Chp. 3 Working with Financial statements

Long-term solvency ratios measure what aspect of the firm's financial position?

Its financial leverage

Which one of the following equations defines the total asset turnover ratio?

Sales/Total Assets

What does it mean when a firm has a days' sales in receivables of 45?

The firm collects its credit sales in 45 days on average.

True or false: It is important to investigate trends in financial ratios to identify the reason for the trend.

True

If sales increase while there is no change in accounts receivable, the receivables turnover ratio will ______.

increase

In a common-size income statement, each item is expressed as a percentage of total

sales

Which of the following represents the receivables turnover ratio?

Sales / Accounts Receivable

A firm with a profit margin of 10% generates ______ in net income for every dollar in sales.

10 cents

A firm with a 26 percent return on equity earned ______ cents in profit for every one dollar in shareholders' equity.

26

Which of the following would help a company take action to improve its ratios?

Comparing to its own historical ratios Comparing to major competitors Comparing to peer companies Comparing to aspirant companies

Which of the following best explains why financial managers use a common-size income statement?

The common-size income statement can show which costs are rising or falling as a percentage of sales.

How is the market-to-book ratio measured?

market value per share/book value per share

True or false: The price-earnings ratio is price per share times earnings per share.

false; divided by

A firm may use a price-sales ratio when it has had ___ earnings over the past year

negative

One of the most important uses of financial statement information within the firm is:

performance evaluation

The price-earnings ratio is

price per share/earnings per share

Return on assets (ROA) is a measure of

profitability

Which of the following items are used to compute the current ratio?

-Cash - Accounts Payable (AP)

What does it mean when a company reports ROA of 12 percent?

The company generates $12 in net income for every $100 invested in assets.

Days' sales in receivables is given by the following ratio:

365/receivables turnover

Which of the following create problems with financial statement analysis?

- The firm or its competitors are global companies - The firm and its competitors operate under different regulatory environments - the firm or its competitors are conglomerates

Which of the following are traditional financial ratio categories?

- Turnover Ratios - Profitability Ratios - Financial Leverage Ratios

True or false: There is a solid and prescriptive method to select which ratios to use in financial statement analysis.

false There is no theory or set method to select the ratios to use in financial statement analysis.

True or false: Market-to-book ratio equals book value per share divided by market value per share.

false; market value/book value

Long-term solvency ratios are also known as:

financial leverage ratios

______ are the prime source of information about a firm's financial health.

financial statements

If the management of a company has been unsuccessful at creating value for their stockholders, the market-to -book ratio will be

less than 1

Which of the following items is added back to EBIT while calculating the cash coverage ratio, but not while calculating the times interest earned ratio?

non-cash expenses

Return on equity (ROE) is a measure of

profitability

Which of the following is the correct representation of the cash coverage ratio?

(EBIT + Depreciation)/Interest Expense

Which of the following is the correct representation of the total debt ratio?

(Total assets − Total equity)/(Total assets)

The information needed to compute the profit margin can be found on the

income statement

If a company has inventory, the quick ratio will always be _________ the current ratio.

less than; Since the quick ratio excludes inventory, it will always be less than the current ratio.

Current assets on the common-size balance sheet over the past three years have increased from 32 to 35 percent, while current liabilities have decreased from 29 to 25 percent. This indicates the firm has increased its

liquidity

Short -term solvency ratios are also called

liquidity ratios

Time-trend analysis is an example of

management by exception

Whenever ___________ information is available, it should be used instead of accounting data.

market

How is the price-earnings (PE) ratio computed?

market price per share/earnings per share

The price-earnings (PE) ratio is a ______ ratio.

market value

_____ group analysis is a way to establish a benchmark when using ratios.

peer

The profit margin is equal to net income divided by ______.

sales

The times interest earned ratio is a measure of long-term

solvency

A common-size balance sheet expresses accounts as a percentage of ______.

total assets

Cal's Market has return on equity (ROE) of 15 percent. What does this mean?

Cal's generated $.15 in profit for every $1 of book value of equity.

Financial statement analysis is primarily "management by ______"

Exception

True or false: Receivables turnover is cost of goods sold divided by accounts receivable.

False

True or false: The current ratio will decrease if current assets increase, while everything else remains unchanged.

False

True or false: If there is a conflict between market and accounting data, accounting data should be given precedence.

False If there is a conflict between market and accounting data, market data should be given precedence.

True or false: Inventory turnover is sales divided by inventory.

False Inventory turnover is cost of goods sold divided by inventory.

True or false: The times interest earned ratio is EBIT minus interest.

False The times interest earned ratio is EBIT divided by interest.

True or false: Financial ratios are computed using only balance sheet information.

False; financial ratios can use information from all financial statements

True or false: Blue Company and Red Company have equal levels of current assets and current liabilities. Blue Company has higher inventory levels than Red Company. Blue Company is more liquid than Red Company.

False; higher levels of inventory result in less liquidity, all else equal.

True or false: if a company has inventory, the quick ratio will always be greater than the current ratio.

False; less than

What will happen to the current ratio if current assets increase, while everything else remains unchanged?

It will increase

Which one of the following is the correct equation for computing return on assets (ROA)?

Net Income/Total Assets

Which of the following is the correct equation for return on equity?

Net Income/Total Equity

The cash coverage ratio adds ______ to operating earnings (EBIT) for a better of measure of how much cash is available to meet interest obligations.

depreciation

Return on assets equals net income _________ by total assets.

divided

True or false: Profit margin equals net income divided by sales.

True

True or false: The cash ratio is found by dividing cash by current liabilities.

True

True or false: The total debt ratio equals the total assets minus total equity divided total assets.

True

How is inventory turnover ratio computed?

Cost of Goods Sold / Inventory

Common-size statements are best used for comparing:

competitors year-to-year for your firm firms of different sizes

Over the past year, the current assets account on the common-size balance sheet of a firm has decreased, while the current liabilities account on the common-size balance sheet of the same firm has increased. The firm has __________ (increased/decreased) its liquidity over the past year.

decreased

If a company has had negative earnings for several periods, they might choose to use a

Price-sales ratio

Receivables turnover is

Sales / Accounts Receivable

What is the impact on the total asset turnover ratio if sales increase significantly while there is no change in any of the other variables?

The total asset turnover ratio will increase.

Which of the following are true of financial ratios?

They are used for comparison purposes. They are developed from a firm's financial information.

Which one of the following best explains why financial managers use a common-size balance sheet?

To track changes in a firm's capital structure

True or false: A way to establish a benchmark for ratio analysis is to identify a peer group.

True

True or false: In a common-size income statement, each item is expressed as a percentage of total sales.

True

The quick ratio provides a more reliable measure of liquidity than the current ratio especially when the company's inventory takes _____ to sell.

a long time; because inventory that is held for a long time is not very liquid.

A problem with the TIE ratio is that it is based on EBIT, which is not a measure of ____ available to pay interest

cash

A firm with a market-to-book value that is greater than 1 is said to have ______ value for shareholders.

created

The current ratio computes the relationship between ____.

current assets - current liabilities

The cash ratio is found by dividing cash by:

current liabilities