CAT Financial Statement Analysis 2 — Questions and Answers
Question 1: A company's current ratio is 2.5 and its quick ratio is 0.8. What does this significant difference indicate?
- The company has strong liquidity
- The company carries a large amount of inventory (Correct answer)
- The company has excessive long-term debt
- The company is highly profitable
Correct answer: The company carries a large amount of inventory
A large gap between current ratio and quick ratio indicates that inventory makes up a significant portion of current assets, since quick ratio excludes inventory.
Question 2: Which financial statement presents revenues and expenses over a specific accounting period?
- Balance sheet
- Statement of cash flows
- Income statement (Correct answer)
- Statement of retained earnings
Correct answer: Income statement
The income statement (also called profit and loss statement) summarizes revenues, expenses, and net income over a defined period such as a quarter or fiscal year.
Question 3: When analyzing a common-size income statement, each line item is expressed as a percentage of:
- Total assets
- Net income
- Net revenue (Correct answer)
- Total equity
Correct answer: Net revenue
In a common-size income statement, all items are expressed as a percentage of net revenue (or net sales), enabling comparison across companies of different sizes.
Question 4: A firm reports net income of $80,000 and average total assets of $640,000. What is its Return on Assets (ROA)?
- 8%
- 12.5% (Correct answer)
- 15%
- 6.25%
Correct answer: 12.5%
ROA = Net Income / Average Total Assets = $80,000 / $640,000 = 12.5%, measuring how efficiently assets generate profit.
Question 5: Which of the following is classified as a non-cash item that reduces net income but not operating cash flow?
- Interest expense
- Depreciation (Correct answer)
- Cost of goods sold
- Wages expense
Correct answer: Depreciation
Depreciation is a non-cash charge that reduces net income on the income statement but is added back in the operating section of the cash flow statement.
Question 6: If a company's days sales outstanding (DSO) increases significantly from one year to the next, this most likely indicates:
- Customers are paying faster
- Inventory turnover has improved
- The company is collecting receivables more slowly (Correct answer)
- Credit sales have decreased
Correct answer: The company is collecting receivables more slowly
A rising DSO means more days are needed to collect receivables, suggesting customers are taking longer to pay or credit policy has loosened.
Question 7: Horizontal analysis compares financial statement data by:
- Expressing each item as a percentage of a base figure within the same year
- Comparing figures across multiple time periods to identify trends (Correct answer)
- Benchmarking against industry competitors
- Calculating financial ratios from a single year
Correct answer: Comparing figures across multiple time periods to identify trends
Horizontal analysis (trend analysis) compares financial data across two or more periods to identify growth rates, patterns, and changes over time.
CAT Financial Statement Analysis 2
A company's current ratio is 2.5 and its quick ratio is 0.8.
What does this significant difference indicate?