CFE Financial Analysis & Reporting 2 — Questions and Answers
Question 1: A company reports a current ratio of 0.8. What does this most directly indicate about its short-term financial position?
- Current liabilities exceed current assets (Correct answer)
- The company is highly profitable
- Long-term debt is well-covered
- Inventory levels are excessive
Correct answer: Current liabilities exceed current assets
A current ratio below 1.0 means current liabilities exceed current assets, signaling potential liquidity risk.
Question 2: Under ASC 842, operating leases are reflected on the lessee's balance sheet as:
- Finance lease liabilities only
- A right-of-use asset and a corresponding lease liability (Correct answer)
- An off-balance-sheet commitment
- Prepaid rent and deferred revenue
Correct answer: A right-of-use asset and a corresponding lease liability
ASC 842 requires lessees to recognize a right-of-use asset and lease liability for virtually all operating leases.
Question 3: Which financial metric best measures how efficiently a company converts its invested capital into profit?
- Gross margin percentage
- Return on invested capital (ROIC) (Correct answer)
- Current ratio
- Debt-to-equity ratio
Correct answer: Return on invested capital (ROIC)
ROIC measures net operating profit after tax divided by invested capital, directly gauging capital efficiency.
Question 4: A financial examiner notices that a company's days sales outstanding (DSO) increased from 32 to 67 days year-over-year. The most likely concern is:
- Declining inventory management
- Deteriorating accounts receivable collectability or aggressive revenue recognition (Correct answer)
- Improved supplier payment terms
- Decreasing operating expenses
Correct answer: Deteriorating accounts receivable collectability or aggressive revenue recognition
A sharp DSO increase suggests customers are paying more slowly or revenue was recognized prematurely, raising fraud and credit risk flags.
Question 5: In a common-size income statement, all line items are expressed as a percentage of:
- Total assets
- Net income
- Net revenues or net sales (Correct answer)
- Shareholders' equity
Correct answer: Net revenues or net sales
Common-size income statements normalize each line item to net revenues, enabling cross-period and cross-company comparisons.
Question 6: Which of the following best describes the difference between FIFO and LIFO inventory accounting during a period of rising prices?
- LIFO produces higher net income than FIFO
- FIFO results in lower ending inventory on the balance sheet
- FIFO produces higher net income and higher ending inventory than LIFO (Correct answer)
- LIFO and FIFO produce identical gross profit
Correct answer: FIFO produces higher net income and higher ending inventory than LIFO
During inflation, FIFO assigns older, lower costs to COGS, resulting in higher net income and a higher balance sheet inventory value than LIFO.
Question 7: The indirect method of presenting the statement of cash flows starts with:
- Cash collected from customers
- Net income, then adjusts for non-cash items and working capital changes (Correct answer)
- Total operating expenses
- Gross profit from operations
Correct answer: Net income, then adjusts for non-cash items and working capital changes
The indirect method reconciles net income to net cash from operations by adding back non-cash charges and adjusting for working capital movements.
CFE Financial Analysis & Reporting 2
A company reports a current ratio of 0.8.
What does this most directly indicate about its short-term financial position?