Preview Extract
Chapter 8 Assessing a New Venture's Financial Strength and Viability
1) Klymit, the company profiled in the opening feature in Chapter 8, makes cold weather apparel
products and related accessories. According to the feature, one of the prominent challenges
Klymit has faced is:
A) cash flow management
B) constructing realistic pro forma financial statements
C) defining its core strategy
D) hiring qualified personnel
E) finding reliable partners
Answer: A
Rationale:
Cash flow management is critical for any business, but especially for a company like Klymit that
likely experiences seasonal fluctuations in demand for its cold weather products. Managing cash
flow effectively ensures the company can meet its financial obligations, invest in growth
opportunities, and navigate challenges such as inventory management and supplier payments.
2) Financial management deals with two things—managing a company's finances and:
A) operations management
B) inventory control
C) raising money
D) production management
E) supply chain management
Answer: C
Rationale:
Financial management encompasses managing a company's finances, including activities such as
budgeting, forecasting, and financial analysis. Raising money, whether through debt or equity, is
a crucial aspect of financial management as it determines the company's ability to fund its
operations and growth.
3) Which of the following was not identified as one of the four main financial objectives of a
firm?
A) stability
B) efficiency
C) timeliness
D) liquidity
E) profitability
Answer: C
Rationale:
Timeliness is not typically considered one of the main financial objectives of a firm. The main
financial objectives are usually stability, efficiency, liquidity, and profitability, as they directly
impact the financial health and success of the business.
4) The four main financial objectives of a firm are:
A) efficiency, effectiveness, strength, and flexibility
B) power, success, efficiency, and effectiveness
C) control, effectiveness, liquidity, and power
D) success, strength, liquidity, and profitability
E) profitability, liquidity, efficiency, and stability
Answer: E
Rationale:
The four main financial objectives of a firm are profitability (ensuring the company generates
profits), liquidity (maintaining enough cash and liquid assets to meet short-term obligations),
efficiency (utilizing resources effectively to minimize waste), and stability (maintaining a stable
financial position to withstand economic fluctuations).
5) Match the financial objective with its correct definition.
A) stability/the overall health of the financial structure of the firm, particularly as it relates to its
debt-to-equity ratio
B) profitability/how productively a firm utilizes its assets
C) liquidity/a company's ability to make a profit
D) efficiency/a company's ability to meet its short-term obligations
E) profitability/the overall health of the financial structure of the firm, particularly as it relates to
its debt-to-equity ratio
Answer: A
Rationale:
Stability refers to the overall health of the financial structure of the firm, particularly as it relates
to its debt-to-equity ratio. This ratio indicates the proportion of debt and equity used to finance
the firm's assets and operations, which affects its stability and risk profile.
6) ________ is a company's ability to meet its short-term financial obligations.
A) Liquidity
B) Profitability
C) Effectiveness
D) Stability
E) Efficiency
Answer: A
Rationale:
Liquidity is a company's ability to meet its short-term financial obligations, such as paying bills
and repaying short-term loans. It indicates the company's ability to convert assets into cash
quickly to meet its financial obligations as they come due.
7) A company's ability to productively utilize its assets relative to its revenue and its profits is
referred to as:
A) efficiency
B) effectiveness
C) stability
D) liquidity
E) profitability
Answer: A
Rationale:
Efficiency refers to a company's ability to productively utilize its assets relative to its revenue
and profits. It measures how well a company uses its resources to generate revenue and profit,
indicating its operational effectiveness.
8) Money owed to a company by its customers is referred to as:
A) accounts obtainable
B) accounts payable
C) accounts receivable
D) inventory
E) accounts collectable
Answer: C
Rationale:
Accounts receivable refers to money owed to a company by its customers for goods or services
provided on credit. It represents the amount of money the company expects to receive in the
future from its customers.
9) Amanda Still owns a seafood restaurant in Clearwater, Florida. She is currently owed $19,000
by a corporation that she catered a meeting for and $2,000 on an overdue account. Amanda has
$21,000 in:
A) accounts receivable
B) inventory
C) accounts collectable
D) accounts obtainable
E) accounts payable
Answer: A
Rationale:
Amanda has $21,000 in accounts receivable, as this represents the total amount of money owed
to her by customers for goods or services provided on credit.
10) A company's merchandise, raw materials, and products waiting to be sold is called its:
A) set aside
B) accumulation
C) reserve
D) inventory
E) stock
Answer: D
Rationale:
Inventory refers to a company's merchandise, raw materials, and products that are waiting to be
sold. It represents one of the key assets of a business and is essential for meeting customer
demand and generating revenue.
11) Peggy Owens owns a store that sells exercise equipment. Each January 1, she makes a very
accurate account of all her merchandise and products waiting to be sold that are in her store. On
January 1, Peggy is taking account of her store's:
A) long-term assets
B) owners' equity
C) accounts payable
D) accounts receivable
E) inventory
Answer: E
Rationale:
Peggy Owens is taking account of her store's inventory on January 1. Inventory refers to the
merchandise and products waiting to be sold, which is a key component of a store's current
assets.
12) Southwest Airlines uses its assets very productively. Its turnaround time, or the time that its
airplanes sit on the ground while they are being loaded and unloaded, is the lowest in the airline
industry. In terms of the primary financial objectives of a firm, this attribute is a measure of
Southwest's:
A) efficiency
B) effectiveness
C) stability
D) liquidity
E) profitability
Answer: A
Rationale:
Southwest Airlines' ability to minimize turnaround time and use its assets effectively is a
measure of its efficiency. Efficiency in this context refers to the company's ability to use its
resources (such as airplanes) in a productive and cost-effective manner.
13) The strength and vigor of a firm's overall financial posture is referred to as:
A) liquidity
B) effectiveness
C) stability
D) profitability
E) efficiency
Answer: C
Rationale:
Stability refers to the strength and vigor of a firm's overall financial posture. It indicates the
firm's ability to maintain a consistent and secure financial position over time, which is essential
for long-term success.
14) A financial statement is a(n):
A) set of ratios which depict relationships between a firm's financial items
B) estimate of a firm's future income and expenses
C) hybrid statement of cash flows
D) itemized forecast of a company's income, expenses, and capital needs
E) written report that quantitatively describes a firm's financial health
Answer: E
Rationale:
A financial statement is a written report that quantitatively describes a firm's financial health. It
typically includes information about the firm's assets, liabilities, equity, income, and expenses.
15) ________ are an estimate of a firm's future income and expenses, based on its past
performance, its current circumstances, and its future plans.
A) Calculation statements
B) Forecasts
C) Statements of cash flow
D) Financial statements
E) Prediction statements
Answer: B
Rationale:
Forecasts are an estimate of a firm's future income and expenses. They are based on factors such
as past performance, current circumstances, and future plans, and are used for financial planning
and decision-making.
16) ________ are itemized forecasts of a company's income, expenses, and capital needs and are
also an important tool for financial planning and control.
A) Profitability statements
B) Financial statements
C) Owners' equity statements
D) Budgets
E) Statements of cash flows
Answer: D
Rationale:
Budgets are itemized forecasts of a company's income, expenses, and capital needs. They are an
important tool for financial planning and control, helping businesses to plan and allocate
resources effectively.
17) Match the financial term with its proper definition.
A) forecasts/depict relationships between items on a firm's financial statements
B) forecasts/written report that quantitatively describes a firm's financial health
C) budgets/itemized forecasts of a company's income, expenses, and capital needs
D) financial ratios/written report that quantitatively describes a firm's financial health
E) financial statements/an estimate of a firm's future income and expenses
Answer: C
Rationale:
Budgets are itemized forecasts of a company's income, expenses, and capital needs. They are
used for financial planning and control, helping businesses to allocate resources effectively.
18) In regard to budgets, which of the following statements is not true?
A) Budgets include an itemized forecast of a company's expenses.
B) Budgets are a poor tool for financial control.
C) Budgets are an important tool for financial planning.
D) Budgets include an itemized forecast of a company's capital needs.
E) Budgets include an itemized forecast of a company's income.
Answer: B
Rationale:
Budgets are not a poor tool for financial control; they are, in fact, an important tool for financial
planning and control. Budgets help businesses to plan and allocate resources effectively,
ensuring that they stay on track financially.
19) ________ depict relationships between items on a firm's financial statements.
A) Financial proportions
B) Fiscal relations
C) Fiscal projections
D) Monetary balances
E) Financial ratios
Answer: E
Rationale:
Financial ratios depict relationships between items on a firm's financial statements. They are
used to analyze and evaluate a company's financial performance and position.
20) The Partnering for Success feature in Chapter 8 focuses on buying groups, and recommends
that small businesses seek out buying groups to participate in. What is a "buying group" in the
context of the feature?
A) a partnership that bands small businesses together to attain volume discounts on common
products and services that they buy
B) a partnership that bands small businesses together to collectively make the commitment to
"buy local" at every available opportunity
C) a partnership that bands small businesses together to get the best prices possible from foreign
importers and manufacturers
D) a partnership that bands small businesses together to get the best possible terms from finance
companies
E) a partnership that bands small businesses together to get the best possible rates on property
and liability insurance
Answer: A
Rationale:
In the context of the feature, a "buying group" is a partnership that bands small businesses
together to attain volume discounts on common products and services that they buy. By
leveraging their collective purchasing power, small businesses can achieve cost savings and
other benefits.
21) ________ reflect past performance and are usually prepared on a quarterly and annual basis.
A) Chronological financial statements
B) Ad-hoc financial statements
C) Historical financial statements
D) Concurrent financial statements
E) Pro forma financial statements
Answer: C
Rationale:
Historical financial statements reflect past performance and are typically prepared on a quarterly
and annual basis. They provide a snapshot of a company's financial position and performance
over a specific period.
22) ________ are projections for future periods based on forecasts and are typically completed
for two to three years into the future.
A) Chronological financial statements
B) Pro forma financial statements
C) Ad-hoc financial statements
D) Concurrent financial statements
E) Historical financial statements
Answer: B
Rationale:
Pro forma financial statements are projections for future periods based on forecasts. They are
typically completed for two to three years into the future and are used for financial planning and
decision-making.
23) Which of the following statements about pro forma financial statements is incorrect?
A) Pro forma financial statements are projections for future periods based on forecasts.
B) Pro forma financial statements are typically completed for two to three years into the future.
C) Pro forma financial statements are required by the SEC.
D) Most companies consider their pro forma financial statements to be confidential and reveal
them to outsiders only on a "need to know basis."
E) Pro forma financial statements are strictly planning tools.
Answer: C
Rationale:
The statement that pro forma financial statements are required by the SEC is incorrect. While
some companies may disclose pro forma financial information in their SEC filings, they are not
typically required by the SEC.
24) Which of the following selections correctly matches the financial statement with its
description?
A) income statement/tells how much a firm is making or losing
B) income statement/depicts the structure of a firm's assets and liabilities
C) balance sheet/shows where a firm's cash is coming from
D) balance sheet/tells how much a firm is making or losing
E) statement of cash flows/depicts the structure of a firm's assets and liabilities
Answer: A
Rationale:
The income statement tells how much a firm is making or losing over a specific period. It
summarizes the revenues, expenses, and profits or losses of a company during a specific
accounting period.
25) A firm's ________ reflects the results of its operations over a specified period and shows
whether it is making a profit or is experiencing a loss.
A) statement of cash flows
B) income statement
C) forecast
D) balance sheet
E) operating budget
Answer: B
Rationale:
The income statement reflects the results of a firm's operations over a specified period, typically
a quarter or a year. It shows whether the firm is making a profit or experiencing a loss by
comparing revenues and expenses.
26) Which financial statement records all of a firm's revenues and expenses for a given period
and shows whether the firm is making a profit or experiencing a loss?
A) balance sheet
B) owner's equity statement
C) statement of cash flows
D) forecast
E) income statement
Answer: E
Rationale:
The income statement records all of a firm's revenues and expenses for a given period and shows
whether the firm is making a profit or experiencing a loss. It is one of the three primary financial
statements used by businesses.
27) On a firm's income statement, net sales consists of:
A) operating expenses minus cost of sales
B) total sales minus allowances for returned goods and discounts
C) cost of sales minus allowances for returned goods and discounts
D) cost of sales minus operating expenses
E) total sales minus operating expenses
Answer: B
Rationale:
Net sales on a firm's income statement consist of total sales minus allowances for returned goods
and discounts. It represents the revenue generated from the sale of goods or services after
deducting returns and discounts.
28) According to the textbook, the three numbers that receive the most attention when evaluating
an income statement are:
A) depreciation, interest income, and income tax expense
B) cost of sales, gross profit, and operating expenses
C) net sales, cost of sales, and operating expenses
D) gross profit, net sales, and incomes tax expense
E) gross profit, other income, and net income
Answer: C
Rationale:
The three numbers that receive the most attention when evaluating an income statement are net
sales, cost of sales, and operating expenses. These numbers are key indicators of a company's
revenue, cost of goods sold, and operating efficiency.
29) A firm's profit margin, or return on sales, is computed by dividing:
A) net income by net sales
B) gross profit by net sales
C) net income by gross profit
D) net income by cost of sales
E) operating income by gross profit
Answer: A
Rationale:
A firm's profit margin, or return on sales, is computed by dividing net income by net sales. It
measures the percentage of each dollar of revenue that represents profit after all expenses are
deducted.
30) A(n) ________ is a snapshot of a company's assets, liabilities, and owners' equity at a
specific point in time.
A) income statement
B) statement of cash flows
C) effectiveness statement
D) balance sheet
E) efficiency statement
Answer: D
Rationale:
A balance sheet is a snapshot of a company's assets, liabilities, and owners' equity at a specific
point in time. It provides a summary of what a company owns (assets), what it owes (liabilities),
and the difference between the two (owners' equity) at a particular moment.
31) Which of the following statement is incorrect regarding how balance sheets are prepared?
A) The left hand side of a balance sheet shows a firm's assets.
B) The assets on a balance sheet are shown in order of liquidity.
C) Assets are recorded at fair market value rather than cost.
D) The right hand side of a balance sheet shows a firm's liabilities and its owners' equity.
E) Intellectual property receives value in some cases and in some cases it does not.
Answer: C
Rationale:
Assets are typically recorded on a balance sheet at cost, not fair market value. Fair market value
is used in certain situations, such as when assets are revalued due to a significant change in
value, but it is not the standard practice for most assets.
32) The Savvy Entrepreneurial Firm feature in Chapter 8 focuses on a scenario involving the
selection of a new CEO for New Venture Fitness Drinks. The lesson learned from the feature
was:
A) compare a firm's financial ratios against its primary competitors and industry norms to fairly
assess how well a firm is performing financially
B) income statements are more effective in assessing how well a firm is performing financially
than are balance sheets and statements of cash flow
C) the most powerful instrument for understanding how well a firm is performing financially is
the statement of cash flows
D) ratio analysis is ineffective
E) look at multiple years of an income statement rather than a single year to fairly assess how
well a firm is performing financially
Answer: E
Rationale:
The lesson learned from the feature was to look at multiple years of an income statement rather
than a single year to fairly assess how well a firm is performing financially. This allows for a
more comprehensive understanding of the firm's financial performance and trends over time.
33) Real estate, buildings, equipment and furniture are classified as ________ on a company's
balance sheet.
A) intermediate term assets
B) fixed assets
C) other assets
D) permanent assets
E) current assets
Answer: B
Rationale:
Real estate, buildings, equipment, and furniture are classified as fixed assets on a company's
balance sheet. These assets are long-term in nature and are used in the operations of the business.
34) Cash plus items that are readily convertible to cash, such as accounts receivable, marketable
securities, and inventories are classified as ________ on a firm's balance sheet.
A) other assets
B) intermediate term assets
C) temporary assets
D) current assets
E) fixed assets
Answer: D
Rationale:
Cash plus items that are readily convertible to cash, such as accounts receivable, marketable
securities, and inventories, are classified as current assets on a firm's balance sheet. These assets
are expected to be converted into cash within one year.
35) Which of the following is an example of a long-term liability?
A) accounts payable
B) real estate mortgage
C) accrued expenses
D) current portion of real estate mortgage
E) owners' equity
Answer: B
Rationale:
A real estate mortgage is an example of a long-term liability. Long-term liabilities are
obligations that are due beyond one year from the date of the balance sheet.
36) When evaluating a balance sheet, the two primary questions are:
A) whether a firm has sufficient short-term assets to cover its short-term debts and whether it is
profitable
B) whether a firm is profitable and whether a firm is financially sound
C) whether its costs of sales is going up and whether it is generating excess cash that could be
used to pay down debt or pay dividends
D) whether a firm has sufficient short-term assets to cover its short-term debts and whether it is
financially sound
E) whether a firm is profitable and whether it is generating excess cash that could be used to pay
down debt or pay dividends
Answer: D
Rationale:
When evaluating a balance sheet, the two primary questions are whether a firm has sufficient
short-term assets to cover its short-term debts and whether it is financially sound. These
questions help assess the liquidity and solvency of the firm.
37) A firm's working capital is its:
A) inventory and accounts receivable minus its current liabilities
B) current assets minus its current liabilities
C) total assets minus its total liabilities
D) cash and cash equivalents minus its current liabilities
E) accounts receivable minus its total accounts payable
Answer: B
Rationale:
A firm's working capital is calculated as its current assets minus its current liabilities. It
represents the amount of capital available to the firm for its day-to-day operations.
38) A firm's ________ is its current assets divided by its current debt.
A) working share
B) present share
C) working capital
D) owners' equity
E) current ratio
Answer: E
Rationale:
A firm's current ratio is calculated as its current assets divided by its current liabilities. It is a
measure of the firm's liquidity and its ability to meet its short-term obligations.
39) Which of the financial statements used by businesses to keep track of their financial affairs is
the most similar to an ordinary person's end-of-the-month bank statement?
A) income statement
B) balance sheet
C) statement of cash flows
D) statement of ratio analysis
E) statement of owners' equity
Answer: C
Rationale:
The statement of cash flows is the most similar to an ordinary person's end-of-the-month bank
statement. It provides a summary of the cash inflows and outflows of a business over a specific
period, similar to how a bank statement summarizes an individual's financial transactions.
40) The statement of cash flows is divided into three separate activities:
A) profitability activities, stability activities, and investing activities
B) stability activities, earning activities, and financing activities
C) operating activities, capital activities, and liquidity activities
D) spending activities, earning activities, and capital activities
E) operating activities, investing activities, and financing activities
Answer: E
Rationale:
The statement of cash flows is divided into three separate activities: operating activities,
investing activities, and financing activities. These categories help classify and analyze the cash
flows of a business, providing insights into how cash is generated and used.
41) In the context of a firm's statement of cash flows, ________ include the purchase, sale, or
investment in fixed assets, such as real estate, equipment, and buildings.
A) operating activities
B) investing activities
C) capital activities
D) financing activities
E) liquidity activities
Answer: B
Rationale:
Investing activities on a firm's statement of cash flows include transactions involving the
purchase, sale, or investment in fixed assets, such as real estate, equipment, and buildings. These
activities affect the long-term assets of the firm.
42) In the context of a firm's statement of cash flows, ________ include cash raised during the
period by borrowing money or selling stock and/or cash used during the period by paying
dividends, buying back outstanding stock, or buying back outstanding bonds.
A) investing activities
B) financing activities
C) operating activities
D) liquidity activities
E) capital activities
Answer: B
Rationale:
Financing activities on a firm's statement of cash flows include transactions involving the raising
of cash through borrowing or equity financing, as well as cash used for paying dividends, buying
back stock, or paying off debt. These activities impact the firm's capital structure and
shareholders' equity.
43) According to the textbook, the most practical way to interpret or make sense of a firm's
historical financial statements is through:
A) profit analysis
B) regression analysis
C) the preparation of pro forma financial statements
D) ratio analysis
E) percentage analysis
Answer: D
Rationale:
Ratio analysis is the most practical way to interpret or make sense of a firm's historical financial
statements. It involves calculating and analyzing various financial ratios that provide insights
into the firm's financial performance, liquidity, solvency, and efficiency.
44) Kevin Pierce was reading the business plan of New Venture Fitness Drinks, and noticed that
prior to its financial forecasts, New Venture Fitness Drinks placed an explanation of the sources
of the numbers for the forecast and the assumptions used to generate them. This explanation is
called a(n):
A) forecast sheet
B) forecast hypothesis
C) estimate statement
D) assumption sheet
E) hypothesis sheet
Answer: D
Rationale:
The explanation of the sources of the numbers for a forecast and the assumptions used to
generate them is called an assumption sheet. It provides transparency and context for the
financial forecasts presented in the business plan.
45) In the context of computing the cost of sales, the common way to do this is to use the
percent-of-sales method, which is a method for expressing:
A) each expense item as a percentage of net sales
B) each expense item as a percentage of gross profit
C) each expense item as a percentage of net income
D) each expense item as a percentage of operating income
E) each expense item as a percentage of cost of sales
Answer: A
Rationale:
The percent-of-sales method is used to express each expense item as a percentage of net sales.
This method helps in forecasting expenses based on the expected level of sales.
46) If a firm determines it can use the percentage-of-sales method and it follows the procedure
described in the textbook, then the net result is that each expense item on its income statement
(with the exception of those items that can be individually forecast) will grow at the same rate as
sales. This approach is called the:
A) continuous percentage method of forecasting
B) stable fraction method of forecasting
C) regular proportion method of forecasting
D) constant ratio method of forecasting
E) steady percentage method of forecasting
Answer: D
Rationale:
The approach described is called the constant ratio method of forecasting. It assumes that each
expense item on the income statement (except those that can be individually forecast) will grow
at the same rate as sales, maintaining a constant ratio to sales.
47) A firm's pro forma financial statements are similar to its historical financial statements
except that:
A) they do not include the income statement
B) they are required by the SEC in all cases
C) they look back rather than forward
D) they look forward rather than back
E) they do not include the statement of cash flows
Answer: D
Rationale:
Pro forma financial statements are similar to historical financial statements, but they look
forward rather than back. They are based on projected future financial performance and are used
for planning and decision-making.
48) The Savvy Entrepreneurial Firm feature for Chapter 8 focuses on Wise Acre Frozen Treats, a
company that made organic popsicles from unrefined sweeteners. According to the feature, Wise
Acre Frozen Treats failed largely because:
A) it grew too quickly, which overwhelmed its cash flow
B) it was not careful enough in preparing its pro forma financial statements
C) it was not efficient in the way it utilized its assets
D) it spent too much money on marketing
E) it did not compare its financial ratios to industry peers
Answer: A
Rationale:
According to the feature, Wise Acre Frozen Treats failed largely because it grew too quickly,
which overwhelmed its cash flow. Rapid growth can strain a company's resources and lead to
cash flow problems if not managed carefully.
49) The ________ provides a firm a sense of how its activities will affect its ability to meet its
short-term liabilities and how its finances will evolve over time.
A) pro forma balance sheet
B) pro forma statement of cash flows
C) pro forma income statement
D) pro forms expense statement
E) pro forma statement of owners' equity
Answer: A
Rationale:
The pro forma balance sheet provides a firm with a sense of how its activities will affect its
ability to meet its short-term liabilities and how its finances will evolve over time. It is a
forward-looking financial statement that helps in financial planning and decision-making.
50) According to the textbook, the most important function of the pro forma statement of cash
flows is to project whether the firm will have sufficient:
A) income to meet its payroll on a weekly or monthly basis
B) income to exceed industry norms
C) cash to meet its needs
D) inventory to meet its sales and production forecasts
E) short-term assets to cover its short-term liabilities
Answer: C
Rationale:
The most important function of the pro forma statement of cash flows is to project whether the
firm will have sufficient cash to meet its needs. It helps in assessing the firm's liquidity and cash
flow management.
51) Financial management deals with two things: raising money and managing a company's
finances in a way that achieves the highest rate of return.
Answer: True
Rationale:
Financial management involves raising money through various sources such as equity or debt,
and then managing these funds efficiently to achieve the highest rate of return for the company.
52) Efficiency is the ability to earn a profit.
Answer: False
Rationale:
Efficiency refers to how well a company utilizes its resources to generate output. It is not solely
focused on earning a profit but also involves minimizing costs and maximizing output.
53) Stability is a company's ability to meet its short-term financial obligations.
Answer: False
Rationale:
Stability refers to the overall health of a company's financial structure, including its ability to
meet both short-term and long-term obligations, maintain consistent profitability, and manage
risks effectively.
54) A company's accounts receivable is money owed to it by its customers.
Answer: True
Rationale:
Accounts receivable represents the amount of money owed to a company by its customers for
goods or services that have been delivered but not yet paid for.
55) If a firm's debt-to-equity ratio gets too high, it may have trouble meeting its obligations and
securing the level of financing needed to fuel its growth.
Answer: True
Rationale:
A high debt-to-equity ratio indicates that a company has more debt than equity in its capital
structure. This can make it more difficult for the company to secure additional financing and may
increase the risk of financial distress.
56) Budgets are itemized forecasts of a company's income, expenses, and capital needs and are
also an important tool for financial planning and control.
Answer: True
Rationale:
Budgets help companies plan and control their finances by setting targets for income, expenses,
and capital needs. They provide a roadmap for financial decision-making and resource
allocation.
57) Historical financial statements reflect past performance and are usually prepared on a
quarterly and annual basis.
Answer: True
Rationale:
Historical financial statements provide a record of a company's financial performance and
position over a specified period, such as a quarter or a year. They are used for analysis, reporting,
and decision-making.
58) Pro forma financial statements are projections for future periods based on forecasts and are
typically completed for 2 to 3 years into the future.
Answer: True
Rationale:
Pro forma financial statements are forward-looking statements that project a company's financial
performance and position for future periods based on forecasts and assumptions. They are often
used for planning and decision-making.
59) The balance sheet reflects the results of the operations of a firm over a specified period of
time.
Answer: False
Rationale:
The balance sheet is a snapshot of a company's financial position at a specific point in time. It
provides information about the company's assets, liabilities, and equity at that moment, not the
results of its operations over a period of time.
60) The income statement records all the revenues and expenses for a given period and shows
whether the firm is making a profit or is experiencing a loss.
Answer: True
Rationale:
The income statement summarizes a company's revenues, expenses, gains, and losses for a
specific period, typically a quarter or a year. It shows whether the company has made a profit or
a loss during that period.
61) A firm's profit margin, or return on sales, is computed by dividing net income by net sales.
Answer: True
Rationale:
The profit margin, or return on sales, is a financial ratio that shows the percentage of profit a
company makes from its revenue. It is calculated by dividing net income by net sales and is used
to assess a company's profitability.
62) A statement of cash flows is a snapshot of a company's assets, liabilities, and owners' equity
at a specific point in time.
Answer: False
Rationale:
A statement of cash flows is a financial statement that shows the changes in a company's cash
and cash equivalents over a period of time, not a snapshot at a specific point in time. It details the
sources and uses of cash during the period.
63) The major categories of assets listed on a balance sheet include current assets, fixed assets,
and other assets.
Answer: True
Rationale:
The major categories of assets listed on a balance sheet include current assets (assets that are
expected to be converted into cash or used up within one year), fixed assets (assets that are longterm and used in the production of goods or services), and other assets (assets that do not fall into
the current or fixed categories).
64) A firm's working capital is defined as its fixed assets minus its long-term liabilities.
Answer: False
Rationale:
A firm's working capital is defined as its current assets minus its current liabilities. It represents
the amount of capital available to a company for its day-to-day operations.
65) The statement of cash flows summarizes the changes in a firm's cash position for a specified
period of time and details why the change occurred.
Answer: True
Rationale:
The statement of cash flows summarizes the changes in a firm's cash position for a specified
period of time and details why the change occurred. It categorizes the cash flows into operating,
investing, and financing activities.
66) In the context of a firm's statement of cash flows, operating activities include the purchase,
sale, or investment in fixed assets, such as real estate, equipment, and buildings.
Answer: False
Rationale:
In the context of a firm's statement of cash flows, operating activities include cash inflows and
outflows related to the core operations of the business, such as sales and purchases of inventory,
payment of wages, and payment of suppliers.
67) The break-even point for a new restaurant or product is the point where the total revenue
received equals total costs associated with the output of the restaurant or the sale of the product.
Answer: True
Rationale:
The break-even point is the point at which total revenue equals total costs, resulting in neither
profit nor loss. It is an important concept in determining the viability of a new restaurant or
product.
68) The pro forma balance sheet provides a firm a sense of how its activities will affect its ability
to meet its short-term liabilities and how its finances will evolve over time.
Answer: True
Rationale:
The pro forma balance sheet is a projected balance sheet that shows the expected financial
position of a company at a future date. It helps a firm understand how its activities will impact its
ability to meet short-term liabilities and how its finances will evolve over time.
69) The pro forma income statement shows the projected flow of cash into and out of the
company during a specified period.
Answer: False
Rationale:
The pro forma income statement shows the projected revenues, expenses, and profits or losses of
a company during a specified period, not the flow of cash into and out of the company.
70) The same financial ratios used to evaluate a firm's historical financial statement should be
used to evaluate the pro forma financial statements.
Answer: True
Rationale:
The same financial ratios used to evaluate a firm's historical financial statements can be used to
evaluate the pro forma financial statements. These ratios help assess the financial health and
performance of a company and can be applied to both historical and projected financial data.
71) Describe each of the four primary financial objectives of firms.
Answer: The four primary financial objectives of most firms are: profitability, liquidity,
efficiency, and stability.
Profitability is the ability to earn a profit. Liquidity is a company's ability to meet its short-term
financial obligations. Efficiency is how productively a firm utilizes its assets relative to its
revenue and its profits. Stability is the strength and vigor of the firm's overall financial posture.
72) Describe the difference between historical and pro forma financial statements.
Answer: Historical financial statements reflect past performance and are usually prepared on a
quarterly and annual basis. Pro forma financial statements are projections for future periods
based on forecasts and are typically completed for two to three years into the future. Pro forma
financial statements are strictly planning tools, while historical financial statements reflect actual
information.
73) Describe the purpose of the income statement, the balance sheet, and the statement of cash
flows.
Answer: The income statement reflects the results of the operations of a firm over a specified
period of time. It records all the revenues and expenses for the given period and shows whether
the firm is making a profit or is experiencing a loss. Unlike the income statement, which covers a
specified period of time, a balance sheet is a snapshot of a company's assets, liabilities, and
owners' equity at a specific point in time. The statement of cash flows summarizes the changes in
a firm's cash position for a specified period of time and details why the change occurred. The
statement of cash flows is similar to a month-end bank statement. It reveals how much cash is on
hand at the end of the month as well as how the cash was acquired and spent during the month.
74) What is ratio analysis? Why is it important?
Answer: The most practical way to interpret or make sense of a firm's historical and pro forma
financial statements is through ratio analysis. The ratios described in the textbook are divided
into profitability ratios, liquidity ratios, and overall financially stability ratios. These ratios
provide a means of interpreting the historical and pro forma financial ratios for a firm.
75) What are forecasts? What role do they play in the preparation of pro forma financial
statements?
Answer: Forecasts are projections of a firm's future sales, expenses, income, and capital
expenditures. A firm's forecasts provide the basis for its pro forma financial statements. A welldeveloped set of pro forma financial statements helps a firm create accurate budgets, build
financial plans, and manage its finances in a proactive rather than a reactive manner.
Test Bank for Entrepreneurship: Successfully Launching New Ventures
Bruce R. Barringer, R. Duane Ireland
9780132555524, 9780131393905, 9780134729534, 9780133797190
