Question 1

In order to accurately estimate cash flow from operations,depreciation must be added back to net income.The reason for this is that even though depreciation is deducted from revenue it is really a non-cash charge.

Accepted Answer

Depreciation is a non-cash charge that reduces net income but does not actually result in an outflow of cash. Therefore, it needs to be added back to net income in order to accurately calculate the cash flow from operations.

Question 2

In accounting,emphasis is placed on determining net income.In finance,the primary emphasis also is on net income because that is what investors use to value the firm.However,a secondary consideration is cash flow because that's what is used to run the business.

Accepted Answer

In finance, the primary emphasis is on cash flow because it determines a firm's ability to fund operations, invest, and return value to shareholders. Net income is important but considered secondary because it is an accounting measure that can be influenced by non-cash items.

Question 3

The financial position of companies whose business is seasonal can be dramatically different depending upon the time of year chosen to construct financial statements.This time sensitivity is especially true with respect to the firm's balance sheet.

Accepted Answer

Seasonal businesses, such as those in the tourism or agricultural industries, experience fluctuations in assets and liabilities depending on the time of year. For example, a ski resort may have high cash balances in the winter season but low cash balances in the summer season. Therefore, the balance sheet can vary significantly depending on the time period chosen for financial statement reporting.

Question 4

The time dimension is important in financial statement analysis.While the balance sheet and income statements represent the firm's financial position at a point in time,the statement of cash flows reports changes that were made to the firm's accounts over a period of time.

Accepted Answer

The balance sheet represents the firm's financial position at a point in time, while both the income statement and the statement of cash flows report changes over a period of time.

Question 5

If a firm has high current and quick ratios,this always is a good indication that a firm is managing its liquidity position well.

Accepted Answer

High current and quick ratios indicate that a firm has more short-term assets relative to its short-term liabilities, which suggests good liquidity. However, excessively high ratios may also indicate that the firm is not using its assets efficiently or is under-leveraged, which could be a sign of poor financial management.

Question 6

As long as sales revenues exceed all costs over part of an accounting period,a firm will avoid any cash shortage.

Accepted Answer

Sales revenues exceeding costs may result in profits on paper, but if cash inflows do not match or exceed outflows, the firm can still experience a cash shortage. It is important to properly manage cash flow to avoid liquidity issues.

Question 7

A decline in the inventory turnover ratio suggests that the firm's liquidity position is improving.

Accepted Answer

A decline in inventory turnover ratio suggests that the firm is taking longer to sell its inventory, which means that the liquidity position is worsening. A high inventory turnover ratio indicates that the firm is efficiently managing its inventory and converting it into cash, thereby indicating a better liquidity position.

Question 8

Differences in cash flow cycles and variations in accounting methods among firms can invalidate financial comparisons between firms.

Accepted Answer

Cash flow cycles and accounting methods can significantly impact a company's financial statements, making it difficult to compare them with other firms. For example, one company may have a longer cash flow cycle than another, which can make their financial statements look worse in comparison. Additionally, different accounting methods can impact how revenue and expenses are recorded, further distorting financial comparisons between firms.

Question 9

The inventory turnover ratio and days sales outstanding (DSO)are two ratios that can be used to assess how effectively the firm is managing its assets in consideration of current and projected operating levels.

Accepted Answer

The inventory turnover ratio and days sales outstanding (DSO) are indeed two ratios that are useful in measuring how well a company is managing its assets based on its current and projected operating levels.

Question 10

Funds supplied by common stockholders mainly include capital stock,paid-in capital,and retained earnings,while total equity is comprised of common equity plus preferred stock.

Accepted Answer

Common stockholders contribute funds through capital stock and paid-in capital, and also retain earnings over time. Total equity includes both common equity and preferred stock.

Question 11

A stock dividend and a stock split should,at least conceptually,have the same effect on shareholders' wealth.

Accepted Answer

Both a stock dividend and a stock split result in an increase in the number of shares outstanding and a decrease in the stock price per share. However, the proportionate ownership in the company remains the same, so the overall value of the shareholders' holdings should remain the same. Therefore, they should have the same effect on shareholders' wealth.

Question 12

Retained earnings is the cash that has been generated by the firm through its operations which has not been paid out to stockholders as dividends.Retained earnings are kept in cash or near cash accounts and thus,these cash accounts,when added together,will always be equal to the total retained earnings of the firm.

Accepted Answer

Retained earnings represent the cumulative amount of net income earned by a company that has not been distributed to shareholders as dividends. It is not necessarily held in cash or near-cash accounts; it can be reinvested in assets, used for debt repayment, or kept for future use in various forms, not just cash.

Question 13

The times-interest-earned ratio is one indication of a firm's ability to meet both long-term and short-term obligations.

Accepted Answer

The times-interest-earned ratio measures a firm's ability to cover its interest expenses with its earnings. This includes both long-term and short-term obligations, making it a useful indicator of overall financial health.

Question 14

The retained earnings account on the balance sheet does not represent cash and in fact,represents a claim against the existing assets of the firm.This implies that retained earnings are in fact the reinvested earnings of stockholders.

Accepted Answer

Retained earnings represent the portion of a company's net income that is reinvested instead of being distributed as dividends to shareholders. It is not cash but rather a part of the company's equity, which represents the accumulated earnings of the company that have not been paid out as dividends. Therefore, it represents a claim against the assets of the firm and reflects the reinvested earnings of the stockholders.

Question 15

Determining whether a firm's financial position is improving or deteriorating requires analysis of more than one set of financial statements.Trend analysis is one method of measuring a firm's performance over time.

Accepted Answer

Trend analysis is indeed a method of measuring a firm's performance over time, and determining whether their financial position is improving or deteriorating requires analysis of multiple financial statements.

Question 16

Since 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

Two firms with the same EBIT may have different levels of assets, which would result in different ROAs. For example, if Firm A and Firm B both have an EBIT of $100, but Firm A has total assets of $500 and Firm B has total assets of $1,000, Firm B would have a higher ROA because it is generating the same amount of earnings with fewer assets.

Question 17

The degree to which the managers of a firm attempt to magnify the returns to owners' capital through the use of financial leverage is captured in debt management ratios.

Accepted Answer

This is true. Debt management ratios such as debt-to-equity ratio, debt-to-assets ratio, and interest coverage ratio are used to measure the extent to which managers utilize debt to increase the returns to owners' capital.

Question 18

Market value ratios provide management with a current assessment of how investors in the market view the firm's past performance and future prospects.

Accepted Answer

Market value ratios such as price-to-earnings (P/E) ratio, price-to-sales (P/S) ratio, and market-to-book ratio reflect the market's assessment of a company's current and future performance. These ratios are commonly used by investors to evaluate the attractiveness of an investment in the company. Therefore, management can utilize these ratios as a gauge of the firm's performance from the investor's perspective.

Question 19

Even if a stock split has no information content,and even if the dividend per share adjusted for the split does not increase,there can still be a real benefit (i.e. ,a higher value for shareholders)from such a split,but any such benefit is probably small.

Accepted Answer

A stock split can lead to increased liquidity, more trading activity, and potentially attract new investors who may be attracted to a lower share price. However, any benefit from a stock split is typically small and may not have a significant impact on shareholder value in the long run.

Question 20

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

Accepted Answer

Profitability ratios are calculated to measure the profitability of a company and show how efficient the company is in generating profits from its operations by taking into account liquidity, asset management, and debt management. Therefore, the given statement is true.

Quiz 7: Analysis of Financial Statements