Question 1

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 2

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

Selling inventory on credit would increase the accounts receivable asset, which is included in both the current and quick ratio calculations. This would decrease the ratios, indicating a potential liquidity risk for the firm.

Question 3

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 is true. The current ratio and quick ratio are both used to assess a company's liquidity, with the former measuring its current assets in relation to current liabilities and the latter measuring its ability to pay off short-term debts without relying on inventory sales.

Question 4

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

Accepted Answer

The answer of The more conservative a firm's management is,...

Question 5

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

Accepted Answer

Profitability ratios take into account multiple aspects of a firm's financial performance, including its liquidity, asset management, and debt management, in order to provide a comprehensive view of its ability to generate profits.

Question 6

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

Accepted Answer

The higher a firm's debt ratio, the higher its interest expense will be, which will lower its TIE (times interest earned) ratio.

Question 7

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

The statement is true.

Question 8

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 analyzing its financial statements, such as the balance sheet and income statement. It involves calculating various financial ratios, such as liquidity ratios, profitability ratios, and solvency ratios, which can provide insights into a company's financial position, performance, and risk.

Question 9

The operating margin measures operating income per dollar of assets.

Accepted Answer

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

Question 10

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 would both increase, as cash (an asset) has increased while the denominator (current liabilities in the current ratio and current assets minus inventory in the quick ratio) remains the same.

Question 11

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 company is generating more revenue per dollar invested in fixed assets. This could be because the company is using its fixed assets more efficiently or because it is operating at overcapacity. However, it is not an indication that the company should add more fixed assets, as this decision would depend on other factors such as future demand and expected returns on investment.

Question 12

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 efficiently a company is managing its inventory while the DSO measures the average number of days it takes for a company to collect payments from its customers. Both ratios are used to assess the effectiveness of a company's current asset management.

Question 13

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

Accepted Answer

While high current and quick ratios are generally considered favorable indicators of liquidity management, they do not always guarantee that a firm is managing its liquidity position well. Other factors such as the types of assets held by the firm, its debt obligations, and its ability to generate cash flow can also impact its ability to meet short-term financial obligations.

Question 14

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 current ratio is calculated by dividing current assets by current liabilities, and including inventory (which is part of current assets) in the calculation. Therefore, if inventory is sold on credit, current assets and current liabilities will both decrease by the same amount, leaving the current ratio relatively unchanged. However, the quick ratio is calculated by dividing quick assets (current assets minus inventory) by current liabilities, so if inventory is sold on credit, quick assets will increase while current liabilities remain the same, resulting in an increase in the quick ratio.

Question 15

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

This is true. Other indicators of a firm's ability to meet its debt obligations include the debt-to-equity ratio, the current ratio, and the quick ratio.

Question 16

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

In general, it's better to have a high inventory turnover ratio as it indicates that the firm is efficiently managing its inventory and not holding excess stock, which can result in unnecessary costs. However, it is important for the ratio to be balanced and not too high, as that could indicate the firm is not holding enough inventory to meet demand.

Question 17

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 like debt-to-equity and interest coverage ratio show how much debt a company is using to finance its operations and how well it can meet its interest payments. By using debt, a company can magnify its returns on owners' capital, but it also increases the risk of financial distress and bankruptcy.

Question 18

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 a company is holding onto its inventory for a longer time period, which can indicate poor inventory management and may negatively impact liquidity. Therefore, a decline in inventory turnover ratio does not suggest that a company is becoming more liquid, but rather the opposite.

Question 19

The profit margin measures net income per dollar of sales.

Accepted Answer

The profit margin formula is net income divided by total revenue (sales), so it measures how much profit a company earns per dollar of sales.

Question 20

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 statement is true - while a cash budget provides a more comprehensive picture of a firm's liquidity, the current and quick ratios are commonly used as quick estimates of liquidity.

Quiz 4: Statement Analysis