Essential Financial Accounting & Analysis Questions
Test and solidify your understanding of core financial concepts with this curated set of questions and detailed explanations. Ideal for students and professionals preparing for exams or interviews.
Balance Sheet Fundamentals
Q1. Which of the following is NOT a component of a balance sheet?
- (a) Assets
- (b) Liabilities
- (c) Revenue
- (d) Equity
Answer: (c) Revenue
Explanation: Revenue is reported on the income statement, not the balance sheet. The balance sheet’s core components are assets, liabilities, and equity.
Q4. Which ratio measures a firm’s ability to meet short‑term obligations?
- (a) Debt‑to‑Equity ratio
- (b) Current ratio
- (c) Return on Equity
- (d) Gross profit margin
Answer: (b) Current ratio
Explanation: The current ratio (Current Assets ÷ Current Liabilities) is a key liquidity metric that assesses short‑term solvency.
Q9. How is “working capital” calculated?
- (a) Total Assets – Total Liabilities
- (b) Current Assets – Current Liabilities
- (c) Fixed Assets – Long‑term Debt
- (d) Share Capital + Reserves
Answer: (b) Current Assets – Current Liabilities
Explanation: Working capital represents a company’s short‑term financial health and operational efficiency.
Q11. The “quick ratio” (acid‑test) excludes which of the following from current assets?
- (a) Cash and bank balances
- (b) Marketable securities
- (c) Inventory
- (d) Accounts receivable
Answer: (c) Inventory
Explanation: The quick ratio uses only the most liquid assets (cash, securities, receivables). It excludes inventory, which is less readily convertible to cash.
Income Statement & Profitability
Q8. Which financial statement shows the result of operations for a period?
- (a) Balance Sheet
- (b) Statement of Cash Flows
- (c) Income Statement (Profit & Loss Account)
- (d) Notes to Accounts
Answer: (c) Income Statement
Explanation: The income statement summarizes revenues, expenses, and the resulting profit or loss over a specific period.
Q10. Which of the following is a non‑cash expense?
- (a) Salaries paid
- (b) Rent expense
- (c) Depreciation
- (d) Interest paid
Answer: (c) Depreciation
Explanation: Depreciation reduces reported profit but does not involve an actual cash outflow in the period it is recorded.
Q14. What does the term “EBITDA” stand for?
- (a) Earnings Before Interest, Taxes, Depreciation, and Amortization
- (b) Earnings Before Income Tax, Dividends, and Amortization
- (c) Economic Benefit of Internal Trade, Depreciation, and Amortization
- (d) Estimated Business Income After Tax, Depreciation, and Amortization
Answer: (a) Earnings Before Interest, Taxes, Depreciation, and Amortization
Explanation: EBITDA is a common measure of a company’s operational profitability, excluding financing and accounting decisions.
Cash Flow Statement
Q2. What is the primary purpose of the cash flow statement?
- (a) Profitability of the firm over a period
- (b) Sources and uses of cash during a period
- (c) Changes in owners’ equity
- (d) Market value of assets
Answer: (b) Sources and uses of cash during a period
Explanation: It details cash inflows and outflows from operating, investing, and financing activities.
Q6. Which item appears under “Operating Activities” in the cash flow statement?
- (a) Purchase of machinery
- (b) Payment of dividends
- (c) Collection from customers
- (d) Issue of share capital
Answer: (c) Collection from customers
Explanation: Cash received from customers is a core component of cash flows from operating activities.
Q18. In the indirect method cash flow statement, an increase in accounts receivable is:
- (a) Added to net income
- (b) Subtracted from net income
- (c) Ignored
- (d) Multiplied by tax rate
Answer: (b) Subtracted from net income
Explanation: An increase in receivables indicates sales revenue not yet collected as cash, so it is subtracted to adjust net income to operating cash flow.
Q23. Which is an example of a financing activity?
- (a) Payment to suppliers
- (b) Receipt of dividend income
- (c) Repayment of a bank loan
- (d) Purchase of office equipment
Answer: (c) Repayment of a bank loan
Explanation: Transactions with lenders and owners, like loan repayments or equity issuance, are financing activities.
Core Accounting Principles & Ratios
Q3. Why is depreciation expense recorded?
- (a) Increase net profit
- (b) Reflect the reduction in market value of an asset each year
- (c) Allocate the cost of a tangible fixed asset over its useful life
- (d) Decrease tax liability directly
Answer: (c) Allocate the cost of a tangible fixed asset over its useful life
Explanation: Depreciation applies the matching principle, spreading an asset’s historical cost across the periods it benefits.
Q7. The accounting equation is correctly expressed as:
- (a) Assets = Liabilities – Equity
- (b) Assets + Liabilities = Equity
- (c) Assets = Liabilities + Equity
- (d) Equity = Assets + Liabilities
Answer: (c) Assets = Liabilities + Equity
Explanation: This is the fundamental equation that keeps the balance sheet in balance.
Q17. Which ratio measures how efficiently a company uses its assets to generate sales?
- (a) Net profit margin
- (b) Return on Assets
- (c) Asset turnover ratio
- (d) Inventory turnover ratio
Answer: (c) Asset turnover ratio
Explanation: Asset Turnover (Sales ÷ Average Total Assets) indicates sales generated per unit of asset investment.
Q20. How is the “times interest earned” ratio calculated?
- (a) Net Income ÷ Interest Expense
- (b) EBIT ÷ Interest Expense
- (c) EBITDA ÷ Interest Expense
- (d) Gross Profit ÷ Interest Expense
Answer: (b) EBIT ÷ Interest Expense
Explanation: This ratio (Interest Coverage) measures a company’s ability to meet its interest obligations from operating earnings.
Q24. The “debt service coverage ratio” (DSCR) primarily measures:
- (a) Profitability relative to sales
- (b) Ability to cover interest and principal repayments from operating income
- (c) Market valuation of equity
- (d) Efficiency of inventory management
Answer: (b) Ability to cover interest and principal repayments from operating income
Explanation: DSCR assesses the sufficiency of operating cash flow to service total debt commitments.
Specific Items & Classifications
Q5. What is a “contingent liability”?
- (a) A liability that is certain and measurable
- (b) A possible obligation arising from past events, confirmed by uncertain future events
- (c) An amount already paid in advance
- (d) Equity contributed by shareholders
Answer: (b) A possible obligation arising from past events, confirmed by uncertain future events
Explanation: Examples include pending lawsuits or product warranties. They are disclosed in notes if probable and estimable.
Q12. Where are “long‑term investments” shown on a classified balance sheet?
- (a) Current Assets
- (b) Fixed Assets
- (c) Investments (non‑current)
- (d) Current Liabilities
Answer: (c) Investments (non‑current)
Explanation: Long-term investments are held for periods longer than one year and are classified as non-current assets.
Q13. Which is true about preference shares?
- (a) They carry voting rights equal to equity shares
- (b) Dividends are paid after equity dividends
- (c) They have a preferential claim on dividends and assets in liquidation
- (d) They cannot be redeemed
Answer: (c) They have a preferential claim on dividends and assets in liquidation
Explanation: Preference shares have priority over common equity for dividends and capital repayment, but often lack voting rights.
Q16. How is “Goodwill” classified in the balance sheet?
- (a) Tangible fixed asset
- (b) Current asset
- (c) Intangible asset
- (d) Liability
Answer: (c) Intangible asset
Explanation: Goodwill is an intangible asset representing the excess purchase price over the fair value of identifiable net assets in an acquisition.
Business Structures & Calculations
Q19. Which is NOT a characteristic of a sole proprietorship?
- (a) Unlimited liability
- (b) Separate legal entity
- (c) Simple to set up
- (d) Owner retains all profits
Answer: (b) Separate legal entity
Explanation: A sole proprietorship has no legal distinction between the business and its owner.
Q21. Which statement provides information about changes in equity during a period?
- (a) Balance Sheet
- (b) Income Statement
- (c) Statement of Changes in Equity
- (d) Cash Flow Statement
Answer: (c) Statement of Changes in Equity
Explanation: This statement details movements in share capital, reserves, and retained earnings.
Q22. If the current ratio is 1.5 and current liabilities are ₹2,00,000, what are current assets?
- (a) ₹1,00,000
- (b) ₹2,00,000
- (c) ₹3,00,000
- (d) ₹4,00,000
Answer: (c) ₹3,00,000
Explanation: Current Assets = Current Ratio × Current Liabilities = 1.5 × 2,00,000 = ₹3,00,000.
Q25. In a not‑for‑profit organization, the excess of income over expenditure is transferred to:
- (a) Profit and Loss Appropriation Account
- (b) Capital Fund
- (c) General Reserve
- (d) Share Capital Account
Answer: (b) Capital Fund
Explanation: The surplus is added to the Capital Fund, which is analogous to equity in a for-profit business.
Debt & Financial Decisions
Q15. Which action would increase a company’s debt‑to‑equity ratio?
- (a) Issuing new equity shares
- (b) Repaying a long‑term loan
- (c) Purchasing inventory on credit
- (d) Converting debentures into equity shares
Answer: (c) Purchasing inventory on credit
Explanation: This increases current liabilities (debt) while equity is unchanged, raising the debt-to-equity ratio.
