CHAPTER 04 14ANALYSIS OF FINANCIAL STATEMENTS
Chapter 4: Analysis of Financial Statements
To keep this chapter from involving too much memorization, we provide our students with a formula sheet for use on exams. That makes a few of the questions trivially easy, but most require some thought, and some are downright challenging. Even the very easy ones make students think about the ratios. The challenging questions are labeled CHALLENGING, and most students will agree with that designation.
Some of these questions are just definitions, but others require real thought about the make-up of the ratios and relationships among the ratios. We tell out students that to answer some of these questions it is useful (1) to write out the relevant ratio or ratios, (2) then to think about how the ratios would change if the accounting data changed, and (3) occasionally to make up illustrative data to test their conclusions.
Note that there is some overlap between the True/False and the multiple choice questions, as some T/F statements are used in the MC questions.
1. Ratio analysis involves analyzing financial statements to help appraise a firm’s financial position and strength.
a. True
b. False
ANSWER: True
2. The current and quick ratios both help us measure a firm’s liquidity. The current ratio measures the relationship of the firm’s current assets to its current liabilities, while the quick ratio measures the firm’s ability to pay off short- term obligations without relying on the sale of inventories.
a. True
b. False
ANSWER: True
3. Although a full liquidity analysis requires the use of a cash budget, the current and quick ratios provide fast and easy-to-use estimates of a firm’s liquidity position.
a. True
b. False
ANSWER: True
4. High current and quick ratios always indicate that the firm is managing its liquidity position well.
a. True
b. False
ANSWER: False
RATIONALE: It might have too much liquidity. Liquid assets generally provide low returns.
5. If a firm sold some inventory for cash and left the
To keep this chapter from involving too much memorization, we provide our students with a formula sheet for use on exams. That makes a few of the questions trivially easy, but most require some thought, and some are downright challenging. Even the very easy ones make students think about the ratios. The challenging questions are labeled CHALLENGING, and most students will agree with that designation.
Some of these questions are just definitions, but others require real thought about the make-up of the ratios and relationships among the ratios. We tell out students that to answer some of these questions it is useful (1) to write out the relevant ratio or ratios, (2) then to think about how the ratios would change if the accounting data changed, and (3) occasionally to make up illustrative data to test their conclusions.
Note that there is some overlap between the True/False and the multiple choice questions, as some T/F statements are used in the MC questions.
1. Ratio analysis involves analyzing financial statements to help appraise a firm’s financial position and strength.
a. True
b. False
ANSWER: True
2. The current and quick ratios both help us measure a firm’s liquidity. The current ratio measures the relationship of the firm’s current assets to its current liabilities, while the quick ratio measures the firm’s ability to pay off short- term obligations without relying on the sale of inventories.
a. True
b. False
ANSWER: True
3. Although a full liquidity analysis requires the use of a cash budget, the current and quick ratios provide fast and easy-to-use estimates of a firm’s liquidity position.
a. True
b. False
ANSWER: True
4. High current and quick ratios always indicate that the firm is managing its liquidity position well.
a. True
b. False
ANSWER: False
RATIONALE: It might have too much liquidity. Liquid assets generally provide low returns.
5. If a firm sold some inventory for cash and left the