Financial Statements review questions

Question: If a firm is reporting its income in accordance with generally accepted accounting principles, then its net income as reported on the income statement should be equal to its free cash flow.

Answer Choices:

Answer: B – False

Question: The fact that 70% of the interest income received by corporations is excluded from its taxable income encourages firms to finance with more debt than they would in the absence of this tax law provision.

Answer Choices:

Answer: B – False

Question: Both interest and dividends paid by a corporation are deductible operating expenses, hence they decrease the firm’s taxes.

Answer Choices:

Answer: B – False

Question: The balance sheet measures the flow of funds into and out of various accounts over time, while the income statement measures the firm’s financial position at a point in time.

Answer Choices:

Answer: B – False

Question: Assume that two firms are both following generally accepted accounting principles. Both firms commenced operations two years ago with $1 million of identical fixed assets, and neither firm sold any of those assets or purchased any new fixed assets. The two firms would be required to report the same amount of net fixed assets on their balance sheets as those statements are presented to investors.

Answer Choices:

Answer: B – False

Question: Net operating working capital is equal to current assets minus the difference between current liabilities and notes payable. This definition assumes that the firm has no “excess” cash.

Answer Choices:

Answer: A – True

Question: The next-to-last line on the income statement shows the firm’s earnings, while the last line shows the dividends the company paid. Therefore, the dividends are frequently called “the bottom line.”

Answer Choices:

Answer: B – False

Question: The statement of cash flows has four main sections, one each for operating, investing, and financing activities, and one that shows a summary of the cash and cash equivalents at the end of the year.

Answer Choices:

Answer: A – True

Question: An increase in accounts payable represents an increase in net cash provided by operating activities just like borrowing money from a bank. An increase in accounts payable has an effect similar to taking out a new bank loan. However, these two items show up in different sections of the statement of cash flows to reflect the difference between operating and financing activities.

Answer Choices:

Answer: A – True

Question: An increase in accounts receivable represents an increase in net cash provided by operating activities because receivables will produce cash when they are collected.

Answer Choices:

Answer: B – False

Question: The first major section of a typical statement of cash flows is “Operating Activities,” and the first entry in this section is “Net Income.” Then, also in the first section, we show some items that represent increases or decreases to cash, and the last entry is called “Net Cash Provided by Operating Activities.” This number can be either positive or negative, but if it is negative, the firm is almost certain to soon go bankrupt.

Answer Choices:

Answer: B – False

Question: To estimate the cash flow from operations, depreciation must be added back to net income because it is a non-cash charge that has been deducted from revenue in the net income calculation.

Answer Choices:

Answer: A – True

Question: Two metrics that are used to measure a company’s financial performance are net income and cash flow. Accountants emphasize net income as calculated in accordance with generally accepted accounting principles. Finance people generally put at least as much weight on cash flows as they do on net income.

Answer Choices:

Answer: A – True

Question: Its retained earnings is the actual cash that the firm has generated through operations less the cash that has been paid out to stockholders as dividends. If the firm has sufficient retained earnings, it can purchase assets and pay for them with cash from retained earnings.

Answer Choices:

Answer: B – False

Question: The retained earnings account on the balance sheet does not represent cash. Rather, it represents part of the stockholders’ claims against the firm’s existing assets. Put another way retained earnings are stockholders’ reinvested earnings.

Answer Choices:

Answer: A – True

Question: In finance, we are generally more interested in cash flows than in accounting profits. Free cash flow (FCF) is calculated as after-tax operating income plus depreciation less the sum of capital expenditures and changes in net operating working capital.

Answer Choices:

Answer: A – True

Question: Free cash flow is the amount of cash that if withdrawn would harm the firm’s ability to operate and to produce future cash flows.

Answer Choices:

Answer: B – False

Question: If the tax laws were changed so that $0.50 out of every $1.00 of interest paid by a corporation was allowed as a tax-deductible expense, this would probably encourage companies to use more debt financing than they presently do, other things held constant.

Answer Choices:

Answer: A – True

Question: Interest paid by a corporation is a tax deduction for the paying corporation, but dividends paid are not deductible. This treatment, other things held constant, tends to encourage the use of debt financing by corporations.

Answer Choices:

Answer: A – True