C214: Ratio Analysis Introduction

4.1 Ratio Analysis Introduction—Why Ratios?
Assessment Section 1
1
1/1
The ratios used in financial analysis are defined by GAAP.

 True
 Correct


False

There are no rules for ratios. You can make your own to meet your needs.

2
0/1
Which of the following statements is NOT correct with respect to using ratios to analyze a
firm or firms?

 Ratio analysis can be used to assess the need for cost cutting initiatives.
 You Selected


Ratio analysis can be used to compare three companies with different sizes,
strategies, and risks.

 Correct


A change in ratios reveals the economic character of the firm.

 Analysts can create a new ratio to show more detail about the cost structure of a
company.

Using ratios to assess cost structure and creating new ratios to assess cost structure are
examples of “focus” and “flexibility” in ratio analysis. Using ratios to assess three companies
is an example of “standardization.” The incorrect statement is that ratios (and even changes
in ratios) reveal economic character. Ratios do NOT answer questions; rather, they indicate
where the analyst should dig deeper to understand differences or changes.
3
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Which of the following is NOT one of the common categories of ratios?

 Profitability

,  Correct


Operating

 You Selected


Financing

 Liquidity

We discuss four types of ratios: liquidity, asset use efficiency, financing (leverage), and
profitability.
4
1/1
Ratios help identify the areas of a firm that need investigation.

 Correct


True

 False

Ratios tell you what questions to ask about the company.


4.2 Liquidity Ratios
Assessment Section 1
1
0/1
What is the current ratio of Eastern Family?

 You Selected


1.46

 1.94
 2.18
 Correct


2.49

Current Ratio = 9,,900 = 2.49

2

,1/1
What is the quick ratio for Eastern Family?

 Correct


1.46

 1.94
 2.18
 2.49

Quick Ratio = (9,700 – 4,000)/3,900 = 1.46

3
0/1
If the current ratio of a company is higher than the industry, then which of the following is
true?

 The company has about the same liquidity as the industry.
 You Selected


The company has higher liquidity than the industry.

 The company has lower liquidity than the industry.
 Correct


You cannot tell without looking at other liquidity ratios.

You cannot tell a company’s liquidity compared to the industry by just looking at one ratio.

4
1/1
Suppose the current ratio of a company is higher than the industry. However, the quick ratio
of the same company is lower than the industry. Based on this information, which of the
following is most likely to be correct?

 Correct


The company’s liquidity might be tied up in inventory.

 The firm has too little inventory, resulting in lost sales or stock-outs.
 The firm has lower liquidity than the industry average.
 The firm has higher liquidity than the industry average.

While we can’t say for sure, the firm seems to have much of its current assets tied up in
liquidity. It is difficult, therefore, to determine whether the company is liquid relative to

, other firms in the same industry. Recall that no one ratio can tell you all you need to know.
Instead, these ratios will help guide the questions that need to be asked.


4.3 Efficiency Ratios
Assessment Section 1
1
1/1
Use the following balance sheet and income statement to answer the next two questions:



Eastern Family
Balance Sheet (in '000)
December 31, 20X3

Current Assets Current Liabilities

Cash 1,500 Accounts Payable 1,400

Accounts Receivable 3,000 Notes Payable 1,000

Prepaid Expense 1,200 Accrued Expense 1,500

Inventory 4,000 Total Current Liab. 3,900

Total Current Assets 9,700

Long-Term Debt 7,000

Fixed Assets

Net PP&E 6,500 Owners’ Equity

Common Stock 3,300

Total Assets 16,200 Retained Earnings 2,000

Total Owners’ Equity 5,300



Total Liab. and Equity 16,200




Eastern Family
Income Statement (in '000)
As of December 31, 20X3

Revenue 10,000