Deck 14: Financial Ratios and Firm Performance

Question 1

An example of a financial statement is ________.

A) the Income Statement
B) the Sources and Uses of Cash
C) the Statement of Financial Position (Balance Sheet)
D) All of these

Answer 1

D

Question 2

The term balance sheet is used because the following accounting identity must always hold:

A) Assets = Liabilities - Owners' Equity.
B) Assets = Liabilities + Owners' Equity.
C) Liabilities = Assets + Owners' Equity.
D) Owners' Equity = Liabilities + Assets.

Answer 2

B

Question 3

Total liabilities are $100,000 and total owners' equity is $200,000. What are total assets?

A) We need to know retained earnings before we can compute total assets.
B) We need more information on current and long-term assets before we can compute total assets.
C) $100,000
D) $300,000

Answer 3

D

Question 4

Comparing two companies using ________ may point out differences in management styles.

A) common-size financial statements
B) sales growth
C) historical share prices
D) earnings per share

Question 5

The Balance Sheet, or Statement of Financial Position, is the listing of all assets and all claims against the assets of a company.

Question 6

Which of the statements below is FALSE?

A) Financial statements are a collection of historical and current activities of the company.
B) The collection of value over time found in financial statements requires us to pay attention to how we construct financial ratios so as to glean information for analysis.
C) We want to analyze financial statements so as to compare different companies and their performance relative to our company.
D) All of the above statements are TRUE.

Question 7

________ is the listing of all assets and all claims against the assets of a company.

A) The Balance Sheet or Statement of Financial Position
B) Income Statement
C) The Sources and Uses of Cash
D) All of these

Question 8

Which of the statements below is FALSE?

A) Financial statements are a collection of historical and current activities of the company.
B) The collection of value over time found in financial statements requires us to pay attention to how we construct financial ratios so as to glean information for analysis.
C) All financial statements are constructed with the same accounting principles, so you can always compare different firms based solely on these statements.
D) We want to analyze financial statements so as to compare different companies and their performance relative to our company.

Question 9

EBIT is $10,000 and interest expense is $4,000. If the tax rate is 30%, what is the net income?

A) $3,800
B) $4,200
C) $5,200
D) $8,400

Question 10

To convert a balance sheet into a common-size balance sheet statement, we restate all the numbers as percentages of ________.

A) revenue
B) total assets
C) total owners' equity
D) total liabilities

Question 11

Income statements are often prepared ________.

A) monthly for external use and quarterly for internal reporting
B) annually for internal use and quarterly for external reporting
C) monthly for internal use and quarterly for external reporting
D) monthly for internal use and annually for external reporting

Question 12

The revenue is $10,000, the cost of goods sold is $2,000, the selling, general and administrative expenses are $3,000, and depreciation is $1,000. What is the EBIT?

A) -$1,000
B) $2,000
C) $3,000
D) $4,000

Question 13

Which of the following statements is true about benchmarking?

A) It compares a company's current performance against its own previous performance.
B) It compares a company's performance against that of its competitors.
C) It provides a standard of comparison for financial measurement.
D) All of the above statements are true about benchmarking.

Question 14

To convert an income statement into a common-size income statement, we restate all the numbers as percentages of ________.

A) total revenues
B) cost of goods sold
C) net income
D) total assets

Question 15

In regards to trend analysis over time, which of the following statements is TRUE?

A) We often look at the past five years of financial statements to establish trends and then predict future performance based on these trends.
B) To look at trends over time requires that we examine a financial statement at one point in time.
C) The net income last year was $20,000 and the past five years has shown an increase of 10% on average for each of these five years. The predicted net income for next year is still $20,000.
D) It is better to predict future performance by basing it solely on net income than on all the individual accounts.

Question 16

The financial statements of a company are the primary sources of information that enable us to communicate the financial results ________.

A) of the company externally
B) of the company internally
C) to internal managers but not externally to the public
D) of the company, both internally and externally

Question 17

Total current liabilities are $100,000 and total owners' equity is $2,000,000. What are total assets?

A) We need to know retained earnings before we can compute total assets.
B) We need more information on long-term liabilities before we can compute total assets.
C) $2,000,000
D) $2,100,000

Question 18

One way to measure a company's financial performance is to benchmark against that of its competition. Which of the below is NOT a problem a company faces when benchmarking this way?

A) A problem arises when we use financial statements of different firms.
B) Firms are of different sizes, and thus comparisons may be troubling
C) We cannot restate common-size financial statements for different firms.
D) All of these are problems.

Question 19

In the business world we need to be able to measure ________ performance and predict ________ performance if we want to deliver positive results.

A) past, future
B) past, present
C) present, future
D) present, past

Question 20

The revenue is $40,000, the cost of goods sold is $26,000, the selling, general and administrative expenses are $7,000, interest expense is $2,000, and depreciation is $3,000. What is the EBIT?

A) $2,000
B) $4,000
C) $7,000
D) $14,000

Question 21

________ help us analyze whether a company is moving toward financial stress or is using debt to benefit the company and ultimately, the owners of the company.

A) Financial leverage ratios
B) Asset management ratios
C) Days' sales in inventory
D) Total asset turnover

Question 22

________ can be helpful for managers to understand short-term cash obligations.

A) Profitability ratios
B) Asset management ratios
C) Solvency ratios
D) Liquidity ratios

Question 23

Profit margin is equal to ________.

A) net income divided by total assets
B) net income divided by total owners' equity
C) net income divided by sales
D) None of these

Question 24

Benchmarking compares a company''s current performance against its own previous performance whereas bookmarking compares a company's current performance against that of its competitors.

Question 25

Which of the statements below is FALSE?

A) When the current ratio is greater than 1, we are also saying that net working capital is positive as current assets are greater than current liabilities.
B) Financial leverage ratios deal with long-term solvency and the use of debt as a financing tool.
C) The debt ratio is total assets minus total equity divided by equity.
D) Times interest earned equals EBIT divided by interest expense.

Question 26

Which of the statements below is FALSE?

A) The cash coverage ratio is EBIT plus depreciation divided by interest expense.
B) Times interest earned equals EBIT divided by interest expense.
C) The times interest earned ratio tells us the number of times a company has resorted to debt financing over the year.
D) The debt ratio basically tells us the amount in debt for every dollar of assets.

Question 27

Which of the following statements is TRUE?

A) The current ratio is current assets divided by current liabilities.
B) Total asset turnover is net income divided by total assets.
C) The cash coverage ratio equals cash divided by current liabilities.
D) The quick ratio equals current assets - current liabilities divided by current liabilities.

Question 28

Benchmarking is often just a starting point for analysis and directs the management team or potential investors to areas of the company that may be performing well or poorly.

Question 29

Which of the statements below is FALSE?

A) The acid ratio test equals current assets minus inventories divided by current liabilities.
B) Examples of liquidity ratios include the current ratio, the cash coverage ratio, and the quick ratio.
C) The current ratio is current assets divided by current liabilities.
D) Inventory turnover equals cost of goods sold divided by inventory.

Question 30

From the financial statements, we can look at specific performance areas of a company by selecting key pieces of information and analyzing this information ________.

A) at a point in time
B) over a specific time horizon
C) at a point in time or over a specific time horizon
D) All of these

Question 31

Benchmarking compares a company's current performance against its own previous performance or against that of its competitors.

Question 32

Common size statements are a particularly ineffective method to compare firms of different size.

Question 33

Debt is a good when ________.

A) we pay for everything later, allowing more positive cash flow today
B) we enjoy the benefits of acquiring an asset early but can still pay for it over time
C) we borrow at low rates
D) we use it very sparingly

Question 34

Name and describe two primary financial statements produced by a company.

Question 35

Briefly describe the major problem that arises when benchmarking against your competitors. Describe how we can overcome this problem.

Question 36

The Balance Sheet is the recording of the business activities over the past business cycle.

Question 37

Briefly describe what benchmarking does.

Question 38

Which of the statements below is TRUE?

A) Inventory turnover is cost of goods sold divided by accounts receivables.
B) Receivables turnover is accounts receivable divided by sales.
C) Total asset turnover is profits divided by total assets.
D) A higher inventory turnover ratio signifies that inventory is moving faster.

Question 39

A current ratio greater than one can tell us that the company ________.

A) should be able to cover the current liabilities
B) should be able to keep away from short-term cash problems
C) may have too much capital tied up in current assets
D) All of these

Question 40

Computing liquidity ratios is ________ but interpreting them is ________.

A) complex, even more complex
B) complex, more straightforward
C) straightforward, more complex
D) None of these

Question 41

Return on equity can increase as a result of an increase in which of the following ratios?

A) Net income/ sales
B) Sales/ total assets
C) Total assets/ equity
D) All of the above will have a positive influence on the ROE.

Question 42

A PEG ratio of 0.5 indicates that a firm is overvalued.

Question 43

The net income is $100, sales are $200, total assets are $500, and total equity is $300. According to the DuPont system of financial ratio analysis, ROE is about 33.33%.

Question 44

The DuPont Model measures ROE by multiplying ________.

A) the current ratio x total asset turnover x the equity multiplier
B) the profitability ratio x times interest earned x the equity multiplier
C) the profitability ratio x total asset turnover x the equity multiplier
D) the current ratio x times interest earned x the equity multiplier

Question 45

Once financial statements are made public, the external analysis of the company begins by ________.

A) financial analysts
B) certified tax planners
C) the advertising department
D) All of these

Question 46

To determine market value for a company, we cannot rely exclusively on its financial statements for our information.

Question 47

Market value ratios try to answer what question for potential investors? Do financial statements contain all of the necessary information to answer this question? Explain in terms of the P/E (price earnings) ratio.

Question 48

Earnings per share is the ________.

A) price per share divided by the earnings per share
B) net income divided by the number of outstanding shares
C) market value per shares divided by the book value per share
D) P/E ratio divided by the earnings growth rate times 100

Question 49

A standard interpretation of the P/E ratio is that firms with high P/E ratios need to have high growth rates to justify the current price.

Question 50

Which of the statements below is TRUE?

Question 51

________ break(s) down the return-on-equity into three components.

A) The DuPont Model
B) Market value ratios
C) Profitability ratios
D) Asset management ratios

Question 52

Name and describe three of the five classes of financial ratios.

Question 53

The higher the current ratio, the better.

Question 54

Describe the three components of the DuPont ratio.

Question 55

The current ratio, the quick ratio, and the cash ratio are asset management ratios.

Question 56

Liquidity ratios address the question of whether a company can meet its obligations over the long term, and financial leverage ratios address the question of whether a company can meet its obligations over the short term.

Question 57

If the stock price is $20, earnings per share is $1, and the earnings growth rate is 5%, then the PEG ratio is four.

Question 58

Firms with P/E ratios below 50 may have great growth and earnings potential not yet demonstrated in current earnings.

Question 59

________ is the percentage of sales dollars that reaches net income on the common-size statements.

A) The return on assets
B) The income margin
C) The profit margin
D) The return on equity

Question 60

Orange Electronics Inc. has a profitability ratio of 0.14, an asset turnover ratio of 1.7, a debt to equity ratio of 0.60 and a total asset to equity ratio of 1.60. What is the firm's ROE?

A) 14.28%
B) 22.85%
C) 38.08%
D) 41.76%

Question 61

What does it mean to benchmark by industry? Why is this needed when conducting a financial ratio analysis?

Question 62

The oil and gas industry, with its very high leverage, is usually able to produce a higher return on equity.

Question 63

Describe why firms in the the oil and gas industry have so much debt compared to other industries. What industry has the lowest profit margin? What industry converts the greatest amount of sales dollars into profit?

Question 64

Financial analysts provide recommendations to their clients about what company to buy (invest) but not what company to sell (divest).

Question 65

Financial analysts provide recommendations to their clients about what company ________.

A) to buy
B) to invest in
C) to sell or divest
D) All of these

Question 66

When performing financial ratio analysis, what we need to know is not only what the ratios are but also what the trends are over time.

Question 67

Which industry has the lowest average industry debt-to-equity ratio?

A) Auto
B) Retail
C) Oil and gas
D) Airlines

Question 68

Financial ratio analysis is designed to help the user to ask better questions rather than to provide answers to problems.

Question 69

When one begins to compare companies from different industries without considering the norms of the different industries, the evaluation may lead to a poor buy or sell decision.

Question 70

Because financial ratios can vary across industries, it is ________ these ratios by industry.

A) not necessary to study
B) unimportant to benchmark
C) important to benchmark
D) futile to examine

Question 71

Industries operate differently in terms of ________.

A) labor intensity
B) cash management
C) capital intensity
D) All of these

Question 72

One simplifying characteristic of ratio analysis is that once we have created common size statements, the benchmarking of industry ratios becomes redundant because all industries have the same ratios when using common size values.

Question 73

Which industry has the highest average industry debt-to-equity ratio?

A) Oil and gas
B) Airlines
C) Auto
D) Drugs

Question 74

The debt-to-equity ratios for Firm 1, Firm 2, Firm 3, and Firm 4 are 0.2, 0.3, 0.35, and 0.4, respectively. The earnings per share for Firm 1, Firm 2, Firm 3, and Firm 4 are $4, $3, $2.5, and $2, respectively. Everything else equal, which firm is placing more burdens on its borrowing?

A) Firm 1
B) Firm 2
C) Firm 3
D) Firm 4

Question 75

Cross sectional ratio analysis compares the firm of interest with other firms or an industry benchmark whereas time-series ratio analysis typically compares the firm with itself over time.

Question 76

Financial ratios ________ industries.

A) can vary across
B) are unchanging across
C) are homogeneous across
D) are always different across

Question 77

The debt-to-equity ratios for Firm 1, Firm 2, Firm 3, and Firm 4 are 0.25, 0.35, 0.35, and 0.45, respectively. The earnings per share for Firm 1, Firm 2, Firm 3, and Firm 4 are $4.5, $3.5, $3, and $2.5, respectively. Generally speaking,which firm is placing fewer burdens on its borrowing?

A) Firm 1
B) Firm 2
C) Firm 3
D) Firm 4

Question 78

Everything else equal, an industry with more leverage will have a ________.

A) higher return on assets
B) higher return on equity
C) lower return on equity
D) Both A & B