Deck 5: The Analysis of Financial Statements

Question 1

An increasing average collection period implies the firm has tightened its credit policies.

Answer 1

False

Question 2

The first step in a financial statement analysis is to calculate ratios.

Answer 2

False

Question 3

Using comparative statistical ratios to help determine a company's relative position within its industry is misleading due to the many accounting choices and techniques firms choose to report information.

Answer 3

False

Question 4

A creditor is ultimately concerned with the ability of the borrower to make interest and principal payments on borrowed funds.

Question 5

Financial statement analysis from the standpoint of management does not relate to the same questions raised by investors and creditors.

Question 6

The current and quick ratios measure the short-run solvency of a firm.

Question 7

Before beginning the analysis of a firm's financial statements, it is necessary to specify the objectives of the analysis.

Question 8

In order for a firm to benefit from debt financing, the fixed interest payments must be greater than the operating earnings.

Question 9

Cash flow ratios add to a financial statement analysis by ensuring that profits are being translated into cash flows.

Question 10

A low number of days inventory held is usually a sign of efficient management; however, too low a number could indicate understocking and lost orders.

Question 11

The smaller the fixed asset turnover ratio is the lower the investment in property, plant and equipment.

Question 12

The current and quick ratio may contradict the cash flow liquidity ratio, requiring the analyst to explore the underlying components of each ratio.

Question 13

Sources of information outside the company's annual report should not be relied upon in a financial statement analysis.

Question 14

The cash interest coverage ratio can be misleading if a company generates high profits, but no cash flow from operations.

Question 15

Sources of information for analysts include the Form 10-K, proxy statement, auditor's report, and management discussion and analysis.

Question 16

To improve the cash conversion cycle a firm would want to decrease the average collection period, decrease days inventory held and increase days payable outstanding.

Question 17

Financial ratios do not provide answers in and of themselves, and they are not predictive.

Question 18

Liquidity ratios measure the extent of a firm's financing with debt relative to equity.

Question 19

The investor attempts to arrive at an estimation of a company's future earnings stream in order to attach a value to the securities being considered for purchase or liquidation.

Question 20

Tools and techniques used to evaluate a firm's financial condition should include common size financial statements, financial ratios, trend and structural analysis and industry comparisons.

Question 21

Which of the following statements is false?

A) Financial ratios can indicate areas of potential strength and weakness.
B) Financial ratios can serve as screening devices.
C) Financial ratios are predictive.
D) No rules of thumb apply to the interpretation of financial ratios.

Question 22

When the financial leverage index is less than one, this indicates the firm is employing debt beneficially.

Question 23

Which of the following ratios would be useful in assessing short-term liquidity?

A) Current ratio, inventory turnover, fixed asset turnover.
B) Quick ratio, average collection period, cash conversion cycle.
C) Average collection period, debt ratio, return on assets.
D) Current ratio, cash interest coverage, cash-flow liquidity ratio.

Question 24

What type of ratios measure the firm's ability to meet cash needs as they arise?

A) Activity ratios.
B) Liquidity ratios.
C) Leverage ratios.
D) Profitability ratios.

Question 25

What type of ratios measure the liquidity of specific assets and the efficiency of managing those assets?

A) Activity ratios.
B) Liquidity ratios.
C) Leverage ratios.
D) Profitability ratios.

Question 26

Which of the following items is an outside source of information from the corporate annual report?

A) Auditor's report.
B) Supplementary schedule of segment information.
C) Comparative statistical ratios from Annual Statement Studies.
D) Management's discussion and analysis.

Question 27

The Du Pont System helps the analyst see how a firm's decisions and activities over an accounting period interact to produce an overall return to the firm's shareholders, the return on equity.

Question 28

What relationship exists between the average collection period and accounts receivable turnover?

A) There is a direct and proportional relationship.
B) Both ratios are expressed in number of times receivables are collected per year.
C) Both ratios are expressed in number of days.
D) As average collection period increases (decreases) the accounts receivable turnover decreases (increases).

Question 29

What is the cash conversion or net trade cycle?

A) The amount of time needed to complete the normal operating cycle of a firm.
B) The amount of time it takes to manufacture or buy inventory.
C) The amount of time it takes to sell inventory.
D) The amount of time it takes to be profitable.

Question 30

The accounting and finance scandals, including Lehman Brothers, Enron, and WorldCom, illustrated the importance to investors of earnings numbers and market ratios based on those earnings numbers.

Question 31

What type of ratios measure the extent of a firm's financing with debt relative to equity and its ability to cover interest and fixed charges?

A) Activity ratios.
B) Liquidity ratios.
C) Market ratios.
D) Leverage ratios.

Question 32

Short-term liquidity focuses on assessment of the key components of the income statement.

Question 33

Which of the following tools and techniques are the least useful to the financial statement analyst?

A) Financial ratios.
B) Public relations material and pro forma statements prepared by the firm.
C) Trend and structural analysis.
D) Common size financial statements.

Question 34

An upward trend in asset turnover ratios indicates improved operating efficiency.

Question 35

If a firm is using financial leverage successfully what would be the impact of doubling operating earnings?

A) The return on equity will double.
B) The return on equity will increase, but not double.
C) The return on equity will more than double.
D) The return on equity will decline by half.