Question 1

Small businesses with high leverage ratios are more vulnerable to economic downturns, but they have greater potential for large profits.

Accepted Answer

Small businesses with high leverage ratios have borrowed more money to finance their operations, which means they have more debt to repay. In an economic downturn, their revenue may decrease, making it harder for them to repay their debt obligations. However, if their business is successful, they have the potential for larger profits, as they have used borrowed money to invest in their business and possibly increase productivity and output.

Question 2

A quick ratio of more than 1:1 suggests that a small company is overly dependent on inventory and future sales to satisfy its short-term debt.

Accepted Answer

The answer of A quick ratio of more than 1:1...

Question 3

Creditors often look for a times-interest-earned ratio of at least 4:1 to 6:1 before pronouncing a company a good credit risk.

Accepted Answer

This statement is true. Creditors prefer a higher times-interest-earned ratio as it indicates that the company has sufficient earnings to meet its interest obligations.

Question 4

Operating ratios measure the extent to which an entrepreneur relies on debt capital rather than equity capital to finance the business.

Accepted Answer

Operating ratios measure the efficiency of a company's operations and do not specifically measure the capital structure of the business.

Question 5

The average inventory turnover ratio measures the number of times a company's inventory is sold out during the accounting period.

Accepted Answer

This is correct, the average inventory turnover ratio does measure the number of times a company's inventory is sold out during the accounting period.

Question 6

Liquidity ratios, such as the current ratio and the quick ratio, tell whether a small business will be able to meet its short-term obligations as they come due.

Accepted Answer

Liquidity ratios like the current ratio and quick ratio are used to determine a company's ability to meet its current debt obligations as they fall due.

Question 7

The times-interest-earned ratio tells how many times the company's earnings cover the interest payments on the debt it is carrying.

Accepted Answer

The times-interest-earned ratio calculates the company's ability to pay its interest expense from its earnings. A higher ratio indicates that the company has sufficient earnings to cover its interest payments, while a lower ratio suggests that the company may struggle to meet its debt obligations.

Question 8

The small business with a high debt-to-net worth ratio has more borrowing capacity than a firm with a low ratio.

Accepted Answer

A high debt-to-net worth ratio indicates that a small business has borrowed a significant portion of its net worth, making it a riskier borrower. Therefore, lenders may be less willing to approve additional borrowing, making it more difficult for the business to obtain new funds. On the other hand, a low debt-to-net worth ratio suggests that the business has a stronger financial position and is less reliant on borrowing, making it a more attractive borrower with easier access to financing.

Question 9

Liquidity ratios help a business owner evaluate a small company's performance and indicate how effectively it employs its resources.

Accepted Answer

The answer of Liquidity ratios help a business owner evaluate...

Question 10

Ratio analysis is a useful managerial tool that can help business owners maintain financial control over their businesses, but it is of no use to a business owner trying to obtain a bank loan.

Accepted Answer

Ratio analysis can also be helpful for business owners trying to obtain a bank loan, as it provides comprehensive information about the financial health and performance of the business, which can help convince the bank of the business's creditworthiness.

Question 11

Leverage ratios measure the financing supplied by the firm's owner against that supplied by his creditors.

Accepted Answer

The answer of Leverage ratios measure the financing supplied by...

Question 12

A current ratio of 2.4:1 means that a small company has $2.40 in current liabilities for every $1 has in current assets.

Accepted Answer

A current ratio of 2.4:1 means that a small company has $2.40 in current assets for every $1 it has in current liabilities. The ratio is expressed as current assets divided by current liabilities, not the other way around.

Question 13

A high current ratio guarantees that the small firm's assets are being used in the most profitable manner.

Accepted Answer

A high current ratio may indicate that a firm has more current assets than current liabilities, but it does not necessarily mean that the assets are being used in the most profitable manner. A high current ratio can also suggest that a firm is not investing in long-term growth opportunities or is holding too much cash, which can lead to lower profitability.

Question 14

A company with a times-interest-earned ratio that is well above the industry average would likely have difficulty making the interest payments on its loans, as creditors would see that it was overextended in its debts.

Accepted Answer

A company with a times-interest-earned ratio that is well above the industry average would likely be in a stronger financial position, as it would have more income available to cover its interest payments.

Question 15

Taking on debt destroys a business; therefore, small business owners should avoid it at all costs.

Accepted Answer

Taking on debt may be necessary for small business growth and expansion. However, it is important for small business owners to carefully manage debt and have a plan to pay it off in a timely manner to avoid causing financial strain on the business.

Question 16

Ratio analysis allows a business owner to identify potential problem areas in her business before they become business-threatening crises.

Accepted Answer

Ratio analysis is a useful tool for identifying financial trends and comparing a business's financial performance to its competitors. By analyzing key financial ratios, business owners can identify potential problem areas in their business and take corrective action before they become serious issues. For example, if a business's liquidity ratio is declining over time, it may indicate that the business is struggling to meet its short-term obligations and may need to implement new cash management strategies to avoid a cash flow crisis. Similarly, a declining profitability ratio may indicate that the business is not generating enough profits to sustain its operations over the long term, and may need to restructure its operations or seek new revenue streams to improve its financial position.

Question 17

Generally, the higher the current ratio, the stronger the small firm's financial position.

Accepted Answer

A current ratio measures a small firm's ability to pay its short-term debts using its current assets. A higher current ratio indicates that the company has more current assets relative to its current liabilities, thus indicating a stronger financial position.

Question 18

A company with a low debt-to-net worth ratio has less capacity to borrow than a company with a high debt-to-net worth ratio.

Accepted Answer

A low debt-to-net worth ratio means that a company has less debt in relation to its net worth, indicating a lower financial risk and potentially making it more attractive to lenders. On the other hand, a high debt-to-net worth ratio indicates a higher level of debt in relation to net worth, which may make it riskier to lend to but also may provide the company with greater borrowing capacity. Therefore, a company with a high debt-to-net worth ratio has more capacity to borrow than a company with a low debt-to-net worth ratio.

Question 19

As a company's debt-to-net worth ratio approaches 1:1, its creditors' interest in that business approaches that of the owners.

Accepted Answer

This is because as the debt-to-net worth ratio approaches 1:1, the company's level of debt is high relative to its equity. This means that the creditors have a significant stake in the company's finances and may have more influence over its operations and decision-making. In this sense, their interest in the business approaches that of the owners.

Question 20

Most firms calculate their quick assets by subtracting the value of their inventory from their current asset total.

Accepted Answer

Quick assets are calculated by subtracting inventory from current assets to determine what can be converted quickly into cash.

Quiz 11: Creating a Successful Financial Plan