Question 1

The cash ratio is a measure of the degree of current asset liquidity.

Accepted Answer

The cash ratio is a financial ratio that measures a company's ability to cover its short-term obligations with its most liquid assets, specifically with cash and cash equivalents. Therefore, it is a measure of current asset liquidity.

Question 2

When calculating the times interest earned adjustments should normally be made for existence of operating leases. A portion of rental payments should be reclassified as interest.

Accepted Answer

When adjusting for operating leases, a portion of rental payments should be reclassified as interest to accurately calculate the times interest earned ratio. This is because operating leases are a form of financing and can have an impact on the company's ability to meet its interest obligations.

Question 3

Analysis of profitability of a company is more important when considering short-term liquidity than when considering long-term solvency of a company.

Accepted Answer

Analysis of profitability is crucial for understanding a company's long-term solvency as it indicates the company's ability to generate earnings over the long term. Short-term liquidity, on the other hand, is more directly assessed through measures of current assets and liabilities, focusing on the company's ability to meet its short-term obligations.

Question 4

The higher the company's inventory turnover the better is company.

Accepted Answer

A higher inventory turnover indicates efficient management, but excessively high turnover might suggest inadequate inventory levels, leading to stockouts and lost sales.

Question 5

If accounts payable turnover decreases this could be an indication that suppliers are cutting off credit to the company.

Accepted Answer

A decrease in accounts payable turnover typically indicates that a company is taking longer to pay off its suppliers, not necessarily that suppliers are cutting off credit. It could be due to a variety of reasons such as cash flow management strategies or renegotiated payment terms.

Question 6

Management Discussion and Analysis provides information that is useful in helping assess company's liquidity.

Accepted Answer

Management Discussion and Analysis (MD&A) includes information about a company's financial condition, results of operations, cash flows, and other factors that may affect its liquidity. Therefore, MD&A can be helpful in evaluating a company's ability to meet its short-term obligations and manage its cash flows, which are important indicators of liquidity.

Question 7

For purposes of long-term solvency analysis the calculation of balance sheet ratios such as debt/equity or debt to total capital are of limited value and are used mostly as screening mechanisms to indicate whether further analysis is warranted.

Accepted Answer

Balance sheet ratios such as debt/equity or debt to total capital can provide a general idea about a company's leverage position, but long-term solvency analysis requires more in-depth analysis of a company's financial statements, cash flows, and operations. Therefore, these ratios are used as initial indicators to identify companies that may require further analysis to assess their long-term solvency.

Question 8

One would expect restaurants to have lower inventory turnovers than general merchandise stores.

Accepted Answer

The answer of One would expect restaurants to have lower...

Question 9

An increase in the current ratio over time is always a good indication of increased liquidity of the firm.

Accepted Answer

An increase in the current ratio may indicate improved liquidity, but it could also result from inefficient use of assets or excessive inventory, not necessarily reflecting better financial health.

Question 10

A decrease in provision for doubtful accounts relative to gross accounts receivable could indicate improved collection of accounts receivable or it could indicate that management has failed to make adequate provisions for non-collectible accounts.

Accepted Answer

A decrease in provision for doubtful accounts relative to gross accounts receivable could indicate improved collection of accounts receivable, but it could also be a red flag that management has not made adequate provisions for non-collectible accounts. Therefore, it is important to look at other factors such as changes in customer creditworthiness and payment patterns, as well as overall economic conditions.

Question 11

When examining the current ratio and trends in the current ratio it is important to evaluate the turnover rate of current assets and current liabilities and trends in these turnover ratios.

Accepted Answer

Evaluating the turnover rate of current assets and current liabilities and trends in these turnover ratios is important when examining the current ratio and its trends.

Question 12

If a company's days receivables outstanding increases this could be an indication that there are problems with the quality of the company's products.

Accepted Answer

An increase in days receivables outstanding could indicate issues with the company's credit and collections policies, customer payment behavior, or general economic conditions. It is not necessarily a direct indication of product quality.

Question 13

In assessing the quality of receivables it is important to consider the revenue recognition methods used by a company.

Accepted Answer

The revenue recognition methods used by a company can have an impact on the quality of its receivables, as certain methods can result in higher or lower levels of bad debts or uncollectible accounts. Therefore, it is important to consider these methods when evaluating the quality and collectibility of a company's receivables.

Question 14

If a company sells its receivables this is an indication that it has very high quality receivables.

Accepted Answer

Selling receivables may indicate that a company is in need of cash and is willing to sell its receivables at a discount, regardless of their quality. Therefore, it does not necessarily infer high quality receivables.

Question 15

The lower equity is as a proportion of total capital, all other things equal, the greater the risk borne by the other providers of capital.

Accepted Answer

With lower equity as a proportion of total capital, the company has taken on more debt or other forms of financing such as bonds. This increases the risk to other providers of capital such as bondholders or lenders as they have less protection in case the company defaults. On the other hand, if a company has a greater proportion of equity, it is less risky for other providers of capital as equity holders bear the most risk in case of company failure.

Question 16

When calculating earnings coverage ratios it is common to remove the effects of extraordinary gains and losses and other one-time gains and losses from the numerator.

Accepted Answer

When calculating earnings coverage ratios, it is common to use adjusted earnings that exclude items like extraordinary gains and losses or one-time gains and losses in order to provide a better representation of the company's ongoing profitability.

Question 17

The use of LIFO will inflate the current ratio under normal economic conditions.

Accepted Answer

LIFO (Last In, First Out) typically results in lower ending inventory values on the balance sheet under normal economic conditions because the most recent, and often higher, costs are expensed first. This can lead to a lower current ratio, as the current ratio is calculated as current assets divided by current liabilities, and a lower inventory value decreases current assets.

Question 18

An increase in the current ratio due to increased inventory and receivables could be consistent with a recession in the economy.

Accepted Answer

During a recession, sales may slow down and customers may take longer to pay their bills, leading to an increase in inventory and receivables. This would result in an increase in the current ratio, but it does not necessarily indicate a healthy financial position as it may also imply decreased liquidity.

Question 19

Determination of short-term liquidity is important to both investors and creditors.

Accepted Answer

Determination of short-term liquidity is important to both investors and creditors as it helps them assess a company's ability to meet its financial obligations in the near future. Investors can use this information to make informed decisions about investing in a company, while creditors can use it to evaluate the creditworthiness of a borrower before extending credit.

Question 20

If a company switches from FIFO to LIFO during a period of rising prices, inventory turnover will probably increase.

Accepted Answer

The answer of If a company switches from FIFO to...

Quiz 10: Credit Analysis