Question 1

Operating activities involve the income statement and current accounts of the balance sheet.

Accepted Answer

Operating activities are those that involve the day-to-day operations of a business, including the revenue and expenses reported on the income statement and the current assets and liabilities reflected in the current accounts of the balance sheet. Examples of operating activities include sales, purchases, and payments to suppliers and employees.

Question 2

Profitability ratios give an indication of how investors feel about the company's financial future.

Accepted Answer

Profitability ratios measure a company's ability to generate earnings relative to its revenue, assets, or equity, not directly how investors feel about its financial future. Investor sentiment is more closely reflected in market-based metrics like stock price movements and valuation ratios.

Question 3

Liquidity Ratios measure the firm's ability to meet its short-term financial obligations.

Accepted Answer

Liquidity ratios are specifically designed to measure a company's ability to pay off its short-term obligations. Examples of liquidity ratios include the current ratio and the quick ratio.

Question 4

Many companies tolerate customers who take longer than the typical 30 days to pay their bills. Therefore , it is not alarming, and is even acceptable, for a company to have a 60 day ACP.

Accepted Answer

While some companies may tolerate longer payment periods, a 60-day average collection period (ACP) can indicate potential cash flow issues and inefficiencies in collecting receivables, which may not be acceptable for all businesses.

Question 5

The liquidity measure provided by the current ratio depends on the conversion of inventory to cash in a reasonable time.

Accepted Answer

The current ratio is calculated by dividing current assets by current liabilities, providing a measure of a company's ability to meet its short-term obligations. However, the accuracy of this liquidity measure depends on the ability of the company to convert inventory to cash in a timely manner, as inventory is a current asset that may not be easily converted to cash if it is slow-moving or obsolete. Therefore, the liquidity measure provided by the current ratio is dependent on the inventory turnover ratio, which measures the number of times a company sells and replaces its inventory in a given period.

Question 6

Although it is recommended that the return on assets ratio be formulated to reflect average assets, either way (average assets or ending assets), the result discloses the firm's capacity to utilize its assets efficiently without regard to the sources of capital that fund the assets, while the return on equity can bias the results by the degree to which the company leverages itself (uses debt).

Accepted Answer

The statement accurately reflects the difference between the return on assets ratio and the return on equity ratio.

Question 7

Return on Assets (ROA) measures a firm's ability to utilize its assets without regard to the sources of capital that fund those assets. The return on equity can bias the results by the degree to which the company leverages itself (uses debt).

Accepted Answer

Return on Assets (ROA) is calculated as net income divided by total assets, which means it disregards the funding sources like debt or equity. On the other hand, the return on equity considers the leverage used by a company and can bias the results.

Question 8

A low turnover figure can mean some old inventory is on the books that isn't being used.

Accepted Answer

A low turnover figure indicates that a company is not selling its inventory quickly, which can be due to having old inventory on the books that is not being used or sold.

Question 9

Ratios are typically compared with similar figures from history, the competition, and budget.

Accepted Answer

Ratios are typically compared with similar figures from history, the competition, and budget to gain insights and make informed decisions.

Question 10

The current ratio concept suggests that it is a measure of the cash required to fund all debt coming due within 12 months with consideration of all of the firm's existing economic resources.

Accepted Answer

The current ratio measures a company's ability to meet its short-term obligations by comparing its current assets to its current liabilities. It takes into consideration all of the firm's existing economic resources, including cash, accounts receivable, and inventory, among other things.

Question 11

A firm can never go out of business as long as it makes a profit, even if it manages its cash poorly.

Accepted Answer

Managing cash poorly can lead to a situation where the firm cannot meet its financial obligations such as paying rent, salaries, and suppliers, even if it is making a profit. This can eventually lead to bankruptcy and going out of business. Proper cash management is crucial for the survival and success of any business.

Question 12

Financing activities also include long-term purchases and sales of financial assets.

Accepted Answer

Financing activities primarily involve transactions related to raising capital (debt and equity) and repaying investors, including dividends, not the purchase and sale of long-term financial assets, which are considered investing activities.

Question 13

A common size income statement presents each line item as a percent of assets.

Accepted Answer

A common size income statement presents each line item as a percent of revenue or sales, not assets.

Question 14

If a firm has sales revenue (spread evenly through a 360-day year) of $1,170,000 and accounts receivable of $130,000, its average collection period, or days sales outstanding, is 40 days.

Accepted Answer

Days sales outstanding is calculated by dividing the accounts receivable balance by average daily sales revenue.

Average daily sales revenue = annual sales revenue / 360 days = $1,170,000 / 360 = $3,250

Days sales outstanding = accounts receivable balance / average daily sales revenue = $130,000 / $3,250 = 40 days

Question 15

Ratio analysis involves taking a set of numbers out of the financial statements and forming ratios with them.

Accepted Answer

Ratio analysis involves calculating ratios by dividing one financial statement item by another to evaluate a company's financial performance and status.

Question 16

A debt to equity ratio of 2:1 suggests that for every dollar the firm has in equity, it has two dollars of long-term debt.

Accepted Answer

A debt to equity ratio of 2:1 indicates that the company has twice as much debt as equity, meaning for every dollar of equity, there are two dollars of debt.

Question 17

Ratio analysis is of significant value in comparing the performance of a firm against its history, its budget, and its competitors.

Accepted Answer

Ratio analysis helps in comparing a firm's current performance with its past performance, its budgeted performance, and even with its competitors. This makes it a valuable tool for assessing a firm's financial health and identifying areas for improvement.

Question 18

To evaluate a firm's debt capacity effectively, the analyst should construct both the debt ratio and the debt to equity ratio, because they are mutually exclusive indicators of the firm's capacity to assume additional debt.

Accepted Answer

The statement is incorrect. The debt ratio and the debt to equity ratio are not mutually exclusive indicators of a firm's debt capacity. In fact, they both provide different perspectives on the firm's capital structure and level of leverage. Other factors, such as the interest coverage ratio and the free cash flow to debt ratio, should also be considered when evaluating a firm's debt capacity.

Question 19

The significance of a price/earnings ratio, lies in its comparative and predictive qualities. Specifically, when a company has an earnings multiple of 15 and the industry has an earnings multiple of 12, the company's stock is viewed as outperforming the industry.

Accepted Answer

A price/earnings ratio can be used to compare a company's stock performance to that of the industry. A higher earnings multiple than the industry average suggests that the company is performing well and investors may have confidence in its future growth potential. Therefore, a company with a P/E ratio of 15 compared to an industry average of 12 is considered to be outperforming the industry.

Question 20

Operating activitieshave to do with running the business on a day-to-day basis.

Accepted Answer

Operating activities are the activities that a company performs in order to generate revenue and operate on a day-to-day basis, such as sales, purchasing inventory, paying employees and suppliers, and other expenses related to running the business.

Quiz 3: Cash Flows and Financial Analysis