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Ch4 Solns - Analysis of Financial Statements Answers to...

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Chapter 4 Analysis of Financial Statements Answers to End-of-Chapter Questions 4-1 The emphasis of the various types of analysts is by no means uniform nor should it be.  Management is interested in all types of ratios for two reasons.  First, the ratios point out  weaknesses that should be strengthened; second, management recognizes that the other parties  are interested in all the ratios and that financial appearances must be kept up if the firm is to be  regarded highly by creditors and equity investors. Equity investors (stockholders) are interested  primarily in profitability, but they examine the other ratios to get information on the riskiness of  equity commitments.  Credit analysts are more interested in the debt, TIE, and EBITDA coverage  ratios, as well as the profitability ratios.  Short-term creditors emphasize liquidity and look most  carefully at the current ratio. 4-2 The inventory turnover ratio is important to a grocery store because of the much larger inventory  required and because some of that inventory is perishable.  An insurance company would have  no inventory to speak of since its line of business is selling insurance policies or other similar  financial products—contracts written on paper and entered into between the company and the  insured.  This question demonstrates that the student should not take a routine approach to  financial analysis but rather should examine the business that he or she is analyzing. 4-3 Given that sales have not changed, a decrease in the total assets turnover means that the  company’s assets have increased.  Also, the fact that the fixed assets turnover ratio remained  constant implies that the company increased its current assets.  Since the company’s current  ratio increased, and yet, its cash and equivalents and DSO are unchanged means that the  company has increased its inventories.  This is also consistent with a decline in the total assets  turnover ratio. 4-4 Differences in the amounts of assets necessary to generate a dollar of sales cause asset turnover  ratios to vary among industries.  For example, a steel company needs a greater number of dollars  in assets to produce a dollar in sales than does a grocery store chain.  Also, profit margins and  turnover ratios may vary due to differences in the amount of expenses incurred to produce sales.  For example, one would expect a grocery store chain to spend more per dollar of sales than does  a steel company.  Often, a large turnover will be associated with a low profit margin, and vice  versa.
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