Question 1

Using total sales instead of credit sales in the accounts receivable turnover calculation can produce misleading results and is a problem primarily for companies that have a material amount of cash sales.

Accepted Answer

Total sales include both cash and credit sales, while accounts receivable turnover calculation should only consider credit sales because only credit sales result in accounts receivable. Therefore, if a company has a material amount of cash sales, using total sales instead of credit sales in the calculation can make it seem like the company is collecting its receivables more slowly than it actually is.

Question 2

The accounts receivable turnover ratio can be used by the analyst to spot changing customer payment patterns.

Accepted Answer

The accounts receivable turnover ratio measures how quickly a company collects payments from its customers. If the ratio starts to decrease, it could indicate that customers are taking longer to pay their invoices, which would signal a change in customer payment patterns. Therefore, the analyst can use this ratio to spot changing customer payment patterns.

Question 3

There is more than one commonly used debt ratio.

Accepted Answer

There are multiple debt ratios used in financial analysis, such as debt-to-equity ratio, debt-to-capitalization ratio, and debt-to-asset ratio.

Question 4

The quick ratio measures the most immediate liquidity of a company.

Accepted Answer

The quick ratio, also known as the acid-test ratio, measures a company's ability to meet its short-term obligations with its most liquid assets. It excludes inventory, which may not be quickly converted into cash, and therefore provides a more immediate picture of a company's liquidity compared to the current ratio.

Question 5

The interest coverage ratio reflects the cushion between operating profit inflows and required interest payments.

Accepted Answer

The interest coverage ratio measures the ability of a company to pay interest expenses out of its operating profit or earnings. A higher interest coverage ratio indicates that the company has a larger cushion to cover its interest expenses, while a lower ratio indicates a higher risk of default on interest payments. Therefore, the statement that the interest coverage ratio reflects the cushion between operating profit inflows and required interest payments is true.

Question 6

Disparate operating and cash conversion cycles can spell a dangerous mismatch between cash outflows and inflows.

Accepted Answer

Disparate operating and cash conversion cycles mean that a company is taking longer to turn its inventory into cash and collect payments from customers, while also paying its own suppliers and other expenses. This can result in a dangerous mismatch between cash outflows and inflows, potentially leading to cash flow problems and financial distress.

Question 7

Lenders have several courses of action available when a borrower is in default.

Accepted Answer

Lenders have the legal right to take action against a borrower when they default, including but not limited to foreclosure, collections, and legal action.

Question 8

The quick ratio does not include inventory in the denominator because few businesses can instantaneously convert their inventories into cash.

Accepted Answer

The quick ratio does not include inventory in the numerator, not the denominator, because it measures a company's ability to meet short-term obligations without relying on the sale of inventory.

Question 9

Activity ratios describe the profitability of a company.

Accepted Answer

Activity ratios, also known as efficiency ratios, measure how effectively a company is utilizing its assets and resources, such as inventory and accounts receivable. They do not directly describe the profitability of a company, but rather its operational efficiency. Profitability ratios, such as return on investment and net profit margin, are used to measure a company's profitability.

Question 10

Solvency refers to the long-term ability to generate sufficient cash to satisfy plant capacity needs,fuel growth,and to repay debt when due.

Accepted Answer

Solvency refers to the ability of a business to meet its long-term financial obligations, including repaying debts. This requires generating enough cash flow to cover these obligations, as well as fueling future growth and investment in plant capacity. Therefore, the statement is true.

Question 11

The statement of cash flows is an important source of information when analyzing a company's credit risk.

Accepted Answer

The statement of cash flows provides information about a company's inflows and outflows of cash, which can be useful in assessing its ability to generate sufficient cash flow to pay debts and meet its financial obligations. Therefore, it is an important factor to consider when evaluating a company's creditworthiness.

Question 12

Credit risk analysis using financial ratios typically involves an assessment of profitability and solvency.

Accepted Answer

The answer of Credit risk analysis using financial ratios typically...

Question 13

Lenders typically petition to have a borrower judged insolvent by a court when the borrower is in default.

Accepted Answer

Lenders usually try to work out a solution with the borrower or pursue other means of debt recovery before petitioning to have them judged insolvent, as declaring insolvency is a last resort and involves legal proceedings.

Question 14

Credit risk refers to the risk of payment default by the borrower,and the resulting loss to the lender of interest and loan principal payments.

Accepted Answer

Credit risk is indeed the risk of payment default by the borrower, resulting in financial loss to the lender.

Question 15

A low-credit-risk company generates operating cash flows substantially in excess of what are required to sustain its business activities.

Accepted Answer

A low-credit-risk company has a strong ability to generate cash flows, which are sufficient to cover their business activities and also potentially invest in growth opportunities or return cash to shareholders. This is typically reflected in their credit rating and financial stability, making them attractive to lenders and investors.

Question 16

Although a company's earnings are important,an analysis of its cash flows is central to all credit evaluations and lending decisions.

Accepted Answer

Cash flows are crucial in determining a company's ability to repay debts and finance its operations, making it essential in credit evaluations and lending decisions. While earnings may provide insight into a company's profitability, it is the cash flows that measure a company's liquidity and ability to generate cash.

Question 17

The more a company relies on long-term borrowing to finance its business activities,the lower its debt ratio and long-term solvency risk.

Accepted Answer

The statement is incorrect. The more a company relies on long-term borrowing, the higher its debt ratio and long-term solvency risk. Long-term borrowing adds to a company's long-term liabilities, increasing its debt-to-equity ratio and consequently, its long-term solvency risk.

Question 18

The long-term asset turnover ratio helps the analyst identify efficiency gains from improved accounts receivable and inventory management.

Accepted Answer

The long-term asset turnover ratio measures how efficiently a company uses its long-term assets to generate sales, not specifically how it manages accounts receivable and inventory, which are current assets.

Question 19

The Z-score model combines five financial ratios in a precise way to estimate a company's default risk.

Accepted Answer

The Z-score model is a formula that combines five financial ratios - working capital/total assets, retained earnings/total assets, earnings before interest and taxes/total assets, market value of equity/book value of total liabilities, and sales/total assets. The resulting score is used to estimate a company's likelihood of default or bankruptcy.

Question 20

Days payable outstanding helps analysts understand the company's pattern of cash receipts from customers.

Accepted Answer

Days payable outstanding is a metric that measures the average number of days it takes a company to pay its suppliers. It does not provide any information about the company's pattern of cash receipts from customers.

Quiz 5: Essentials of Financial Statement Analysis