Question 1

The term financial leverage describes financing with debt and preferred stock to increase the potential return to the residual common shareholders' equity.

Accepted Answer

Financial leverage refers to the use of debt and preferred stock to increase the potential return on the shareholders' equity. By using financial leverage, a company can magnify the potential return to common shareholders, but it also increases the risk of financial distress and bankruptcy if the company is unable to meet its debt obligations.

Question 2

A quick ratio approximately one-half of the current ratio is typical, although this varies by industry.

Accepted Answer

A quick ratio is a more conservative measure of liquidity than the current ratio and it excludes inventory from current assets. Therefore, it is typical for the quick ratio to be about half of the current ratio. However, it can vary by industry as some industries may have higher inventory levels than others.

Question 3

If the firm offers terms of "net 45 days," a days receivable outstanding of 45 days indicates that the firm handles accounts receivable well.

Accepted Answer

A days receivable outstanding (DRO) of 45 days means that it takes the firm, on average, 45 days to collect payment from its customers. If the firm offers terms of "net 45 days," it means that the customers have 45 days to pay their invoices. So, if the DRO is also 45 days, it indicates that the firm is collecting payments from customers within the terms offered, and is managing its accounts receivable well.

Question 4

Theoretical and empirical research has shown that the expected return from investing in a firm relates, in part, to the expected profitability of the firm.

Accepted Answer

The expected return from investing in a firm is influenced by various factors such as the expected profitability of the firm, the risk associated with the investment, and market conditions. The theoretical and empirical research has shown that there is a positive relationship between the expected return and the expected profitability of the firm. Therefore, option A is correct.

Question 5

The rate of return on common shareholders' equity (ROCE) measures a firm's performance in using and financing assets to generate earnings.

Accepted Answer

The statement accurately describes the meaning of ROCE.

Question 6

In theory, the numerator of the accounts receivable turnover ratio should include only sales made on account if the objective is to measure how quickly a firm collects its accounts receivable.

Accepted Answer

The accounts receivable turnover ratio is calculated by dividing the net credit sales by the average accounts receivable. So, the numerator should include only sales made on account (i.e., credit sales) to measure how quickly the firm collects its accounts receivable. Cash sales are not included in the numerator as they do not affect the accounts receivable balance.

Question 7

ROA has particular relevance to the lenders, or creditors, of a firm.

Accepted Answer

ROA (Return on Assets) is a ratio that shows the profitability of a firm's assets. This ratio is important for creditors as it helps them to understand the effectiveness of a firm's assets to generate profits and repay debts. Therefore, ROA has particular relevance to the lenders or creditors of a firm.

Question 8

Most firms want to extend their payables as long as they can, but they also want to maintain their relations with suppliers.Businesses, therefore, negotiate hard for favorable payment terms and then delay paying until just before the last agreed moment.

Accepted Answer

This is a common strategy used by many firms to manage their cash flow and maintain good relationships with suppliers.

Question 9

Some analysts find the reciprocal of the fixed asset turnover ratio helpful in comparing the operating characteristics of different firms, because it measures dollars of fixed assets required to generate one dollar of sales.

Accepted Answer

The reciprocal of the fixed asset turnover ratio measures the dollars of fixed assets required to generate one dollar of sales, making it helpful in comparing the operating characteristics of different firms.

Question 10

Total assets turnover reflects the effects of turnover ratios for accounts receivable, inventory, and fixed assets.

Accepted Answer

Total assets turnover takes the ratio of net sales to total assets, which includes all three categories of accounts receivable, inventory, and fixed assets. Therefore, it reflects the effects of their turnover ratios on the overall performance of the company.

Question 11

The accounts receivable turnover ratio indicates how quickly a firm collects its accounts receivable.

Accepted Answer

The answer of The accounts receivable turnover ratio indicates how...

Question 12

Three measures of profitability for a firm engaging in operations selling merchandise in its stores, to generate net income are: (1) Rate of return on assets, (2) Rate of return on common shareholders' equity, and (3) Earnings per share of common stock.

Accepted Answer

These are indeed three common measures of profitability for a firm engaged in selling merchandise in its stores.

Question 13

Common shareholders have a residual claim on all income after creditors and preferred shareholders receive amounts contractually owed them.

Accepted Answer

This statement is true. Common shareholders are the last to receive any earnings or profits after all other obligations have been met. They have a residual claim on the company's income.

Question 14

Inventory turnover equals cost of goods sold divided by the average inventory during the period.

Accepted Answer

This is the correct formula for calculating inventory turnover.

Question 15

Financial statement ratios alone provide direct indicators of good or poor management.

Accepted Answer

Financial statement ratios provide useful information regarding a company's financial performance, but they should not be the only factor used to evaluate management. Other factors such as industry trends, market competition, and company strategy should also be considered. Additionally, financial ratios can be manipulated or skewed, so it is important to analyze them in conjunction with other information rather than relying solely on them.

Question 16

When a firm has securities outstanding that, if exchanged for shares of common stock, would decrease basic earnings per share by 30% or more, generally accepted accounting principles require a dual presentation: basic earnings per share and diluted earnings per share.

Accepted Answer

The answer of When a firm has securities outstanding that,...

Question 17

Some analysts calculate the inventory turnover ratio by dividing sales, rather than cost of goods sold, by the average inventory.Using sales in the numerator will lead to correct measures of the inventory turnover ratio for calculating the average number of days that inventory is on hand until sale.

Accepted Answer

The inventory turnover ratio is more accurately calculated using the cost of goods sold (COGS) in the numerator, not sales, because COGS reflects the actual cost of the inventory that was sold, providing a more accurate measure of how efficiently a company manages its inventory. Using sales can overstate the turnover ratio since sales include a markup over the cost.

Question 18

To study changes in ROA, the analyst can disaggregate ROA into the product of two other ratios: the profit margin for ROA ratio and the total assets turnover ratio.

Accepted Answer

Disaggregating ROA into the product of profit margin and total assets turnover can help determine which component may be driving changes in overall ROA.

Question 19

The return from investing in the shares of common stock has two components: cash dividends and the change in the market price of the common stock.

Accepted Answer

The cash dividends represent the income generated by the investment in the common stock, while the change in the market price of the common stock reflects the capital appreciation or depreciation of the investment. Therefore, both components contribute to the total return of the investment in common stock.

Question 20

Four measures for assessing short-term liquidity risk are (1) Current ratio, (2) Quick ratio, (3) Cash flow from operations to current liabilities ratio, and (4) Working capital turnover ratios.

Accepted Answer

These are all commonly used measures for assessing short-term liquidity risk in a business.

Quiz 7: Introduction to Financial Statement Analysis