Short term creditors are primarily interested in the

The three parties are not primarily interested in the same characteristics of a company. Short-term
creditors are primarily interested in the liquidity of the company. In contrast, long-term creditors
and stockholders are primarily interested in the profitability and solvency of the company.
2. (a) Comparison of financial information can be made on an intracompany basis, an intercompany
basis, and an industry average basis (or norms).
(1) An intracompany basis compares an item or financial relationship within a company in
the current year with the same item or relationship in one or more prior years.
(2) The industry averages basis compares an item or financial relationship of a company
with industry averages (or norms) published by financial rating organizations.
(3) An intercompany basis compares an item or financial relationship of one company with
the same item or relationship in one or more competing companies.
(b) The intracompany basis of comparison is useful in detecting changes in financial relationships
and significant trends within a company.
The industry averages basis provides information as to a company’s relative performance
within the industry.
The intercompany basis of comparison provides insight into a company’s competitive position.
3. Horizontal analysis (also called trend analysis) measures the dollar and percentage increase or
decrease of an item over a period of time. In this approach, the amount of the item on one statement
is compared with the amount of that same item on one or more earlier statements. Vertical analysis
expresses each item within a financial statement in terms of a percent of a base amount.
4. (a) $360,000 X 1.245 = $448,200, 2009 net income.
(b) $360,000 ÷ .06 = $6,000,000, 2008 revenue.
5. A ratio expresses the mathematical relationship between one quantity and another. The relationship
is expressed in terms of either a percentage (200%), a rate (2 times), or a simple proportion (2:1).
Ratios can provide clues to underlying conditions that may not be apparent from individual financial
statement components. The ratio is more meaningful when compared to the same ratio in earlier
periods or to competitors’ ratios or to industry ratios.
6. (a) Liquidity ratios: Current ratio, acid-test ratio, receivables turnover, and inventory turnover.
(b) Solvency ratios: Debt to total assets and times interest earned.
7. Cindy is correct. A single ratio by itself may not be very meaningful and is best interpreted by
comparison with: (1) past ratios of the same company, (2) ratios of other companies, or (3) industry
norms or predetermined standards. In addition, other ratios of the company are necessary to de-
termine overall financial well-being.
8. (a) Liquidity ratios measure the short-term ability of the company to pay its maturing obligations
and to meet unexpected needs for cash.
(b) Profitability ratios measure the income or operating success of a company for a given period of time.
(c) Solvency ratios measure the ability of the company to survive over a long period of time.
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14-4

Questions Chapter 14 (Continued)