Question 1

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

Accepted Answer

Profitability ratios, such as return on assets (ROA) and return on equity (ROE), consider a company's ability to generate earnings from its assets and equity, taking into account the firm's liquidity, asset management, and debt management. Therefore, profitability ratios reflect the combined impact of these factors on a company's operating results.

Question 2

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, as DSO measures the collection period after a sale, and it can be compared with the credit terms to gauge the timeliness of customer payments.

Question 3

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

The times-interest-earned ratio measures a firm's ability to cover the interest expenses on its debt with its earnings before interest and taxes (EBIT). However, there are other factors that can impact a firm's ability to meet its debt obligations, such as cash flow, liquidity, and overall financial health. Therefore, the times-interest-earned ratio should not be the only factor considered when assessing a firm's debt-paying ability.

Question 4

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

Accepted Answer

Conservative management is likely to prefer lower levels of debt and therefore have a lower debt ratio. Non-conservative or aggressive management may be more willing to take on higher levels of debt for growth opportunities.

Question 5

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 is necessary for a complete liquidity analysis, the current and quick ratios can provide a quick estimate of a company's liquidity position.

Question 6

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

Both inventory turnover ratio and DSO are commonly used ratios to evaluate a firm's management of current assets. Inventory turnover ratio measures how well a company is managing its inventory by calculating how many times a company is able to sell its entire inventory in a given period. DSO, on the other hand, measures the average number of days it takes for a company to collect payment for its sales.

Question 7

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

Accepted Answer

While a high current ratio and quick ratio can be indicators of good liquidity management, they alone do not guarantee it. Other factors such as cash flow, debt obligations, and inventory management also play a role in a company's overall liquidity position.

Question 8

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 means that the firm is holding onto its inventory for a longer period, which could indicate poor inventory management or slower sales. This could lead to a decrease in liquidity, as their cash is tied up in inventory for a longer period. Therefore, the statement in the question is incorrect.

Question 9

The profit margin measures net income per dollar of sales.

Accepted Answer

The profit margin is calculated as net income divided by sales. This ratio tells us how much profit is earned per dollar of sales.

Question 10

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, such as debt-to-equity and interest coverage ratios, are used to assess a company's use of financial leverage and its ability to manage its debt obligations. Higher leverage can magnify returns but also increase financial risk, so these ratios can help investors and creditors evaluate a company's financial health and management decisions.

Question 11

Ratio analysis involves analyzing financial statements to help appraise a firm's financial position and strength.

Accepted Answer

Ratio analysis is a commonly used technique in financial statement analysis to evaluate a firm's financial performance, liquidity, solvency, and profitability by calculating and comparing various financial ratios.

Question 12

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 firm's accounts receivable, which would decrease its liquidity ratios such as the current ratio and quick ratio.

Question 13

The operating margin measures operating income per dollar of assets.

Accepted Answer

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

Question 14

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 answer of If a firm sold some inventory for...

Question 15

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

The answer of In general, it's better to have a...

Question 16

The current and inventory turnover 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 inventory turnover ratio gives us an indication of how long it takes the firm to convert its inventory into cash.

Accepted Answer

The statement is correct. The current ratio and inventory turnover ratio are both used to evaluate a firm's liquidity.

Question 17

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 18

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

Accepted Answer

The answer of Other things held constant, the higher a...

Question 19

If a firm's fixed assets turnover ratio is significantly higher than its industry average, this could indicate that it uses its fixed assets efficiently or is operating at over capacity and should probably add fixed assets.

Accepted Answer

A higher fixed assets turnover ratio indicates that a company is generating more revenue per dollar of fixed assets, which could mean it is using its assets efficiently. However, if the company is operating at overcapacity and cannot meet demand, adding fixed assets may be necessary to maintain efficiency and profitability. Therefore, both factors should be considered before making a decision.

Question 20

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 answer of If a firm sold some inventory on...

Quiz 4: Analysis of Financial Statements