Interpret Financial Statements - Series 65

1. What is the current ratio formula used to assess short-term liquidity?

   $\text{Current ratio}=\frac{\text{Current assets}}{\text{Current liabilities}}$. This liquidity metric evaluates a company's ability to meet short-term obligations using assets readily convertible to cash.

2. What is working capital, stated as a formula using balance sheet terms?

   $\text{Working capital}=\text{Current assets}-\text{Current liabilities}$. This metric assesses short-term financial stability by showing the net liquid assets available for daily operations.

3. Identify the cash flow effect of an increase in accounts payable under the indirect method.

   Increase CFO (add the increase in A/P). In the indirect method, growing A/P indicates expenses accrued but unpaid, adding back to net income for cash flow adjustment.

4. Which cash flow section includes cash received from customers and cash paid to suppliers?

   Cash flows from operating activities (CFO). CFO captures cash generated from core business, adjusting for transactions like customer receipts and supplier payments.

5. What is the formula for net income using revenue and total expenses?

   $\text{Net income}=\text{Revenue}-\text{Total expenses}$. This represents the bottom-line profit after deducting all costs, including operating, interest, taxes, and other expenses from revenue.

6. What is the book value per share formula using common equity and shares outstanding?

   $\text{BVPS}=\frac{\text{Common equity}}{\text{Shares outstanding}}$. BVPS quantifies the per-share value of net assets, useful for assessing stock valuation against market price.

7. What does an income statement measure over a period (as opposed to a point in time)?

   Revenues, expenses, and net income for a period. The income statement captures a company's financial performance by summarizing revenues earned, expenses incurred, and resulting net income over a specific period.

8. What is the formula for free cash flow using CFO and capital expenditures?

   $\text{FCF}=\text{CFO}-\text{Capital expenditures}$. FCF indicates cash available for discretionary uses after funding operations and necessary investments in fixed assets.

9. What does a statement of cash flows explain about a company over a period?

   Sources and uses of cash during a period. The cash flow statement tracks inflows and outflows of cash, revealing how the company manages its liquidity over a period.

10. What does a balance sheet report, and at what moment in time is it measured?

    Assets, liabilities, and equity at a specific date. The balance sheet provides a snapshot of a company's financial position, detailing what it owns and owes as of a particular date.

11. State the accounting equation that must always balance on the balance sheet.

    $\text{Assets}=\text{Liabilities}+\text{Equity}$. This fundamental equation ensures the balance sheet reflects that resources are financed by either debt or ownership claims.

12. Which balance sheet category includes cash, inventory, and accounts receivable?

    Current assets. These are short-term resources expected to be converted to cash within a year, indicating liquidity for ongoing operations.

13. What is the quick ratio formula (acid-test) for liquidity?

    $\text{Quick ratio}=\frac{\text{Cash}+\text{Marketable securities}+\text{A/R}}{\text{Current liabilities}}$. This stricter liquidity test excludes inventory, focusing on highly liquid assets to cover short-term liabilities.

14. Which term describes revenue recognized when earned, regardless of cash collection?

    Accrual basis revenue recognition. This accounting principle records revenue when it is earned and realizable, aligning with performance rather than cash timing.

15. Which cash flow section includes purchases or sales of property, plant, and equipment?

    Cash flows from investing activities (CFI). CFI reflects cash used or gained from long-term asset transactions, indicating investment in future growth or divestitures.

16. Identify the cash flow effect of an increase in inventory under the indirect method.

    Decrease CFO (subtract the increase in inventory). In the indirect method, inventory buildup represents cash outflow for unsold goods, subtracted to derive operating cash flow.

17. Which balance sheet category includes accounts payable and short-term debt?

    Current liabilities. These represent short-term obligations due within a year, impacting a company's immediate financial health and liquidity.

18. If net income is $100$ and depreciation is $20$, what is CFO before working-capital changes?

    $120$. In the indirect method, adding back non-cash depreciation to net income adjusts for expenses that did not reduce cash.

19. Which income statement line item is typically deducted from revenue to compute gross profit?

    Cost of goods sold (COGS). COGS includes direct costs like materials and labor, subtracted from revenue to reflect profitability before overhead expenses.

20. What is the formula for gross profit on an income statement?

    $\text{Gross profit}=\text{Revenue}-\text{COGS}$. This calculation shows profitability from core operations by deducting direct production costs from sales revenue.

21. What is the indirect-method starting point used to compute cash flow from operations?

    Net income. The indirect method begins with accrual-based profit and adjusts for non-cash items to arrive at actual cash from operations.

22. What is the formula for operating income (EBIT) in basic terms?

    $\text{EBIT}=\text{Gross profit}-\text{Operating expenses}$. EBIT measures operational profitability by subtracting costs like salaries and rent from gross profit, excluding interest and taxes.

23. Which cash flow section includes issuing debt/equity and paying dividends?

    Cash flows from financing activities (CFF). CFF shows cash movements from capital structure changes, such as borrowing, stock issuance, or shareholder distributions.

24. What is the debt-to-equity ratio formula as commonly tested?

    $\text{Debt-to-equity}=\frac{\text{Total liabilities}}{\text{Total equity}}$. This leverage ratio compares total debt to ownership capital, indicating reliance on borrowed funds versus equity financing.

25. Identify the cash flow effect of an increase in accounts receivable under the indirect method.

    Decrease CFO (subtract the increase in A/R). In the indirect method, rising A/R means revenue recognized without cash inflow, requiring subtraction to reconcile to cash basis.

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