Analyzing Business Financial Statments Questions

If the gross profit margin for a business decrease, what might that indicate?

Rising costs of raw material and labor, with no increase in price for its products

(If raw materials and labor costs increase and product prices do not increase, gross profit margin will decrease. Changes in sales and administrative expenses do not impact gross profit margins because they are included in operating expenses, not costs of goods sold

What are three measures of liquidity

Current ratio

Quick ratio

Working capital

What can you conclude if the current ratio for a business is greater than 1.0, and the quick ratio is less than 1.0?

The business would need to liquidate some of its inventory to pay all current liabilities

(A business with a current ratio greater than 1 is generally considered liquid because it can cover current liabilities with current assets. IF the quick ratio is less than 1, it indicates that the business would have to liquidate some inventory in order to cover all current liabilities. Liquidity is not necessarily an indicator of borrowing need, as a business that is liquid may still need to borrow to finance timing differences or capital purchases

What is leverage?

Leverage refers to the extent to which a business uses debt to support it total assets. Leverage can be measured by comparing debt to total assets or by comparing debt to equity

What is capital structure?

Capital structure refers to the relationship between debt and equity, and the proportion of debts that are current and noncurrent

What would you expect to see if a business has intangible assets and no subordinated debt?

The debt to equity ratio would be less than the debt to tangible net worth ratio

(If a business has intangible assets, the amount of these assets would be used to reduce the amount of equity for the purpose of calculated debt to tangible net worth. This adjustment would lower the denominator, and result in the debt to equity ratio being less than the debt to tangible net worth ratio. If there is no subordinated debt, the debt to tangible net wroth ratio and the adjusted debt to adjusted tangible net worth ratios would be the same. For example, if the business had total liabilities of $800,00, owner’s equity of %600,00 and intangible assets of $100,000, the debt to equity ratio would be 1.33, and he debt to tangible net worth ratio would be 1.60

Which business is better positioned to support the highest amount of debt to equity in its capital structure?

A middle-aged operating business with high profit margins in a capital-intensive industry (Generally middle-aged businesses with high profit margins are better positioned to support greater proportions of debt on their balance sheets than businesses that have low or uncertain profitability or are cyclical or too young to have proven finanical stability

Which combination indicates declining efficiency?

A decreasing sales to assets ratio combined with increasing INVDOH indicates declining efficiency. Inventory turnover would be slowing and the business would be generating less sales with the same assets

Which two financial indicators combine to produce returns on assets?

Sales to assets and pretax profit margin