Financial Statements study guide

Question: The basic earning power ratio (BEP) reflects the earning power of a firm’s assets after giving consideration to financial leverage and tax effects.

Answer Choices:

Answer: A – True

Question: The operating margin measures operating income per dollar of assets.

Answer Choices:

Answer: B – False

Question: The profit margin measures net income per dollar of sales.

Answer Choices:

Answer: A – True

Question: The return on invested capital measures the total return that a company has provided for its investors.

Answer Choices:

Answer: A – True

Question: The “apparent,” but not necessarily the “true,” financial position of a company whose sales are seasonal can change dramatically during a given year, depending on the time of year when the financial statements are constructed.

Answer Choices:

Answer: A – True

Question: Significant variations in accounting methods among firms make meaningful ratio comparisons between firms more difficult than if all firms used the same or similar accounting methods.

Answer Choices:

Answer: A – True

Question: The inventory turnover and current ratio are related. The combination of a high current ratio and a low inventory turnover ratio, relative to industry norms, suggests that the firm has an above-average inventory level and/or that part of the inventory is obsolete or damaged.

Answer Choices:

Answer: A – True

Question: It is appropriate to use the fixed assets turnover ratio to appraise firms’ effectiveness in managing their fixed assets if and only if the firms being compared have the same proportion of fixed assets to total assets.

Answer Choices:

Answer: B – False

Question: Other things held constant, the more debt a firm uses, the lower its profit margin will be.

Answer Choices:

Answer: A – True

Question: Suppose you are analyzing two firms in the same industry. Firm A has a profit margin of 10% versus a profit margin of 8% for Firm B. Firm A’s total debt to total capital ratio [measured as (Short-term debt + Long-term debt)/(Debt + Preferred stock + Common equity)] is 70% versus one of 20% for Firm B. Based only on these two facts, you cannot reach a conclusion as to which firm is better managed, because the difference in debt, not better management, could be the cause of Firm A’s higher profit margin.

Answer Choices:

Answer: B – False

Question: Other things held constant, a decline in sales accompanied by an increase in financial leverage must result in a lower profit margin.

Answer Choices:

Answer: B – False

Question: Other things held constant, the more debt a firm uses, the lower its operating margin will be.

Answer Choices:

Answer: B – False

Question: The advantage of the basic earning power ratio (BEP) over the return on total assets for judging a company’s operating efficiency is that the BEP does not reflect the effects of debt and taxes.

Answer Choices:

Answer: B – False

Question: Other things held constant, the more debt a firm uses, the lower its return on total assets will be.

Answer Choices:

Answer: A – True

Question: Since the ROA measures the firm’s effective utilization of assets without considering how these assets are financed, two firms with the same EBIT must have the same ROA.

Answer Choices:

Answer: B – False

Question: Market value ratios provide management with an indication of how investors view the firm’s past performance and especially its future prospects.

Answer Choices:

Answer: A – True

Question: In general, if investors regard a company as being relatively risky and/or having relatively poor growth prospects, then it will have relatively high P/E and M/B ratios.

Answer Choices:

Answer: B – False

Question: The price/earnings (P/E) ratio tells us how much investors are willing to pay for a dollar of current earnings. In general, investors regard companies with higher P/E ratios as being less risky and/or more likely to enjoy higher growth in the future.

Answer Choices:

Answer: A – True

Question: The market/book (M/B) ratio tells us how much investors are willing to pay for a dollar of accounting book value. In general, investors regard companies with higher M/B ratios as being less risky and/or more likely to enjoy higher growth in the future.

Answer Choices:

Answer: B – False