Question 1

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

Accepted Answer

An increasing average collection period means that it takes longer for the firm to collect payment from its customers. This is usually a sign that the firm has relaxed its credit policies, allowing customers more time to pay. A decreasing average collection period would indicate that the firm has tightened its credit policies and is collecting payment more quickly.

Question 2

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

Accepted Answer

The first step in a financial statement analysis is to understand the business environment and gather relevant financial statements, not to calculate ratios. Ratio calculation comes later in the analysis process.

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.

Accepted Answer

Comparative statistical ratios, despite the variety of accounting choices and techniques firms use, are a fundamental tool in financial analysis to help determine a company's relative position within its industry. They allow for the assessment of a company's performance, efficiency, and financial health in comparison to its peers, taking into account industry-specific norms and standards.

Question 4

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

Accepted Answer

This is because the creditor's primary interest is in ensuring the repayment of the loaned funds, which includes the interest and principal payments. If the borrower is unable to make these payments, it puts the creditor at risk of losing money.

Question 5

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

Accepted Answer

Management, investors, and creditors often seek answers to similar fundamental questions regarding a company's financial health, profitability, liquidity, and future prospects through financial statement analysis, even though their specific interests and objectives may vary.

Question 6

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

Accepted Answer

The current ratio and quick ratio are both liquidity ratios that measure a firm's ability to meet its short-term obligations. Therefore, they are used to assess 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.

Accepted Answer

It is important to define the purpose and objectives of the analysis before starting, as it will determine what information needs to be extracted and how it should be interpreted.

Question 8

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

Accepted Answer

For a firm to benefit from debt financing, the operating earnings must be greater than the fixed interest payments, so that the firm can generate enough cash flow to cover the debt service. If the fixed interest payments are greater than the operating earnings, the firm may struggle to meet its debt obligations and may face financial distress.

Question 9

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

Accepted Answer

Cash flow ratios provide insight into how efficiently a company generates cash from its operations and how it uses it to pay off debts, invest in projects, and pay dividends. This information complements the profit and loss statements by showing if a company's positive profits are resulting in positive cash flows, which is an important factor in determining the overall financial health of a company.

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.

Accepted Answer

A low number of days inventory held is generally a sign of efficient management as it means the company is not tying up money in excess inventory. However, if the number is too low, it could indicate understocking and lost orders, which can negatively impact customer satisfaction and revenue. Therefore, it is important to strike a balance between efficient inventory management and meeting customer demand.

Question 11

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

Accepted Answer

The fixed asset turnover ratio is calculated by dividing net sales by the average value of property, plant, and equipment. A lower ratio indicates that a company is generating fewer sales relative to its investment in fixed assets. Therefore, a company with a smaller fixed asset turnover ratio is likely to have a higher 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.

Accepted Answer

The current and quick ratios are based on balance sheet data, while the cash flow liquidity ratio is based on cash flow statement data. These ratios may have different results depending on the timing of cash inflows and outflows. Therefore, further analysis is needed to understand the reasons behind any discrepancies between the ratios.

Question 13

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

Accepted Answer

Sources of information outside the company's annual report, such as industry reports, news articles, and analyst reports, can provide valuable insights and context for a financial statement analysis. However, it is important to consider the credibility and reliability of these sources before incorporating them into the analysis. Additionally, any information obtained from external sources should be clearly cited and disclosed in the analysis.

Question 14

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

Accepted Answer

The answer of The cash interest coverage ratio can be...

Question 15

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

Accepted Answer

These are all common sources of information that analysts use to gather data and insights about companies they are analyzing. The Form 10-K is an annual report filed with the SEC that provides a comprehensive overview of a company's financial performance, business strategy, risks, and more. The proxy statement is also filed with the SEC and provides information about a company's executive compensation, Board of Directors, and shareholder proposals. The auditor's report is a statement from an independent auditor verifying the accuracy of a company's financial statements. Lastly, the management discussion and analysis is a section within the Form 10-K where management provides their perspective on the company's performance and future outlook.

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.

Accepted Answer

This statement is true. A decrease in the average collection period and days inventory held will decrease the time it takes for a firm to convert its investments into cash, resulting in a shorter cash conversion cycle. Additionally, increasing days payable outstanding extends the amount of time a firm has to pay its bills, effectively increasing its cash on hand and again reducing the cash conversion cycle.

Question 17

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

Accepted Answer

Financial ratios can provide useful insight and analysis, but they should not be relied upon as the sole source of information. They should be used in conjunction with other factors and considerations in making financial decisions. Additionally, past performance does not guarantee future results, so ratios should not be used to make predictions.

Question 18

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

Accepted Answer

Liquidity ratios measure a firm's ability to meet short-term financial obligations using current assets. They do not measure the extent of a firm's financing with debt relative to equity, which is measured by leverage ratios.

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.

Accepted Answer

This statement is true. Investors use various methods to analyze a company's financials and assess its potential future earnings to determine the value of its securities.

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.

Accepted Answer

These are all effective tools and techniques for evaluating a firm's financial condition.

Quiz 5: The Analysis of Financial Statements