HOW DID YOU DO?
FINANCIAL LITERACY QUIZ ANSWERS
Which of the following is / are valuable to a company?
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.
Which of the following is not an asset to a company?
Money others owe us
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.
Revenue is ...
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.
Expenses is ...
Money others lend to us
Cash we spend
An activity that sacrifices value
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.
Equity is ...
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.
Buying inventory is ...
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.
One of the ways to improve a company's EBITDA is to manage ...
Depreciation and amortization
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.
In a Balance Sheet, which of Assets, Liabilities and Equity would a for-profit business most likely to grow?
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.
Profit for the year in the Profit & Loss statement is captured in the Balance Sheet as ...
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.
Which of the following does not contribute to growth in return on equity?
Increasing asset velocity
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.