QXP+14 - CHAPTER 14 DISCUSSION QUESTIONS 1. One purpose of...

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CHAPTER 14 DISCUSSION QUESTIONS 1. One purpose of financial statement analysis is to evaluate the performance of a com- pany with an eye toward identifying problem areas. Another purpose of financial state- ment analysis is to use the past perform- ance of a company to predict how it will do in the future. 2. Disagree. An analysis of a company’s finan- cial ratios usually does not provide detailed information about what the causes of a com- pany’s problems are, but it does identify areas in which more detailed data should be gathered. 3. The usefulness of financial ratios is greatly enhanced when they are compared with past values for the same company and with values for other firms in the same industry. 4. Current ratio is a measure of a company’s li- quidity, which is the company’s ability to pay its debts in the short run. 5. It is impossible to tell whether Company A’s return on sales of 6% is high or low. The re- turn on sales value must be analyzed in light of the appropriate industry. For example, a normal return on sales for supermarkets is around 1% or 2%, whereas the return on sales for a high-tech company such as Mi- crosoft can be in excess of 20%. 6. The price-earnings ratio differs from most other financial ratios in that it is not the ratio of two financial statement numbers. Instead, the PE ratio is a comparison of a financial statement number to a market value num- ber. 7. A common-size financial statement is a fin- ancial statement with all numbers for a given year divided by sales for the year. Thus, all amounts for a given year are shown as a percentage of sales for that year. Common- size financial statements make it possible to make comparisons even when the size of companies is different. In addition, common- size financial statements allow comparison of a company’s numbers to equivalent num- bers in prior years when the sales level may have been much different. 8. If an analysis of common-size financial statements suggests that a company has problems, the way to find out what is caus- ing these problems is to gather information from outside the financial statements—ask management, read press releases, talk to financial analysts who follow the firm, read industry newsletters, and dig into the notes to the financial statements. 9. The most informative section of the common-size balance sheet is the asset section. This section can be used to determ- ine how efficiently a company is using its as- sets. 10. The DuPont framework provides a system- atic approach to identifying general factors causing ROE to deviate from normal. The DuPont system also provides a framework for computation of financial ratios to yield more in-depth analysis of a company’s areas of strength and weakness. 11.
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This note was uploaded on 11/16/2009 for the course ACCOUNTING 2101 taught by Professor Malkie during the Spring '09 term at ITT Tech Flint.

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QXP+14 - CHAPTER 14 DISCUSSION QUESTIONS 1. One purpose of...

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