Question

A company reports accounting data in its financial statements. This data is used for financial analyses that provide insights into a company's strengths, weaknesses, performance in specific areas, and trends in performance. These analyses are often used to compare a company's performance to that of its competitors, or to its past or expected future performance. Such insight helps managers and analysts improve their decision making. 

Most decision makers and analysts use five groups of ratios to examine the different aspects of a company's performance. Indicate whether each of the following statements regarding financial ratios are true or false? 

Statement True False 

• A company exhibiting a high liquidity ratio means it is likely to have enough resources to pay off its short-term obligations. 

• Asset management ratios provide insights into management's efficiency in using a firm's working capital and long-term assets. 

• Debt management or financial leverage ratios help analysts determine whether a company has sufficient cash to repay its short- term debt obligations.

• One possible explanation for an increase in a firm's profitability ratios over a certain time span is that the company's income has increased. 

• Market value ratios help analysts figure out what investors and the markets think about the firm's growth prospects or current and future operational performance. 

Ratio analysis is an important component of evaluating company performance. It can provide great insights into how a company matches up against itself over time and against other players within the industry. 

However, like many tools and techniques, ratio analysis has a few limitations and weaknesses. 

Which of the following statements represent a weakness or limitation of ratio analysis? Check all that apply. 

• Seasonal factors can distort data. 

• Window dressing might be in effect. 

• Market data are not sufficiently considered.

Answer 1

A company exhibiting a high liquidity ratio means it is likely to have enough resources to pay off its short term obligations	TRUE
Asset management ratios provide insights into managements efficiency in using a firms working capital and long term assets	TRUE
Debt management or financial leverage ratios help analysts determine whether a company has sufficient cash to repay its short term debt obligations	FALSE
One possible explanation for an increase in a firms profitability ratios over a certain time span is that the company's income has increases.	TRUE
Market-value or Market-based ratios help analysis figure out what investors and the markets think about the firms growth prospects and current and future operational performance.	TRUE
Below statements represents weakness or limitations of ratio analysis
Seasonal factors can distort data.
Window dressing might be in effect.