Question 1

The profit margin measures net income per dollar of sales.

Accepted Answer

The profit margin is calculated by dividing net income by total revenue (sales), which results in a percentage that represents how much of every dollar of sales is profit. Therefore, the statement "the profit margin measures net income per dollar of sales" is true.

Question 2

Although a full liquidity analysis requires the use of a cash budget, the current and quick ratios provide fast and easy-to-use estimates of a firm's liquidity position.

Accepted Answer

The current and quick ratios are commonly used to estimate a firm's liquidity position, but a more thorough analysis requires the use of a cash budget to understand the timing and sources of cash inflows and outflows.

Question 3

If a firm sold some inventory for cash and left the funds in its bank account, its current ratio would probably not change much, but its quick ratio would decline.

Accepted Answer

The current ratio and quick ratio both consider cash as a current asset, so if a firm sold inventory for cash and left the funds in its bank account, both ratios would be affected the same way. The current ratio measures the firm's ability to pay off all its current liabilities with its current assets, while the quick ratio measures the firm's ability to pay off its current liabilities without relying on inventory. Since the sale of inventory for cash would increase both current assets and current liabilities by the same amount, the current ratio would not change much. However, the quick ratio would decline because inventory is a quick asset, and it is excluded from the quick ratio calculation.

Question 4

The inventory turnover ratio and days sales outstanding (DSO) are two ratios that are used to assess how effectively a firm is managing its current assets.

Accepted Answer

The inventory turnover ratio measures how quickly a company is selling its inventory, while DSO measures how quickly a company is collecting payment from its customers. Both ratios are indicators of how well a company is managing its current assets.

Question 5

High current and quick ratios always indicate that the firm is managing its liquidity position well.

Accepted Answer

While high current and quick ratios can be a positive sign for a firm's liquidity, they do not always indicate effective management. Other factors such as inventory turnover, accounts receivable turnover, and debt-to-equity ratio should also be considered. Additionally, different industries may have varying acceptable ranges for liquidity ratios.

Question 6

Ratio analysis involves analyzing financial statements to help appraise a firm's financial position and strength.

Accepted Answer

Ratio analysis is a tool used to evaluate a company's financial health by examining its financial statements such as the balance sheet, income statement, and cash flow statement. This analysis helps investors and analysts to better understand a company's financial performance, profitability, liquidity, and solvency. Therefore, the statement is true.

Question 7

Profitability ratios show the combined effects of liquidity, asset management, and debt management on a firm's operating results.

Accepted Answer

This is true, as profitability ratios take into account various factors including how efficiently a company manages its assets and liabilities, as well as its ability to generate profits from its operations.

Question 8

Other things held constant, the higher a firm's debt ratio, the higher its TIE ratio will be.

Accepted Answer

The TIE (Times Interest Earned) ratio measures a firm's ability to meet its interest obligations. A higher debt ratio typically means more interest expenses, which would lower the TIE ratio, not increase it.

Question 9

In general, it's better to have a low inventory turnover ratio than a high one, as a low ratio indicates that the firm has an adequate stock of inventory relative to sales and thus will not lose sales as a result of running out of stock.

Accepted Answer

This statement is actually the opposite of the truth. A high inventory turnover ratio is generally preferred because it means the company is selling its inventory quickly and efficiently, without excess stockpiling. A low inventory turnover ratio can indicate that the company is holding onto too much inventory, which can lead to increased costs and decreased profits.

Question 10

The days sales outstanding tells us how long it takes, on average, to collect after a sale is made. The DSO can be compared with the firm's credit terms to get an idea of whether customers are paying on time.

Accepted Answer

Days sales outstanding (DSO) is a measure of how long it takes on average for a company to collect payment after a sale has been made, so comparing it to the firm's credit terms can provide insight into whether customers are paying on time.

Question 11

The operating margin measures operating income per dollar of assets.

Accepted Answer

The operating margin measures operating income per dollar of sales, not assets.

Question 12

The times-interest-earned ratio is one, but not the only, indication of a firm's ability to meet its long-term and short-term debt obligations.

Accepted Answer

The times-interest-earned ratio is a useful tool for assessing a company's debt payment capabilities, but it is not the only factor to consider. Other factors such as cash flow, profitability, and overall financial health must also be taken into account.

Question 13

If a firm's fixed assets turnover ratio is significantly higher than its industry average, this could indicate that it uses its fixed assets very efficiently or is operating at over capacity and should probably add fixed assets.

Accepted Answer

A higher fixed assets turnover ratio indicates that the firm is generating more revenue from its fixed assets than its competitors, suggesting that it uses its fixed assets efficiently relative to its industry average. However, it does not necessarily indicate operating at over capacity or needing to add more fixed assets.

Question 14

The more conservative a firm's management is, the higher its debt ratio is likely to be.

Accepted Answer

Conservative management typically prefers lower debt levels to minimize financial risk, leading to a lower debt ratio.

Question 15

A decline in a firm's inventory turnover ratio suggests that it is improving both its inventory management and its liquidity position, i.e., that it is becoming more liquid.

Accepted Answer

A decline in inventory turnover ratio indicates that the company is holding onto inventory for a longer period, which could mean poor inventory management or slow sales. This would negatively affect the company's liquidity position as it ties up cash in inventory. Therefore, a decline in inventory turnover ratio does not suggest improvement in inventory management or liquidity position.

Question 16

The current and quick ratios both help us measure a firm's liquidity. The current ratio measures the relationship of the firm's current assets to its current liabilities, while the quick ratio measures the firm's ability to pay off short-term obligations without relying on the sale of inventories.

Accepted Answer

The statement accurately describes the current and quick ratios and their respective measures of a firm's liquidity.

Question 17

If a firm sold some inventory on credit as opposed to cash, there is no reason to think that either its current or quick ratio would change.

Accepted Answer

If a firm sold inventory on credit, its accounts receivable would increase, thus decreasing its quick ratio. However, there would be no impact on its current ratio if the credit sales did not affect current liabilities.

Question 18

Debt management ratios show the extent to which a firm's managers are attempting to magnify returns on owners' capital through the use of financial leverage.

Accepted Answer

Debt management ratios, such as the debt-to-equity ratio, indicate how much debt a company is using to finance its operations and can provide insight into the level of financial leverage being utilized by management. The higher the level of financial leverage, the greater the potential return on owners' equity, but also the higher the risk. Therefore, debt management ratios can be a useful tool for evaluating a company's financial health and management's strategies for maximizing returns.

Question 19

The basic earning power ratio (BEP) reflects the earning power of a firm's assets after giving consideration to financial leverage and tax effects.

Accepted Answer

The basic earning power (BEP) ratio measures a firm's earning power from its assets without considering the impact of financial leverage and tax effects; it focuses solely on operating income and total assets.

Question 20

If a firm sold some inventory on credit, its current ratio would probably not change much, but its quick ratio would increase.

Accepted Answer

The answer of If a firm sold some inventory on...

Quiz 4: Statement Analysis