6) Benchmarking is a type of cross-sectional analysis in which a firm’s ratios are compared to a key
competitor firm within the same industry, primarily to identify areas for improvement.
7) Time-series analysis evaluates the performance of various firms at the same point in time using
financial ratios.
8) Ratios merely direct an analyst to potential areas of concern and it does not provide conclusive
evidence as to the existence of a problem.
9) A single key ratio of a firm provides all the information required to judge the overall performance of
the firm.
10) Due to inflationary effects, inventory costs and depreciation write-offs can differ from their
replacement values, thereby distorting profits.
11) In ratio analysis, the financial statements being used for comparison should be dated at the same
point in time during the year. If not, the effect of seasonality may produce erroneous conclusions and
decisions.
12) The use of the unaudited financial statements for ratio analysis is preferable because it reflects the
firm’s true financial condition.
13) The use of differing accounting treatments—especially relative to inventory and depreciation—can
distort the results of ratio analysis, regardless of whether cross-sectional or time-series analysis is used.
14) Ratios provide a ________ measure of a company’s performance and condition.
A) definitive
B) gross
C) relative
D) absolute
15) Present and prospective shareholders are mainly concerned with a firm’s ________.
A) risk and return
B) profitability
C) leverage
D) liquidity
16) ________ analysis involves the comparison of different firms’ financial ratios at the same point in time.
A) Time-series
B) Cross-sectional
C) Marginal
D) Technical
17) ________ analysis involves comparison of current to past performance and the evaluation of
developing trends.
A) Time-series
B) Cross-sectional
C) Marginal
D) Break-even
18) Which of the following is used to analyze a firm’s financial performance over different years?
A) time-series analysis
B) break-even analysis
C) gap analysis
D) marginal analysis
19) Which of the following is true of benchmarking?
A) It is an analysis in which a firm’s ratio values are analyzed to project the fundamental values of the
assets for upcoming years or business cycle.
B) It is an analysis in which a firm’s ratio values are compared with those of a key competitor or with a
group of competitors that it wishes to emulate.
C) It is an analysis in which a firm’s financial performance over time is evaluated using financial ratio
analysis.
D) It is a financial statement analysis technique which is primarily used for forecasting future
performance.
20) Cross-sectional ratio analysis is used to ________.
A) correct expected problems in operations
B) isolate the causes of problems
C) provide conclusive evidence of the existence of a problem
D) measure relative performance of a firm with its peers
21) Time-series analysis is often used to ________.
A) assess developing trends
B) correct errors of judgment
C) evaluate the value of a firm or its assets
D) standardize results
22) Which of the following is a limitation of ratio analysis?
A) Financial ratios cannot be used to assess a firm’s profitability.
B) Ratios that reveal large deviations from the norm merely indicate the possibility of a problem.
C) It is difficult to access audited financial statements for ratio analysis.
D) Ratio analysis assumes that inflation has no effect on a firm’s business.
23) An analyst should be careful when conducting ratio analysis to ensure that ________.
A) the overall performance of a firm is not judged on a single ratio
B) the role of inflation is ignored
C) ratios being compared should be calculated using financial statements dated at different points in time
during the year
D) different accounting procedures are used
24) Without adjustment, inflation may tend to cause ________ firms to appear more efficient and
profitable than ________ firms.
A) larger; smaller
B) older; newer
C) smaller; larger
D) newer; older
25) Which of the following groups of ratios primarily measure risk?
A) liquidity, activity, and profitability
B) liquidity, profitability, and market
C) liquidity, activity, and debt
D) activity, debt, and profitability
26) Discuss the limitations of ratio analysis and the cautions which must be taken when reviewing a
cross-sectional and time-series analysis.
3.3 Liquidity ratios
1) The liquidity of a business firm refers to its ability to pay its short-term obligations as they come due.
2) The two basic measures of liquidity are the debt–to-equity ratio and the asset turnover ratio.
3) The liquidity of a business firm is measured by its ability to satisfy its long-term obligations as they
come due.
4) The current ratio provides a measure of a firm’s ability to meet its long-term obligations.
5) The ________ of a business firm is measured by its ability to satisfy its short-term obligations as they
come due.
A) activity
B) liquidity
C) debt
D) profitability
6) The two basic measures of liquidity are ________.
A) inventory turnover and current ratio
B) current ratio and quick ratio
C) gross profit margin and ROE
D) current ratio and total asset turnover
7) A firm has a current ratio of 1. To increase that ratio the firm might ________.
A) develop a better inventory management system so the firm doesn’t have to hold as many items in
inventory at one time
B) hold lower cash balances at the bank and increase holdings of interest–earning marketable securities
C) take out a long-term bank loan and simultaneously offer customers better credit terms, allowing them
to pay their bills more slowly
D) issue bonds and use the proceeds to purchase new equipment
8) If the only information you are given about Ryan Corporation, a large public company in business for
many years, is that it has a current ratio of 2.9, what could you infer from this?
A) It can likely meet its short-term obligations without difficulty.
B) You could determine that Ryan has too much liquidity because the average current ratio among firms
in Ryan’s industry is 2.0.
C) Nothing, you would also need the current ratio’s from the last few years of the S&P 500 Index.
D) You could determine that Ryan is running a great risk that it will not be able to pay short-term
liabilities when they come due.
9) Which of the following is true of the current ratio?
A) The more predictable a firm’s cash flows, the higher the acceptable current ratio.
B) A higher current ratio indicates a higher return on equity.
C) The more predictable a firm’s current ratio, the higher the current liabilities.
D) A higher current ratio indicates a greater degree of liquidity.
10) Which of the following is excluded when calculating the quick ratio?
A) accounts receivable
B) accounts payable
C) cash
D) inventory
11) Clearly firms want to be able to pay their bills when they come due, so having liquidity is important.
Can a firm have too much liquidity? Explain.
12) In general, large retail chain stores (like Walmart and Target) tend to operate with lower current and
quick ratios than do firms in the computer hardware industry. Why might this be so?
3.4 Activity ratios
1) ________ ratios are a measure of the speed with which various accounts are converted into sales or
cash.
A) Activity
B) Liquidity
C) Debt
D) Profitability
2) Nico Corporation has cost of goods sold of $300,000 and inventory of $30,000, then the inventory
turnover is ________ and the average age of inventory is ________.
A) 36.5; 10
B) 10; 36.5
C) 36.0; 10
D) 30; 36.0
3) The ________ measures the activity, or liquidity, of a firm‘s stock of goods.
A) average collection period
B) inventory turnover ratio
C) average payment period
D) total asset turnover ratio
4) A(n) ________ is useful in evaluating credit policies.
A) average payment period
B) current ratio
C) average collection period
D) inventory turnover ratio
5) The ________ ratio may indicate poor collections procedures or a relaxed credit policy.
A) average payment period
B) inventory turnover
C) average collection period
D) quick
6) ABC Corp. extends credit terms of 45 days to its customers. Its credit collection would likely be
considered poor if its average collection period was ________.
A) 30 days
B) 36 days
C) 44 days
D) 57 days
7) A firm with a total asset turnover lower than industry standard may have ________.
A) excessive debt
B) excessive interest costs
C) insufficient sales
D) insufficient fixed assets
8) An unusually high ________ may indicate a firm is experiencing stockouts and lost sales.
A) average payment period
B) inventory turnover ratio
C) average collection period
D) quick
9) If you divide the inventory turnover ratio into 365, you get a measure of ________.
A) financial efficiency
B) the average age of the inventory
C) sales turnover
D) the average collection period
10) The ________ is useful in evaluating credit policies that a firm extends to its customers.
A) average payment period
B) current ratio
C) average collection period
D) inventory turnover ratio
11) Which of the following ratios is difficult for the creditors of a firm to analyze from the published
financial statements?
A) debt equity ratio
B) average payment period
C) quick ratio
D) total asset turnover
12) Nico Corporation has annual purchases of $300,000 and accounts payable of $30,000, then average
purchases per day are ________ and the average payment period is ________.
A) 36.5; 821.9
B) 82.2; 365
C) 821.9; 36.5
D) 833.3; 36.0
13) The ________ ratio indicates the efficiency with which a firm uses its assets to generate sales.
A) inventory turnover
B) total asset turnover
C) quick
D) current asset turnover
14) A firm’s total asset turnover increased from 0.75 to 0.90. Which of the following is true about the given
data?
A) The firm is generating more dollars of sales per dollar of assets now than it was before.
B) The firm is generating fewer dollars of sales per dollar of assets now than it was before.
C) By cutting back on assets, the firm runs the risk of creating problems like inventory stockouts and
production delays.
D) The firm’s stock price will go up because it is using asset more efficiently.
15) The average age of inventory is viewed as the average length of time inventory is held by a firm or as
the average number of days’ sales in inventory.
16) The average age of inventory can be calculated as inventory divided by 365.
17) The average age of inventory can be calculated as inventory turnover divided by 365.
18) The average age of inventory can be calculated as 365 divided by inventory turnover.
19) The average payment period can be calculated as accounts payable divided by average sales per day.
20) The average payment period can be calculated as accounts payable divided by average purchases per
day.
21) The total asset turnover ratio measures the liquidity of a firm’s assets.
22) In a recent year Walmart reported total asset turnover of 2.44 whereas Target reported total asset
turnover of 1.84. One interpretation of this is that Walmart managed its assets more efficiently than did
Target. Can you think of another reason that might explain the difference in turnover ratios that does not
imply that Target managers are performing poorly relative to their peers at Walmart?
23) Below are recent inventory turnover ratios for four companies. The companies, listed in no particular
order are Tiffany & Co. (a manufacturer and retailer of fine jewelry), Deere & Co. (maker of heavy duty
agricultural equipment), Boeing (aircraft manufacturer), and Sprouts (a grocery chain focusing on organic
products). Think about which of these companies operate in businesses that tend to have very slow or
very fast inventory turnover. Which one below is the inventory turnover ratio for Sprouts?
A) 1.7
B) 14.4
C) 0.7
D) 5.7
24) In 1979 International Business Machines Corp. (IBM) was one of the world’s largest companies, and it
dominated the market for huge mainframe computers. Back then, IBM’s inventory turnover ratio was
about 3.3. Through the years, IBM switched from mainframe to personal computers, and today the
company earns most of its revenues from a variety of services rather than from selling hardware. By
2017, IBM’s inventory turnover ratio had risen to 23.9. What do you think might account for the
tremendous increase in IBM’s inventory turnover between 1979 and 2017?
3.5 Debt ratios
1) The less fixed-cost debt (financial leverage) a firm uses, the greater will be its risk and return.
2) In general, the more debt a firm uses, the smaller its financial leverage.
3) The lower the fixed-payment coverage ratio, the lower is the firm’s financial leverage.
4) The higher the debt ratio, the more the financial leverage a firm has and thus, the greater will be its risk
and return.
5) Typically, higher coverage ratios are preferred, but a very high ratio may indicate under-utilization of
fixed-payment obligations, which may result in unnecessarily low risk and return.
6) The higher the value of the times interest earned ratio, the higher is the proportion of the firm’s interest
income compared to its contractual interest payments.
7) ________ is a term used to describe the magnification of risk and return introduced through the use of
fixed-cost financing, such as preferred stock and debt.
A) Financial leverage
B) Operating leverage
C) Fixed-payment coverage
D) Benchmarking
8) The ________ ratio measures the proportion of total assets financed by the firm’s creditors.
A) total asset turnover
B) inventory turnover
C) current
D) debt
9) The ________ ratio measures a firm’s ability to pay contractual interest payments.
A) times interest earned
B) fixed-payment coverage
C) debt
D) average payment period
10) The ________ ratio indicates whether a firm will be able to meet interest obligations due on
outstanding debt.
A) debt-to-equity
B) interest turnover
C) total assets turnover
D) times interest earned
11) The higher, the value of the ________ ratio, the better able a firm is to fulfill its interest obligations.
A) dividend payout
B) average collection period
C) times interest earned
D) average payment period
12) When assessing the fixed-payment coverage ratio, ________.
A) the lower its value the more risky is the firm
B) the lower its value, the higher is the firm’s financial leverage
C) preferred stock dividend payments can be disregarded
D) the higher its value, the more difficult it is for a firm to pay its debts
13) The magnification of risk and return introduced through the use of fixed-cost financing, such as debt
and preferred stock is called financial leverage.
14) The financial leverage multiplier is the ratio of a firm’s total assets to common stock equity.
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3.6 Profitability ratios
1) The gross profit margin measures the percentage of each sales dollar left after a firm has paid for its
goods and operating expenses.
2) Key Financial Data
Income Statement, Dreamscape, Inc.
For the Year Ended December 31, 2020
Prepare a common-size income statement for Dreamscape, Inc. for the year ended December 31, 2020.
Evaluate the company’s performance against industry average ratios and against last year’s results.
3) Two frequently cited ratios of profitability that can be read directly from the common-size income
statement are ________.
A) the earnings per share and the return on total assets
B) the gross profit margin and the earnings per share
C) the gross profit margin and the return on total assets
D) the gross profit margin and the net profit margin