Leverage, ROA, Total Asset TO Question finance, correct, increase, management

metoyoushe

Could someone please explain how answer A is correct? I thought that overstating assets would increase the financial leverage ratio which would mean being more dependent on debt for finance.

Thanks for your help in advance.


Management will least likely understate assets to improve:

A. Financial leverage ratios
B. Return on assets
C. Total asset turnover


Answer: A

In order to improve financial leverage ratios, management will need to overstate its assets.
Understating assets will improve return on assets and total asset turnover ratios.

koba

Management will least likely understate assets = Management will probably overstate assets to improve:

A. leverage ratio. This is true because debt is always fixed, so if you overstate assets, you overstate equity which will reduce your leverage (ratio)

Siddimaula

think about it in a real world situation.....say you go to the bank and ask to borrow $100k. who are they going to give the money to: the guy with no assets or the guy with a $1 million house?
the more assets you have compared to your debt, the better your leverage ratios will be.

the financial leverage ratio is assets / equity. or to look at it another way (seeing as the accounting equation tells us that assets = liabilities + equity):
financial leverage ratio = (liabilities + equity) / equity.

if you understate your assets you reduce the equity. the liabilities, or debt, stays the same. therefore the ratio goes up, which makes your business more highly leveraged (ie the ratio gets worse).

hope this makes sense, cheers

shootingstar

I make this mistake sometimes and it drives me crazy...
Focus on the words 'least likely' 'should NOT' etc

Micholien

yeah, circle those words draw a star on them whatever works