiable net assets in an acquisition
Goodwill represents the premium paid in an acquisition above the fair value of identifiable net assets, reflecting brand, customer relationships, and synergies.
Question 4: An analyst reviewing trend analysis observes a company's gross margin shrinking from 42% to 31% over three years. This most likely indicates:
- Improved operational leverage
- Rising cost of goods sold relative to revenue (Correct answer)
- Declining selling, general, and administrative expenses
- Stronger pricing power
Correct answer: Rising cost of goods sold relative to revenue
A falling gross margin means the cost of producing or purchasing goods is rising faster than sales prices, compressing profitability at the production level.
Question 5: Which section of the cash flow statement would reflect a company's purchase of a new manufacturing facility?
- Operating activities
- Financing activities
- Investing activities (Correct answer)
- Supplemental disclosures
Correct answer: Investing activities
Purchases of long-term assets such as property, plant, and equipment are classified as investing activities on the cash flow statement.
Question 6: A borrower's financial statements show a debt service coverage ratio (DSCR) of 0.85. How should a bank analyst interpret this?
- The borrower generates 85% more cash than needed to cover debt service
- The borrower's cash flow is insufficient to cover principal and interest payments (Correct answer)
- The loan is well-secured and low risk
- The borrower has an adequate liquidity cushion
Correct answer: The borrower's cash flow is insufficient to cover principal and interest payments
A DSCR below 1.0 means the borrower's net operating income does not fully cover debt service obligations, indicating a cash flow shortfall.
Question 7: Which financial ratio would a bank most likely use to assess a company's short-term liquidity position?
- Price-to-earnings ratio
- Debt-to-equity ratio
- Current ratio (Correct answer)
- Return on assets
Correct answer: Current ratio
The current ratio (Current Assets ÷ Current Liabilities) measures whether a company has enough short-term assets to cover short-term obligations.
Banking Exam Financial Statement Analysis 3
A company's quick ratio is 0.6 while its current ratio is 2.1.
The large discrepancy is most likely due to: