US CMA Part 2 · Chapter 1
Financial statement analysis: liquidity, activity and solvency MCQs with Answers
15 multiple-choice questions on Financial statement analysis: liquidity, activity and solvency for US CMA Part 2 Strategic Financial Management. Try each one before revealing the answer and explanation.
Practise this chapter interactivelyQuestion 1
In a common-size (vertical) analysis of the income statement, each line item is expressed as a percentage of which amount?
- A) Total assets at the end of the period
- B) The same line item in the base year
- C) Net income for the same period
- D) Net sales (revenue) for the same period
Show answer & explanation
Answer: D) Net sales (revenue) for the same period
Vertical (common-size) analysis of the income statement expresses every line item as a percentage of net sales for the same period, so that cost structures can be compared across periods and between companies of different sizes. Expressing an item as a percentage of the same item in a base year is horizontal (trend) analysis. Common-size balance sheets use total assets as the base, not the income statement.
Question 2
Harlow Supply Co. reported net sales of $840,000 in Year 1 and $966,000 in Year 2. Using horizontal analysis with Year 1 as the base year, what is the percentage change in net sales?
- A) 15.0%
- B) 115.0%
- C) 7.0%
- D) 13.0%
Show answer & explanation
Answer: A) 15.0%
Horizontal analysis measures the change from the base year: ($966,000 - $840,000) / $840,000 = $126,000 / $840,000 = 15.0%. Dividing the change by Year 2 sales (13.0%) uses the wrong base, and 115.0% is Year 2 expressed as a percentage of Year 1 rather than the change.
Question 3
Brennan Tools Inc. has current assets of $612,000 and current liabilities of $340,000. What is its current ratio?
- A) 0.80
- B) 0.56
- C) 1.80
- D) 0.44
Show answer & explanation
Answer: C) 1.80
Current ratio = current assets / current liabilities = $612,000 / $340,000 = 1.80 (rounded to two decimals). The reciprocal (0.56) inverts the ratio, while the other figures divide working capital ($272,000) by one side of the balance sheet, which is not the current ratio.
Question 4
Calder Electronics has the following current items: Cash $48,000 Marketable securities $30,000 Accounts receivable (net) $126,000 Inventory $210,000 Prepaid expenses $18,000 Current liabilities $240,000 What is the quick (acid-test) ratio?
- A) 0.93
- B) 1.80
- C) 0.33
- D) 0.85
Show answer & explanation
Answer: D) 0.85
The quick ratio includes only cash, marketable securities and net receivables: ($48,000 + $30,000 + $126,000) / $240,000 = $204,000 / $240,000 = 0.85. Inventory and prepaid expenses are excluded because they cannot quickly be converted to cash. Including prepaids gives 0.93, the current ratio is 1.80, and 0.33 is the cash ratio.
Question 5
Dunmore Corp. has a current ratio of 1.6. If the company uses cash to pay an account payable, what will be the effect on the current ratio and on net working capital?
- A) The current ratio increases and net working capital is unchanged
- B) The current ratio decreases and net working capital decreases
- C) The current ratio is unchanged and net working capital is unchanged
- D) The current ratio increases and net working capital increases
Show answer & explanation
Answer: A) The current ratio increases and net working capital is unchanged
Paying a payable reduces current assets and current liabilities by the same amount, so net working capital (current assets minus current liabilities) does not change. When the current ratio is above 1, reducing numerator and denominator by the same amount raises the ratio. For example, 160/100 = 1.6 becomes 150/90 = 1.67 after a payment of 10.
Question 6
Which liquidity measure is the most conservative because it compares only cash and marketable securities with current liabilities?
- A) Quick ratio
- B) Times interest earned ratio
- C) Current ratio
- D) Cash ratio
Show answer & explanation
Answer: D) Cash ratio
The cash ratio = (cash + marketable securities) / current liabilities. It excludes receivables and inventory, which the quick and current ratios respectively include, so it is the most conservative liquidity measure. Times interest earned is a solvency (coverage) measure, not a liquidity measure.
Question 7
Ellison Fabrics had credit sales of $2,190,000 for the year. Accounts receivable were $168,000 at the beginning of the year and $192,000 at the end. Using average receivables and a 365-day year, what is the average collection period (days sales outstanding)?
- A) 30.0 days
- B) 32.0 days
- C) 12.2 days
- D) 28.0 days
Show answer & explanation
Answer: A) 30.0 days
Average receivables = ($168,000 + $192,000) / 2 = $180,000. Receivables turnover = $2,190,000 / $180,000 = 12.17 times. Days sales outstanding = 365 / 12.1667 = 30.0 days (rounded to one decimal). Using only ending receivables gives 32.0 days, and 12.2 is the turnover ratio, not a number of days.
Question 8
Fenwick Hardware reported cost of goods sold of $1,512,000. Inventory was $240,000 at the start of the year and $192,000 at the end. Using average inventory and a 365-day year, what are the inventory turnover and days inventory outstanding?
- A) 6.3 times; 57.9 days
- B) 7.9 times; 46.3 days
- C) 7.0 times; 52.1 days
- D) 7.0 times; 104.3 days
Show answer & explanation
Answer: C) 7.0 times; 52.1 days
Average inventory = ($240,000 + $192,000) / 2 = $216,000. Inventory turnover = $1,512,000 / $216,000 = 7.0 times. Days inventory outstanding = 365 / 7.0 = 52.1 days (rounded to one decimal). The distractors use only ending or only beginning inventory, or double the days figure.
Question 9
Garrick Instruments has days inventory outstanding of 52 days, days sales outstanding of 30 days and days payables outstanding of 38 days. What is its cash conversion cycle?
- A) 120 days
- B) 82 days
- C) 44 days
- D) 60 days
Show answer & explanation
Answer: C) 44 days
The operating cycle = days inventory outstanding + days sales outstanding = 52 + 30 = 82 days. The cash conversion cycle deducts the period for which suppliers finance the business: 82 - 38 = 44 days. 82 days is the operating cycle, not the cash conversion cycle, and adding payables days reverses the effect of trade credit.
Question 10
Halden Corp. has total liabilities of $900,000 and total shareholders' equity of $1,200,000. What is its debt-to-equity ratio?
- A) 0.57
- B) 0.75
- C) 0.43
- D) 1.33
Show answer & explanation
Answer: B) 0.75
Debt-to-equity = total liabilities / total equity = $900,000 / $1,200,000 = 0.75. 0.43 is the debt-to-total-assets (debt) ratio, 1.33 is the inverse, and 0.57 is the equity ratio.
Question 11
Irvine Logistics reported net income of $420,000, income tax expense of $140,000 and interest expense of $90,000. What is its times interest earned ratio (rounded to two decimals)?
- A) 7.22 times
- B) 4.67 times
- C) 6.22 times
- D) 5.67 times
Show answer & explanation
Answer: A) 7.22 times
Times interest earned = EBIT / interest expense. EBIT = net income + income tax + interest = $420,000 + $140,000 + $90,000 = $650,000. TIE = $650,000 / $90,000 = 7.22 times. Using net income (4.67) or pre-tax income (6.22) omits amounts that are available to pay interest.
Question 12
Jansen Retail has earnings before interest and taxes of $650,000 (after deducting lease payments), interest expense of $90,000 and annual lease payments of $60,000. What is the fixed charge coverage ratio (rounded to two decimals)?
- A) 7.89 times
- B) 4.73 times
- C) 7.22 times
- D) 4.33 times
Show answer & explanation
Answer: B) 4.73 times
Fixed charge coverage = (EBIT + lease payments) / (interest + lease payments). Lease payments are added back to the numerator because they were deducted in arriving at EBIT. ($650,000 + $60,000) / ($90,000 + $60,000) = $710,000 / $150,000 = 4.73 times. Failing to add back the lease payments gives 4.33, and 7.22 is the times interest earned ratio.
Question 13
Kessler Manufacturing has EBIT of $500,000 and interest expense of $100,000. It has no preferred stock. If EBIT increases by 8%, by approximately what percentage will earnings per share increase?
- A) 6.4%
- B) 8.0%
- C) 40.0%
- D) 10.0%
Show answer & explanation
Answer: D) 10.0%
Degree of financial leverage (DFL) = EBIT / (EBIT - interest) = $500,000 / $400,000 = 1.25. The percentage change in EPS = DFL x percentage change in EBIT = 1.25 x 8% = 10.0%. Because interest is fixed, EPS changes proportionally more than EBIT.
Question 14
Lambert Products has sales of $1,000,000, variable costs of $600,000 and fixed operating costs of $250,000. If sales increase by 6% with no change in cost behavior, by what percentage will operating income increase?
- A) 16.0%
- B) 2.4%
- C) 15.0%
- D) 6.0%
Show answer & explanation
Answer: A) 16.0%
Contribution margin = $1,000,000 - $600,000 = $400,000; operating income = $400,000 - $250,000 = $150,000. Degree of operating leverage = $400,000 / $150,000 = 2.667. Change in operating income = 2.667 x 6% = 16.0%. Check: new CM = $424,000, new operating income = $174,000, an increase of $24,000 / $150,000 = 16.0%.
Question 15
Which of the following transactions will DECREASE a company's net working capital?
- A) Purchasing manufacturing equipment for cash
- B) Collecting an account receivable
- C) Purchasing inventory on credit
- D) Issuing long-term bonds for cash
Show answer & explanation
Answer: A) Purchasing manufacturing equipment for cash
Buying equipment for cash reduces a current asset (cash) and increases a noncurrent asset, so working capital falls. Collecting a receivable swaps one current asset for another, and buying inventory on credit increases current assets and current liabilities equally, so neither changes working capital. Issuing long-term bonds for cash increases current assets without increasing current liabilities, so working capital rises.