COB 300 Finance Chp 4 Exam Questions
Correct Answers New Update
Ratios - Answers -✔✔ help evaluate financial statements, make comparisons.
Standardizes numbers and facilitates comparisons. ratios highlight strengths and
weaknesses. Compared with trend analysis and peer (or industry) analysis.
Used by: Lenders to determine creditworthiness, stockholders to estimate future cash
flows and risk, managers to determine strengths or weaknesses.
Five categories:
Liquidity: Give an idea of the firm's ability to pay off debts that are maturing within a year
Asset management ratios: give an idea of how efficiently the firm is using its assets
Debt management ratios: give an idea of how the firm has financed its assets as well as
the firm's ability to repay its long-term debt.
Profitability ratios: give an idea of how profitably the firm is operating and utilizing its
assets.
Market value ratios: give an idea of what investors think about the firm and its future
prospects.
ROE is main focal point
Liquidity ratios - Answers -✔✔ Ratios that show the relationship of a firm's cash and
other current assets to its current liabilities. How quickly can we turn something into
cash?
Types: current ratio, quick/acid test ratio.
Current ratio: Calculated by dividing
current assets/current liabilities.
It indicates the extent to wchih current liabilities are covered by those assets expected
to be converted to cash in the near future. Current liabilities rising faster then current
assets, ratio will fall, sign of possible trouble. Too high may be good, or the result of too
much old inventory, or too many old AR resulting in bad debt. Must be thuroughly
examined.
Quick/Acid-Test ratio: calculated by =
, current assets- inventories / current liabilities.
this measures the firm's ability to pay-off short-term obligations without relying on the
sale of inventories. More on the operating cycles
Current assets - Answers -✔✔ cash, marketable securities, accounts receivable, and
inventories
Current liabilities - Answers -✔✔ accounts payable, accrued wages and taxes, and
notes payable
Low vs. High liquidity - Answers -✔✔ sign of financial difficulties , small amount of
current assets compared to liabilities.
Higher could mean a lot of inventory, may not be able to sell it.
What is the least liquid asset? - Answers -✔✔ inventory
Current ratio - Answers -✔✔ Liquidity ratio. Calculated by dividing current
assets/current liabilities. It indicates the extent to wchih current liabilities are covered by
those assets expected to be converted to cash in the near future.
Current liabilities rising faster then current assets, ratio will fall, sign of possible trouble.
Too high may be good, or the result of too much old inventory, or too many old AR
resulting in bad debt. Must thoroughly examine.
Quick (acid test ratio) - Answers -✔✔ calculated by = current assets- inventories /
current liabilities.
this measures the firm's ability to pay-off short-term obligations without relying on the
sale of inventories.
Operating cycle - Answers -✔✔ Continuation of liquitidy and ratios. the length of time it
takes for the investment of cash in inventory to be returned in the form of payments
from customers. The longer the operating cycle, the greater the need for liquidity.
Days sales outstanding DSO= AR/Annual credit sales/365
How long it takes to collect cash from customers
Days sales in inventory DSI = Inventory/ COGS/365
How long it takes raw materials and convert it into a sale. Production process.
Days Payable outstanding DPO= Accounts payable/Purchases/365
How many days it takes to pay on accounts payable.
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