CHAPTER 5

EVALUATING FINANCIAL PERFORMANCE

True-False Questions

T. 1. Showing the relationships between two or more financial variable and/or

time, financial ratios are useful means of summarizing large amounts of
financial data for comparative purposes.

F. 2. Second-round, mezzanine, and liquidity-stage financing generally occur

during a venture’s survival stage.

F. 3. Commercial banks are important users of financial ratios and measures

during the development and startup stages of ventures.

T. 4. Investment bankers are users of financial ratios and measures of ventures

primarily during the rapid-growth stage relative to the development and
startup stages.

T. 5. Trend analysis is used to examine a venture’s performance over time.

F. 6. Cross-sectional analysis is used to examine a venture’s performance over

time.

F. 7. “Cash burn” is the cash a venture expends on its operating, financing,

and depreciation expenses.

T. 8. “Net cash burn” occurs when cash burn exceeds cash build in a specified
time period.

T. 9. The “cash burn rate” is the cash burn for a fixed period of time, typically a
month.

T. 10. The term “cash build” as used in Chapter 5 is equal to net sales minus the
change in receivables.

F. 11. Liquidity ratios indicate the venture’s ability to pay short term assets
from short-term liabilities.

F. 12. Net working capital reflects current assets deducted from current
liabilities.

F. 13. “Net working capital” is calculated as fixed assets minus current liabilities.

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32 Chapter 5: Evaluating Financial Performance

T. 14. A venture’s cash, marketable securities, and receivables comprise the

venture’s “liquid assets”.

T. 15. Conversion period ratios show the average time in days it takes to convert
certain current assets and current liabilities into cash.

F. 16. The sum of the inventory-to-sale conversion period and the purchase-to-
payment conversion period minus the sale-to-cash conversion period is called
the cash conversion cycle.

F. 17. How efficiently a venture controls its expenses and uses its assets and debt
is evaluated with profitability and efficiency ratios.

F. 18. The cash conversion cycle refers to the time it takes to convert a sale
into net income.

F. 19. The “cash conversion cycle” measures the time it takes to pay off the
principal on a loan.

F. 20. The sale-to-cash conversion period is calculated by dividing average

revenues by net sales per day.

T. 21. During the development and startup stages of a venture’s life cycle,
important financial ratios and measures include cash burn rates, liquidity
ratios, and conversion period ratios.

T. 22. During the development and startup stages of a venture’s life cycle,
important users of financial ratios and measures include the entrepreneur,
business angels, and venture capitalists (VCs).

T. 23. Leverage ratios are generally considered to be more important during the
survival and rapid-growth stages compared to the development and startup
stages.

F. 24. The equity multiplier is considered an efficiency ratio.

T. 25. The extent to which a venture is in debt and in its ability to repay its debt
obligations is indicated by leverage ratios.

T. 26. The equity multiplier shows the extent by which assets are supported by
equity and debt.

T. 27. Accounting rules require that the current maturities of long-term debt
obligations be classified as short-term liabilities.
 Chapter 5: Evaluating Financial Performance 33

F. 28. Profitability and efficiency ratios are generally considered to be more

important during the development and startup stages compared to the survival
and rapid-growth stages.

T. 29. The part of a venture’s interest payment that is subsidized by the

government because of the deductibility of interest is called the interest tax
shield.

F. 30. How efficiently a venture controls its expenses and uses its assets and debt
is evaluated with profitability and efficiency ratios.

F. 31. The Return on Assets model states: ROA = net profit margin × asset
turnover × the equity multiplier.

T. 32. If a firm has positive net income, a drop in a venture’s asset intensity ratio
will increase its ROE.

Multiple-Choice Questions

d. 1. Investment bankers and commercial banks are important users of financial

ratios and measures during which of the following life cycle stages?
a. Development stage
b. Startup stage
c. Survival stage
d. Rapid-growth stage
e. All four stages

e. 2. The entrepreneur, angels, and VCs are important users of financial ratios
and measures during which of the following life cycle stages?
a. Development stage
b. Startup stage
c. Survival stage
d. Rapid-growth stage
e. All four stages

b. 3. Which of the following is used to examine a venture’s performance over

time?
a. qualitative analysis
b. trend analysis
c. cross sectional analysis
d. industry comparable analysis

c. 4. Which of the following is used to compare a venture’s performance against

another firm at the same point in time?
a. qualitative analysis
34 Chapter 5: Evaluating Financial Performance

b. trend analysis
c. cross sectional analysis
d. industry comparable analysis

d. 5. Which of the following is used to compare a venture’s performance against

the average performance of other firms in the same industry?
a. qualitative analysis
b. trend analysis
c. cross sectional analysis
d. industry comparable analysis

b. 6. Which one of the following is not a basic ratio techniques used to conduct
financial analysis?
a. trend analysis
b. sensitivity analysis
c. cross-sectional analysis
d. industry comparables analysis

c. 7. The term “cash build” is measured as:

a. net income plus depreciation
b. net sales minus expenses minus (plus) an increase (decrease) in
inventories
c. net sales minus (plus) an increase (decrease) in receivables
d. net income plus depreciation minus (plus) an increase (decrease) in
payables

c. 8. “Net cash burn” is calculated as:

a. cash burn plus cash build
b. cash build minus cash burn
c. cash burn minus cash build
d. cash burn minus cash build squared

b. 9. Using the following information, determine the average monthly net cash
burn rate: annual net income = $20,000; annual interest = $10,000; annual
cash build = $150,000; and annual cash burn = $186,000.
a. $1,000
b. $3,000
c. $4,000
d. $6,000
e. $7,000

e. 10. Use the following information to determine a firm’s “cash build:” net
sales = $150,000; net income = $15,000; beginning-of-period accounts
receivable = $60,000; end-of-period accounts receivable = $90,000; and
interest = $10,000.
 Chapter 5: Evaluating Financial Performance 35

a. $10,000
b. $15,000
c. $30,000
d. $60,000
e. $120,000

d. 11. Which of the following is not part of the operating cycle?

a. time it takes to purchase products
b. time it takes to produce products
c. time it takes to sell the products
d. time it takes to pay suppliers
e. time it takes to collect receivables

a. 12. Which one of the following “measures” the average days of sales
committed to the extension of trade credit?
a. sale-to-cash conversion period
b. inventory-to-sale conversion period
c. purchase-to-payment conversion period
d. cash conversion cycle period

b. 13. Which of the following is measured by dividing the average daily cost of
goods sold into the average inventory?
a. sale-to-cash conversion period
b. inventory-to-sale conversion period
c. purchase-to-payment conversion period
d. cash conversion cycle

d. 14. A firm has the following balance sheet information: total assets =
$100,000; current assets = $30,000; inventories = $10,000; cash = $5,000; total
liabilities = $30,000; current liabilities = $15,000; notes payable = $2,000.
What are the firm’s quick and NWC-to-Total-Assets ratios?
a. 1.00 and .13
b. 1.33 and .13
c. 1.00 and .15
d. 1.33 and .15

c. 15. Which of the following measures the average time from purchase of
materials and labor to actual cash payment?
a. sale-to-cash conversion period
b. inventory-to-sale conversion period
c. purchase-to-payment conversion period
d. cash conversion cycle
36 Chapter 5: Evaluating Financial Performance

d. 16. Which of the following measures the average time it takes a firm to
complete its operating cycle after deducting the days supported by trade credit
and delayed payroll financing?
a. sale-to-cash conversion period
b. inventory-to-sale conversion period
c. purchase-to-payment conversion period
d. cash conversion cycle

c. 17. Which one of the following conversion periods operates to reduce the
length of the cash conversion cycle?
a. inventory-to-sale conversion period
b. sale-to-cash conversion period
c. purchase-to-payment conversion period
d. fixed assets-to-usage conversion period

d. 18. Which one of the following conversion periods is not a component in the
cash conversion cycle?
a. inventory-to-sale conversion period
b. sale-to-cash conversion period
c. purchase-to-payment conversion period
d. fixed assets-to-usage conversion period

a. 19. Calculate the inventory-to-sale conversion period based on the following

information: average inventories = $120,000; average receivables = $90,000;
average payables = $40,000; cost of goods sold = $182,500; and net sales =
$365,000.
a. 240.0 days
b. 180.0 days
c. 90.0 days
d. 60.0 days
e. 45.0 days

c. 20. Calculate the sale-to-cash conversion period based on the following

information: average inventories = $120,000; average receivables = $90,000;
average payables = $40,000; cost of goods sold = $182,500; and net sales =
$365,000.
a. 240.0 days
b. 180.0 days
c. 90.0 days
d. 60.0 days
e. 45.0 days

c. 21. Based on the following information, determine the venture’s cash

conversion cycle: Inventory-to-sale conversion period = 112.9 days; Sale-to-
 Chapter 5: Evaluating Financial Performance 37

cash conversion period= 57.1 days; and Purchase-to-payment conversion

period = 76.8 days.
a. 170.0 days
b. 189.7 days
c. 93.2 days
d. 246.8 days
e. 133.9 days

a. 22. Determine the cash conversion cycle based on the following information:
inventory-to-sale conversion period = 112.9 days; sale-to-cash conversion
period = 57.1 days; and purchase-to-payment conversion period = 76.8 days.
a. 93.2 days
b. 132.6 days
c. 170.0 days
d. 246.8 days
e. 365.0 days

a. 23. Based on the following information, determine the average receivables

(rounded to thousands of dollars) that were outstanding: Net sales = $575,000;
Sale-to-cash conversion period = 57.1 days; Purchase-to-payment conversion
period = 76.8 days; and Cost of goods sold = $380,000.
a. $90,000
b. $180,000
c. $121,000
d. $31,000
e. $41,000

d. 24. Based on the following information, determine the venture’s inventory-to-

sale conversion period: cash conversion cycle = 250 days; sale-to-cash
conversion period = 60 days; and purchase-to-payment conversion period = 70
days.
a. 70 days
b. 140 days
c. 240 days
d. 260 days
e. 330 days

e. 25. The difference between a venture’s ability to generate cash to pay interest
and the amount of interest it has to pay is determined by which of the
following ratios?
a. fixed charges coverage
b. debt to asset
c. equity multiplier
d. debt to equity
e. interest coverage
38 Chapter 5: Evaluating Financial Performance

d. 26. Last year, Nemo’s Fish ‘n Chips recorded the following financial data:
sales = $85,000; cost of goods sold = $45,000; selling and administrative
expenses = $25,000; depreciation and amortization = $7,000; interest expense
= $12,000. The tax rate was 30%. Find Nemo’s interest coverage for last year.
a. -.29 times
b. .66 times
c. .86 times
d. 1.25 times
e. 3.33 times

d. 27. Which of the following is not a profitability and efficiency ratio?

a. sales-to-total-assets
b. return on equity
c. return on assets
d. inventory-to-total assets
e. NOPAT profit margin

b. 28. Which of the following is true?

a. ROA is always greater than or equal to ROE
b. an increase in the asset turnover ratio implies a decrease in the asset
intensity ratio
c. a and b
d. none of the above

a. 29. Last year, Lenny’s Lemonade had $3,500 in sales, and cost of goods sold
was $2,000. Depreciation expenses totaled $500 and interest expense was
$700. If the tax rate is 25%, what is the net profit margin for Lenny’s
Lemonade? What is its NOPAT margin?
a. 6.43% and 21.43%
b. 20.7% and 21.43%
c. 2.14% and 32.14%
d. 22.86% and 32.14%

Note: The following information should be used for the next eleven (30 through 40)
problems.
In its closing financial statements for its first year in business, the Runs and
Goses Company, had cash of $242, accounts receivable of $850, inventory of
$820, net fixed assets of $3,408, accounts payable of $700, short-term notes
payable of $740, long-term liabilities of $1,100, common stock of $1,160,
retained earnings of $1,620, net sales of $2,768, cost of goods sold of $1,210,
depreciation of $360, interest expense of $160, taxes of $312, addition to
retained earnings of $508, and dividends paid of $218.
 Chapter 5: Evaluating Financial Performance 39

a. 30. What is the return on equity for Runs and Goses?

a. 26.1%
b. 44.7%
c. 62.6%
d. 18.4%
e. 7.9%

b. 31. What is Runs and Goses’ return on total assets?

a. 9.6%
b. 13.6%
c. 19.1%
d. 37.9%
e. 22.5%

e. 32. What is the net profit margin for Runs and Goses?
a. 60.0%
b. 22.7%
c. 7.9%
d. 18.4%
e. 26.2%

c. 33. Runs and Goses operating profit margin is?

a. 26.2%
b. 56.3%
c. 43.3%
d. 30.3%
e. 60.0%

d. 34. The gross profit margin for Runs and Goses is?
a. 26.2%
b. 30.3%
c. 43.3%
d. 56.3%
e. 60.0%

c. 35. What is Runs and Goses’ sales to total asset ratio?

a. 1.91
b. 0.25
c. 0.52
d. 0.23
e. 0.57

b. 36. What is the current ratio for Runs and Goses?

a. 1.46
b. 1.33
40 Chapter 5: Evaluating Financial Performance

c. 1.23
d. 1.21
e. 1.13

a. 37. The total-debt-total-asset ratio for Runs and Goses is?

a. 0.48
b. 0.71
c. 0.27
d. 0.53
e. 0.82

a. 38. What is Runs and Goses’ debt-to-equity ratio?

a. 0.91
b. 2.15
c. 0.48
d. 1.12
e. 2.32

e. 39. What is the equity multiplier for Runs and Goses?

a. 4.59 times
b. 2.35 times
c. 0.48 times
d. 1.12 times
e. 1.91 times

c. 40. The interest coverage ratio for Runs and Goses is:
a. 6.5 times
b. 4.5 times
c. 9.7 times
d. 3.5 times
e. 1.5 times