Question 1

Since the ROA measures the firm's effective utilization of assets (without considering how these assets are financed),two firms with the same EBIT must have the same ROA.

Accepted Answer

EBIT = Sales revenues − Operating costs Net income = EBIT − Interest − Taxes = (EBIT − Interest) × (1 − T) ROA = Net income after taxes/Assets Two firms could have identical EBITs but very different amounts of interest, different tax rates, and different assets, and thus very different ROAs.

Question 2

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

BEP = EBIT/Assets. This is before the effects of leverage (interest) and taxes, so the statement is false.

Question 3

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

Accepted Answer

A decline in inventory turnover ratio means that the firm is holding onto its inventory for a longer period of time and not selling it as quickly, which indicates potential issues with efficiency and liquidity.

Question 4

Determining whether a firm's financial position is improving or deteriorating requires analyzing more than the ratios for a given year.Trend analysis is one method of measuring changes in a firm's performance over time.

Accepted Answer

Trend analysis compares financial data from multiple years to identify patterns and changes over time, allowing for a more comprehensive evaluation of a firm's financial position.

Question 5

The inventory turnover and current ratio are related.The combination of a high current ratio and a low inventory turnover ratio,relative to industry norms,suggests that the firm has an above-average inventory level and/or that part of the inventory is obsolete or damaged.

Accepted Answer

A high current ratio is consistent with a lot of inventory. A low inventory turnover is also consistent with a lot of inventory. If the CR exceeds industry norms and the turnover is below the norms, then the firm has more inventory than most other firms, given its sales. It could just be carrying a lot of good inventory, but it might also have a normal amount of "good" inventory plus some "bad" inventory that has not been written off. So the statement is true.

Question 6

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

Accepted Answer

The answer of Although a full liquidity analysis requires the...

Question 7

The current ratio and inventory turnover ratios both help us measure the firm's liquidity.The current ratio measures the relationship of a firm's current assets to its current liabilities,while the inventory turnover ratio gives us an indication of how long it takes the firm to convert its inventory into cash.

Accepted Answer

The statement is true. Both ratios are used to measure a firm's liquidity.

Question 8

Suppose firms follow similar financing policies,face similar risks,have equal access to capital,and operate in competitive product and capital markets.Under these conditions,then firms that have high profit margins will tend to have high asset turnover ratios,and firms with low profit margins will tend to have low turnover ratios.

Accepted Answer

Asset turnover ratio is a measure of how efficiently a company uses its assets to generate sales, and it is not directly correlated with profit margins. A firm can have a high profit margin with a low asset turnover if it sells high-margin products less frequently, or a low profit margin with a high asset turnover if it sells low-margin products more frequently.

Question 9

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

Accepted Answer

High current and quick ratios may indicate that a firm has a strong liquidity position, but it does not necessarily mean that the firm is managing its liquidity position well. Other factors, such as the timing of cash flows and the effectiveness of working capital management, also play a role in determining how well a firm manages its liquidity.

Question 10

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 measures a company's ability to pay its interest expenses from its earnings. However, there are other factors that also affect a firm's ability to meet its debt obligations, such as cash flow, liquidity, and overall financial health. Therefore, the times-interest-earned ratio is only one of the many indicators of a company's financial stability.

Question 11

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 debt-to-equity ratio and interest coverage ratio, measure a company's ability to meet its debt obligations and show how much debt the company is using to finance its operations. If a company has a high debt-to-equity ratio, it means that the company is relying heavily on borrowing to finance its operations and increase returns on owners' capital through financial leverage. Therefore, the statement is true.

Question 12

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

Accepted Answer

Ratio analysis is a common financial analysis tool that involves comparing and evaluating financial ratios derived from a company's financial statements to assess its financial strength, performance, and position. It helps in making informed decisions about investment, creditworthiness, and business strategies. Therefore, the statement is true.

Question 13

The "apparent," but not the "true," financial position of a company whose sales are seasonal can differ dramatically,depending on the time of year when the financial statements are constructed.

Accepted Answer

Many of the ratios show sales over some past period such as the last 12 months divided by an asset such as inventories as of a specific date. Assets like inventories vary at different times of the year for a seasonal business, thus leading to big changes in the ratio.

Question 14

Market value ratios provide management with an indication of how investors view the firm's past performance and especially its future prospects.

Accepted Answer

Market value ratios, such as the price-to-earnings ratio, reflect the market's perception of a company's future profitability and growth potential. This can be useful for management in understanding how investors are valuing the company and making strategic decisions accordingly.

Question 15

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

Accepted Answer

This is true. The inventory turnover ratio indicates how many times a company's inventory is sold and replaced over a period of time, while the DSO ratio measures the average number of days it takes for a company to collect payment from its customers. Both ratios provide insight into how efficiently a company is managing its assets.

Question 16

Significant variations in accounting methods among firms make meaningful ratio comparisons between firms more difficult than if all firms used similar accounting methods.

Accepted Answer

Different accounting methods can impact the values of financial ratios, making it more challenging to accurately compare performance and financial health between firms.

Question 17

Even though Firm A's current ratio exceeds that of Firm B,Firm B's quick ratio might exceed that of A.However,if A's quick ratio exceeds B's,then we can be certain that A's current ratio is also larger than that of B.

Accepted Answer

The quick ratio excludes inventory from current assets, focusing on more liquid assets, while the current ratio includes all current assets. It's possible for Firm A to have a higher quick ratio due to more liquid assets but still have a lower current ratio if Firm B has significantly more inventory or other current assets.

Question 18

It is appropriate to use the fixed assets turnover ratio to appraise firms' effectiveness in managing their fixed assets if and only if all the firms being compared have the same proportion of fixed assets to total assets.

Accepted Answer

The FA turnover is Sales/FA, and it gives an indication of how effectively the firm utilizes its FA. The proportion of FA to TA is not relevant to this usage.

Question 19

Firms A and B have the same current ratio,0.75,the same amount of sales and cost of goods sold,and the same amount of current liabilities.However,Firm A has a higher inventory turnover ratio than B.Therefore,we can conclude that A's quick ratio must be smaller than B's.

Accepted Answer

Firm A has the higher inventory turnover, so given the same cost of goods, it must have less inventory. Thus, since the two firms have the same CR, then A must have the higher QR, not the lower one. Therefore, the statement is false.

Question 20

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

Accepted Answer

Profitability ratios include measures such as return on assets (ROA), return on equity (ROE), and net profit margin, which take into account a company's ability to efficiently use its assets and manage its debts to generate profit. Therefore, profitability ratios show the combined effects of liquidity, asset management, and debt management on operating results.

Quiz 7: Analysis of Financial Statements