Commercial Underwriting Principles Test 6
Equation for Acid-Test Ratio is:
(Cash+Marketable Securities+Accounts Receivable)/Current Liabilities.
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:
1.75 times.
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?
75%. [(35-20)/20]*100=75%.
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.)
ABC's current ratio is 3.00 ($3 million/$1 million=3.00).
Which one of the following is an example of an efficiency ratio?
Accounts receivable turnover ratio
The DuPont identity allows analysis of ROA by breaking it into component parts. Under this method, the component parts of ROA are:
Asset turnover and net profit margin.
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:
Asset turnover.
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?
Burkhart Co. is more profitable than Sandford Co.
An underwriter uses a firm's current assets when calculating the current ratio. Current assets are:
Cash and easily-liquidated assets.
Common size statements are frequently used during vertical analysis. Which one of the following is true regarding common size statements?
Common size statements are good for inter-company comparisons because they correct for differences in company size.
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:
Company B is generating a higher level of sales in proportion to its assets than Company A.
The Calculation for Inventory turnover ratio is:
Cost of goods sold ÷ inventory.
The accounts receivable turnover ratio is calculated by taking:
Credit sales divided by accounts receivable.
Which one of the following best describes why it is important to analyze leverage ratios?
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 ratios can be used to analyze how the assets of a company are being financed?
Debt-to-assets ratio
All of the following are examples of efficiency ratios, EXCEPT:
Debt-to-equity ratio
Which one of the following is an example of a leverage ratio?
Debt-to-equity ratio
As a financial analysis tool, common-size statements are most useful when comparing:
Financial statements of two or more different sized businesses.
Efficiency ratios measure:
How well a company manages and uses its assets.
While trend analysis can be used on various financial statements, it is most commonly applied to:
Income statements.
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?
Investment in overly risky investments
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:
Is carrying a higher level of inventory than its peers.
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:
It does not include inventory as an asset.
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:
Less efficient than UPD, Inc. based on their accounts receivable turnover ratio.
Ratio analysis is a common technique used by underwriters to analyze an organization's financial statements. The four broad categories these ratios can be grouped into for this purpose are:
Leverage, Liquidity, Profitability, and Efficiency
With ratio analysis, ratios are grouped into the following broad categories: efficiency, liquidity, profitability, and:
Leverage.
In financial statement analysis, what term refers to cash as well as short-term securities that can easily be converted to cash?
Liquidity
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?
Liquidity ratio
All of the following are common profitability measures used in ratio analysis:
Net profit margin, Return on assets, and Return on equity.
A significant limitation of financial ratio analysis is that:
No concrete guidance is available for determining which ratios are the most important or at what level they are too high or too low.
Trend analysis often involves creating comparative financial statements, which allow the user to:
Observe period to period variations that might indicate financial deterioration or growth.
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:
Only cash, marketable securities, and accounts receivable in the numerator.
Which one of the following is true regarding ratio analysis?
Ratio analysis can be used to both analyze single companies and make inter-company comparisons.
Which one of the following is an example of a profitability ratio?
Return on equity ratio
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?
Subtract the value of the company's inventory from the calculation.
If a nonfinancial company has a debt-to-equity ratio greater than 100 percent, it indicates:
That the company is financed mostly by debt.
If a company's inventory turnover ratio is higher than the industry benchmark, it indicates that:
The company is selling its inventory more quickly than its competitors.
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?
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 $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?
The company's accounts receivable turnover ratio is 2 ($4 million/$2 million).
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?
The company's assets are financed mostly through debt. Total liabilities/total assets. A Ration over .5 indicates financing mostly by debt.
In financial statement analysis, leverage ratios measure which one of the following?
The extent to which a company has borrowed money
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?
The inventory increase was caused by a change in the inventory valuation method.
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?
The percentage of inventories to total assets increased
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:
The percentage of net receivables to total assets increased by 2 percent.
Which one of the following is a limitation of the use of ratios in financial statement analysis?
There is no concrete guidance for determining which ratios are 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. The analysis is most limited by the fact that:
There is no concrete guidance for determining which ratios are the most important.
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?
To screen the loan as acceptable or unacceptable
Equity multiplier is calculated by taking:
Total assets divided by owners' equity.
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?
Twenty-five percent of the company's sales is left after all expenses are paid.
Which one of the following types of analysis helps an underwriter identify abnormal values reported by an organization?
Vertical analysis
