Fin355 Chapter 2 Answers
Chapter 2 Textbook Solutions
QUESTIONS
3. Why is EBIT an important line item in the income statement? What does EBIT show us?
ANSWER Earnings before interest and taxes (EBIT) is the lowest line on the income statement that isn 't affected by the firm 's method of financing (the relative amounts of debt and equity used). It is important because it allows an evaluation of physical business operations separate from the influence of financing decisions. It is therefore often called operating income.
4. What is meant by liquidity in financial statements?
ANSWER In financial statements liquidity implies the ease with which assets can be converted into cash without substantial loss. With respect to liabilities it is related to the immediacy with which they require cash.
5. What are the common misstatements of balance sheet figures and why do they present a problem?
ANSWER Receivables are often overstated in that they contain uncollectible accounts. Inventories are overstated when items are carried at values that exceed what they 're actually worth. Less frequently, payables omit legitimate liabilities of the company. Such misstatements represent a firm as being worth more than it actually is. That deceives investors and others interested in dealing with the company.
6. Do the definitions of current assets and current liabilities suggest a quick way of looking at the firm 's ability to meet its financial obligations (pay its bills) over the near term? (Hint: Think in terms of ratios.) ANSWER Current assets represent things that are expected to become cash within a year (inflows), while current liabilities require cash within a year (outflows). Being able to pay the bills means the inflows have to exceed the outflows in the short run. This suggests forming the ratio of current assets to current liabilities (called the current ratio). If that ratio exceeds 1.0, the firm should be able to pay its bills in the next year.
7. How are capital and working
QUESTIONS
3. Why is EBIT an important line item in the income statement? What does EBIT show us?
ANSWER Earnings before interest and taxes (EBIT) is the lowest line on the income statement that isn 't affected by the firm 's method of financing (the relative amounts of debt and equity used). It is important because it allows an evaluation of physical business operations separate from the influence of financing decisions. It is therefore often called operating income.
4. What is meant by liquidity in financial statements?
ANSWER In financial statements liquidity implies the ease with which assets can be converted into cash without substantial loss. With respect to liabilities it is related to the immediacy with which they require cash.
5. What are the common misstatements of balance sheet figures and why do they present a problem?
ANSWER Receivables are often overstated in that they contain uncollectible accounts. Inventories are overstated when items are carried at values that exceed what they 're actually worth. Less frequently, payables omit legitimate liabilities of the company. Such misstatements represent a firm as being worth more than it actually is. That deceives investors and others interested in dealing with the company.
6. Do the definitions of current assets and current liabilities suggest a quick way of looking at the firm 's ability to meet its financial obligations (pay its bills) over the near term? (Hint: Think in terms of ratios.) ANSWER Current assets represent things that are expected to become cash within a year (inflows), while current liabilities require cash within a year (outflows). Being able to pay the bills means the inflows have to exceed the outflows in the short run. This suggests forming the ratio of current assets to current liabilities (called the current ratio). If that ratio exceeds 1.0, the firm should be able to pay its bills in the next year.
7. How are capital and working