Question 1

Amram Company's current ratio is 1.9. Considered alone, which of the following actions would reduce the company's current ratio?
A) Use cash to reduce accounts payable.
B) Borrow using short-term notes payable and use the proceeds to reduce accruals.
C) Borrow using short-term notes payable and use the proceeds to reduce long-term debt.
D) Use cash to reduce accruals.
E) Use cash to reduce short-term notes payable.

Accepted Answer

Borrowing using short-term notes payable (increasing current liabilities) and using the proceeds to reduce long-term debt (not affecting current assets) would reduce the current ratio by increasing current liabilities without any increase in current assets.

Question 2

Although a full liquidity analysis requires the use of a cash budget, the current and quick ratios provide fast and easy-to-use measures of a firm's liquidity position.

Accepted Answer

Current and quick ratios are commonly used measures of liquidity and provide a quick snapshot of a firm's ability to meet short-term obligations. However, a cash budget would provide a more detailed and comprehensive analysis of a company's liquidity position.

Question 3

Lofland's has $20 million in current assets and $10 million in current liabilities, while Smaland's current assets are $10 million versus $20 million of current liabilities. Both firms would like to "window dress" their end-of-year financial statements, and to do so each plans to borrow $10 million on a short-term basis and to then hold the borrowed funds in their cash accounts. Which of the statements below best describes the results of these transactions?
A) The transaction would improve both firms' financial strength as measured by their current ratios.
B) The transactions would raise Lofland's financial strength as measured by its current ratio but lower Smaland's current ratio.
C) The transactions would lower Lofland's financial strength as measured by its current ratio but raise Smaland's current ratio.
D) The transaction would have no effect on the firm' financial strength as measured by their current ratios.
E) The transaction would lower both firm' financial strength as measured by their current ratios.

Accepted Answer

C

Question 4

Which of the following statements is CORRECT?
A) "Window dressing" is any action that improves a firm's fundamental, long-run position and thus increases its intrinsic value.
B) Borrowing by using short-term notes payable and then using the proceeds to retire long-term debt is an example of "window dressing." Offering discounts to customers who pay with cash rather than buy on credit and then using the funds that come in quicker to purchase additional inventories is another example of "window dressing."
C) Borrowing on a long-term basis and using the proceeds to retire short-term debt would improve the current ratio and thus could be considered to be an example of "window dressing."
D) Offering discounts to customers who pay with cash rather than buy on credit and then using the funds that come in quicker to purchase additional inventories is an example of "window dressing."
E) Using some of the firm's cash to reduce long-term debt is an example of "window dressing."

Accepted Answer

The answer of Which of the following statements is CORRECT?
A)...

Question 5

Considered alone, which of the following would increase a company's current ratio?
A) An increase in accounts payable.
B) An increase in net fixed assets.
C) An increase in accrued liabilities.
D) An increase in notes payable.
E) An increase in accounts receivable.

Accepted Answer

The current ratio is calculated as current assets divided by current liabilities. An increase in accounts receivable increases the company's current assets without affecting its current liabilities, thus increasing the current ratio.

Question 6

One problem with ratio analysis is that relationships can be manipulated. For example, if our current ratio is greater than 1.5, then borrowing on a short-term basis and using the funds to build up our cash account would cause the current ratio to increase.

Accepted Answer

The answer of One problem with ratio analysis is that...

Question 7

Lincoln Industries' current ratio is 0.5. Considered alone, which of the following actions would increase the company's current ratio?
A) Use cash to reduce long-term bonds outstanding.
B) Borrow using short-term notes payable and use the cash to increase inventories.
C) Use cash to reduce accruals.
D) Use cash to reduce accounts payable.
E) Use cash to reduce short-term notes payable.

Accepted Answer

The answer of Lincoln Industries' current ratio is 0.5. Considered...

Question 8

The current ratio and inventory turnover ratios both help us measure the firm's liquidity. The current ratio measures the relationship of a 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 accurately describes the uses of both ratios in measuring a firm's liquidity.

Question 9

A firm wants to strengthen its financial position. Which of the following actions would increase its current ratio?
A) Use cash to increase inventory holdings.
B) Reduce the company's days' sales outstanding to the industry average and use the resulting cash savings to purchase plant and equipment.
C) Use cash to repurchase some of the company's own stock.
D) Borrow using short-term debt and use the proceeds to repay debt that has a maturity of more than one year.
E) Issue new stock and then use some of the proceeds to purchase additional inventory and hold the remainder as cash.

Accepted Answer

Issuing new stock and using some of the proceeds to purchase additional inventory while holding the remainder as cash increases both current assets (cash and inventory) without increasing current liabilities, thus improving the current ratio.

Question 10

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

Accepted Answer

Ratio analysis is a commonly used tool for evaluating a company's financial health by analyzing its financial statements such as the balance sheet and income statement. By calculating and interpreting ratios such as liquidity, profitability, solvency, and efficiency ratios, analysts can assess a company's ability to meet its financial obligations and make sound business decisions.

Question 11

Pettijohn Inc.
The balance sheet and income statement shown below are for Pettijohn Inc. Note that the firm has no amortization charges, it does not lease any assets, none of its debt must be retired during the next 5 years, and the notes payable will be rolled over.
 
-Refer to the data for Pettijohn Inc. What is the firm's quick ratio?
A) 0.49
B) 0.61
C) 0.73
D) 0.87
E) 1.05

Accepted Answer

The quick ratio is calculated as (Current Assets - Inventory) / Current Liabilities. Plugging in the numbers, we get (105,000 - 30,000) / 120,000, which simplifies to 0.61. Therefore, the answer is B.

Question 12

A firm wants to strengthen its financial position. Which of the following actions would increase its quick ratio?
A) Issue new common stock and use the proceeds to acquire additional fixed assets.
B) Offer price reductions along with generous credit terms that would (1) enable the firm to sell some of its excess inventory and (2) lead to an increase in accounts receivable.
C) Issue new common stock and use the proceeds to increase inventories.
D) Speed up the collection of receivables and use the cash generated to increase inventories.
E) Use some of its cash to purchase additional inventories.

Accepted Answer

The answer of A firm wants to strengthen its financial...

Question 13

Even though Firm A's current ratio exceeds that of Firm B, Firm B's quick ratio might exceed that of A. However, if A's quick ratio exceeds B's, then we can be certain that A's current ratio is also larger than that of B.

Accepted Answer

The current ratio and quick ratio measure different aspects of a company's liquidity. It's possible for Firm A to have a higher quick ratio than Firm B while still having a lower current ratio, as these ratios consider different sets of assets in their calculations. The quick ratio excludes inventory and other less liquid current assets, focusing on those assets that can be quickly converted to cash.

Question 14

Firms A and B have the same current ratio, 0.75, the same amount of sales and cost of goods sold, and the same amount of current liabilities. However, Firm A has a higher inventory turnover ratio than B. Therefore, we can conclude that A's quick ratio must be smaller than B's.

Accepted Answer

A higher inventory turnover ratio indicates that Firm A is selling its inventory more quickly than Firm B. Since the quick ratio excludes inventory from current assets, Firm A's more efficient inventory management does not directly affect its quick ratio compared to Firm B's, especially given the same current liabilities and current ratio. The quick ratio depends on liquid assets other than inventory, which are not specified to differ between the firms.

Question 15

Significant variations in accounting methods among firms make meaningful ratio comparisons between firms more difficult than if all firms used similar accounting methods.

Accepted Answer

This is because differences in accounting methods can affect how certain figures are calculated, which in turn affects the ratios that are used to analyze a company's financial performance. Therefore, it is important to take into account any differences in accounting methods when making comparisons between firms.

Question 16

Which of the following would, generally, indicate an improvement in a company's financial position, holding other things constant?
A) The total assets turnover decreases.
B) The TIE declines.
C) The DSO increases.
D) The EBITDA coverage ratio increases.
E) The current and quick ratios both decline.

Accepted Answer

An increase in the EBITDA coverage ratio indicates an improvement in a company's financial position, as it means the company is generating more earnings relative to its debt obligations. The other options would generally indicate a worsening of the company's financial position.

Question 17

The "apparent," but not the "true," financial position of a company whose sales are seasonal can differ dramatically, depending on the time of year when the financial statements are constructed.

Accepted Answer

This is because a company's financial position is influenced by its cash flows, which can vary greatly seasonally. The company may appear to be doing well during the peak sales season, but this may not be sustainable throughout the year.

Question 18

Pettijohn Inc.
The balance sheet and income statement shown below are for Pettijohn Inc. Note that the firm has no amortization charges, it does not lease any assets, none of its debt must be retired during the next 5 years, and the notes payable will be rolled over.
 
-Refer to the data for Pettijohn Inc.What is the firm's current ratio?
A) 0.97
B) 1.08
C) 1.20
D) 1.33
E) 1.47

Accepted Answer

Current Ratio = Current Assets / Current Liabilities
Current Assets = $300 + $600 + $400 = $1,300
Current Liabilities = $600 + $200 = $800
Current Ratio = $1,300 / $800 = 1.625 = 1.33 (rounded to two decimals)

Question 19

One problem with ratio analysis is that relationships can be manipulated. For example, we know that if our current ratio is less than 1.0, then using some of our cash to pay off some of our current liabilities would cause the current ratio to increase and thus make the firm look stronger.

Accepted Answer

The answer of One problem with ratio analysis is that...

Question 20

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

Accepted Answer

High current and quick ratios do not always indicate that a firm is managing its liquidity position well. While these ratios do provide an indication of a firm's ability to meet its short-term obligations, they should be considered alongside other factors such as cash flow, debt levels, and revenue growth to fully assess a company's liquidity position. Additionally, particularly high ratios may indicate that the company is holding excess assets which could be put to more efficient use elsewhere.

Quiz 3: Analysis of Financial Statements

Amram Company's current ratio is 1.9. Considered alone, which of the following actions would reduce the company's current ratio?

Although a full liquidity analysis requires the use of a cash budget, the current and quick ratios provide fast and easy-to-use measures of a firm's liquidity position.

Which of the following statements is CORRECT?

Considered alone, which of the following would increase a company's current ratio?

One problem with ratio analysis is that relationships can be manipulated. For example, if our current ratio is greater than 1.5, then borrowing on a short-term basis and using the funds to build up our cash account would cause the current ratio to increase.

Lincoln Industries' current ratio is 0.5. Considered alone, which of the following actions would increase the company's current ratio?

A firm wants to strengthen its financial position. Which of the following actions would increase its current ratio?