Finance for Non-Finance Managers Financial Statement Analysis 3 — Questions and Answers
Question 1: What does EBITDA stand for and why is it used in financial analysis?
- Earnings Before Interest, Taxes, Depreciation, and Amortization — approximates operating cash flow (Correct answer)
- Earnings Before Income Tax, Dividends, and Adjustments — measures shareholder returns
- Estimated Business Income Tax and Debt Analysis — a regulatory measure
- Equity Balance Including Total Debt Allocations — a balance sheet metric
Correct answer: Earnings Before Interest, Taxes, Depreciation, and Amortization — approximates operating cash flow
EBITDA strips out financing and accounting decisions to show core operating profitability, useful for comparing companies across industries.
Question 2: A company has net income of $200,000 and revenue of $2,000,000. What is its net profit margin?
- 5%
- 10% (Correct answer)
- 15%
- 20%
Correct answer: 10%
Net profit margin = Net Income / Revenue = $200,000 / $2,000,000 = 10%.
Question 3: Which financial statement links the income statement and balance sheet?
- The cash flow statement
- The statement of retained earnings (Correct answer)
- The notes to financial statements
- The auditor's report
Correct answer: The statement of retained earnings
The statement of retained earnings shows how net income (from the income statement) flows into retained earnings on the balance sheet.
Question 4: What does a high price-to-earnings (P/E) ratio generally suggest?
- The stock is undervalued relative to earnings
- Investors expect strong future earnings growth (Correct answer)
- The company has high debt levels
- Dividends per share are above average
Correct answer: Investors expect strong future earnings growth
A high P/E ratio indicates investors are willing to pay a premium, typically because they anticipate significant earnings growth.
Question 5: Under accrual accounting, when is revenue recognized?
- When cash is received from the customer
- When the product or service is delivered (Correct answer)
- When the invoice is sent
- When the customer places the order
Correct answer: When the product or service is delivered
Accrual accounting recognizes revenue when goods or services are delivered, regardless of when payment is received.
Question 6: What does 'working capital' measure?
- Total assets minus total liabilities
- Current assets minus current liabilities (Correct answer)
- Fixed assets minus long-term debt
- Gross profit minus operating expenses
Correct answer: Current assets minus current liabilities
Working capital = Current Assets − Current Liabilities, representing the short-term liquidity available to fund daily operations.
Question 7: A company's return on equity (ROE) increases while net income stays flat. Which scenario most likely explains this?
- The company issued additional shares of stock
- The company repurchased shares, reducing equity (Correct answer)
- Revenue growth outpaced expense growth
- Accounts receivable collection improved
Correct answer: The company repurchased shares, reducing equity
ROE = Net Income / Shareholders' Equity; if equity decreases through buybacks while net income is flat, ROE rises.
Finance for Non-Finance Managers Financial Statement Analysis 3
What does EBITDA stand for and why is it used in financial analysis?