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1. What is the purpose of a balance sheet? An income statement? 2. Why is the analysis of trends in financial ratios important? 3. Auxier Manufacturing Company has a current ratio of 4 to 1 but is unable to pay its bills. Why? 4. Can a firm generate a 25 percent return on assets and still be technically insolvent (unable to pay its bills)? Explain. 5. The traditional definitions of collection period and inventory turnover are criticized because in both cases balance sheet figures that are a result of approximately the last month of sales are related to annual sales in the former case) or annual cost of goods sold (in the latter case). Why do these definitions present problems? Suggest a solution. 6. Explain why a long-term creditor should be interested in liquidity ratios. 7. Which financial ratios would you be most likely to consult if you were the following? Why? a. A banker considering the financing of seasonal inventory b. A wealthy equity investor c. The manager of a pension fund considering the purchase of a firm's bonds d. The president of a consumer products firm 8. In trying to judge whether a company has too much debt, what financial ratios would you use and for what purpose? 9. Why might it be possible for a company to make large operating profits, yet still be unable to meet debt payments when due? What financial ratios might be employed to detect such a condition? 10. Does increasing a firm's inventory turnover ratio increase its profitability? Why should this ratio be computed using cost of goods sold (rather than sales, as is done by some compilers of financial statistics)? 159

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