g. Times interest earned ratio provides a relative measure of how well the firm’s operating earnings can
cover current interest obligations.
h. Profit margin is the accounting measure of bottom-line profit per dollar of sales.
i.Return on assets is a measure of bottom-line profit per dollar of total assets.
j.Return on equity is a measure of bottom-line profit per dollar of equity.
k.Price-earnings ratio reflects how much value per share the market places on a dollar of accounting
earnings for a firm.
5. Common size financial statements express all balance sheet accounts as a percentage of total assets and all
income statement accounts as a percentage of total sales. Using these percentage values rather than nominal
dollar values facilitates comparisons between firms of different size or business type. Common-base year
financial statements express each account as a ratio between their current year nominal dollar value and some
reference year nominal dollar value. Using these ratios allows the total growth trend in the accounts to be
6. Peer group analysis involves comparing the financial ratios and operating performance of a particular firm to a
set of peer group firms in the same industry or line of business. Comparing a firm to its peers allows the
financial manager to evaluate whether some aspects of the firm’s operations, finances, or investment activities
are out of line with the norm, thereby providing some guidance on appropriate actions to take to adjust these
ratios if appropriate. An aspirant group would be a set of firms whose performance the company in question
would like to emulate. The financial manager often uses the financial ratios of aspirant groups as the target
ratios for his or her firm; some managers are evaluated by how well they match the performance of an
identified aspirant group.
7. Return on equity is probably the most important accounting ratio that measures the bottom-line performance of
the firm with respect to the equity shareholders. The Du Pont identity emphasizes the role of a firm’s
profitability, asset utilization efficiency, and financial leverage in achieving an ROE figure. For example, a
firm with ROE of 20% would seem to be doing well, but this figure may be misleading if it were marginally
profitable (low profit margin) and highly levered (high equity multiplier). If the firm’s margins were to erode
slightly, the ROE would be heavily impacted.
8. The book-to-bill ratio is intended to measure whether demand is growing or falling. It is closely followed
because it is a barometer for the entire high-tech industry where levels of revenues and earnings have been
9. If a company is growing by opening new stores, then presumably total revenues would be rising. Comparing
total sales at two different points in time might be misleading. Same-store sales control for this by only looking
at revenues of stores open within a specific period.
10. a. For an electric utility such as Con Ed, expressing costs on a per kilowatt hour basis would be a way to
compare costs with other utilities of different sizes.
b. For a retailer such as Sears, expressing sales on a per square foot basis would be useful in
comparing revenue production against other retailers.
c.For an airline such as Southwest, expressing costs on a per passenger mile basis allows for
comparisons with other airlines by examining how much it costs to fly one passenger one mile.