AU 60 - Assignment 6 - Analyzing Financial Statements
Day sales outstanding
= 365 ÷ Accounts receivable turnover ratio
Inventory Turnover Ratio
= Cost of goods sold ÷ Inventory
Accounts Receivable Turnover Ratio
= Credit sales ÷ Accounts receivable
Working Capital
= Current assets - Current liabilities
Current Ratio
= Current assets ÷ Current liabilities
Debt-to-Equity Ratio
= Long-term debt ÷ Shareholders' equity
Net Profit Margin
= Net income ÷ Sales
Return on Equity (ROE)
= Net income ÷ Shareholders' equity = ROA × Equity multiplier = Net profit margin × Asset turnover × Equity multiplier = (Net income ÷ Sales) × (Sales ÷ Total assets) × (Total assets ÷ Equity)
Return on Assets (ROA)
= Net income ÷ Total assets = Net profit margin × Asset turnover ratio = (Net income ÷ Sales) × (Sales ÷ Total assets)
Asset Turnover Ratio
= Sales ÷ Total assets
Debt-to-Assets Ratio
= Total liabilities ÷ Total assets
D. $6 million.
A company shows the following amounts in its end of year financial statements: Current assets: Cash $300,000 Accounts receivable 700,000 Inventory 10,000,000 Total current assets $11,000,000 Total current liabilities $5,000,000 Its working capital is A. −$4 million. B. $1.1 million. C. $5 million. D. $6 million.
C. The percentage of inventories to total assets increased
A company's common-size statement lists two years, 20X3 and 20X4. In 20X3, the inventories line was five percent, and in 20X4 the inventories line was seven percent. Which one of the following could an underwriter infer from this information? A. Inventories fell by two percent B. Inventories increased by two percent C. The percentage of inventories to total assets increased D. Percent of inventories changed with inflation
Trend analysis
A comparison of financial statement data across two or more periods.
Comparative financial statements
A financial analysis tool that provides figures for the current and the prior year side by side to enable the report user to observe variations that might indicate financial deterioration or growth.
Ratio analysis
A financial analysis tool used to study the financial condition of an account; two or more data items from accounting records of a company are related to one another and the result is compared to results for prior accounting periods or for similar businesses.
Leverage ratio
A financial ratio that indicates the relationship between the amount of funds supplied by creditors and the funds supplied by the owners of the company.
Common-size statement
A financial statement in which amounts are reported as a percentage of a base figure.
Debt-to-equity ratio
A leverage ratio that measures the extent to which a company is financed using borrowings rather than its own funds (owners' equity).
Debt-to-assets ratio
A leverage ratio that shows the extent to which a company's assets are financed by debt; uses balance sheet data and is calculated by dividing total liabilities by total assets.
Working capital
A liquidity measure that is calculated by subtracting current liabilities from current assets. It is used to determine a company's ability to finance immediate operations (to buy inventory, finance growth, and obtain credit).
Current ratio
A liquidity ratio that indicates the company's ability to meet its short-term financial obligations; calculated by dividing current assets by current liabilities.
Acid-test ratio (quick ratio)
A liquidity ratio that provides a measure of a company's ability to meet its current obligations if it cannot sell its inventory.
Days sales outstanding
A measure of the number of days it takes, on average, for a company to collect its accounts receivable.
Return on equity (ROE)
A profitability ratio expressed as a percentage by dividing a company's net income by its net worth (book value). Depending on the context, net worth is sometimes called shareholders' equity, owners' equity, or policyholders' surplus.
Net profit margin
A profitability ratio that measures the percentage of sales remaining after deducting all expenses that indicates how effective an insurer is at cost control, uses income statement data, and is calculated by dividing net income after taxes by sales.
Return on assets (ROA)
A profitability ratio that shows how well a company has used its resources by comparing net income to the assets invested to generate that income.
D. Inventory is excluded from the calculation of the acid-test ratio.
A significant difference between the current ratio and the acid-test ratio is that A. The current ratio is a more conservative measure of liquidity. B. Cash is excluded from the calculation of the acid-test ratio. C. The current ratio uses balance sheet data in the calculation. D. Inventory is excluded from the calculation of the acid-test ratio.
C. No concrete guidance is available for determining which ratios are the most important or at what level they are too high or too low.
A significant limitation of financial ratio analysis is that A. There is no basis for determining which financial ratios are within the normal range for a specific industry. B. Its use is limited to a comparison of an individual company's current financial results to prior years to determine whether it is prospering or declining. C. No concrete guidance is available for determining which ratios are the most important or at what level they are too high or too low. D. Its use is limited to a comparison of companies of the same size and in similar businesses.
C. 20 times.
ABC Retail shows the following amounts in its end of year financial statements: Accounts receivable $500,000 Inventory $5,000,000 Credit sales $10,000,000 Cost of goods sold $20,000,000 Based on these figures, its accounts receivable turnover ratio is A. 4 times. B. 10 times. C. 20 times. D. 40 times.
D. Turnover of assets
All of the following are common profitability measures used in ratio analysis, EXCEPT: A. Net profit margin B. Return on assets C. Return on equity D. Turnover of assets
D. Debt-to-equity ratio
All of the following are examples of efficiency ratios, EXCEPT: A. Inventory turnover B. Asset turnover C. Accounts receivable turnover D. Debt-to-equity ratio
DuPont identity
An analysis of ROA and ROE by breaking them down into their component ratios.
A. Company B is generating a higher level of sales in proportion to its assets than Company A.
An analyst is comparing the financial data of two companies that compete in the same industry, Company A and Company B. Each of the two companies has the same return on assets ratio (ROA), and the analyst wants to understand how each is using its resources to achieve this result. Further analysis reveals that Company A has a lower asset turnover ratio than Company B. This analysis indicates that A. Company B is generating a higher level of sales in proportion to its assets than Company A. B. Company A is generating a higher level of sales in proportion to its assets than Company B. C. Company B is retaining a higher level of net income relative to sales than Company A. D. Company A may or may not be retaining a higher level of net income relative to sales than Company B.
Accounts receivable turnover ratio
An efficiency ratio that indicates how quickly a business collects the amounts owed by its customers.
Inventory turnover ratio
An efficiency ratio that indicates how quickly inventory is sold, generating either cash (from cash sales) or accounts receivable (from credit sales).
Gross profit
An income statement value that represents sales or operating revenue minus the cost of goods sold.
C. There is no concrete guidance for determining which ratios are the most important.
An investor is considering purchasing stock in one of two insurance companies. The companies in question have published the following ratios for the previous fiscal year: Company A Company B Combined Ratio 97% 98.5% Premium to Surplus Ratio 2.5:1 3.25:1 Current Ratio 1.6:1 1.3:1 The analysis is most limited by the fact that A. Ratio analysis over-complicates the financial statement review process. B. Ratios cannot be used to compare relative performance of companies in the same industry. C. There is no concrete guidance for determining which ratios are the most important. D. There are no published benchmarks available for reference when analyzing ratios.
A. 2
An underwriter is attempting to conduct ratio analysis on a company. The underwriter notices that the company has $12 million in total sales, $8 million in cash sales, $4 million in credit sales, and a $2 million accounts receivable balance. Based on these figures, what is the company's accounts receivable turnover ratio? A. 2 B. 3 C. 4 D. 6
B. The company may not be able to meet its short term obligations because its acid test ratio is less than one.
An underwriter is attempting to conduct ratio analysis on a company. The underwriter notices that the company has $2 million in cash, $1 million in marketable securities, $3 million in inventory, $2 million in accounts receivable, and $7 million in current liabilities. Which one of the following conclusions can the underwriter reach by calculating liquidity ratios? A. The company should be able to meet its short term obligations because its working capital ratio is greater than one. B. The company may not be able to meet its short term obligations because its acid test ratio is less than one. C. The company should able to meet its short term obligations because its acid test ratio is greater than one. D. The company may not be able to meet its short term obligations because its current ratio is less than one.
D. The company's assets are financed mostly through debt.
An underwriter is attempting to conduct ratio analysis on a company. The underwriter notices that the company has $3 million in total assets, $1 million in current assets, $2 million in total liabilities, and $1 million in current liabilities. Which one of the following conclusions can the underwriter reach by calculating the company's debt-to-assets ratio? A. The company's assets are financed mostly through shareholder's equity. B. The company has adequate working capital. C. The company is very profitable. D. The company's assets are financed mostly through debt.
B. Twenty-five percent of the company's sales is left after all expenses are paid.
An underwriter is attempting to conduct ratio analysis on a company. The underwriter notices that the company has $8 million in sales, $5 million in gross profit, and $2 million in net income. Which one of the following conclusions can the underwriter reach by calculating the company's net profit margin? A. Twenty-five percent of the company's sales is used to pay expenses. B. Twenty-five percent of the company's sales is left after all expenses are paid. C. Forty percent of the company's sales is used to pay expenses. D. Forty percent of the company's sales is left after all expenses are paid.
A. Subtract the value of the company's inventory from the calculation.
An underwriter is conducting ratio analysis and determines that a company has a current ratio of 1.2. Which one of the following adjustments to the calculation should the underwriter make to ensure that the company is able to meet its short term obligations? A. Subtract the value of the company's inventory from the calculation. B. Subtract the value of the company's cash from the calculation. C. Subtract the value of the company's long-term debt from the calculation. D. Subtract the value of the company's accounts receivable from the calculation.
C. The debt to equity ratio is .50 and the company is mostly financed by equity.
An underwriter is conducting ratio analysis and notices that a company has $1.5 million in long-term debt, $3 million in shareholder's equity, and $5 million in assets. Which one of the following statements is true based on the company's debt to equity ratio? A. The debt to equity ratio is .30 and the company is mostly financed by equity. B. The debt to equity ratio is .50 and the company is equally funded by long term debt and equity. C. The debt to equity ratio is .50 and the company is mostly financed by equity. D. The debt to equity ratio is .60 and the company is mostly financed by equity.
A. The percentage of net receivables to total assets increased by 2 percent.
An underwriter is conducting vertical analysis using a common-size balance sheet for the past two fiscal years. The underwriter notices the figure listed under "net receivables" is 11.5 percent for the current fiscal year compared to 9.5 percent for the prior fiscal year. These figures indicate that A. The percentage of net receivables to total assets increased by 2 percent. B. The company efficiency has decreased by 2 percent. C. The balance of the company's net receivables increased by 2 percent. D. The company's net sales increased by 2 percent.
D. Is carrying a higher level of inventory than its peers.
An underwriter is reviewing the financial statements for a prospective insured. She has determined that the insured's current ratio is higher than the benchmark average for companies comparable in size and operations, and that its acid-test ratio is lower than the benchmark average. The underwriter should request further information because these results indicate that the prospective insured A. Is collecting its receivables too frequently. B. Is carrying too much debt relative to its peers. C. Is not making efficient use of borrowing. D. Is carrying a higher level of inventory than its peers.
C. 25 times
An underwriter is trying to determine XYZ Manufacturing's efficiency using the accounts receivable (A/R) turnover ratio. XYZ's income statement shows $10 million in sales (half of which is attributable to credit sales) and the balance sheet shows $200,000 in A/R. What is XYZ's accounts receivable turnover ratio? A. .02 times B. .04 times C. 25 times D. 50 times
B. 0.25
An underwriter is trying to determine how efficiently Company ABC is using its assets to generate sales. ABC's income statement provides that sales were $2 million. The balance sheet provides that total assets are $8 million, total current assets are $1.5 million, and accounts receivable are $1.0 million. What is ABC's asset turnover ratio? (Round to nearest hundredth.) A. 0.13 B. 0.25 C. 0.66 D. 1.33
A. Cash and easily-liquidated assets.
An underwriter uses a firm's current assets when calculating the current ratio. Current assets are A. Cash and easily-liquidated assets. B. Assets purchased with cash. C. The excess of assets to liabilities. D. Assets purchased within the year.
C. 1.5
An underwriter wants to determine a company's ability to pay off its short-term debt obligations. The company's current assets are $12 million, current liabilities are $8 million, cash is $3 million, total liabilities are $15 million, and total assets are $30 million. Which one of the following is the measure of the company's ability to convert assets to cash in order to satisfy its obligations? A. 0.5 B. 0.7 C. 1.5 D. 2.0
B. Liquidity ratio
An underwriter wants to estimate if a particular firm can pay off its debt and if a debt repayment will cause a strain in cash. Further, the underwriter wants to identify potential moral or morale hazards. Which one of the following ratios would be most appropriate? A. Efficiency ratio B. Liquidity ratio C. Profitability ratio D. Leverage ratio
B. Investment in overly risky investments
An underwriter's ratio analysis of a company reveals ratio results that are significantly better than expected. The underwriter believes that their results reflect a management decision to sacrifice long-term profitability and growth for short-term profitability. Which one of the following decisions would reflect such a sacrifice? A. Investment in too many risk-free investments B. Investment in overly risky investments C. Investment in strong employee training D. Investment in a strong employee benefits plan
C. Financial statements of two or more different sized businesses.
As a financial analysis tool, common-size statements are most useful when comparing A. Trends for three or more businesses. B. Past performance to industry standards. C. Financial statements of two or more different sized businesses. D. Financial statements of more than three similarly sized organizations.
C. Common size statements are good for inter-company comparisons because they correct for differences in company size.
Common size statements are frequently used during vertical analysis. Which one of the following is true regarding common size statements? A. Common size statements typically use a competitor's or industry average as the base amount for percentage calculations. B. Common size statements are not able to account for inflation when analyzing figures over time. C. Common size statements are good for inter-company comparisons because they correct for differences in company size. D. Common size statements can be used to show percentage increases or decreases in figures over time.
B. How well a company manages and uses its assets.
Efficiency ratios measure A. A company's ability to convert assets to cash in order to satisfy its obligations. B. How well a company manages and uses its assets. C. The extent to which a company has borrowed money. D. The amount of a company's current assets after deducting its current liabilities.
B. Total assets divided by owners' equity.
Equity multiplier is calculated by taking A. Total sales divided by owners' equity. B. Total assets divided by owners' equity. C. Net income divided by owners' equity. D. Operating income divided by owners' equity.
C. 3.2
Excerpts from the consolidated balance sheet for AJD Retail, Inc. (AJD) are shown below. In its consolidated income statement for the same period, shown in thousands, AJD reports total sales of $23,000, consisting of cash sales of $18,000 and credit sales of $5,000. Cost of goods sold is shown at $16,000. AJD Retail, Inc. Consolidated Balance Sheet Amounts in Thousands Assets Current assets: Cash $50 Accounts receivable 800 Inventory 5,000 Other current assets 80 Total current assets $5,930 Property and equipment 15,000 Receivables 30 Goodwill 250 Other 50 Total assets $21,260 Using this information, which one of the following is the inventory turnover ratio for AJD? A. .2 B. .3 C. 3.2 D. 4.6
C. The company is selling its inventory more quickly than its competitors.
If a company's inventory turnover ratio is higher than the industry benchmark, it indicates that A. Its inventory is becoming obsolete compared to that of its competitors. B. The company is holding its inventory longer than its competitors. C. The company is selling its inventory more quickly than its competitors. D. The company's inventory is generating higher costs than that of its competitors.
Leverage Ratios
In financial statement analysis, ____ ratios measure the extent to which a company has borrowed money.
B. The extent to which a company has borrowed money
In financial statement analysis, leverage ratios measure which one of the following? A. A company's ability to control costs and earn profits B. The extent to which a company has borrowed money C. How well a company manages and uses its assets D. A company's ability to fund the liabilities it owes
D. Liquidity
In financial statement analysis, what term refers to cash as well as short-term securities that can easily be converted to cash? A. Capital adequacy B. Leverage C. Profitability D. Liquidity
A. The larger the margin of safety the company possesses to cover its short-term debts.
Liquidity ratios are used to determine a company's ability to pay off its short-term debts. Typically, the higher the value of the ratio, A. The larger the margin of safety the company possesses to cover its short-term debts. B. The smaller the amount of long-term debt the company has incurred. C. The smaller the margin of safety the company possesses to cover its short-term debts. D. The larger the amount of long-term debt the company has incurred.
D. It does not include inventory as an asset.
Liquidity ratios such as the acid-test ratio and the current ratio measure a company's ability to convert assets to cash in order to satisfy its obligations. The acid-test ratio is a more conservative measure of liquidity because A. It does not include cash as an asset. B. It considers only current liabilities. C. It assumes that inventory will sell very quickly. D. It does not include inventory as an asset.
Trend Analysis
Once the comparative financial statements are created, ____ can continue by reviewing the period-to-period percentage changes identified in common-size statements. The purpose is to identify patterns and highlight changes in specific statement items over time.
B. Only cash, marketable securities, and accounts receivable in the numerator.
One type of liquidity ratio that an underwriter may choose is an acid-test ratio. This ratio is a more conservative measure of liquidity than the current ratio because it includes A. Inventory as a part of current assets in the numerator. B. Only cash, marketable securities, and accounts receivable in the numerator. C. Only notes payable and accruals in the denominator. D. Capital stock as a part of current liabilities in the denominator.
B. Less efficient than UPD, Inc. based on their accounts receivable turnover ratio.
RGT, Inc. has $12,750 in credit sales and $850 in accounts receivable. UPD, Inc. has $14,250 in credit sales and $675 in accounts receivable. Therefore, RGT, Inc. is A. Not as competitive as UPD, Inc. because they have a lower accounts receivable turnover ratio. B. Less efficient than UPD, Inc. based on their accounts receivable turnover ratio. C. More likely to have their customers pay their bills because the greater the days of sales outstanding increases the chance that they will be paid. D. More efficient than UPD, Inc. based on their accounts payable ratio.
D. Solvency
Ratio analysis is a common technique used by underwriters to analyze an organization's financial statements. Each of the following is one of the four broad categories these ratios can be grouped into for this purpose, EXCEPT: A. Leverage B. Profitability C. Efficiency D. Solvency
C. 1.75 times.
Ren is underwriting a property policy for XYZ, Inc. He is particularly concerned with how much inventory is on hand and how fast it can be sold. XYZ's income statement shows sales of $500,000 and cost of goods sold (COGS) of $350,000. The balance sheet shows inventory at $200,000 and cash of $150,000. Using the inventory turnover ratio, Ren finds that XYZ can convert inventory to sales A. 0.57 times. B. 0.75 times. C. 1.75 times. D. 2.50 times.
Fixed assets
Resources that cannot be expected to be sold or consumed within the business's normal operating cycle and that are usually considered to be long lived.
D. Burkhart Co. is more profitable than Sandford Co.
Sandford Co. and Burkhart Co. are both general merchandise stores. Sanford Co. has $5,000 as net income and $150,000 in sales at the end of the year. Burkhart Co. has $8,000 in net income and $130,000 in sales. The benchmark for the industry is a 2.8 percent profit margin. Which one of the following is true? A. Neither company is close to being profitable. B. We cannot determine profitability without knowing the companies' total assets. C. Sandford Co. is more profitable than Burkhart Co. D. Burkhart Co. is more profitable than Sandford Co.
C. To screen the loan as acceptable or unacceptable
Sherman Industries, Inc. applied for a loan to finance a major equipment purchase. The loan officer calculated Sherman's debt-to-asset ratio as part of the loan approval process. What is the likely use of this ratio? A. To evaluate Sherman's liquidity position B. To estimate Sherman's next year's total interest expense C. To screen the loan as acceptable or unacceptable D. To forecast Sherman's upcoming year's net income or loss
A. .33
Suppose ABC Company comes to insurer XYZ. The underwriter wants to use a debt-to-equity (D/E) ratio to help determine the extent to which ABC is financed through borrowings rather than its own funds. Based on the financial information below, what is ABC's debt-to-equity ratio? Long-term debt: $10 million Shareholder's equity: $30 million Total liabilities: $15 million Total assets: $60 million A. .33 B. .50 C. 3.0 D. 4.0
D. 3.00
Suppose Jamie is underwriting a policy for ABC Company. The company's current assets are $3 million, total assets are $5 million, current liabilities are $1 million, and total liabilities are $3 million. What is ABC's current ratio? (Round to nearest hundredth.) A. 0.33 B. 0.60 C. 1.66 D. 3.00
B. Asset turnover and net profit margin.
The DuPont identity allows analysis of ROA by breaking it into component parts. Under this method, the component parts of ROA are A. Return on equity and asset turnover. B. Asset turnover and net profit margin. C. Asset turnover and equity multiplier. D. Equity multiplier and net profit margin.
C. Asset turnover.
The DuPont identity allows return on assets (ROA) to be examined in two components. It is helpful for an insurance professional to understand which of these two components is responsible for the resulting ROA, especially when reviewing an account whose ROA is below the industry benchmark. The two components of ROA using DuPont identity are net profit margin and A. Sales. B. Equity multiplier. C. Asset turnover. D. Owners' equity.
DuPont Identity
The ____ (named after the company that developed it) illustrates a method of analyzing financial statements by breaking down the ROA and ROE ratios into component ratios. ROA and ROE ratios are considered measures of profitability. However, efficiency and leverage directly affect profitability. Therefore, several efficiency and leverage ratios are component ratios within ROA and ROE. These component ratios allow the analyst to determine what factors are driving an organization's returns.
Current Ratio
The ____ ratio is a liquidity ratio that indicates the adequacy of a company's working capital to meet its current financial obligations.
Quick Ratio
The ____ ratio is a more conservative measure of liquidity than the current ratio because it includes only cash, marketable securities, and accounts receivable in its numerator.
Accounts Receivable Turnover Ratio
The ____ ratio is an efficiency ratio indicating how quickly a business collects the funds it is owed. This ratio relates credit sales over a period of time to the balance in accounts receivable at the end of the period.
Debt-to-Equity Ratio
The ____ ratio is commonly used to assess the relative extent of an organization's debt financing as compared to other organizations in the same industry.
Inventory Turnover Ratio
The ____ ratio relates the amount of cost of goods sold for a given period to the amount of inventory held at the end of the period.
Debt-to-Assets Ratio
The ____ ratio, or debt ratio, is a leverage ratio that shows the extent to which a company's assets are financed by debt. For this ratio, the term "debt" is used in a broad sense to include not only borrowed funds but also other obligations such as accounts payable.
A. Credit sales divided by accounts receivable.
The accounts receivable turnover ratio is calculated by taking A. Credit sales divided by accounts receivable. B. Total sales divided by accounts receivable. C. Accounts receivable divided by total sales. D. Accounts receivable divided by credit sales.
C. 1.15.
The most recent financial statements for Buddy's Burger Hut reveal the following: Cash $50,000 Equipment $25,000 Inventory $15,000 Accounts Receivable $2,500 Cost of Goods Sold $125,000 Marketable Securities $5,000 Current Liabilities $50,000 Based on this information, Buddy's Burger Hut's Acid-Test Ratio is A. 0.46. B. 0.56. C. 1.15. D. 1.45.
Leverage
The practice of using borrowed money to invest.
D. Do not include inventory.
The primary difference between quick assets and current assets is that the quick assets A. Include cash. B. Do not include cash. C. Include inventory. D. Do not include inventory.
Vertical analysis
The use of common-size statements to highlight basic relationships among items within a single set of financial statements.
C. Observe period to period variations that might indicate financial deterioration or growth.
Trend analysis often involves creating comparative financial statements, which allow the user to A. View various financial figures as a percentage of a base amount. B. Highlight relationships between items that appear within a single financial statement. C. Observe period to period variations that might indicate financial deterioration or growth. D. Compare an organization's profitability to a competitor or industry benchmark.
D. The inventory increase was caused by a change in the inventory valuation method.
Underwriters must be careful when comparing financial statements using trend analysis because false impressions about a company can be created. Which one of the following might cause an underwriter to have a false impression about a company's health because of an inventories increase on the financial statement? A. The inventory increase was caused by obsolete or damaged inventory. B. The inventory increase was caused by robust sales and growth. C. The inventory increase was caused by a decline in seasonal sales. D. The inventory increase was caused by a change in the inventory valuation method.
B. Net profit margin and asset turnover
Using the DuPont identity, the return on assets can be broken down into which component ratios? A. Return on equity and net profit margin B. Net profit margin and asset turnover C. Asset turnover and inventory turnover D. Inventory turnover and accounts receivable turnover
D. 75%
Using trend analysis, an underwriter calculates the percentage change in certain items over time. If ABC Company's sales increased from $20 million in 20X5 to $35 million in 20X6, what is the percentage change? A. 18% B. 34% C. 43% D. 75%
D. Cash, marketable securities, and accounts receivable
When calculating the acid-test (quick) ratio, which one of the following groups of assets is measured against current liabilities? A. Total current assets, less cash B. Cash, accounts receivable, and inventory C. Total assets, less inventory D. Cash, marketable securities, and accounts receivable
D. Net profit margin
When trend analysis is applied to several years of reported values, it is particularly effective for identifying changes in important financial statement items including all of the following, EXCEPT: A. Total assets B. Sales C. Net income D. Net profit margin
A. An analyst may substitute total liabilities for long-term debt—that is, calculate the debt-to-equity ratio by dividing total liabilities by shareholders' equity.
Which of the following statements is correct? A. An analyst may substitute total liabilities for long-term debt—that is, calculate the debt-to-equity ratio by dividing total liabilities by shareholders' equity. B. An analyst may substitute total assets for long-term debt—that is, calculate the debt-to-equity ratio by dividing total assets by shareholders' equity. C. An analyst may substitute current liabilities for long-term debt—that is, calculate the debt-to-equity ratio by dividing current liabilities by shareholders' equity. D. An analyst may substitute current assets for long-term debt—that is, calculate the debt-to-equity ratio by dividing current assets by shareholders' equity.
A. Debt obligations need to be repaid regardless of a company's profit, which can lead to decreased distributions to shareholders.
Which one of the following best describes why it is important to analyze leverage ratios? A. Debt obligations need to be repaid regardless of a company's profit, which can lead to decreased distributions to shareholders. B. Well-run companies should have low leverage and finance their operations by issuing shares. C. Companies that are highly leveraged are not profitable because a large portion of their revenue is applied towards debt payments. D. Highly leveraged companies typically grow at a faster rate because they have more funds available to finance their expansion.
C. The company expects to collect accounts receivable throughout the year.
Which one of the following explains why a firm can have a negative working capital liquidity ratio and remain in operation? A. The company plans to issues new shares. B. The company expects to collect accounts payable throughout the year. C. The company expects to collect accounts receivable throughout the year. D. The company has access to debt to pay off other debts.
C. There is no concrete guidance for determining which ratios are most important.
Which one of the following is a limitation of the use of ratios in financial statement analysis? A. They cannot be used to determine whether a company is prospering or declining. B. They fail to provide a basis for identifying areas that need further review. C. There is no concrete guidance for determining which ratios are most important. D. Their use is inappropriate for determining relative performance among companies in the same industry
C. Debt-to-equity ratio
Which one of the following is an example of a leverage ratio? A. DuPont identity B. Quick ratio C. Debt-to-equity ratio D. Inventory turnover ratio
D. Acid-test ratio
Which one of the following is an example of a liquidity ratio? A. Return on equity B. Inventory turnover ratio C. Debt-to-assets ratio D. Acid-test ratio
D. Return on equity ratio
Which one of the following is an example of a profitability ratio? A. Debt-to-assets ratio B. Current ratio C. Accounts receivable turnover ratio D. Return on equity ratio
A. Accounts receivable turnover ratio
Which one of the following is an example of an efficiency ratio? A. Accounts receivable turnover ratio B. Net profit margin C. Current ratio D. Debt-to-assets-ratio
A. Ratio analysis can be used to both analyze single companies and make inter-company comparisons.
Which one of the following is true regarding ratio analysis? A. Ratio analysis can be used to both analyze single companies and make inter-company comparisons. B. Underwriters should only look into ratio results that are below the industry average or benchmark. C. Ratio analysis does not require any benchmarks or baselines. D. Ratio analysis is broken down into two main categories: profitability ratios and efficiency ratios.
B. Debt-to-assets ratio
Which one of the following ratios can be used to analyze how the assets of a company are being financed? A. Return on assets B. Debt-to-assets ratio C. Asset turnover ratio D. Debt-to-equity ratio
A. Debt-to-equity ratio
Which one of the following ratios can be used to assess the extent of an organization's debt financing compared to other organizations in the same industry? A. Debt-to-equity ratio B. Acid-test ratio C. Current ratio D. Debt-to-assets ratio
A. Current ratio
Which one of the following ratios indicates the adequacy of a company's working capital to meet its current financial obligations? A. Current ratio B. Debt-to-assets ratio C. Debt-to-equity ratio D. Asset turnover ratio
A. If a nonfinancial company has a debt-to-equity ratio greater than 100 percent, it indicates that the company is financed mostly by debt.
Which one of the following statements is true? A. If a nonfinancial company has a debt-to-equity ratio greater than 100 percent, it indicates that the company is financed mostly by debt. B. A nonfinancial company with a low debt-to-equity ratio is considered to be highly leveraged. C. As profits increase, the amount of debt repayments decreases. D. Interest payments on debt are payable after profits have been returned to the company's owners.
A. Vertical analysis
Which one of the following types of analysis helps an underwriter identify abnormal values reported by an organization? A. Vertical analysis B. Historical analysis C. Ratio analysis D. Trend analysis
B. Income statements.
While trend analysis can be used on various financial statements, it is most commonly applied to A. Changes in equity statements. B. Income statements. C. Cash flow statements. D. Balance sheets.
D. Leverage.
With ratio analysis, ratios are grouped into the following broad categories: efficiency, liquidity, profitability, and A. Equity. B. Operations. C. Income. D. Leverage.
A. Positive working capital.
Working capital is the excess of a company's current assets over its current liabilities. Most financially sound companies have a A. Positive working capital. B. Negative working capital. C. Working capital equal to zero. D. Working capital less than one percent.
Current Assets
____ are cash and those assets that are likely to be converted to cash within one year of the balance sheet date—primarily marketable securities, accounts receivable, and inventory and are those obligations that will need to be paid within the same one-year period, including accounts payable; the current portion of loans payable; and accrued expenses such as wages payable, interest payable, and taxes payable.
Ratios
____ can highlight relationships between items that appear within a single financial statement, as well as relationships between items on different financial statements. As a result, ____ are used to analyze single companies and to compare one company with another and are grouped into the following broad categories: profitability, efficiency, liquidity, and leverage.
Return on Assets (ROA)
____ is a profitability ratio that shows how well a company has used its resources. The higher the return on assets, the more efficiently management has used those assets to generate earnings.
Working Capital
____ is the excess of a company's current assets over its current liabilities.
Vertical Analysis
____ looks for any unusual percentages in the common-size statements that identify items as having an excessively large (or small) value when compared with those of competitors or with another benchmark, such as an average for an industry. For example, assume that the industry average for inventories is only 15 percent of total assets. This information might alert the underwriter to obsolete inventory and to a potential moral hazard if the company's inventories are 35 percent of total assets.
Liquidity Ratios
____ ratios are used to determine a company's ability to pay off its short-term debt obligations.
Efficiency Ratios
____ ratios examine how well a company manages and uses its assets. The ratios that measure this type of performance—the accounts receivable ratio, the asset turnover ratio, and the inventory turnover ratio—are typically used in generally accepted accounting principles (GAAP)-based efficiency analysis.
Profitability Ratios
____ ratios look at how well a company generates the income needed to be profitable. Commonly used ____ ratios are net profit margin, return on assets, return on equity, and the DuPont identity.
Liquidity Ratios
____ ratios measure a company's ability to convert assets to cash to satisfy its obligations.
Leverage Ratios
____ ratios, which include the debt-to-equity ratio and the debt-to-assets ratio, measure the extent to which a company has borrowed money to finance its operations.
Ratio Analysis
____ shows the extent to which a company can meet its current financial obligations.
Vertical Analysis
_____ begins with the creation of a common-size statement, which shows the relative size of the amounts on each line. For example, the income statement may report each line amount as a percentage of revenue, or the balance sheet may report each line amount as a percentage of total assets.
