3. Financial Ratios

Question 1

Liquidity

Answer 1

Current Ratio [Balance Sheet]
- 2:1 (ideal)

Quick Ratio (Acid Test Ratio) [Balance Sheet]
- 1:1 (ideal)

HIGHER = money could be invested (inefficient)
LOWER = cannot pay bills

Question 2

Gearing/Solvency

Answer 2

Debt to Equity Ratio [Balance Sheet]
- less than 100% (ideal)

HIGHER (100% or above) = greater reliance on borrowed
funds
- excessive gearing = insolvency
LOWER = may be missing out on investment
opportunities and lower risk

Question 3

Profitability

Answer 3

Gross Profit Ratio [Revenue Statement]

HIGHER = low supply costs and/or low priced products 
LOWER = high supply costs and/or low priced products

Net Profit Ratio [Revenue Statement]

HIGHER = low costs and sound financial management
LOWER = excessive costs

Return on Owner’s Equity Ratio [Balance Sheet][Revenue Statement]

Return on Total Assets Ratio [Balance Sheet][Revenue Statement]

Question 4

Efficiency

Answer 4

Operating Expenses Ratio [Revenue Statement]

Accounts Receivable Ratio [Balance Sheet][Revenue Statement]