Question 1

Managers' decisions regarding financing, investment, and working capital are reflected in the financial statements.

Accepted Answer

Managers' decisions regarding financing (such as issuing bonds or taking out loans), investment (such as purchasing new equipment or investing in research and development), and working capital (such as managing inventory and accounts payable) all have an impact on the financial statements, including the balance sheet, income statement, and cash flow statement.

Question 2

A firm that has no debt will have its ROA equal to its ROE.

Accepted Answer

When a firm has no debt (i.e., its capital structure is 100% equity), its ROA (return on assets) will be equal to its ROE (return on equity) because there is no interest expense to be deducted from operating profit. Therefore, all of the earnings belong to the shareholders. However, if the firm has debt, the interest expense will reduce the net income available to the shareholders, causing the ROE to be lower than the ROA.

Question 3

The higher the times interest earned ratio, the more comfortable are a firm's creditors in the ability of the firm to meet its interest obligations.

Accepted Answer

A higher times interest earned ratio indicates that the firm has sufficient earnings to cover its interest obligations. Thus, creditors will be more comfortable in lending to the firm, as they can be more confident in the firm's ability to pay back its debts.

Question 4

Liquidity ratios are concerned with the firm's ability to pay its current bills without putting the firm in financial difficulty.

Accepted Answer

Liquidity ratios are designed to measure a company's ability to meet its short-term liabilities and obligations. These ratios help to determine the company's ability to pay its bills and other financial obligations when they become due without putting undue strain on the company's finances.

Question 5

The most frequent method of adjusting balance sheets to a common-size basis is to divide each of the accounts by total assets, expressing each account as a percentage of total assets.

Accepted Answer

This statement is true. Dividing each account in a balance sheet by total assets and expressing the result as a percentage is the most common way to create a common-size balance sheet.

Question 6

A financial statement analysis conducted over a three- to five-year period is called trend analysis.

Accepted Answer

Trend analysis involves comparing financial statements over a period of time, usually three to five years, to identify patterns and trends in the company's financial performance.

Question 7

A company can improve its liquidity by increasing its accounts payable, while holding all else constant.

Accepted Answer

The answer of A company can improve its liquidity by...

Question 8

Total asset turnover is more relevant for service industry firms, while the fixed asset turnover ratio is more relevant for manufacturing industry firms.

Accepted Answer

Total asset turnover is a measure of how efficiently a company uses its assets to generate revenue, which is more applicable for service industry firms that rely heavily on the performance of their human capital and intangible assets. Fixed asset turnover, on the other hand, is a measure of how well a company utilizes its fixed assets to generate sales, which is more fitting for manufacturing industry firms that rely heavily on the utilization of equipment and machinery.

Question 9

Shareholders focus on the value of their stock but not on how much cash they can expect to receive from dividends and/or capital appreciation.

Accepted Answer

Shareholders may focus on both the value of their stock and the amount of cash they can expect to receive from dividends and/or capital appreciation. Both factors are important to the overall return on their investment.

Question 10

For a given level of after-tax income, the lower the level of equity a firm has, the higher the return on equity its shareholders will earn.

Accepted Answer

This is true because a lower level of equity means that the firm is financing its operations more with debt. As a result, the financial leverage will magnify the returns earned from the equity investment, leading to a higher return on equity. However, this also increases the risk of the investment, as the use of debt can be risky if the company is unable to meet its financial obligations.

Question 11

The equity multiplier is computed by dividing equity by total assets.

Accepted Answer

The equity multiplier is computed by dividing total assets by equity.

Question 12

A firm increased its days' sales outstanding from 35 days to 43 days. This implies the firm is more efficient.

Accepted Answer

An increase in days' sales outstanding means that the firm is taking longer to collect payments from its customers. This indicates that the firm is less efficient in its collection process and may have difficulty managing its cash flow. Therefore, statement is false.

Question 13

Financial statement analysis can help us determine why a firm's cash flows are increasing or decreasing

Accepted Answer

Financial statement analysis can help identify the sources and uses of cash, as well as trends and changes over time, which can provide insights into why a firm's cash flows are increasing or decreasing.

Question 14

Turnover ratios are used by managers to identify operational inefficiencies.

Accepted Answer

Turnover ratios, such as inventory turnover and accounts receivable turnover, can help managers identify areas where assets are tied up and not being used efficiently. By analyzing these ratios and implementing changes to improve them, managers can increase profitability and operational efficiency.

Question 15

For a given share price of a firm's stock, the lower the EPS the lower the price-earnings ratio.

Accepted Answer

The price-earnings ratio (P/E ratio) is calculated by dividing the market price per share by the earnings per share (EPS). Therefore, the lower the EPS, the higher the P/E ratio (assuming the market price per share remains constant).

Question 16

The purchase of additional inventory by a firm should decrease a firm's quick ratio.

Accepted Answer

The quick ratio is a measure of a company's ability to meet its short-term obligations with highly liquid assets such as cash, marketable securities, and accounts receivable. When a firm purchases additional inventory, it increases its current assets, such as inventory, but does not increase its highly liquid assets. This would cause the denominator of the quick ratio to increase, leading to a decrease in the overall ratio. Therefore, the purchase of additional inventory should decrease a firm's quick ratio.

Question 17

A firm's current ratio changed from 1.4 times in the previous year to 1.6 times year. Concluding that the firm's liquidity improved is ___________.

Accepted Answer

An increase in the current ratio indicates that the firm has more current assets to cover its current liabilities, which means an improvement in liquidity. Therefore, the statement is true.

Question 18

A typical way common size income statement is constructed is by dividing all expense items in an income statement by net income.

Accepted Answer

A common size income statement is constructed by dividing each income statement item by total revenue, not net income. This allows for a comparison of the proportion of each expense or revenue item to the total revenue generated.

Question 19

Financial leverage refers to the use of preferred stock in a firm's capital structure.

Accepted Answer

Financial leverage refers to the use of debt in a firm's capital structure, not preferred stock. Preferred stock is a form of equity financing.

Question 20

A benchmark for a financial statement analysis is the performance of a multinational firm in the same industry from another country.

Accepted Answer

The answer of A benchmark for a financial statement analysis...

Quiz 4: Analysing Financial Statements