Question 1

The times-interest-earned ratio measures the extent to which operating income can decline before the firm is unable to meet its annual interest costs.

Accepted Answer

This statement is true. The times-interest-earned ratio calculates the amount of operating income available to cover a company's interest payments on debt obligations. A higher ratio indicates that the company has more earnings available to cover these costs, providing greater financial stability and a lower risk of default. Conversely, a lower ratio suggests that the company may struggle to meet its interest obligations if operating income declines, increasing the risk of default.

Question 2

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

The inventory turnover ratio and DSO are both commonly used ratios to evaluate a firm's current asset management. The inventory turnover ratio measures how efficiently a company is turning its inventory into revenue, while DSO measures how quickly a company is collecting payments from its customers.

Question 3

Other things held constant,the higher a firm's total debt to total capital ratio [measured as (Short-term debt + Long-term debt)/(Debt + Preferred stock + common equity)],the higher its TIE ratio will be.

Accepted Answer

The TIE (Times Interest Earned) ratio measures a firm's ability to meet its interest obligations. A higher total debt to total capital ratio indicates more debt, which typically leads to higher interest expenses, potentially lowering the TIE ratio, not increasing it.

Question 4

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 quick ratio only considers liquid assets that can be easily converted to cash, such as cash on hand, marketable securities, and accounts receivable. Since the firm sold inventory for cash and left it in the bank account, it would still be considered part of the current assets, but not part of the quick assets. Therefore, the quick ratio would decline while the current ratio would remain relatively unchanged.

Question 5

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

Accepted Answer

A higher fixed assets turnover ratio indicates that the firm is generating more revenue per dollar of fixed assets, which implies that the firm is using its fixed assets efficiently. It does not necessarily mean that the firm is operating at overcapacity and needs to add fixed assets.

Question 6

The more conservative a firm's management is,the higher its total debt to total capital ratio [measured as (Short-term debt + Long-term debt)/(Debt + Preferred stock + Common equity)] is likely to be.

Accepted Answer

A more conservative firm's management typically prefers lower levels of debt, resulting in a lower total debt to total capital ratio.

Question 7

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...

Question 8

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

Accepted Answer

High current and quick ratios may indicate that a firm is managing its liquidity well, but they do not necessarily guarantee it. Other factors, such as the nature of the firm's industry or the quality of its accounts receivables, should also be considered when evaluating a company's liquidity position.

Question 9

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 10

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

Accepted Answer

Profitability ratios are financial metrics that help assess a company's ability to generate earnings relative to its expenses and other costs associated with generating those earnings. These ratios take into account factors such as liquidity, asset management, and debt management to provide a comprehensive view of a firm's profitability. Examples of profitability ratios include return on assets (ROA), return on equity (ROE), gross profit margin, and net profit margin.

Question 11

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 low...

Question 12

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. Although a cash budget is the most comprehensive way to analyze liquidity, the current and quick ratios can provide a quick estimate of a company's liquidity position.

Question 13

The profit margin measures net income per dollar of sales.

Accepted Answer

The profit margin is calculated by dividing net income by sales revenue, thus giving a measure of how much profit is earned for every dollar of sales.

Question 14

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 indicates that the firm is holding onto inventory for a longer period of time, which can lead to lower liquidity and indicates poor inventory management. Therefore, it suggests that the firm is becoming less liquid.

Question 15

The operating margin measures operating income per dollar of assets.

Accepted Answer

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

Question 16

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 accurately describes the role and significance of days sales outstanding (DSO) in measuring the effectiveness of a company's collections practices and credit policies. By comparing the DSO with the firm's credit terms, managers can determine if customers are paying promptly or if there are issues with delinquency or default.

Question 17

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

Accepted Answer

Ratio analysis is a common tool used by investors, analysts and creditors to assess a company's financial health. It involves analyzing financial statements to calculate important financial ratios which help to assess the company's financial position, performance and strength.

Question 18

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

If a firm sells inventory on credit, its accounts receivable would increase, which would decrease its quick ratio. Its current ratio may or may not be affected depending on the timing of the sale and the payment of the accounts receivable.

Question 19

The current and quick 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 quick ratio measures the firm's ability to pay off short-term obligations without relying on the sale of inventories.

Accepted Answer

The statement accurately describes the differences between the current ratio and quick ratio in measuring a firm's liquidity.

Question 20

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 like debt-to-equity ratio, interest coverage ratio, and debt-to-asset ratio indicate the level of debt or financial leverage a company is using to generate profits. This shows how the managers are utilizing owners' capital to maximize returns.

Quiz 4: Analysis of Financial Statements