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Unformatted text preview: CHAPTER 3 FINANCIAL STATEMENTS ANALYSIS AND LONG-TERM PLANNING Answers to Concepts Review and Critical Thinking Questions 1. Time trend analysis gives picture of changes in the companys financial situation over time. Comparing a firm to itself over time allows the financial manager to evaluate whether some aspects of the firms operations, finances, or investment activities have changed. Peer group analysis involves comparing the financial ratios and operating performance of a particular firm to a set of peer group firms in the same industry or line of business. Comparing a firm to its peers allows the financial manager to evaluate whether some aspects of the firms operations, finances, or investment activities are out of line with the norm, thereby providing some guidance on appropriate actions to take to adjust these ratios if appropriate. Both allow an investigation into what is different about a company from a financial perspective, but neither method gives an indication of whether the difference is positive or negative. For example, suppose a companys current ratio is increasing over time. It could mean that the company had been facing liquidity problems in the past and is rectifying those problems, or it could mean the company has become less efficient in managing its current accounts. Similar arguments could be made for a peer group comparison. A company with a current ratio lower than its peers could be more efficient at managing its current accounts, or it could be facing liquidity problems. Neither analysis method tells us whether a ratio is good or bad, both simply show that something is different, and tells us where to look. 2. If a company is growing by opening new stores, then presumably total revenues would be rising. Comparing total sales at two different points in time might be misleading. Same-store sales control for this by only looking at revenues of stores open within a specific period. 3. The reason is that, ultimately, sales are the driving force behind a business. A firms assets, employees, and, in fact, just about every aspect of its operations and financing exist to directly or indirectly support sales. Put differently, a firms future need for things like capital assets, employees, inventory, and financing are determined by its future sales level. 4. Two assumptions of the sustainable growth formula are that the company does not want to sell new equity, and that financial policy is fixed. If the company raises outside equity, or increases its debt- equity ratio, it can grow at a higher rate than the sustainable growth rate. Of course, the company could also grow faster than its profit margin increases, if it changes its dividend policy by increasing the retention ratio, or its total asset turnover increases....
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This note was uploaded on 01/26/2011 for the course FIN 357 taught by Professor Hadaway during the Spring '06 term at University of Texas at Austin.
- Spring '06