A common-size analysis of the balance sheet is most likely to signal investors that the company -has increased sales -is using assets efficiently -is becoming more leveraged -cam meet its short-term obligations I would appreciate your answers and explanation. Thanks!
mino, let’s start by quickly reviewing the definition of a common-size balance sheet and why they’re useful. All balance sheet accounts are adjusted to be expressed as a percentage of total assets, which facilitates our comparison of companies of varying sizes. Moving along to the answer choices: Has increased sales: Sales is an income statement item. We’d use current and historical income statements to assess trends in sales. Is using assets efficiently: Mixed ratios would be more useful in answering this question, particularly total asset turnover (sales/avg. assets) and inventory turnover (COGS/avg. inventory). This requires both an income statement and balance sheet. Again, the common-size balance sheet isn’t terribly helpful here. Is becoming more leveraged: Financial leverage is the proportion of debt to assets. In a common-size balance sheet, we can see what percentage the long-term and short-term debt represents as a percentage of assets, or equity to assets, which are good indicators of leverage. Can meet its short-term obligations: A variety of ratios would be useful to us in answering this question, including: 1) current ratio: current assets / current liabilities 2) quick ratio: current assets (excluding inventory) / current liabilities 3) cash ratio cash & equivalents / current liabilities 4) interest coverage: EBIT / interest expense 5) [probably some others I’m forgetting right now…] The first three are pure balance sheet ratios, but I don’t see why a common-size statement would be any more helpful than a standard balance sheet for these ratios. THe fourth ratio I listed relates to the income statement. So, given the choices, I’d select the third. Input from others is always welcomed.
C-becoming more leveraged. Since the common-size BS is based on BS items such as a % of Assets and therefore an increase in debt financing in terms of leverage is clear. A- sales are an IS item so no dice B- the common size BS does not illuminate efficient use of assets. Ratios such as ROE and ROA show efficient asset allocation (both ratios have IS numbers) D- at first glance you would think a common size BS could show you quick and current ratios which one my think implies a positive working capital ratio (i.e. can meet ST liabilities), but current assets can also be restricted and the CS-BS is not a good indicator alone, really you need the IS or statement of CF to figure out debt service (or other ST) coverage ratios. this is my reasoning at least… although with FSA I never cease to be amazed what the “correct” answers are.
Thank you very much for your detailed answers! Yes, the correct answer was C, but I could not understand why. Now I see it
I did this question last night and got it correct but I thought it was poorly worded. Perhaps if the choice was “degree to which company is leveraged” it would be more clear.