FIN Ch.4 Analysis of Financial Statements

An alternative definition of the inventory turnover ratio replaces sales in the numerator with what?

cost of goods sold

If the DSO trend has been rising and _________ policy has not changed, this would indicate a need to speed up the collection of receivables

credit

Debt Management ratios measure the extent to which a firm uses financial leverage and the degree of safety afforded to __________.

creditors

The first ratio (debt to capital) analyzes debt by looking at

firms balance sheet

There can be problems interpreting the fixed asset turnover ratio due to ______________, particularly when an older firm is compared with a newer company.

inflation

the last two ratios (2) Times interest earned ratio (TIE), and (3) EBITDA coverage ratio analyze debt by

looking at the firm's income statement sheet.

Excess inventory is unproductive and represents an investment with a _______ rate of return.

low

Debt management ratios include

(1) Debt-to-capital ratio, (2) Times interest earned ratio (TIE), and (3) EBITDA coverage ratio.

What are the five ratio categories?

(1) Liquidity, (2) Asset management, (3) Debt management, (4) Profitability, (5) Market Value

Financial analysis indicates a company's relative strengths and weaknesses. Who uses this informationt to improve the firm's operations and stock price?

Managers

How to find Total Assets formula:

Total Assets= Sales/Total Asset Turnover Formula

Most decision makers and analysts use five groups of ratios to examine the different aspects of a company's performance. Indicate whether each of the following statements regarding financial ratios is true or false. A company exhibiting a high liquidity ratio is likely to have enough resources to pay off its short-term obligations.

True

Most decision makers and analysts use five groups of ratios to examine the different aspects of a company's performance. Indicate whether each of the following statements regarding financial ratios is true or false. Asset management or activity ratios provide insights into management's efficiency in using a firm's working capital and long-term assets.

True

Most decision makers and analysts use five groups of ratios to examine the different aspects of a company's performance. Indicate whether each of the following statements regarding financial ratios is true or false. Market value or market based ratios help analysts figure out what investors and the markets think about the firm's growth prospects or current and future operational performance.

True

Most decision makers and analysts use five groups of ratios to examine the different aspects of a company's performance. Indicate whether each of the following statements regarding financial ratios is true or false. One possible explanation for an increase in a firm's profitability ratios over a certain time span is that the company's income has increased.

True

What is the Current-Ratio formula?

Current Ratio= Current Assets/Current Liabilities

Which of the following statements are true regarding Free Spirit Industries Inc. and LeBron Sports Equipment Inc.?

1. Free Spirit Industries Inc. has less liquidity but also a great reliance on outside cash flow to finance its short-term obligations than LeBron Sports Equipment Inc. 2. A current ratio of 1 indicates that the book value of the company's current assets is equal to the book value of its current liabilities 3. If a company has a quick ratio of less than 1 but a current ratio of more than 1 and if the difference between the two ratios is large, then the company depends heavily on the sale of its inventory to meet its short-term obligations

Like Games: A/R: $21,600 Net FA: $440,000 Total Assets: $760,000 Our Play: A/R: $31,200 Net FA: $640,000 Total Assets: $1,000,000 Industry Average: A/R: $30,800 Net FA: $1,734,000 Total Assets: $1,876,800 1. A _______ days of sales outstanding represents an efficient credit and collection policy. Between the two companies, _____ is collecting cash from its customers faster than ______, but both companies are collecting their receivables less quickly than the industry average 2. Our Play's fixed assets turnover ratio is ______ than that of Like Games. This could be because Our Play is a relatively new company, so the acquisition cost of its fixed assets is ______ than the recorded cost of Like Games's next fixed assets 3. Like Games's total asset turnover ratio is _____, which is ______ than the industry's average total assets turnover ratio. In general, a higher total assets turnover ratio indicates greater efficiency

1. low; Like Games; Our Play 2. lower; higher 3. 1.05x; lower

You work for a brokerage firm. Your boss asked you to analyze Blue Parrot Manufacturing's performance for the past three years and to write a report that includes a benchmarking of the company's performance. Which of the following components would be best for you to include in your financial statement analysis? A. A comparison of the firm's performance with other firms in the same industry based on their financial ratios B. Financial statements based solely on information given to analysts and brokerage firms

A. A comparison of the firm's performance with other firms in the same industry based on their financial ratios

Decision makers and analysts look deeply into profitability ratios to identify trends in a company's profitability. Profitability ratios give insights into both the survivability of a company and the benefits that shareholders receive. Identify which of the following statements are true about profitability ratios. Check all that apply. A. A higher operating margin than the industry average indicates either lower operating costs, higher product pricing, or both. B. If a company's operating margin increases but its profit margin decreases, it could mean that the company paid more in interest or taxes. C. An increase in a company's earnings means that the profit margin is increasing. D. If a company issues new common shares but its net income does not increase, return on common equity will increase.

A. A higher operating margin than the industry average indicates either lower operating costs, higher product pricing, or both. B. If a company's operating margin increases but its profit margin decreases, it could mean that the company paid more in interest or taxes.

There are several groups of ratios most decision makers and analysts use to examine different aspects of a company's performance. Based on the descriptions of ratios listed, identify the relevant category of ratios. Ratios that help determine the efficiency with which a company manages its day-to-day tasks and assets are called A. Asset Management or Activity B. Profitability C. Market Value or Market Based D. Debt or Financial Leverage Management E. Dividend Policy

A. Asset Management or Activity

Company A uses long-term debt to finance its assets, and company B uses capital generated from shareholders to finance its assets. Which company would be considered a financially leveraged firm? A. Company A B. Company B

A. Company A

Which of the following statements is true about market value ratios? A. Low P/E ratios could mean that the company has a great deal of uncertainty in its future earnings. B. Companies with high research and development (R&D) expenses tend to have P/E ratios C. High P/E ratios could mean that the company has a great deal of uncertainty in its future earnings. D. Companies with high research hand development (R&D) expenses tend to have low P/E ratios.

A. Low P/E ratios could mean that the company has a great deal of uncertainty in its future earnings. B. Companies with high research and development (R&D) expenses tend to have P/E ratios

You decide also to conduct a qualitative analysis based on the factors summarized by the American Association of Individual Investors (AAII). According to your understanding, a company with one key product is considered to be ____ risky than companies with a wide range of products. A. More B. Less

A. More

Most firms borrow money to finance some of their assets, and most will choose to borrow some long-term funds and some short-term funds. Which group of lenders would put greater emphasis on a firm's liquidity ratio when evaluating a potential borrower? A. Short-Term Lender B. Long-Term Lender

A. Short-Term Lenders

Which of the following statements represent a weakness or limitation of ratio analysis? Check all that apply. A. Ratio analysis is conducted using benchmarking techniques. B. A firm's ratios can lead to conflicting conclusions—some ratios might be "good" and some "bad." C. Inflation can distort balance sheet data. D. Seasonal factors can distort data. E. Window dressing might be in effect. F. Market data is not sufficiently considered. G. Different firms may use different accounting practices. H. A firm's financial statements show only one period of financial data. I. A firm may operate in multiple industries.

B. A firm's ratios can lead to conflicting conclusions—some ratios might be "good" and some "bad." C. Inflation can distort balance sheet data. D. Seasonal factors can distort data. E. Window dressing might be in effect. G. Different firms may use different accounting practices. I. A firm may operate in multiple industries. ... Benchmarking is not considered to be a limitation or weakness of ratio analysis. ... It is assumed that market data are sufficiently considered when conducting ratio analysis. This does not represent a weakness or limitation of ratio analysis.

Suppose you are trying to decide whether to invest in a company that generates a high expected ROE, and you want to conduct further analysis on the company's performance. If you wanted to conduct a trend analysis, you would: A. Compare the firm's financial ratios with other firms in the industry for a particular year B. Analyze the firm's financial ratios over time

B. Analyze the firm's financial ratios over time

Based on your understanding of the uses and limitations of ROE, which of the following projects will a manager likely choose if his or her bonus is solely based on the ROE of the next project? A. High ROE and High Risk B. High ROE and Low Risk

B. High ROE and Low Risk

You decide also to conduct a qualitative analysis based on the factors summarized by the American Association of Individual Investors (AAII). According to your understanding, a company with less competition is considered to be ______________ risky than companies with multiple competitors. A. More B. Less

B. Less

There are several groups of ratios most decision makers and analysts use to examine different aspects of a company's performance. Based on the descriptions of ratios listed, identify the relevant category of ratios. ____________________ ratios help measure a company's ability to generate income and profits based on its invested capital. A. Asset Management or Activity B. Profitability C. Market Value or Market Based D. Debt or Financial Leverage Management E. Dividend Policy

B. Profitability Ratios

The Purchasing Policy Guidelines of the Southern Supply Inc. indicate that the company is committed to procuring its goods, products, and services from a diversified pool of vendors, contractors, and service providers. Despite these guidelines, Southern's purchasing manager prefers to maintain a small cadre of suppliers that he knows and trusts. How would you expect this situation to affect the assessment of Southern's financial condition and performance? A. Although nonquantitative factors may be relevant to a company's financial evaluation in general terms, the details of this specific situation are not relevant to the firm's financial condition or performance. B. The purchasing manager's behavior should be expected to increase Southern's riskiness by increasing its exposure to potential supply shortages or mistimed deliveries. C. The purchasing manager's behavior should be expected to decrease Southern's riskiness. His belief that the use of trusted suppliers will prevent or eliminate any inventory or supply delays or outages is, no doubt, correct.

B. The purchasing manager's behavior should be expected to increase Southern's riskiness by increasing its exposure to potential supply shortages or mistimed deliveries.

Which of the following is true about the leveraging effect? Select all that apply... A. Under economic growth conditions, firms with relatively low leverage will have higher expected returns. B. Under economic growth conditions, firms with relatively more leverage will have higher expected returns. C. Using leverage can generate shareholder wealth, but if a company fails to make the interest and principal payments on its debt, credit default can reduce shareholder wealth

B. Under economic growth conditions, firms with relatively more leverage will have higher expected returns. C. Using leverage can generate shareholder wealth, but if a company fails to make the interest and principal payments on its debt, credit default can reduce shareholder wealth

The inventory turnover ratio across companies in the telecommunications industry is 9.284x. Based on this information, which of the following statements is true for Walker Telecommunications? A. Walker Telecommunications is holding less inventory per dollar of sales compared with the industry average. B. Walker Telecommunications is holding more inventory per dollar of sales compared with the industry average.

B. Walker Telecommunications is holding more inventory per dollar of sales compared with the industry average.

There are several groups of ratios most decision makers and analysts use to examine different aspects of a company's performance. Based on the descriptions of ratios listed, identify the relevant category of ratios. ________________ ratios examine the market value of a company's share price, its profits and cash dividends, and the book value of the firm's assets and relate them to other data items to determine how the firm is perceived in the stock market A. Asset Management or Activity B. Profitability C. Market Value or Market Based D. Debt or Financial Leverage Management E. Dividend Policy

C. Market Value or Market Based Ratios Market value or market based ratios help you determine what investors think about the firm's growth prospects, using the company's stock price, its cash dividends, and the book value of the company's assets.

Analysts and investors often use return on equity (ROE) to compare profitability of a company with other firms in the industry. ROE is considered a very important measure, and managers strive to make the company's ROE numbers look good. If a firm takes steps that increase its expected future ROE, its stock price will______ increase. A. Always B. Never C. Not Necessarily

C. Not Necessarily

What is the Inventory Turnover Ratio Formula?

Cost of Goods Sold/Average Inventory

Liquidity RatiosLiquidity ratios are used to measure a firm's ability to meet its ______ obligations as they come due. Two of the most commonly used liquidity ratios are the: (1) Current ratio and (2) Quick, or acid test, ratio. The current ratio is the most commonly used measure of _______ solvency. Its equation is:Current ration: Current assets/ Current liabilities If a firm is having financial difficulty, it typically begins to pay its accounts payable more slowly and to borrow from the bank—both of which will increase its current _______ causing a decline in the current ratio. The quick ratio is a measure of a firm's ability to pay off ______ obligations without relying on the sale of _____ , which are typically the least liquid of a firm's current assets. Its equation is:Quick, or acid test, ratio= Current assets-Inventories/ Current liabilities

Current, Short Term Liabilities, Short Term, Inventories

There are several groups of ratios most decision makers and analysts use to examine different aspects of a company's performance. Based on the descriptions of ratios listed, identify the relevant category of ratios. Ratios that help assess a company's ability to service the interest and repayment obligations on its long-term debt and the degree to which it uses borrowed versus invested financial capital are called A. Asset Management or Activity B. Profitability C. Market Value or Market Based D. Debt or Financial Leverage Management E. Dividend Policy

D. Debt or Financial Leverage Management Ratios

There are several groups of ratios most decision makers and analysts use to examine different aspects of a company's performance. Based on the descriptions of ratios listed, identify the relevant category of ratios. Ratios that help determine whether a company can access its cash and pay its short-term obligations are called A. Profitability B. Market Value or Market Based C. Debt or Financial Leverage Management D. Liquidity E. Dividend Policy

D. Liquidity Ratio

What is the debt ratio formula?

Debt Ratio=Total Debt / Total Assets =Total Debt / Total Debt & Equity

Steps to find Time-Interest Earned Ratio:

EBIT=Total Sales - Total Operating Costs =$25 million - $ 11.25 million =$13.750000 million Interest Charges=Interest Rate x Debt Outstanding =7% x $2.5 million =$0.175000 million TIE Ratio=EBIT / Interest Charges =$13.750000 million / $0.175000 million =78.57x

The US tax structure influences a firm's willingness to finance with debt. The tax structure (encourages/ discourages) more debt?

Encourages

Most decision makers and analysts use five groups of ratios to examine the different aspects of a company's performance. Indicate whether each of the following statements regarding financial ratios is true or false. Debt or financial leverage ratios help analysts determine whether a company has sufficient cash to repay its short-term debt obligations.

False Debt or financial leverage ratios indicate whether a company has sufficient cash to repay its LONG-TERM—not its short-term—debt obligations.

What is the formula for Inventory?

Inventories= Current Assets - (Cash + Accounts Receivable)

Who uses Financial analysis to eveluate whether borrowers have the ability to pay off loans

Lenders

What is the Quick-Ratio formula?

Quick Ratio = (Current Assets - Inventories) /Current Liabilities

What is the Days of Sales Outstanding formula?

Receivables/Average Sales per Day

What is the Fixed Assets Turnover Ratio formula?

Sales/Net Fixed Assets

What is the Total Assets Turnover Ratio formula?

Sales/Total Assets

Who uses financial analysis to forecast earnings, dividends, and stock prices?

Security Analyst

Walker Telecommunications has a quick ratio of 2.00x, $35,550 in cash, $19,750 in accounts receivable, some inventory, total current assets of $79,000, and total current liabilities of $27,650. The company reported annual sales of $200,000 in the most recent annual report. Over the past year, how often did Walker Telecommunications sell and replace its inventory? A. 2.86x B. 8.01x C. 8.44x D. 9.28x

Step 1. Inventories= Current Assets - (Cash + Accounts Receivable) Inventories= 79,000 - (35,550 + 19,750) Inventories= 23,700 Step 2. Inventory Turnover Ratio = Cost of goods sold / Inventories ITR= 20,000/23,700 ITR=.8438 ITR= 8.44x Answer: C. 8.44x

Cute Camel Woodcraft Company just reported earnings after tax (also called net income) of $9,750,000 and a current stock price of $28.50 per share. The company is forecasting an increase of 25% for its after-tax income next year, but it also expects it will have to issue 2,900,000 new shares of stock (raising its shares outstanding from 5,500,000 to 8,400,000). If Cute Camel's forecast turns out to be correct and its price/earning (P/E) ratio does not change, what does the company's management expect its stock price to be one year from now?

Step 1: EPS= NI/Shares Outstanding =9,750,000/5,500,000shares =1.77 Step 2: P/E Ratio= Price per share/EPS = $28.50 /1.77 = 16.1017x Step 3: Expected Stock Price= Expected EPSx P/E Ratio =1.45 x 16.1017 =23.35 per share

One year later, Cute Carmel's share are trading a $54.56 per share, and the company reports the value of its total common equity as $39,228,000. Given the information, Cute Carmel's market-to-book ratio is?

Step 1: BVPS= Common Equity/Shares Outstanding =39,228,000/8,400,000 shares =$4.67 Step 2: M/B Ratio= Market Price per Share/BVPS =$54.56 per share/ $4.67 =11.68x

Can a company's shares exhibit a negative P/E ratio?

Yes

Profitability ratios help in the analysis of the combined impact of liquidity ratios, asset management ratios, and debt management ratios on the operating performance of a firm. Your boss has asked you to calculate the profitability ratios of Petroxy Oil Co. and make comments on its second-year performance as compared with its first-year performance. The following shows Petroxy Oil Co.'s income statement for the last two years. The company had assets of $10,575 million in the first year and $16,916 million in the second year. Common equity was equal to $5,625 million in the first year, and the company distributed 100% of its earnings out as dividends during the first and the second years. In addition, the firm did not issue new stock during either year. Calculate the profitability ratios of Petroxy Oil Co. in the following table. Convert all calculations to a percentage rounded to two decimal places.

operating margin= 71.11% = operating income/net sales = 4064/5715 profit margin = 46.8% = net income/net sales = 2106/4500 return on total assets = 16.22% = net income/assets = 2743/16916 return on common equity = 48.76% = net income/common equity = 2743/5625 basic earning power = 28.86% = operating income/assets = 3052/10575

The debt-to-capital ratio measures the

percentage of funds provided by debtholders

The DSO can also be evaluated by comparison with the terms on which the firm _________ its goods.

sells