IAR Financial Analysis & Reporting 2 — Questions and Answers
Question 1: Which financial ratio measures how efficiently a company uses its assets to generate sales?
- Asset turnover ratio (Correct answer)
- Current ratio
- Debt-to-equity ratio
- Gross profit margin
Correct answer: Asset turnover ratio
Asset turnover ratio (Sales / Average Total Assets) measures how efficiently a company generates revenue from its asset base.
Question 2: Under GAAP, which inventory costing method typically results in the highest net income during periods of rising prices?
- FIFO (Correct answer)
- LIFO
- Weighted average
- Specific identification
Correct answer: FIFO
FIFO assigns the oldest (lower) costs to COGS first, leaving newer higher-cost items in inventory, resulting in lower COGS and higher net income during inflation.
Question 3: A company reports operating cash flow of $500,000 and capital expenditures of $200,000. What is its free cash flow?
- $300,000 (Correct answer)
- $700,000
- $500,000
- $200,000
Correct answer: $300,000
Free cash flow = Operating cash flow − Capital expenditures = $500,000 − $200,000 = $300,000.
Question 4: Which section of the cash flow statement reflects cash received from customers and paid to suppliers?
- Operating activities (Correct answer)
- Investing activities
- Financing activities
- Non-cash activities
Correct answer: Operating activities
Operating activities capture the core business cash flows including receipts from customers and payments to suppliers and employees.
Question 5: An analyst notices a company's accounts receivable days outstanding has risen from 35 to 65 days year-over-year. This most likely indicates:
- Customers are taking longer to pay, increasing collection risk (Correct answer)
- The company has improved its credit policies
- Revenue has declined sharply
- The company is collecting cash faster
Correct answer: Customers are taking longer to pay, increasing collection risk
Rising DSO (Days Sales Outstanding) suggests customers are slower to pay, which can signal credit quality deterioration or aggressive revenue recognition.
Question 6: Which profitability metric is most useful for comparing companies across different capital structures?
- EBIT margin (Correct answer)
- Net profit margin
- Return on equity
- Earnings per share
Correct answer: EBIT margin
EBIT margin (Earnings Before Interest and Taxes / Revenue) excludes the effect of financing decisions, making it better for cross-company comparisons regardless of debt levels.
Question 7: Which of the following best describes the purpose of the notes to financial statements?
- To provide additional detail and context for amounts reported in the primary statements (Correct answer)
- To summarize management's strategic plans for the next fiscal year
- To replace the auditor's opinion when an audit is not required
- To report only contingent liabilities not shown on the balance sheet
Correct answer: To provide additional detail and context for amounts reported in the primary statements
Notes (footnotes) to financial statements disclose accounting policies, breakdowns of line items, commitments, contingencies, and other information essential to understanding the financials.
IAR Financial Analysis & Reporting 2
Which financial ratio measures how efficiently a company uses its assets to generate sales?