Finance for Non-Finance Managers Financial Statement Analysis 4 — Questions and Answers
Question 1: What is the difference between depreciation and amortization?
- Depreciation applies to intangible assets; amortization applies to tangible assets
- Depreciation applies to tangible assets; amortization applies to intangible assets (Correct answer)
- Both apply only to current assets
- Depreciation is a cash expense; amortization is non-cash
Correct answer: Depreciation applies to tangible assets; amortization applies to intangible assets
Depreciation allocates the cost of tangible fixed assets over time, while amortization does the same for intangible assets like patents.
Question 2: Which ratio best measures a company's ability to cover its interest payments from operating income?
- Current ratio
- Interest coverage ratio (Correct answer)
- Debt-to-equity ratio
- Return on assets
Correct answer: Interest coverage ratio
Interest coverage ratio = EBIT / Interest Expense, showing how many times operating earnings can cover interest obligations.
Question 3: On a balance sheet, which item is typically listed under 'long-term liabilities'?
- Accounts payable
- Accrued expenses
- Bonds payable due in 10 years (Correct answer)
- Short-term bank overdraft
Correct answer: Bonds payable due in 10 years
Long-term liabilities are obligations due beyond one year, such as bonds or long-term loans, unlike accounts payable which are short-term.
Question 4: What does a negative free cash flow indicate?
- The company is highly profitable
- The company is spending more cash than it generates from operations (Correct answer)
- The company has no debt obligations
- Dividends are being paid to shareholders
Correct answer: The company is spending more cash than it generates from operations
Negative free cash flow means operating cash flow is insufficient to cover capital expenditures, which may signal heavy investment or financial strain.
Question 5: Which accounting method results in lower net income during a period of rising prices — FIFO or LIFO?
- FIFO, because older lower-cost items are expensed first
- LIFO, because newer higher-cost items are expensed first (Correct answer)
- Both produce the same net income
- It depends on the depreciation method used
Correct answer: LIFO, because newer higher-cost items are expensed first
Under LIFO, the most recently purchased (higher-cost) inventory is sold first, increasing COGS and reducing net income when prices are rising.
Question 6: What does a rising accounts payable balance relative to purchases typically suggest?
- The company is collecting customer payments faster
- The company is taking longer to pay its suppliers (Correct answer)
- Inventory levels are declining
- Revenue is growing rapidly
Correct answer: The company is taking longer to pay its suppliers
A rising accounts payable balance indicates the company is deferring supplier payments longer, which can be a cash conservation strategy or a sign of cash strain.
Question 7: When performing a trend analysis, what is an analyst primarily examining?
- A company's financials compared to a single competitor
- Changes in a company's own financials over multiple periods (Correct answer)
- The industry average for a single year
- Regulatory filings from the past quarter only
Correct answer: Changes in a company's own financials over multiple periods
Trend analysis tracks a company's financial data over time to identify patterns, growth rates, and potential warning signs.
Finance for Non-Finance Managers Financial Statement Analysis 4
What is the difference between depreciation and amortization?