Banking Exam Financial Statement Analysis 4 — Questions and Answers
Question 1: When evaluating a company's earnings quality, which of the following is considered a red flag?
- Operating cash flow exceeds net income consistently
- Revenue growth is supported by proportional increases in accounts receivable
- Net income is primarily driven by non-recurring gains (Correct answer)
- Depreciation expense increases in line with capital expenditures
Correct 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.
Question 2: A company's return on equity (ROE) increases while return on assets (ROA) remains flat. Using DuPont analysis, this is most consistent with:
- Improved asset turnover
- Higher net profit margins
- Increased financial leverage (Correct answer)
- Reduced operating expenses
Correct answer: Increased financial leverage
ROE = ROA × Equity Multiplier; if ROA is unchanged but ROE rises, the equity multiplier (financial leverage) must have increased.
Question 3: Which accounting method recognizes revenue only when cash is received from the customer?
- Accrual basis
- Percentage-of-completion method
- Cash basis (Correct answer)
- Installment sales method
Correct answer: Cash basis
Cash basis accounting records revenue when cash is actually received, rather than when goods or services are delivered.
Question 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:
- 0.42
- 2.4 (Correct answer)
- 35
- 1.0
Correct 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.
Question 5: In bank lending, which financial statement is most critical for assessing a business borrower's repayment capacity?
- Balance sheet
- Statement of retained earnings
- Cash flow statement (Correct answer)
- Notes to financial statements
Correct 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.
Question 6: A company capitalizes a major expense rather than expensing it immediately. What is the immediate effect on the financial statements?
- Lower net income and lower assets
- Higher net income and higher assets (Correct answer)
- No effect on assets; lower net income
- Higher net income and lower equity
Correct 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.
Question 7: Which of the following ratios is most useful for comparing the profitability of companies with different capital structures?
- Return on equity (ROE)
- Net profit margin
- EBITDA margin (Correct answer)
- Earnings per share (EPS)
Correct 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.
Banking Exam Financial Statement Analysis 4
When evaluating a company's earnings quality, which of the following is considered a red flag?