Chapter 10 - Financial Analysis and Business Planning

Question 1

Liquidity Ratios (2)

Answer 1

• Current ratio
• Quick ratio

Question 2

Solvency Ratios (3)

Answer 2

• Leverage ratio
• Interest coverage
• Debt ratio

Question 3

Profitability Ratios (3)

Answer 3

• Gross profit margin
• Cost ratios
• Return on assets

Question 4

Operations and Productivity Ratios (4)

Answer 4

• Total asset turnover
• Inventory turnover
• Average collection period
• Productivity and marketing

Question 5

Liquidity is a measure of

Answer 5

a company’s ability to meet current obligations, (bank overdraft, accounts payable,
and income taxes as they come due)

Question 6

Quick Ratio

Answer 6

(Current assets – Least liquid items) /
Current liabilities

Question 7

Leverage Ratio - equation and what it measures

Answer 7

Total debt / Equity

also called long-term debt to equity, reflects to what extent the company has borrowed to finance its operations: the greater the debt, the higher the ratio.

Question 8

Interest Coverage - equation and what it measures

Answer 8

Net income before taxes and interest / Interest

measures the ability to pay interest charges on debt and to protect creditors from interest payment default

Question 9

Debt Ratio - equation and what it measures

Answer 9

Total debt / Total assets

represents the percentage of the company’s assets coming from creditors.
complements the debt/equity ratio.

Question 10

profitability ratios measure what?

Answer 10

Relate profit to management’s performance by looking at how well management has employed assets to generate a profit on sales and thereby create a return on shareholders’ equity.

Question 11

Gross Profit Margin - equation and what it measures

Answer 11

Gross profit / Sales

corresponds to the excess of sales over the cost of products sold. indicates the efficiency of management in turning over the company’s goods at a profit by measuring the gross profit generated by each dollar of sales

Question 12

Return on Assets - equation and what it measures

Answer 12

Net profits / Total assets

The return on assets ratio measures the overall performance of management. The return takes into account not only the net profit margin but also the amount invested.

Question 12

Asset activity ratios measure

Answer 12

management’s effectiveness in using assets to generate earnings

Question 12

Total Asset Turnover

Answer 12

Sales Total assets

measures how efficiently a company has used its assets to generate sales revenue.

Question 13

Inventory Turnover

Answer 13

Cost of goods sold / Inventory

This ratio indicates the rate at which inventories are being converted into sales

Question 14

Average Collection Period

Answer 14

Sales / Receivables

The average collection period ratio represents the number of days sales are outstanding in accounts receivable at any time

Question 15

___ is the senior level of company operations

Answer 15

The board of directors

Question 16

Ratio analysis limits rules of thumb: (5)

Answer 16

• meaningful only if understanding of purpose of each relationship.
• as valid as data in financial statements themselves.
• require a basis for comparison.
• Only point to areas needing further investigation.
• rarely supply answers.

Question 17

In practice, the quick ratio can be calculated in different ways. Most often one of the following techniques is used (3)

Answer 17

• (Cash + near-cash + receivables) / Current liabilities
• (Current assets - inventory) / Current liabilities
• (Current assets - inventory - prepaid expenses) / Current liabilities