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ch13 - Chapter 13 Analyzing Financial Statements A...

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Chapter 13 Analyzing Financial Statements: A Managerial Perspective QUESTIONS 1. By analyzing financial statements, managers decide what suppliers to use, what businesses to partner with, and how to pay off the firm’s debts. 2. Horizontal analysis consists of analyzing the dollar value and percentage changes in financial statement amounts across time (e.g., from year to year or from quarter to quarter). Vertical analysis consists of analyzing financial statement amounts in comparison to a base amount. The base for the balance sheet is total assets, while net sales is the base for the income statement. 3. Net income, when much higher than cash flow from operations, indicates the possibility that earnings have been managed upward. 4. The management discussion and analysis section of the annual report, credit reports, and news articles can be used to gain insight into a company's current and future financial performance. 5. Three profitability ratios are the gross margin percentage, return on total assets, and return on common stockholders' equity. Gross margin percentage is used to assess how much incremental profit is generated by each dollar of sales. Return on assets is used to assess how much income is generated by a company’s total assets. Return on common stockholders’ equity is used to determine how much income is generated relative to a firm’s level of common stockholders’ equity. 6. Three turnover ratios are asset turnover, accounts receivable turnover, and inventory turnover. Asset turnover is used to assess how efficiently a firm uses its assets to generate sales. Accounts receivable turnover assesses how often a firm collects its accounts receivable. Inventory turnover assess how often a firm sells its inventory. 7. Three debt-related ratios are the current ratio, the debt-to-equity ratio, and times interest earned. The current ratio assesses how well a firm is able to meet its short-term obligations. The debt-to-equity ratio determines how much debt a firm has relative to its total stockholders’ equity. Times interest earned assesses a firm’s operating income level relative to its interest expense.
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13-2 Jiambalvo Managerial Accounting 8. Davis Company’s current ratio is expected to be highest in October. In this month, the company has its sales peak for the year, thus making it most likely to meet its short-term obligations at this time. 9. Many of the company’s assets may be inventory. The company may not be able to quickly convert its inventory into sales and then to cash to satisfy its current liabilities. If this were the case, then the company’s quick ratio would be much lower than its current ratio since the quick ratio does not consider inventory. 10. The gross margin percentage is calculated by dividing gross margin by net sales and provides a rough estimate of the incremental profit generated by each dollar of sales. A drop in gross margin percentage like that seen in Souki Corporation indicates that a firm is generating a higher cost of sales. This could hurt the firm’s overall profitability.
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