Common-Size "Vertical" Analysis & Trend Analysis

What is the main goal of trend analysis?

• Identify short-term financial misstatements

• Determine trends in absolute and relative changes

• Compare only two periods

• Calculate financial ratios

Answer explanation

The main goal of trend analysis is to determine trends in absolute and relative changes over time, helping to identify patterns and insights in financial data, rather than just comparing two periods or calculating ratios.

What does a high proportion of cash in total assets indicate?

• Strong liquidity but potential inefficiency in asset utilization

• The company is facing a cash shortage

• The company has excessive liabilities

• High levels of accounts receivable

Answer explanation

A high proportion of cash in total assets indicates strong liquidity, meaning the company can easily meet short-term obligations. However, it may also suggest inefficiency in utilizing assets for growth, as cash could be invested elsewhere.

Which of the following is NOT a typical base used in common-size analysis?

• Total Revenue for the Income Statement

• Total Assets for the Balance Sheet

• Total Cash for the Cash Flow Statement

• Operating Expenses for the Income Statement

Answer explanation

Operating Expenses are not a typical base for common-size analysis, which usually uses Total Revenue for the Income Statement, Total Assets for the Balance Sheet, and Total Cash for the Cash Flow Statement.

Why is it important to analyze both absolute and relative changes in financial analysis?

• To simplify accounting processes

• Because either may appear large or small on its own

• To enhance marketing strategies

• To improve customer service

Answer explanation

Analyzing both absolute and relative changes is crucial because either can seem significant or insignificant on its own. This perspective helps in making informed financial decisions and understanding the true impact of changes.

What does Trend Analysis help to identify over multiple time periods?

• Overall business direction and trends

• Tax savings opportunities

• Employee performance issues

• Customer demographic changes

Answer explanation

Trend Analysis helps to identify the overall business direction and trends by analyzing data over multiple time periods, allowing businesses to make informed decisions based on observed patterns.

Which financial statement tells the story about a company's profitability?

• P&L (Income Statement)

• Balance Sheet

• Statement of Cash Flow

• Statement of Changes in Equity

Answer explanation

The P&L (Income Statement) details a company's revenues and expenses, ultimately showing its profitability over a specific period. This makes it the primary financial statement for assessing profitability.

Which of the following analyses describes an analysis where each item on a financial statement is converted to a percentage using a common denominator? (hint: requires only one time period)

• Common-Size Vertical Analysis

• Jason Lortie Analysis

• Horizontal Analysis

• Trend Analysis

Answer explanation

Common-Size Vertical Analysis converts each item on a financial statement to a percentage of a common denominator, typically total revenue or total assets, allowing for easy comparison within a single time period.

Which analysis is concerned with expressing all numbers as a percentage of a common size?

• Trend Analysis

• Comparative Horizontal Analysis

• Common-Size Vertical Analysis

• Break-even Analysis

Answer explanation

Common-Size Vertical Analysis expresses all numbers as a percentage of a common size, typically total revenue or total assets, allowing for easy comparison across different periods or entities.

A significant drop in accounts receivable as a percentage of total assets may suggest:

• Improved cash collections

• A decline in total sales

• Changes in credit policies

• All of the above

Answer explanation

A significant drop in accounts receivable as a percentage of total assets may indicate improved cash collections, a decline in total sales, or changes in credit policies, making 'All of the above' the correct choice.

Why is common-size analysis useful for comparing companies of different sizes?

• It eliminates differences in business models

• It removes the impact of inflation

• It allows for proportional comparisons rather than absolute values

• It ignores profitability

Answer explanation

Common-size analysis is useful because it allows for proportional comparisons rather than absolute values, making it easier to compare companies of different sizes on a relative basis.