Financial Statements and Ratios Questions and Answers

Answer: A

It is a snapshot on the closing date, listing what the firm owns and owes at that instant. The income statement and the cash flow statement both cover a period instead, which is why a ratio combining the two often uses an average balance sheet figure.

Answer: B

Everything the firm holds has been financed either by creditors or by the owners, so the two sides must agree by construction. A balance sheet that fails to balance contains an error rather than an interesting fact about the business.

Answer: C

Cash, receivables, inventory and prepayments qualify, and the classification matters because the liquidity ratios compare them with the liabilities falling due in the same period. Plant and buildings are non-current by contrast.

Answer: D

It measures the buffer of short-term resources over short-term obligations, and a negative figure means the firm depends on refinancing to meet its debts. Managing it is largely a matter of controlling inventory and receivables.

Answer: A

Correct answer: revenue and expenses over a period

An income statement covers an interval - a quarter or a year - and reports what was earned and what it cost to earn it. The balance sheet is the other kind of statement, reporting position at a single date. Confusing the two is the commonest error in reading accounts, since a flow and a stock cannot be compared directly.

Answer: B

Correct answer: cost of goods sold

Gross profit is the margin on the trading itself, before any of the costs of running the business are taken off. Deducting the operating expenses gives operating profit, and deducting interest and tax gives net profit. Each level answers a different question, which is why the statement is laid out in that order.

Answer: C

It shows what the business earned from operations irrespective of how it was financed or taxed, which makes it the fairer basis for comparing two firms with different debt levels. Net profit is what is left for the owners.

Answer: D

Revenue is recognised when earned and expenses when incurred, regardless of when the money moves, and non-cash charges such as depreciation are deducted. A firm can therefore report a healthy profit while its bank balance falls.

Answer: A

Operating covers the trading cycle, investing the purchase and sale of long-term assets, and financing the raising and repayment of debt and equity. Separating them shows whether the firm's cash is coming from its business or from borrowing.

Answer: B

Growth ties cash up in inventory and receivables faster than trading releases it, so a firm can trade profitably into insolvency. It is why the cash flow statement is read alongside the income statement rather than after it.