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Unformatted text preview: 98 Chapter 5 Basics of Analysis QUESTIONS 5 - 1. A ratio is a fraction comparing two numbers. Ratios make the comparisons in relative, rather than absolute, terms, which helps alleviate the problem of size difference. 5 - 2. a. Liquidity is the ability to meet current obligations. Short-term creditors such as banks or suppliers would be particularly interested in these ratios. b. Borrowing capacity measures the protection of long-term creditors. Long-term bond holders would be particularly interested in these ratios. c. Profitability means earning ability. Investors would be particularly interested in these ratios. 5 - 3. Comparisons of historical data, industry average, earnings of competitors, etc. 5 - 4. An absolute change would be plus or minus X dollars; a percentage change would be plus or minus X percent of the base. Percentage changes usually give better measures because they recognize the difference in the size of the base. 5 - 5. Horizontal analysis expresses an item in relation to that same item for a previous base year. This analysis measures change over time. Example In 2010, sales were $750,000; in 2009, they were $500,000. Horizontal analysis shows 2010 sales as 150% of those in 2009. Vertical analysis compares one item with another base item for that same year. Example In 2010, selling expenses were $75,000 and sales were $750,000. Vertical analysis would show selling expenses as 10% of 2010 sales. 5 - 6. Trend analysis involves comparing the past to the present. It can be used both for ratios and absolute figures. 5 - 7. When comparing two firms of different size, relative figures are most meaningful. These include ratios and common-size analysis. The relative amounts of sales, assets, profits, or market share help evaluate relative size. 5 - 8. While managers make great use of financial reports, investors, creditors, 99 employers, suppliers, regulators, auditor, and consumers also use financial reports. 5 - 9. Managers analyze data to study profitability and the overall financial position of the firm. Investors study profitability and the chance to earn on their investment. Creditors study the ability of the firm to handle debt. 5 -10. a. Best Buy Co. (Exhibit 5-3) Current assets is the single-largest asset category. This would be typical for a retailer. Property and equipment will often be a high category unless it is held down by leases which limit investment in productive (capital) assets. Kelly Services, Inc. (Exhibit 5-4) Current assets is the single-largest asset category. This would be typical for a service firm. Cooper Tire & Rubber Company (Exhibit 5-5) Current assets is the largest asset category. Property, plant, and equipment would typically also be high for a manufacturer....
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