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HOW DID YOU DO?

FINANCIAL LITERACY QUIZ ANSWERS

QUESTION 1

Which of the following is / are valuable to a company? 

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Liability

Expenses

Income

Assets

Equity

Answer: Assets 

Of the five, only assets are valuable to a company. Often people would include income and equity as valuable. However, income is simply an activity that generates value but is not valuable. Technically, equity is an obligation to shareholders for what they invest in a company, and as such is a valuable thing for the company. The investment itself (say cash investment) is captured as an asset.  

QUESTION 2

Which of the following is not an asset to a company? 

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People

Equipment

Money others owe us

Intellectual property

Answer: People 

We often hear ‘people are our greatest assets’. While we believe people are valuable and make a difference in businesses, from a financial perspective, people are not assets. There are two criteria for something to be considered an asset – it must be measurable and controllable. The latter indicates that a company has control over the asset and can, as an example, sell the asset if it wishes to. This is a level of control companies cannot claim to have over their employees.

QUESTION 3

Revenue is ...

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An activity that generates value 

Cash received for our services 

Profit after deducting expenses 

A valuable thing

Answer: An activity that generates value

Another popular answer is that income or revenue is money we receive. Revenue is an activity that leads to the generation of valuable things i.e. assets. We may sell a product today (revenue recorded) but may not receive cash for it immediately. The two (revenue and cash) are related but not the same thing. This too leads to the widespread misconception that profit and cash are the same thing.

QUESTION 4

Expenses is ...

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Money others lend to us 

Cash we spend 

An activity that sacrifices value 

An investment

Answer: An activity that sacrifices value 

A popular answer is that expenses are money we spend. An expense is an activity leads to a reduction in our assets. While related, an expense when incurred does not equate cash being spent at the point it is incurred. We could hire a window cleaner who cleans the window today (expense incurred) but we may pay (spend money) later. This is one of misconception that leads to another major one that people make, that profit equals cash.

QUESTION 5

Equity is ...

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Cash that we invest in companies 

Obligation to owners 

Cash we borrow from a lender 

An activity that generates value

Answer: Obligation to owners

Equity is an obligation to shareholders for their investment in the company. Among others, it includes the value of capital invested by the shareholders and the profits generated by the company. Understanding equity is important as the purpose of business is to return greater value to its shareholders.

QUESTION 6

Buying inventory is ...

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An expense to create sales 

Buying an asset 

Like borrowing goods 

Is cost of goods sold

Answer: Buying an asset

Inventory are valuable things for a business. When buying inventory with cash, an asset (cash) is used to acquire another asset (inventory). There are no expenses as value is not sacrificed (see answer 3 above on Expenses). $10 of cash is converted into $10 of inventory – the value of assets remain the same. Just because money is spent, people make the mistake of regarding it an expense. 

QUESTION 7

One of the ways to improve a company's EBITDA is to manage ...

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Tax expenses 

Depreciation and amortization 

Salary expenses 

Interest expenses

Answer: Salary expenses

EBITDA is earnings before interest, tax, depreciation and amortization.  It is the profit without taking into account these costs, hence any change in them will not affect the EBITDA.  Salary like other overheads like rental and utilities can impact.  An understanding of the structure of an income statement would help us analyse and better manage the business’ activities and profitability.

QUESTION 8

In a Balance Sheet, which of Assets, Liabilities and Equity would a for-profit business most likely to grow?

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Liabilities 

Equity 

Income

Asset

Answer: Equity

The purpose of a for-profit business is to grow returns to the shareholders, the owners of the business. This is done when the business generates more value than it sacrifices, resulting in profit.

QUESTION 9

Profit for the year in the Profit & Loss statement is captured in the Balance Sheet as​ ...

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Liabilities 

Equity 

Income

Asset

Answer: Equity

Shareholders take a risk when the invest in a business. There is no legal obligation for the company to give dividends every year or guarantee the value of share prices.  When a company is bankrupt, the lenders get priority claim.  As such any profit generated by the business should be due to the shareholders.

QUESTION 10

Which of the following does not contribute to growth in return on equity?

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Increasing asset velocity

Increasing profitability

Increasing funding of expansion through debt

Speeding up the cash conversion cycle

Answer: Speeding up the cash conversion cycle

Faster, smarter and bigger! Increasing the revenue generated per dollar asset, increasing the profit from those revenues and funding growth through debt instead of equity all contribute to growth in return on equity. This is captured in what is known as the DuPont analysis – a breakdown of return on equity into three parts and is useful for businesses with the same underlying elements.