Chapter 1 Questions

1-1.

Describe business analysis and identify its objectives.

Business analysis is the evaluation of a company’s prospects and risks for the purpose of making business decisions. Objectives: aids in making informed decisions by helping structure the decision task through an evaluation of a company’s business environment, its strategies, and its financial position and performance. 1-2.

Explain the claim: Financial statement analysis is an integral part of business analysis.

1-3.

Describe the different types of business analysis. Identify the category of users of financial statements that applies to each different type of business analysis.

1-4.

What are the main differences between credit analysis and equity analysis? How do these impact the financial statement information that is important for each type of analysis?

1-5.

What is fundamental analysis? What is its main objective?

1-6.

What are the various component processes in business analysis? Explain with reference to equity analysis.

1-7.

Describe the importance of accounting analysis for financial analysis.

1-8.

Describe financial statement analysis and identify its objectives.

1-9.

Identify at least five different internal and external users of financial statements.

1-10. Identify and discuss the four major activities of a business enterprise.

1-11. Explain how financial statements reflect the business activities of a company.

1-12. Identify and discuss the four primary financial statements of a business.

1-13. Explain why financial statements are important to the decision-making process in financial analysis. Also, identify and discuss some of their limitations for analysis purposes.

1-14. Identify at least seven additional sources of financial reporting information (beyond financial statements) that are useful for analysis.

1-15. Identify and discuss at least two areas of financial analysis.

1-16. Identify and describe at least four categories of financial analysis tools.

1-17. Comparative analysis is an important tool in financial analysis. a. Explain the usefulness of comparative financial statement analysis. b. Describe how financial statement comparisons are effectively made. c. Discuss the necessary precautions an analyst should take in performing comparative analysis. 1-18. Is past trend a good predictor of future trend? Justify your response.

1-19. Compare the “absolute amount of change” with the percent change as an indicator of change. Which is better for analysis?

1-20. Identify conditions that prevent computation of a valid percent change. Provide an example.

1-21. Describe criteria in selecting a base year for index-number trend analysis.

1-22. Explain what useful information is derived from index-number trend analysis.

1-23. Common-size analysis is an important tool in financial analysis. a. Describe a common-size financial statement. Explain how one is prepared. b. Explain what a common-size financial statement report communicates about a company. 1-24. What is a necessary condition for usefulness of a ratio of financial numbers? Explain.

1-25. Identify and describe limitations of ratio analysis.

1-26. Ratio analysis is an important tool in financial analysis. Identify at least

four ratios using:

a. Balance sheet data exclusively. b. Income statement data exclusively. c. Both balance sheet and income statement data. 1-27. Identify four specialized financial analysis tools.

1-28. What is meant by “time value of money”? Explain the role of this concept in valuation.

1-29. Explain the following claim: While we theoretically use the effective interest rate to compute a bond’s present value, in practice it is the other way around.

1-30. What is amiss with the claim: The value of a stock is the discounted value of expected future cash flows?

1-31. Identify and describe a technique to compute equity value only using accounting variables.

1-32. Explain how the efficient market hypothesis (EMH) depicts the reaction of market prices to financial and other data.

1-33. Discuss implications of the efficient market hypothesis (EMH) for financial statement analysis.