Evaluate Financial Performance And Position
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CPA Business Analysis and Reporting (BAR) › Evaluate Financial Performance And Position
A company reports: net income $180,000, depreciation $40,000, increase in accounts receivable $65,000, increase in inventory $30,000, and decrease in accounts payable $20,000. Using the indirect method, what is cash flow from operations?
$155,000
$220,000
$85,000
$105,000
Explanation
CFO (indirect) = Net income + Non-cash items +/- Working capital changes = $180,000 + $40,000 - $65,000 - $30,000 - $20,000 = $105,000. Increases in AR and inventory use cash (subtract); a decrease in AP also uses cash (subtract). Option A omits the accounts payable change. Option C adds all items rather than subtracting working capital uses. Option D applies an incorrect sign to the depreciation add-back.
A company has current assets of $840,000, current liabilities of $280,000, inventory of $200,000, and prepaid expenses of $40,000. What is the quick ratio?
1.86
2.14
2.57
3.00
Explanation
Quick assets = Current assets - Inventory - Prepaid expenses = $840,000 - $200,000 - $40,000 = $600,000. Quick ratio = $600,000 / $280,000 = 2.14. Option A is the current ratio ($840,000 / $280,000 = 3.00), which includes all current assets. Option B excludes inventory but retains prepaid expenses. Option D uses an incorrect numerator.
A company reports EBIT of $600,000 and interest expense of $120,000. What is the times interest earned ratio?
6.25x
3.75x
5.0x
4.0x
Explanation
Times interest earned = EBIT / Interest expense = $600,000 / $120,000 = 5.0x. This means operating earnings cover interest obligations five times, indicating a comfortable debt service cushion. Option A divides net income (after estimated taxes) by interest. Option B divides EBIT by a larger interest figure. Option C divides by an understated interest amount.
A company has days sales outstanding of 45 days, days inventory outstanding of 60 days, and days payable outstanding of 35 days. What is the cash conversion cycle?
35 days
70 days
105 days
140 days
Explanation
Cash conversion cycle = DSO + DIO - DPO = 45 + 60 - 35 = 70 days. The CCC measures the number of days from cash outlay for inventory to cash collection from customers. Longer CCC means more capital is tied up in working capital. Option B adds all three components. Option C sums DSO and DIO without subtracting DPO. Option D subtracts DPO from DSO alone.
In the context of financial position evaluation, working capital is defined as which of the following?
Total current assets less total current liabilities
Operating assets less operating liabilities across all time horizons
Cash and cash equivalents less the current portion of long-term debt
Total current assets less total long-term liabilities
Explanation
Working capital = Current assets - Current liabilities. It measures the short-term financial cushion available to meet near-term obligations. Positive working capital indicates the company can cover its current obligations from current assets. Option A incorrectly uses long-term liabilities. Option C is a much narrower measure than working capital. Option D describes net operating assets or a broader capital measure, not working capital.
A company reports average total assets of $2,500,000 and average shareholders' equity of $1,000,000. What is the equity multiplier?
2.5x
0.4x
4.0x
3.5x
Explanation
Equity multiplier = Average total assets / Average shareholders' equity = $2,500,000 / $1,000,000 = 2.5x. The equity multiplier measures financial leverage - a higher multiple means more assets are financed by debt relative to equity. Option A inverts the formula partially. Option B inverts the formula entirely. Option C uses incorrect figures.
Using the DuPont three-factor model with a net profit margin of 5%, asset turnover of 2.0x, and an equity multiplier of 2.5x, what is the return on equity?
10%
12.5%
20%
25%
Explanation
DuPont ROE = Net profit margin x Asset turnover x Equity multiplier = 5% x 2.0 x 2.5 = 25%. The DuPont framework decomposes ROE into profitability, efficiency, and leverage components. Option B multiplies only margin and turnover, omitting the equity multiplier. Option C applies only two of the three components incorrectly. Option D applies an incorrect formula.
A company has long-term debt of $1,800,000 and EBITDA of $600,000. What is the debt-to-EBITDA leverage ratio?
2.0x
0.67x
3.0x
4.5x
Explanation
Debt/EBITDA = $1,800,000 / $600,000 = 3.0x. This ratio is widely used by lenders to assess leverage; it measures how many years of EBITDA would be needed to repay outstanding debt. Option A inverts the ratio. Option C uses an incorrect denominator. Option D uses a different denominator.
A company reports operating cash flow of $800,000 and capital expenditures of $320,000. What is free cash flow?
$630,000
$150,000
$480,000
$800,000
Explanation
Free cash flow = Operating cash flow - Capital expenditures = $800,000 - $320,000 = $480,000. Free cash flow represents the cash generated by operations after maintaining and expanding the asset base. Option A represents an unrelated figure. Option B reports operating cash flow before subtracting capex. Option C subtracts an incorrect capex amount.
A company's net income has grown 15% annually for three years, but operating cash flow has been flat and accounts receivable has grown 40% over the same period. Which earnings quality concern does this pattern raise?
Revenue may be recognized prematurely or collections are deteriorating, inflating reported earnings without corresponding cash generation
The AR growth indicates expanding customer relationships, which supports the revenue trend
Growing net income with stable cash flow is a normal pattern for capital-intensive businesses
Flat operating cash flow confirms the company is reinvesting heavily in growth, which is a positive operational indicator
Explanation
When net income grows substantially but operating cash flow does not follow, and accounts receivable grow faster than revenue, it signals that earnings may be of low quality. Revenue recognized but not collected (swelling AR) inflates reported net income without generating cash. This pattern can indicate aggressive revenue recognition, deteriorating collection performance, or both. Option B mischaracterizes flat cash flow; heavy reinvestment would appear in the investing section, not as flat operating cash flow. Option C is incorrect; capital-intensive businesses typically show lower cash flow due to capex, not flat operating cash flow. Option D treats AR growth as inherently positive without considering the cash flow signal.