CFA Practice Question

There are 534 practice questions for this study session.

CFA Practice Question

Which of the following statements is true when analyzing a company's financial ratios?

I. Ratios only measure effects; they do not say anything about the causes that led to that particular effect.
II. As long as the accounting methods used are similar, it is possible to compare two companies even if they operate in different industries.
III. The usefulness of ratios largely depends on the assumption that future relationships between accounting variables will largely be independent of those in the past.
IV. Balance sheets would be more reflective of economic reality if replacement cost figures were used instead.
A. I and II
B. III and IV
C. I and IV
Explanation: II is incorrect because each industry has its own specific norms when it comes to ratios. For instance, it is usual to see industries that have a low degree of operating leverage carrying higher debt loads.

III is incorrect because the assumption really is that relationships in the future will be very similar to those in the past, indicating that the future is very dependent on the past.

User Contributed Comments 5

User Comment
0000 I. Ratios do not specifically say anything as to the cause of the ratio however it is implied. For example, asset t/o implies how well assets are being used.

II. Ratios can be used to compare anything, II should say ...it is possible to meaningfully compare two companies....

RCapistrano II. Ratio comparisons must compare apples to apples - not apples to something else non-apple. In this case, a firm in one industry is not the same as another firm from a different industry.

For example: A given ratio for financial and non-financial firms do not tell you the same thing.
Joel1980 IV. Income statements would be more reflective of economic reality if replacement cost figures were used instead.

Instead of what?
nike instead of historical cost.
Patdotcom Joel, I understand, instead of what is used: historial cost eg.
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