Financial Statement Analysis: Ratios, Funds Flow/Cash Flow Basics and Interpretation Questions

Question 1

Define financial statement analysis. (concept)

Accepted Answer

Financial statement analysis is evaluating financial statements to judge a firm’s **performance** and **financial position** (concept).

Question 2

What is ratio analysis? (concept)

Accepted Answer

**Ratio analysis** expresses relationships between financial numbers to assess **liquidity**, profitability and solvency (concept).

Question 3

State the formula for current ratio.

Accepted Answer

**Current ratio** = Current assets / Current liabilities (concept).

Question 4

Funds flow statement mainly shows movement of (concept):

Accepted Answer

**Working capital** (concept).

Question 5

Name any one activity in cash flow statement classification.

Accepted Answer

**Operating** activity (or investing/financing) (concept).

Question 6

Debt–equity ratio is a solvency ratio. (True/False)

Accepted Answer

True. **Debt–equity** indicates long-term leverage/solvency risk (concept).

Question 7

Classify ratios into any three categories with one example each (use a small table).

Accepted Answer

Classification of ratios (concept):

| Category | What it measures | Example |
|---|---|---|
| **Liquidity** | short-term payment ability | current ratio |
| **Profitability** | profit earning capacity | net profit margin |
| **Solvency/Leverage** | long-term risk | debt–equity ratio |

Any three categories with examples are acceptable (concept).

Question 8

Differentiate current ratio and quick ratio using a table and give one interpretation point each.

Accepted Answer

Current vs quick ratio (concept):

| Ratio | Formula (basic) | Interpretation (concept) |
|---|---|---|
| **Current ratio** | CA / CL | overall liquidity measure |
| **Quick ratio** | (CA − inventory) / CL | stricter liquidity (inventory excluded) |

Interpretation: a firm may show good current ratio but weak quick ratio if inventory is high (concept).

Question 9

Write any three limitations of ratio analysis (points).

Accepted Answer

Limitations (any three) (concept):

- uses historical data; may not reflect current conditions
- affected by **accounting policies** and estimates
- ratios need comparison (trend/industry); single ratio can mislead
- inflation can distort comparisons (concept)

Any three points are sufficient.

Question 10

Differentiate funds flow and cash flow using a table (brief).

Accepted Answer

Funds flow vs cash flow (concept):

| Point | **Funds flow** | **Cash flow** |
|---|---|---|
| Focus | **working capital** movement | cash and cash equivalents movement |
| Use | shows sources/uses affecting WC | shows liquidity and cash position |
| Output | funds from operations, WC changes (concept) | operating/investing/financing cash flows |

Thus, cash flow is more direct for liquidity assessment (concept).

Question 11

Explain operating, investing and financing activities in cash flow statement with one example each (use a table).

Accepted Answer

Cash flow activities (concept):

| Activity | Meaning | One example |
|---|---|---|
| **Operating** | cash from core business | cash received from customers (concept) |
| **Investing** | cash from long-term assets/investments | purchase of machinery |
| **Financing** | cash from capital and borrowings | repayment of loan / issue of shares (concept) |

Any appropriate examples are acceptable.

Question 12

Explain ROE and Net Profit Margin with formulas and one interpretation point each (use a small table).

Accepted Answer

Profitability ratios (concept):

| Ratio | Formula (basic) | Interpretation (concept) |
|---|---|---|
| **ROE** | Net profit / Equity | return to shareholders; higher may indicate better performance |
| **Net profit margin** | Net profit / Sales | profit per unit of sales; higher margin is generally better |

Interpretation should be supported with trend/industry comparison (concept).

Question 13

Write an exam-style note on liquidity analysis using current ratio and quick ratio (include a small table and conclusion).

Accepted Answer

### Meaning
**Liquidity analysis** evaluates ability to meet short-term obligations.

### Key ratios (table)
| Ratio | Formula (basic) | What it indicates (concept) |
|---|---|---|
| **Current ratio** | CA / CL | overall short-term safety margin |
| **Quick ratio** | (CA − inventory) / CL | immediate liquidity (inventory excluded) |

### Interpretation (exam points)
- higher current ratio generally means better liquidity, but too high may mean idle assets (concept)
- quick ratio reveals whether liquidity depends heavily on inventory

### Conclusion
Use both ratios together and compare with prior years/industry to judge liquidity (concept).

Question 14

Explain solvency/leverage analysis using debt–equity and interest coverage ratios (exam-style) with a table and conclusion.

Accepted Answer

### Meaning
**Solvency/leverage** analysis checks long-term financial risk and ability to service debt.

### Key ratios (table)
| Ratio | Formula (basic) | Interpretation (concept) |
|---|---|---|
| **Debt–equity** | Debt / Equity | higher ratio means higher leverage risk |
| **Interest coverage** | EBIT / Interest | higher ratio means safer interest payment capacity |

### Conclusion
A balanced capital structure with adequate coverage improves solvency and reduces default risk (concept).

Question 15

Explain how to interpret a cash flow statement at a basic level (use a flow and conclusion).

Accepted Answer

### Basic interpretation approach (flow)
Operating cash flow → check if core business generates cash (concept)
Investing cash flow → check if firm is expanding (outflows) or selling assets (inflows) (concept)
Financing cash flow → check borrowing/repayment and dividend payments (concept)

### Key exam points
- positive **operating** cash flow is generally healthy
- investing outflow can be good if it supports growth
- financing inflows may indicate increased leverage; outflows may indicate repayment

### Conclusion
Interpret cash flow by linking all three activities to liquidity, growth strategy and financing pattern (concept).

Category	What it measures	Example
Liquidity	short-term payment ability	current ratio
Profitability	profit earning capacity	net profit margin
Solvency/Leverage	long-term risk	debt–equity ratio

Financial Statement Analysis: Ratios, Funds Flow/Cash Flow Basics and Interpretation

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