Financial Statement Analysis

Question 1

What is the purpose of comparative financial statement analysis?

Answer 1

To address size differences by stating each item as a percentage of a relevant base amount.

This method allows for meaningful comparisons between companies of different sizes or the same company over different periods.

Question 2

What is vertical analysis in financial statements?

Answer 2

It expresses each component as a percentage of a total, allowing comparison of companies of different sizes during the same period.

Also known as common-size financial statements, it helps in analyzing the relative size of financial statement components.

Question 3

How are line items presented in a vertical common-size income statement?

Answer 3

• As percentages of total revenues.
• Alternatively, as percentages of total operating expenses.

This presentation helps in comparing the relative size of each line item to the total.

Question 4

What is horizontal trend analysis?

Answer 4

It evaluates trends for a single business over several years by presenting financial statement amounts as percentages of a base year.

Also known as common-base year analysis, it helps in identifying trends over time.

Question 5

How is a common base year statement calculated?

Answer 5

Line Item Amount (%) = (New Line Item Amount × 100) / Base Year Line Item Amount

This formula converts financial statement amounts into percentages of a base year amount.

Question 6

What are the classifications of financial statement ratios used in the FMAA exam?

Answer 6

• Liquidity ratios
• Leverage, capital structure, solvency, and earnings coverage ratios
• Activity ratios
• Profitability analysis

Each classification measures different aspects of a firm’s financial health and performance.

Question 7

What rule should be followed when calculating ratios that include both balance sheet and income statement items?

Answer 7

Use average balances of balance sheet items instead of ending balances.

This ensures the relationship between the income statement and balance sheet amounts is meaningful.

Question 8

How should income statement amounts be annualized if the period is less than one year?

Answer 8

• Multiply by 4 if for one quarter
• Multiply by 12 if for one month
• Divide by the number of months and multiply by 12 if for several months
• Divide by the number of days and multiply by 365 if for a non-standard period

Annualizing ensures comparability with full-year figures.