Page 711 - Accounting Principles (A Business Perspective)

17. Analysis and interpretation of financial statements

➢ Can you think of a situation where the current ratio is very misleading as an indicator of short-term,
debt-paying ability? Does the acid-test ratio offer a remedy to the situation you have described?

Describe a situation where the acid-test ratio does not suffice either.
➢ Before the Marvin Company issued USD 20,000 of long-term notes (due more than a year from the
date of issue) in exchange for a like amount of accounts payable, its current ratio was 2:1 and its acid-
test ratio was 1:1. Will this transaction increase, decrease, or have no effect on the current ratio and
acid-test ratio? What would be the effect on the equity ratio?

➢ Through the use of turnover rates, explain why a firm might seek to increase the volume of its sales
even though such an increase can be secured only at reduced prices.

➢ Indicate which of the relationships illustrated in the chapter would be best to judge:
➢ The short-term debt-paying ability of the firm.
➢ The overall efficiency of the firm without regard to the sources of assets.
➢ The return to owners (stockholders) of a corporation.
➢ The safety of long-term creditors' interest.
➢ The safety of preferred stockholders' dividends.
➢ Indicate how each of the following ratios or measures is calculated:

➢ Payout ratio.
➢ Earnings per share of common stock.
➢ Price-earnings ratio.
➢ Earnings yield on common stock.
➢ Dividend yield on preferred stock.
➢ Times interest earned.

➢ Times preferred dividends earned.
➢ Return on average common stockholders' equity.
➢ Cash flow margin.
➢ How is the rate of return on operating assets determined? Is it possible for two companies with
operating margins of 5 per cent and 1 per cent, respectively, to both have a rate of return of 20 per
cent on operating assets? How?
➢ Cite some of the possible deficiencies in accounting information, especially regarding its use in
analyzing a particular company over a 10-year period.

➢ Real world question From the Consolidated Statements of Income of The Limited in the Annual
report appendix, determine the percentage change in operating income from 2002 to 2003.

➢ Real world question From the Consolidated Statements of Income of The Limited in the Annual
report appendix, determine the 2003 net income per common share.
➢ Real world question From the financial statements of The Limited in the Annual report appendix,
determine the 2003 cash dividends per common share.
➢ Real world question From the financial statements of The Limited in the Annual report appendix,
determine the 2003 cash flow margin.

712