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CHAPTER 8 ANALYSIS OF FINANCIAL STATEMENTS (Difficulty: E = Easy, M = Medium, and T = Tough) True-False Easy: (8.1) Ratio analysis Answer: a Diff: E 1 . Ratio analysis involves a comparison of the relationships between financial statement accounts so as to analyze the financial position and strength of a firm. a. True b. False (8.2) Liquidity ratios Answer: b Diff: E 2 . The current ratio and inventory turnover ratio measure the liquidity of a firm. The current ratio measures the relationship of a firm's current assets to its current liabilities and the inventory turnover ratio measures how rapidly a firm turns its inventory back into a "quick" asset or cash. a. True b. False (8.2) Liquidity ratios Answer: a Diff: E 3 . Although a full liquidity analysis requires the use of a cash budget, the current and quick ratios provide fast and easy-to-use measures of a firm's liquidity position. a. True b. False (8.2) Current ratio Answer: b Diff: E 4 . If a firm has high current and quick ratios, this is always a good indication that a firm is managing its liquidity position well. a. True b. False (8.3) Asset management ratios Answer: a Diff: E 5 . The inventory turnover ratio and days sales outstanding (DSO) are two ratios that can be used to assess how effectively the firm is managing its assets in consideration of current and projected operating levels. a. True b. False Chapter 8: Analysis of Financial Statements Page 1
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(8.3) Inventory turnover ratio Answer: b Diff: E 6 . A decline in the inventory turnover ratio suggests that the firm's liquidity position is improving. a. True b. False (8.4) Debt management ratios Answer: a Diff: E 7 . The degree to which the managers of a firm attempt to magnify the returns to owners' capital through the use of financial leverage is captured in debt management ratios. a. True b. False (8.4) TIE ratio Answer: a Diff: E 8 . The times-interest-earned ratio is one indication of a firm's ability to meet both long-term and short-term obligations. a. True b. False (8.5) Profitability ratios Answer: a Diff: E 9 . Profitability ratios show the combined effects of liquidity, asset management, and debt management on operations. a. True b. False (8.5) ROA Answer: b Diff: E 10 . Since ROA measures the firm's effective utilization of assets (without considering how these assets are financed), two firms with the same EBIT must have the same ROA. a. True b. False (8.6) Market value ratios Answer: a Diff: E 11 . Market value ratios provide management with a current assessment of how investors in the market view the firm's past performance and future prospects. a. True b. False (8.7) Trend analysis Answer: a Diff: E 12 . Determining whether a firm's financial position is improving or deteriorating requires analysis of more than one set of financial statements. Trend analysis is one method of measuring a firm's performance over time.
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